Austrian Economics Overview: Recent Episodes
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Austrian Economics Overview includes comprehensive works that deal with a wide variety of topics within Austrian economics or a general overview.
Recorded at the 2003 Supporters Summit: Prosperty, War, and Depression. Ralph Raico discusses how from Jefferson to Madison, and on to Bastiat, Molinari, and Spencer, the "classical" liberals routinely denounced war as the enemy of freedom, prudence, and natural rights. Instead, militarism and imperialism have long been the domain of the enemies of private property and other apologists for the state.
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Featuring Per Bylund, Lucas Engelhardt, Karl-Friedrich Israel, Tate Fegley, Shawn Ritenour, and Timothy Terrell.
Recorded at the Mises Institute in Auburn, Alabama, on July 28, 2023.
Featuring Mark Thornton, David Gordon, Jeffrey Herbener, Peter Klein, Sandy Klein, Jonathan Newman, and Joseph Salerno.
Recorded at the Mises Institute in Auburn, Alabama, on July 28, 2023.
Download the slides from this lecture at Mises.org/MU23_PPT_38.
Recorded at the Mises Institute in Auburn, Alabama, on 28 July 2023.
Inequality is a good thing in the free market. Economic equality is a disastrous government policy that leads to economic ruin for all—including the poor and workers.
Download the slides from this lecture at Mises.org/MU23_PPT_36.
Recorded at the Mises Institute in Auburn, Alabama, on 28 July 2023.
Experienced entrepreneurs are Austrians.
Download the slides from this lecture at Mises.org/MU23_PPT_35.
Recorded at the Mises Institute in Auburn, Alabama, on 28 July 2023.
Public health during the pandemic was anti-science and anti-health.
Download lecture slides at Mises.org/MU23_PPT_26.
Recorded at the Mises Institute in Auburn, Alabama, on 27 July 2023.
Download lecture slides at Mises.org/MU23_PPT_24.
Recorded at the Mises Institute in Auburn, Alabama, on 26 July 2023.
Few people understand how destructive regulations are.
Download lecture slides at Mises.org/MU23_PPT_23.
Recorded at the Mises Institute in Auburn, Alabama, on 26 July 2023.
Free trade allows for maximizing the total number of mutually beneficial exchangers and promotes economic progress.
Recorded at the Mises Institute in Auburn, Alabama, on 26 July 2023.
There is no clear basis in economics, ethics, efficiency, or fairness for Minimum Wage Laws. The minimum wage works the way it was intended one hundred years ago.
Download lecture slides at Mises.org/MU23_PPT_16.
Recorded at the Mises Institute in Auburn, Alabama, on 25 July 2023.
Government attempts to limit “monopoly power” cannot improve well-being.
Download lecture slides at Mises.org/MU23_PPT_15.
Recorded at the Mises Institute in Auburn, Alabama, on 25 July 2023.
What is a business cycle?
Download lectures slides at Mises.org/MU23_PPT_14.
Recorded at the Mises Institute in Auburn, Alabama, on 25 July 2023.
In 1920, Ludwig von Mises destroyed the intellectual foundations of the case for socialist central planning.
Download lecture slides at Mises.org/MU23_PPT_12.
Recorded at the Mises Institute in Auburn, Alabama, on 25 July 2023.
Time is an irreversible flux. Each moment has a unique place in the sequence of moments of time with respect to action.
Download lecture slides at Mises.org/MU23_PPT_11.
Recorded at the Mises Institute in Auburn, Alabama, on 25 July 2023.
Entrepreneurship is a general feature of the market economy.
Download the slides from this lecture at Mises.org/MU22_PPT_09.
Recorded at the Mises Institute in Auburn, Alabama, on 24 July 2023.
"We would not expect money to be paper, national, or under the control of any entity."
Download the slides from this lecture at Mises.org/MU22_PPT_07.
Recorded at the Mises Institute in Auburn, Alabama, on 24 July 2023.
"The free market and the division of labor does not promote hyper-atomized individuals. It creates social harmony and community."
Download the slides from this lecture at Mises.org/MU23_PPT_06.
Recorded at the Mises Institute in Auburn, Alabama, on 24 July 2023.
Praxeology is the method of economics.
Download the slides from this lecture at Mises.org/MU23_PPT_05.
Recorded at the Mises Institute in Auburn, Alabama, on 24 July 2023.
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.
Jesús Huerta de Soto, who is professor of economics at the Rey Juan Carlos University of Madrid, is the leading representative of the Austrian school of economics in Spain. He is a renowned teacher, and two of his many doctoral students, David Howden and Philipp Bagus, both now themselves professors of economics, have edited a festschrift in his honor. The contributors include students, colleagues, friends, teachers, two of his daughters, and his son. The two-volume festschrift contains many valuable essays, but I cannot do more here than comment on a few of them, as there are no less than twenty-seven essays in the first volume and twenty-four in the second, as well as two introductory essays by the editors, “Jesús Huerta de Soto: A Biographical Sketch” in the first volume and “Jesús Huerta de Soto: An Appreciation” in the second.
The contributors include reminiscences of Huerta de Soto, and the reader will gain from these a vivid sense of his impact as a teacher, his devotion to Austrian economics and libertarian political philosophy, and his immense knowledge of the literature of economics, law, and history. Few know the work of Ludwig von Mises as well as he does, and the festschrift aims to show that he has made creative contributions to both Austrian economics and libertarian legal and political theory.
A theme from Mises that Huerta de Soto has stressed in his work is the importance of uncertainty in human action and the efforts by people to cope with that uncertainty by establishing trust through a network of free market institutions. The uncertainty is of the radical Knightian kind and cannot be dealt with through application of the probability calculus. Several of the festschrift’s contributors carry this theme further. David Howden, in “Defining Money,” argues that because of the uncertainty inherent in economic exchange, it is vital to have an asset that can always be traded at par, and money is the only asset that can fulfill this function. Nothing else, not even very reliable bonds, can serve this purpose. Because this is so, Howden says, the common definition of money as “the most general medium of exchange,” though not wrong, is not complete. To define money this way is to put it at one end of a continuum, since there are other media of exchange that are less general; but if this is done, the uniqueness of money has not been brought out. Howden says, “Money is not first and foremost the most general medium of exchange, though that statement is not entirely wrong. Money is a special financial asset that emerges to alleviate the definite economic problems of (1) plan disruption caused by uncertainty and (2) to facilitate the completion of previously conceived plans. The only way to fulfill these roles is to sell at par value and on demand.”
In their efforts to cope with uncertainty, Jörg Guido Hülsmann points out in “Financial Markets and the Production of Law,” actors in the free market will establish financial markets as they think best. Because they have established these markets themselves, they will find it easy to rely on them, and in this way a network of trust can be built up. Not so, however, if the government interferes by legislation with these market arrangements. Market participants’ trust will be shaken if they are compelled to use financial markets they have not chosen for themselves. Hülsmann uses to great effect the work of the Italian legal theorist Bruno Leoni to show that legislation by the government introduces unnecessary uncertainty and instability. Hülsmann remarks, “Leoni’s analysis of the consequences of statutory law can be summarized by saying that statutory law tends to destroy the law. More precisely, under the impact of legislation, the law tends to become disconnected from the opinions and the will of their citizens, undermining their autonomy. . . . Most importantly, legislated law undermines the stability of the law, and thus one of its basic functions.”
The obvious remedy is to restore free market institutions; but Bagus argues in “The Disinterventionist Spiral” that once the government has interfered with the economy, many difficulties arise in reversing their interventions. Bagus ingeniously applies Mises’s critique of interventionism in an unexpected way. Mises argued that measures of government intervention are inherently unstable because they fail to achieve their ostensible purpose and have undesirable side effects. For example, minimum wage laws do not secure higher wages for all workers but on the contrary cause unemployment. Faced with this consequence, the government must either withdraw the intervention or press on with corrective interventions, which will in turn fail and confront the government with these options again, in a spiraling process. Bagus argues that repeal of an interventionist measure while other government interventions remain in place will lead to an unstable situation that requires either retreat or additional action. “As we can observe, there is not only an interventionist spiral but also an anti-interventionist spiral. Reforms collide with still existing interventions leading to problems from the (official) point of view of reformers and non-reformers alike. There is pressure to abolish further interventions and reduce the role of the state. When further interferences are abolished, there arise new tensions with still existing ones. The reform path is unstable. Either the path is followed through to anarcho-capitalism or reforms are eventually undone by accumulating interventions anew. There is no third path.”
In order to understand the role of uncertainty in the economy, it is necessary to use the Austrian tool of praxeology rather than seek mechanically to discover statistical correlations between macro aggregates. Doing the latter obliterates the individual decision-maker as he endeavors to assess uncertain market conditions. Joseph T. Salerno, in “Milton Friedman’s Views on Method and Money Reconsidered in Light of the Housing Bubble,” subjects to devastating criticism the methodology of Milton Friedman, ever the faithful follower of his mentor Wesley Clair Mitchell, for precisely this failing. Friedman relied on inductive inference, contradicting the strictures of Karl Popper against induction, though he professed to be a follower of Popper’s philosophy of science. Friedman’s faulty methodology led him to make numerous inaccurate predictions about the housing bubble and other issues. Salerno says, “Thus, Friedman’s monetary theory as delineated and ‘tested’ in the Monetary History is a highly aggregative and mechanical version of the quantity theory of money with very few variables and relationships.”
Careful attention to the individual actor is thus a key theme of Huerta de Soto’s economic theory, and the same emphasis is also crucial to the libertarian political philosophy of which he is so distinguished an advocate. In “William of Ockham: An Unknown Libertarian Philosopher,” Lorenzo Bernaldo de Quirós sees the great fourteenth-century Franciscan as an important political thinker. Ockham denied the Thomist view that natural law can be derived by reason from human nature, arguing that the doctrine of fixed essences contradicted the absolute power of God to decide according to his will. Ockham found the Thomist view that what is moral cannot be changed by God an unacceptable constraint on God’s power. But he also held that individuals, who are created in God’s image, should also be free to make arrangements as they prefer, so long as they respect the rights of others to do so, and that attempts to impose legislation on them based on the false doctrine that human reason can discern essences or natures are impermissible. Because it is difficult to know God’s will, those who profess religious doctrines should be tolerant of conflicting views. Bernaldo de Quirós finds in this Ockhamist teaching a precursor of the freedom of thought and expression taught by John Milton in the seventeenth century. But Bernaldo de Quirós also says that “Ockham’s nominalism leads him to undertake an energetic defense of human rights and, specifically, of one fundamental right: that of private ownership. This is not a conventional arrangement created by a social decision but a natural one born of free human action. It is, therefore, a natural right, willed by God, and, thus, inviolable.” One wonders whether this view of private ownership, however welcome we may find it, is consistent with Ockham’s own teaching of God’s absolute power.
In “A Republican Defense of Anarchism,” Juan Ramón Rallo criticizes the influential Careful attention to the individual actor is a key theme of Huerta de Soto’s economic theory, and the same emphasis is also crucial to the libertarian political philosophy of which he is so distinguished an advocate. republican school, of which Philip Pettit and Quentin Skinner are leading advocates, for a false conception of individual autonomy. The republicans are right to say that individuals should be free from domination by others, but they wrongly seek the remedy for domination in democratic decision-making that restricts the free choices of market participants. Democratic decision-making, even under ideal conditions, imposes the will of the majority on dissenters. Respect for individual autonomy mandates the right of secession from the political community and culminates in anarchism. “The key question that republicanism must confront is what to do with those minorities who, even after having scrupulously respected impartial procedures to which they themselves have not voluntarily adhered, feel that the collective decisions agreed upon contravene their conception of the common good and constitute, consequently, an arbitrary interference by majorities in their lives.”
The Emergence of a Tradition is an indispensable contribution to Austrian economics and to libertarian thought, and readers will also gain a clear sense of Huerta de Soto’s major contributions in these areas.
Part III: Intervention, Chapter 9: Regulatory Intervention
How to Think about the Economy: A Primer. Narrated by John Quattrucci.
Part II: Market, Chapter 6: Value, Money, and Price
How to Think about the Economy: A Primer. Narrated by John Quattrucci.
Part II: Market, Chapter 7: Economic Calculation
How to Think about the Economy: A Primer. Narrated by John Quattrucci.
Part II: Market, Chapter 4: A Process, Not a Factory
How to Think about the Economy: A Primer. Narrated by John Quattrucci.
How to Think about the Economy was written to accomplish something big: economic literacy. It is intentionally kept very short to be inviting rather than intimidating. You will gain a life-changing understanding of how the economy works in practically no time.
Narrated by John Quattrucci.
Download the complete audiobook (12 MP3 files) in one ZIP file here. This audiobook is also available on Soundcloud and via RSS.Purchase the Audiobook on Audible/Amazon, or paperback at the Mises Store.
Part I: Economics, Chapter 1: What Economics Is
How to Think about the Economy: A Primer. Narrated by John Quattrucci.
Part III: Intervention, Chapter 8: Monetary Intervention
How to Think about the Economy: A Primer. Narrated by John Quattrucci.
Part I: Economics, Chapter 3: How to Do Economics
How to Think about the Economy: A Primer. Narrated by John Quattrucci.
Part I: Economics, Chapter 2: Economic Theory
How to Think about the Economy: A Primer. Narrated by John Quattrucci.
Conclusion: Action and Interaction, How to Think about the Economy: A Primer.
Narrated by John Quattrucci.
Part II: Market, Chapter 5: Production and Entrepreneurship
How to Think about the Economy: A Primer. Narrated by John Quattrucci.
Jeff and Bob review the history and impact of The Human Action Podcast—formerly Mises Weekends—and discuss where the podcast is headed.
Get Jeff's new book A Strange Liberty: Politics Drops Its Pretenses: Mises.org/Strange
Those adhering to Austrian Economic thinking see the beauty in concepts coming together and providing a way to truthfully assess human action.
Original Article: "Yearning for Beauty in the Truth of Economic Thinking"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Progressivism is collectivist, anti-individual, and ultimately destroys civilization itself. Austrian economics stands against this force.
Original Article: "Austrian Economics Stands against the Collectivism of Progressive Thought"
This Audio Mises Wire is generously sponsored by Christopher Condon.
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.
Lew Rockwell gave this talk, sponsored by the Future of Freedom Foundation and the George Mason University Economics Club, was delivered at George Mason University on September 9, 2009.
While Bitcoin's S2F Model has come under some criticism, the best analysis of its flaws comes from perspective of Austrian Economics.
Original Article: "A Critique of the Bitcoin Stock-to-Flow Model"
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. '
From the Preface ... This little book was written to accomplish something big: economic literacy. It is intentionally kept very short to be inviting rather than intimidating, as economics books typically are. If I managed to meet this bar, you, the reader, will gain life-changing understanding of how the economy works in practically no time. This is lots of value at a very low cost.
If I have managed to exceed expectations, this book will also make you excited about what economics has to offer. Because economic literacy is mind-opening. Sound economic reasoning is an enormously powerful tool for understanding both the economy and society. It uncovers what is going on under the surface and why things are the way they are. In fact, economic literacy is necessary to properly understand the world.
Part I: Economics1. What Economics Is The Economy The Economic Problem Economics as Understanding2. Economic Theory The Starting Point Unpacking Human Action The Genius of the Action Axiom3. How to Do Economics The Meaning of Exchange Price and Value Price Mechanism The Step-by-Step Method Economics as a Social Science
Part II: Market4. A Process, Not a Factory A Coordinated Process Continuous Innovation Continuous Uncertainty5. Production and Entrepreneurship Production to Overcome Scarcity Capital and Production The Role of the Entrepreneur Entrepreneurs Make Mistakes6. Value, Money, and Price The Problem of Measuring Value The Use of Money The Emergence of Money The Importance of Money Money Prices Fiat Currency and Price Inflation7. Economic Calculation The Nature of a Productive Economy The Driving Force The Production of Value Entrepreneurship and Management
Part III: Intervention8. Monetary Intervention The Boom-Bust Cycle The Rate of Return and Capital Investments The Cause and Nature of the Artificial Boom The Turning Point The Corrective Bust9. Regulatory Intervention The Seen The Unseen The UnrealizedConclusion: Action and InteractionFurther ReadingIndex
Featuring Joseph Becker, Anthony Cesari, Felicia Jones, and Alex Voss. Recorded at the Mises Institute in Auburn, Alabama, on 30 July 2022.
Fellowships in Residence at the Mises Institute in Auburn, Alabama, are available to graduate students and post-docs interested in scientific research in the Austrian school and libertarian political economy. For more information, visit Mises.org/fellows.
The Mises Institute’s Master of Arts in Austrian Economics is the first graduate program in the United States dedicated exclusively to the teaching of economics as expounded in the works and great treatises of Ludwig von Mises and Murray N. Rothbard. For more information, visit Mises.org/edu.
Students can also apply for scholarships to Mises Institute events at Mises.org/events.
Inequality is a good thing in the free market. Economic equality is a disastrous government policy that leads to economic ruin for all—including the poor and workers.
Download the slides from this lecture at Mises.org/MU22_PPT_36.
Recorded at the Mises Institute in Auburn, Alabama, on 29 July 2022.
A brief biography of Rothbard and his important works, and a survey of some of his contributions to economics.
Download the slides from this lecture at Mises.org/MU22_PPT_31.
Recorded at the Mises Institute in Auburn, Alabama, on 28 July 2022.
Free trade allows for maximizing total number of mutually beneficial exchangers and promotes economic progress.
Download the slides from this lecture at Mises.org/MU22_PPT_22.
Recorded at the Mises Institute in Auburn, Alabama, on 27 July 2022.
Few people understand how destructive regulations are.
Download the slides from this lecture at Mises.org/MU22_PPT_24.
Recorded at the Mises Institute in Auburn, Alabama, on 27 July 2022.
Time is an irreversible flux. Each moment has a unique place in the sequence of moments of time with respect to action.
Download the slides from this lecture at Mises.org/MU22_PPT_11.
Recorded at the Mises Institute in Auburn, Alabama, on 26 July 2022.
Government attempts to limit “monopoly power” cannot improve well-being.
Download the slides from this lecture at Mises.org/MU22_PPT_15.
Recorded at the Mises Institute in Auburn, Alabama, on 26 July 2022.
In 1920, Ludwig von Mises destroyed the intellectual foundations of the case for socialist central planning.
Download the slides from this lecture at Mises.org/MU22_PPT_12.
Recorded at the Mises Institute in Auburn, Alabama, on 26 July 2022.
Less and less and less?
Download the slides from this lecture at Mises.org/MU22_PPT_17.
Recorded at the Mises Institute in Auburn, Alabama, on 26 July 2022.
Download the slides from this lecture at Mises.org/MU22_PPT_14.
Recorded at the Mises Institute in Auburn, Alabama, on 26 July 2022.
"The free market and the division of labor does not promote hyper-atomized individuals. It creates social harmony and community." Download the slides from this lecture at Mises.org/MU22_PPT_04.
Recorded at the Mises Institute in Auburn, Alabama, on 25 July 2022.
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.
Entrepreneurship is a general feature of the market economy.
Download the slides from this lecture at Mises.org/MU22_PPT_07.
Recorded at the Mises Institute in Auburn, Alabama, on 25 July 2022.
Praxeology is the method of economics.
Download the slides from this lecture at Mises.org/MU22_PPT_03.
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.
"We would not expect money to be paper, national, or under the control of any entity."
Download the slides from this lecture at Mises.org/MU22_PPT_05.
Recorded at the Mises Institute in Auburn, Alabama, on 25 July 2022.
Jeff Deist: It’s a pleasure to speak with the famed investor Jimmy Rogers. How are you doing, sir?
Jim Rogers: I’m delighted to be here, Jeff. I’m a fan of the Mises Institute.
JD: You live in Singapore. How did you and your family fare during the last two years of covid?
JR: Well, Singapore first took the approach of not doing very much. Then they more or less locked down—which in my view backfired. In recent days, travel in Singapore is opening up again and restaurants are opening. Life may be coming back to some kind of normalcy. I would have taken a more free market approach, but we’ll know in a few years who was right and who was wrong.
JD: You were definitely right! But as an aside, some of our readers may not know you grew up in Demopolis, Alabama.
JR: Of course, yes, right down the road . . . well, sort of down the road from Auburn. In fact, I’m going there for my high school reunion soon.
JD: It seems like a long way from Demopolis to Yale and Oxford. How did you manage that?
JR: It was purely an accident; it was a mistake, I can assure you, and when I got to Yale I thought, “Oh my gosh, this is a mistake. What am I doing here?” I was so in over my head, but I pulled it off and I survived and did OK. I was in a club; Yale for some reason gave a scholarship to a member of that club and I applied. What did I know? I certainly didn’t know what I was getting into, but I applied, and lo and behold, I got the scholarship. Then I had to go.
JD: I suspect most of your classmates were from the Northeast rather than the Deep South.
JR: Yale in those days, and even more so now, is very international. In my class at Yale, out of a thousand boys, there were five people from Alabama.
JD: We’ll take five! Not bad.
JR: Needless to say, in those days Yale was still single gender. I was a geographic distribution. When Yale looked at the map, they couldn’t find Demopolis. My phone number was 5, so they said, We got to take this guy. We need somebody from Demopolis, whose phone number is 5.
JD: I noticed after you graduated and began working on Wall Street, you entered the US Army. This was during the Vietnam era. Were you drafted?
JR: In days of the Vietnam War, my draft board was Marengo County, Alabama. It was one lady. She had two sons who were drafted and killed in the Second World War, so no matter who you were, you were going to serve. I was about to be drafted anyway, and so I went to Officer Candidate School.
JD: Our perception today is kids from Yale working on Wall Street don’t end up in the army anymore.
JR: Well, they don’t have a draft board! In my case, it was either vengeance or patriotic duty, but nobody could escape the lady in Marengo County.
JD: You worked closely with George Soros in the 1970s. Is it strange now to think of him as an avatar, a controversial symbol for both sides of the political aisle in the West? Was he just a regular guy then?
JR: Well, Jeff, I haven’t seen or spoken to Soros in forty- two years. You might as well ask me about my first wife.
JD: I won’t do that.
JR: Do you want to ask about my first wife? I haven’t had any contact with her for many years either.
JD: I’m sure she has some questions for you! But we’ll forget Soros and fast-forward. In your early years on Wall Street, had you already discovered economists like Mises? How did that happen?
JR: Early in my life, it was a natural process, I came to the realization that open markets or open societies were much better than letting people tell others what to do. I realized from enough reading of history or philosophy that mankind, markets, societies could figure it out better than a bunch of guys sitting in a central office somewhere, telling us all what to do. I came to that on my own. Having grown up in Demopolis, where there was nobody to tell you what to do, it was pretty clear. And when I got to Yale in New Haven, they had an entirely different view of the world than I did having grown up in the backwoods of Alabama. And I came to this as a natural process of reading philosophy, economics, or whatever it was. Ever since I read Mises and other people like that, it was clear to me that open economies and open societies were the best way.
JD: Do you think Mises and other economists helped you in your business life, in your investing career?
JR: Well, Mises never gave me any hot tips! He never gave me any stocks to buy [laughing]. So in that regard, maybe not. But certainly knowing how the world works and knowing that too much regulation and control will hurt an economy or an industry—this gave me a philosophical basis to help me make decisions and have a thought process. I have gotten involved with investing in countries where nobody else would invest, because I could see the changes taking place as they opened up their economies. That was always the focus of my thought process. More philosophy than specifics.
JD: What about monetary policy? Has your view of money changed with all the extraordinary things central banks did after the ’07 crash—and now in response to covid? Has any of this changed your thinking in the sense we are in uncharted territory?
JR: Well, that’s all the same process. I know that the market is smarter than Alan Greenspan. Alan Greenspan was chair of the Fed in the US for a long time. I know that the market is certainly smarter than most central bankers we’ve had in the world and certainly most Treasury officials we’ve had. That knowledge comes from experience and reading. I know, and I’ve seen it in enough countries around the world, Jeff, to know that markets make many mistakes—but markets make fewer mistakes than Janet Yellen. Janet Yellen has two Ivy League degrees, but Ivy League degrees don’t mean she is always right.
JD: I worked for Ron Paul when your book Hot Commodities came out in 2005. Do you still agree with the central thesis in that book, that the future is bullish for investments in tangible things? Given inflation today, it seems the case for commodities might be stronger than ever.
JR: Well, the thesis of that book was that there were no books about commodities or, if there were, we couldn’t find them! I was trying to explain the commodities market. It was not a book of hot tips. It was just explaining about markets and how you invest. The subtitle was “How Anyone Can Invest Profitably in the World's Best Market.” It was a how-to book rather than a book of hot tips. That part of the thesis is still accurate. If you want to invest in gold, you gotta know how to do it. I happen to be optimistic about commodities right now and have been for a while, but that’s not always the case, as I explained in the book. Commodities have long periods when things are great. They’ve also had long periods when things have been very bad, so it’s not just a question of knowing how—you have to know when. That’s the hard part.
JD: One critique of Austrians is all about timing— economics per se can’t explain when, only why.
JR: I would dispute that. It’s back to what I said before: it’s a way of thinking and a process and a philosophical approach. That’s how Austrians can teach you how to think and teach you how the world works or should work. When the world doesn’t work that way—for instance, the former Soviet Union didn’t work—we understand why. I could remember the first time I went to Russia and the Iron Curtain countries. I came away saying, “This will never work. This cannot work.” And so it happened. We had the right approach, and the Soviets had the wrong approach. But I came to that conclusion by just knowing or thinking I knew how the world worked. Did Austrians teach me that? No, but my knowledge of how things should work, which is Austrian economics, made me realize the Soviet system could not work and would not work.
JD: For at least a decade the markets have been in thrall to tech, FAANG (Facebook, Amazon, Apple, Netflix, Google) stocks, and the digital world. I wonder if covid changed your perspective at all about commodities and the physical, analog world. Covid reminded us how important the old analog world is. We need energy, we need calories, we need medicine, we need food. All of it needs to come to us physically where we live. The market has to bring it to us.
JR: You need rice! There are a few billion people in the world who eat rice every day. I’m not sure that I needed the covid virus to teach me that. It certainly reinforced it and made it clear to all of us that we’ve got to have this stuff and we’ve got to get it somehow—and if we cannot get it, the price is going to go through the roof. Certainly covid made it worse, but this is the way the world works. This is how markets work.
JD: What are your thoughts these days on farmland, mining, natural resources? I know you’ve been a promoter of these sectors in the past. You’ve suggested farmers rather than investment bankers may be the rich guys in society soon enough.
JR: You can go back and look at history or literature. If you go back and read Russian novels, there were these really, really rich agricultural people—the count who has white horses and servants and everything else—and they were very, very rich and successful agricultural people. They were farmers. We’ve also had periods in history, like the 1930s in America, the Dust Bowl, where farmers were absolutely starving. The price of cotton went to a penny—a penny a pound—it was just unbelievably cheap. By the way, the price of cotton in 1861 went from a penny to over a dollar. I presume you know that was because of the Confederate cotton embargo. But in 1931 it went back to under a penny. So as I was saying before, there have been some great cycles in commodities, always have been, always will be. If one can get it right, one can make huge amounts of money in commodities, but if one gets it right, you can make huge amounts of money in just about anything!
JD: So, how do you focus your time these days? What’s your primary day-to-day work?
JR: Well, I still invest my money. I have to because I have to pay my rent, but for many years, I never had children, 16 | The Austrian | Vol. 8, No. 3 I never wanted children. I felt so sorry for my pathetic friends who had children. I had one. I was 60 when I had my first child, and I came to realize I’d been wrong about children all of my life. Now I have two, and they are a major focus for me. I want to spend as much time and energy on and with my children as I can. Anybody reading this who hasn’t had children and you’re at the right age, I urge you to go and have some children. It’s a miracle.
JD: Are you still generally bullish on Asia? Do you still like living and working there?
JR: We moved here because I came to the conclusion twenty-five or thirty years ago that China was going to be the next great country in the world, whether we like it or not. I wanted my children to speak Mandarin and to know Asia. That’s why I came here, and it’s worked. They both speak perfect Mandarin and they can use chopsticks [laughing]. They know what chopsticks are now, so they have learned a lot. I don’t see anything to change the idea that Asia’s going to be the most important part of the world in the next hundred years or so. It has certainly continued to happen that way. Everybody, most people, know that now that it’s happening. Sure, there will certainly be setbacks. The United States became the most important country in the twentieth century, but along the way, we had many depressions, massacres in the streets, a civil war, we had many problems, and yet we became a great success. China’s going to have plenty of problems, but I don’t see anybody else on the horizon. The reason I came was to try to prepare my children for the twenty-first century. You can ask me in eighty years if I got it right.
JD: Presumably their English is pretty good too. English and Mandarin sounds like a good combination.
JR: They speak good English and they speak perfect Mandarin. It’s astonishing, but Chinese TV networks invite my children to come to China to do specials about them because they’re so shocked at their Mandarin. Not me, I speak no Mandarin. I’m still speaking Alabama English, but you know, my children speak proper English and they speak beautiful Mandarin.
JD: Some readers may know your 1994 book Investment Biker, which chronicles your travels around the world, and several emerging markets by motorcycle. The Barber Motorsports Museum in Alabama displays your old motorcycle from one of those trips, a 1988 BMW R100-RT?
JR: That’s exactly what it was. It was a fabulous bike, and that bike’s had two major trips, one around the world and one across China a long time ago. I had a fantastic time on that bike, and it is in a museum in Alabama. George Barber had the good sense to have a rich grandfather and a very rich father, and George too is very rich, so he decided to build the world’s greatest motorcycle museum, and he’s done it. It’s absolutely astonishing, with racetracks and everything else. Since I’m from Alabama, that seemed to be the logical place for that motorcycle to be, and there it is.
JD: And during those hundred thousand miles or so I assume you were dealing with a lot of flats and mechanical problems and such on your own in the middle of nowhere sometimes.
Final question for you. Anything you would like to say to our younger listeners today? Most of them are in the US, some are in Europe, some are in Asia or Central and South America. Many young people in their twenties are not particularly optimistic.
JR: I’ll give you two very strong words of advice. One is learn another language, preferably Chinese or Spanish or something that’s widely spoken. If nothing else, even if you don’t use it very much, it will give you an inspiration and an understanding of other parts of the world, which is extremely important, certainly in the twenty- first century. But probably more important than that, Jeff, is figure out what you love, figure out what your passions are. Don’t listen to your parents, don’t listen to your teachers, don’t listen to your friends. Figure out your own passion and pursue it, and if people laugh at you, you’re really on the right track, you’re really doing the right thing. Because someday you’re going to be a very great success, and Jeff, even if you’re not a great success, you won’t care because you’re happy. You’re doing what you love. You wake up every day, you never go to work, you just wake up and have fun. But those are also the people who are usually the most successful, because they’re doing what they love and they have great fun. So, figure out what you love and do it and learn another language and get yourself a motorcycle and drive around the world. It would teach you a lot about yourself and about the world.
JD: And have some kids.
JR: Oh, have some kids, but be sure you’re ready before you do it.
JD: Thanks so much for your time. We appreciate it.
JR: Let me tell you, I go to the Mises website whenever it pops up. There’s all sorts of good stuff there. It’s astonishing how much good stuff you guys put up there. I show it to my kids because I want them to know the astonishing range of information that’s out there. You have a lot of it, and you certainly don’t have the conventional wisdom. Nobody gets successful following the conventional wisdom, so keep it up.
This week Jeff is solo with very special guest Jimmy Rogers, the famed investor, Alabama native, and fan of Austrian economics.
Listed and linked below are the readings that all students must complete before attending RGS.
All materials are available on Mises.org free of charge, and most readings are available in multiple formats (e.g., PDF, ePub, HTML, audio). Complimentary physical copies of the readings will be available to attendees upon arrival at RGS. Physical copies can be mailed in advance to U.S. addresses upon request by emailing felicia@mises.org.Required ReadingsPower and Market: Government and the EconomySupplementary Readings Readings outline
ScheduleThe conference begins with dinner and opening remarks, Sunday, June 5, at 6:00 p.m. Central Daylight Time, and ends with dinner Friday, June 10. A preliminary schedule is posted here, and a final one will be emailed to each attendee.
Accommodations will be provided with arrival Sunday, June 5, and departure Saturday, June 11. Details forthcoming.
Travel Information Tiger Taxi provides transportation to Auburn from airports in Atlanta, Birmingham, Montgomery AL, and Columbus GA. Reservations and payment can be made on this page. Atlanta and Birmingham are about an hour and 45 minutes from Auburn. Montgomery and Columbus are about an hour from Auburn. Groome Transportation provides transportation to Auburn from Atlanta airport. Reservations and payment can be made on this page. Driving directions are here. Parking is free at the Institute.
Attire Business casual such as slacks, khakis, and collared or polo shirts.
Sometimes people—even other economists—are incredulous that the Austrians deny the possibility of interpersonal utility comparisons.
Original Article: "Why Austrians Stress Ordinal Utility"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Abstract: Economics has long history of “rehabilitations,” including W.H. Hutt’s rehabilitation of Say’s law, and Alfred Marshall’s attempt to rehabilitate David Ricardo. The rehabilitation of Frank A. Fetter should be as important as either of these, especially for economists working in the contemporary Austrian tradition. The historical records reveal that for the last century there has been underway a nearly unbroken series of efforts, especially by Austrian economists, to rehabilitate Fetter’s contributions and use them to revitalize economic theory. This paper relates this history, which chronicles the rise, decline, and rise again of one of the great American economic theorists. Yet crucially, this is not a story about Fetter alone, but also of the fortunes of the Austrian school and its rise, decline, and renaissance.
Matthew McCaffrey (matthew.mccaffrey@manchester.ac.uk) is associate professor of entrepreneurship in the Alliance Manchester Business School at the University of Manchester. This paper is based on the Murray N. Rothbard Memorial Lecture given at the 2021 Austrian Economics Research Conference. I would like to extend my deepest thanks to Joseph Salerno and to the Ludwig von Mises Institute for inviting me to give the lecture, and to Steven and Cassandra Torello for generously sponsoring it. In addition, I am grateful to Robert Fetter for his kind encouragement and for providing me with numerous resources and anecdotes concerning the Fetter family. Sara Goodwin provided outstanding support with the Fetter archives at Indiana University.
JEL Classification: B13, B25, B31, B53, D33, D46
“Among all men of the economics profession that I have known, none has so fully realized my ideal of scholarship without pedantry, intellectuality without pretense, humor without unkindness, and integrity without self-righteousness.”
—Neil Carothers to Frank A. Fetter, 1933
When asked to list Murray Rothbard’s most important contributions to economics, few people think to name his 1977 volume Capital, Interest, and Rent: Essays in the Theory of Distribution. This is understandable, as the book is not an original work of Rothbard’s but an edited collection of papers by a different author. Yet although seldom discussed—and never listed among his major works—this innocuous volume represents a key moment in the history of the Austrian economic tradition and the culmination of a half century of effort by Rothbard and many others to resurrect the ideas of a great unsung economist: Frank A. Fetter.
The life and work of Frank Albert Fetter (1863–1949) should be important to anyone interested in economics, but especially Austrian economics. For fifty years or more, he was the leader of the American branch of the tradition of Carl Menger, Eugen von Böhm-Bawerk, and Friedrich von Wieser, and he played a major role in spreading Mengerian ideas in the United States. He also systematized and extended the work of the older Viennese economists, and in doing so had a profound impact on several generations of their younger students. He was, for example, personally and professionally connected to every major Austrian economist active in the first half of the twentieth century, and often took an active role in promoting their works and careers, and they his (McCaffrey 2019). Moreover, Fetter’s importance was not restricted to the Austrian tradition: he also obtained virtually every professional accolade available to the economists of his day (Howard and Kemmerer 1943).
Despite his importance during his life, however, Fetter is today largely unknown, and receives only a fraction of the attention given to contemporaries like Irving Fisher or John R. Commons. Nevertheless, among a small but growing number of scholars, Fetter’s ideas are playing a more prominent role. It is therefore worth investigating why his reputation declined so precipitously in his later years, and why, so many decades after his death, his work is at last beginning to receive the attention it so richly deserves.
The theme of this paper is rehabilitation, in the sense of repairing a reputation and restoring it to a rightful place of prominence. Economics has a long history of rehabilitations, including W. H. Hutt’s rehabilitation of Say’s law (Hutt 1973), and—significantly for this paper—Alfred Marshall’s attempt to rehabilitate David Ricardo (Ashley 1891). The rehabilitation of Frank Fetter is a far more obscure effort than either of these, but it is my purpose to show that it is every bit as important, especially for economists working in the contemporary Austrian tradition. The historical records reveal that for the last century there has been underway a nearly unbroken series of efforts, especially by Austrian economists, to rehabilitate Fetter’s contributions and use them to revitalize economic theory. It is my aim to relate this history, which chronicles the rise, decline, and rise again of one of the great American economic theorists. Yet crucially, this is not a story about Fetter alone, but also of the fortunes of the Austrian school and its rise, decline, and renaissance.
FRANK ALBERT FETTER (1863–1949) Frank Fetter was one of many American economists in the late nineteenth century who were trained in German universities by members of the German historical school and whose politics were heavily influenced by early American progressivism (McCaffrey 2019; Leonard 2016).Fetter’s early research around social problems was influenced by the progressive ideology of the day, and likely contributed to his early career success among professional economists. Another factor was his work in support of academic freedom, which began with his resignation from Stanford University in protest of the dismissal from the faculty of the ultraprogressive E. A. Ross. Samuels (1985) shows that Fetter’s defense of Ross was driven by a principled support of academic freedom rather than progressive politics. Nevertheless, Fetter was close friends with Ross and other leading progressive economists such as Richard T. Ely, E. R. A. Seligman, and John R. Commons, the first two being founders of the American Economic Association (AEA). It seems reasonable to suggest that their support played a part in Fetter’s rise through the AEA and may even have influenced his choice of topics for his (quite progressive) presidential address, “Population or Prosperity?” Yet he differed from many of his contemporaries in two ways: first, he held many promarket political convictions alongside his more progressive views, and second, he developed a love of economic theory and a strong devotion to the subjectivist economics pioneered by Carl Menger, Eugen von Böhm-Bawerk, and Friedrich von Wieser. Fetter called this approach “psychological,” emphasizing the personal, subjective aspect of value as well as a newer volitional approach to choice, in sharp contrast to the utilitarianism or hedonism of Jeremy Bentham (Coughlan 1965, 80–97).Fetter sometimes described himself as a “welfare economist” as opposed to a “price economist.” Price economics, exemplified by the British classicals, investigated only the superficial, pecuniary aspects of economics, and was limited to studying “prices, exchanges, commercial statistics, and financial operations” (Fetter 1920, 737). Welfare economics, however, sprang from psychological theory, and was a more humane endeavor aiming ultimately at social progress through the study of “the relation of men to their environment, social and physical, consisting of the objects of their choice, as affecting their sustenance, their happiness, and their welfare” (Fetter 1920, 737). Welfare in this sense reflected a deep and abiding type of well-being (see Herbener 1999, 136–39). Price economics was essentially a step toward realizing welfare economics. In fact, Fetter attributed the first use of the term “psychological” to Wieser (FAF, “The Dead Hand in Economic Theory: Some Uncompleted Reforms and Some Unsolved Problems,” 1940). Among the Americans, his main influence was John Bates Clark, who Fetter believed should have been listed alongside Menger and William Stanley Jevons as the third discoverer of the subjective theory of value (Fetter 1923, 593–94). Fetter and several other economists, especially Herbert Davenport and Irving Fisher, came to be known as the “American psychological school,” by which was meant very nearly the American Austrian school (Dorfman 1949, 360–65), with Clark as honorary founder.
In fact, nowhere outside Austria were the ideas of Menger, Böhm-Bawerk, and Wieser developed further than they were in the United States. F. A. Hayek even recalls that when he was a young student, “the work of the American theorists John Bates Clark, Thomas Nixon Carver, Irving Fisher, Frank Fetter, and Herbert Joseph Davenport was more familiar to us in Vienna than that of any foreign economists except perhaps the Swedes” (Hayek 1992, 32). And among the Americans, none was more consistent or—to use a word often applied to Ludwig von Mises—as intransigent as Fetter.
By any standard, he was one of the most successful economists of his day. His teaching career, which lasted well into his seventies, was spent mainly at Princeton, Cornell, Stanford, and Indiana University, and also included positions at Harvard, Columbia, Johns Hopkins, and the University of Illinois.See, for example, the achievements and accolades listed in Howard and Kemmerer (1943), whose account is based on information provided by Fetter. In 1912, he was elected to the presidency of the American Economic Association. As a researcher, he spent the bulk of his career refining and developing the theories of value, price, and distribution along Austrian lines, both in textbooks and in a series of articles published in the leading economics journals. He is especially known for developing original theories of capital, interest, and rent, each of which influenced the Austrians. In the last three decades of his life, Fetter focused mainly on the study of monopoly, especially price discrimination through the basing-point method (e.g., Fetter [1931] 1971, 1948). As a result of his criticism of different forms of monopoly and of the price control and cartelization policies of the New Deal, he eventually took on greater prominence as a public intellectual as well, but he never lost his passion for economic theory, which he continued to explore until his death in 1949. He was in particular a ruthlessly consistent subjective value theorist and an enemy of eclecticism in economics, traits that put him at odds with nearly every important economist of his time, including his friends. Nevertheless, by the time Mises and his students immigrated to the United States, the influence of Fetter and the American psychological school had all but disappeared, replaced in varying degrees by the ideas of economists like Alfred Marshall, Léon Walras, Edward Chamberlin, John Maynard Keynes, and others.
The question, then, is this: If Fetter was indeed such a successful and influential economist, what happened to his work, and why does he need rehabilitation? The answer is that although he was a major force in economics, Fetter’s contributions, just like those of the early Austrians, were never fully incorporated into economic theory and teaching. Again and again his theoretical investigations led him down paths deemed too extreme by his fellow economists, even though his work usually consisted of little more than consistently extending Mengerian value theory. Yet his ideas were continually passed over in favor of more eclectic theories, particularly those that combined elements of classical price theory with insights from the newer subjective-psychological theory.
THE MARGINALIST REVOLUTION To understand why Fetter failed to exert the influence he deserved, it is necessary to revisit the “marginalist revolution” that began to transform economics beginning in 1871. The more superficial accounts of this era overstate its revolutionary character, and imply that the simultaneous discovery of the new value theory by Menger, Jevons, and Walras triggered the immediate overthrow of classical economics and of cost-of-production theories of value, ushering in the neoclassical era. Yet historians of economic thought have known for many years that this neat and optimistic view is mistaken. The truth is that the marginalist revolution was slow, inconsistent, and incomplete. As Mark Blaug put it, “it was not a marginal utility revolution; it was not an abrupt change, but only a gradual transformation in which the old ideas were never definitively rejected; and it did not happen in the 1870’s” (Blaug 1972, 277; emphasis in original).Numerous accounts question the idea that the marginalist revolution was a quick and decisive transition, or that the marginalists themselves were in agreement about the nature and significance of their contributions. See Jaffé (1976), as well as the papers in symposium on the foundations of neoclassical economics in the July 1990 issue of the American Journal of Economics and Sociology and the papers in symposium on the marginalist revolution in the fall 1972 issue of History of Political Economy.
To take one example, Davis Dewey, the managing editor of the American Economic Review, explained to Fetter in a July 26, 1916, letter that he had trouble finding appropriate reviewers for books by the American psychological economists because their views were contrary to prevailing opinion: “I have found some difficulty in getting reviewers for yourself, Davenport, and Fisher. Apparently, the economic fraternity does not like to tackle this trio, due, I suppose, to the fact that its thought seems to run in such different channels that criticism in [sic] aroused” (FAF). Furthermore, as late as the 1920s the subjective theory of value was still met with resistance in the economics journals, and was suffering attacks from Ricardian holdouts as well as new incursions from the rising tide of institutional economics (see, e.g., Fetter 1921, 1923; FAF, “Present State of Economic Theory in the United States of America,” 1926).
Fetter pointed out in many of his works that consistent subjectivism had failed to take hold, and emphasized repeatedly that the promise of the marginalist revolution remained unfulfilled. In fact, for him, “marginalist revolution” was a misnomer: the real revolution was in subjectivism, not marginalism, which was merely one implication of the subjective theory of value:
[T]he term “marginal” is inapt in its suggestion that marginality or finality is the most essential mark of this theory as contrasted with the cost-of-production theory. “Subjective” or “psychological” would much better stress the contrast with that which it displaced…. This feature [marginal analysis] is merely a mechanical, or at best, logical device, far less significant than the broader psychological aspects of the theory. (Fetter 1923, 590n1)
Marginalist methods of analysis existed in economics long before 1871, most famously in David Ricardo’s theory of land rent. They had also been pioneered in England by Alfred Marshall, the great eclectic whose work attempted to bridge classical and neoclassical theory, and in America by Frank Taussig, whom Joseph Schumpeter described as the American Marshall (Schumpeter, Cole, and Mason 1941). It was these kinds of works, still infused with cost-of-production theories of value, which dominated economics teaching and theory after the turn of the century.
As a result, the distinctiveness of the subjective value theory pioneered by Menger was lost. It became the conventional wisdom that the insights of the marginalist revolution had been fully integrated into economics, and that there was no need to distinguish between schools of marginalism (Viner 2013, 57–60). The foundations of economics were generally agreed upon, even if there were slight differences of emphasis between economists in different nations. Even Ludwig von Mises endorsed a version of this view (Mises 2007, 19). Fetter did not accept the naïve interpretation, though, and throughout the 1920s and ’30s stressed the distinctiveness and importance of Mengerian value theory as compared to the versions espoused in the textbooks of Marshall and Taussig. As he put it in an unpublished manuscript from the 1920s,
To make the hallmark of the psychological school the marginal utility method, or to group that school with nearly all recent theory … under the title of “the marginal utility school” as is not infrequently done … reveals a gross misunderstanding or no understanding at all of the major issues in value theory since 1870. (FAF, “Overhead Costs,”)
THE DECLINE OF THE AMERICAN MENGERIAN TRADITION Despite their energy and erudition, the best efforts of Fetter and the American psychological school failed to exercise a lasting impact. There were both personal and professional reasons for this. Personally, controversies among the Americans prevented them from collaborating and presenting a more unified front against competitors. For example, Fetter instigated a rancorous exchange with Herbert Davenport over several issues in economic theory that seems to have destroyed their friendship (Fetter 1914, 1916; Davenport 1916).Fetter and Davenport exchanged many letters of friendly debate in the early 1900s, but after the publication of their later reviews and criticisms, the correspondence ends abruptly. Fetter also debated Irving Fisher on capital, interest, and income, a dispute that began in the early 1900s and continued privately for nearly thirty years, ceasing only when Fisher died (Fetter 1907, 1908; Fisher 1907; FAF, Fisher to Fetter, July 22, 1930, Fisher to Fetter, Aug. 12, 1930). Fisher’s early writings had been more in tune with Austrian work, but drifted into a kind of eclecticism. While this shift likely made his work more palatable to a wider range of economists, it also made it less consistent. Although they remained on friendly terms, Fetter never forgave Fisher for abandoning the pure time preference theory of interest in favor of a partial productivity theory (Fetter 1928b).
Although many of these arguments were based on valid disputes over theory, the damage they caused can also be attributed to a personal failing on Fetter’s part: he could be a savage critic, even to the point of being uncharitable, and once he had latched on to a particular line of criticism, he often found it hard to let go, even in victory. No matter their exact causes, though, these personal and academic conflicts—as well as retirements, deaths, and shifts of research interests—among the American psychological economists effectively decimated the school by the 1920s.See also Salerno (1999) for more on the decline of the Mengerian tradition in the US and around the world. Like the Austrians themselves, the American Mengerians neglected to build scholarly networks and institutions for the purpose of maintaining and advancing subjectivist economics (Salerno 2002).
Yet the problems ran deeper than the personalities of economists. The underlying challenge was that the best and most consistent insights of the Mengerian tradition had never fully taken root in the US, despite the support they received from leading figures such as John Bates Clark. Under the influence of an old guard of economists including Arthur Hadley, Lawrence Laughlin, and Frank Taussig, economic theory in the US remained an eclectic combination of German historicism; the classical economics of Ricardo, Mill, and Marshall; and marginal utility theory (Salerno 2001, 18–20). As a result of this opposition, when the energy of the psychological economists began to dissipate, Fetter was left virtually alone in the battle for economic theory in the United States.
The failure of American audiences to appreciate the uniqueness of the Mengerian tradition was driven home to Fetter repeatedly in the 1920s and 1930s. In 1936, for example, he contributed four chapters on value and price theory to a collaborative textbook on economic principles edited by Walter Spahr. These chapters were Fetter’s last systematic writings on price theory, and represented a state-of-the-art account of the topic at the time. They were explicitly written using the subjective-psychological approach in contrast to the cost-focused Marshallian theory (FAF, Fetter to Vernon Mund, July 5, 1938). Unsurprisingly, they also closely mirrored Böhm-Bawerk’s exposition of the same topics, which Fetter recommended as further reading. Fetter was subsequently invited to revise his chapters in preparation for a new edition of the textbook; however, after he had begun, Spahr unexpectedly rescinded the invitation and entirely removed Fetter’s chapters. As Spahr explained to him in a letter dated July 6, 1939:
A survey of the users of our text by the publisher has revealed that a very large proportion of those who have used our text have not appreciated or perhaps understood your approach to the question of Value and Price. A very considerable number of those who have been using the work have stated that they were discontinuing its use because they preferred the approach to Value and Price which they could find in other works. The publisher is convinced that our work can never be restored in the face of what seems to be a rather prevailing opinion regarding your chapters … [T]he work probably will die unless we boldly face this issue. (FAF)
This kind of example—which here is even supported by some quantitative evidence from Spahr’s surveys—goes a long way toward undermining the claim that by the 1930s all of the major insights of the Mengerians had been absorbed by economic theory and teaching, and that it was only in subsequent debates that the Austrians were clearly distinguished from other neoclassical traditions.Fetter’s correspondence similarly reveals that in the 1930s and ’40s, if not earlier, it was common for him and his colleagues and students to use the term “Austrian economist” to identify members of an intellectual tradition that was not defined by national borders and included scholars of other nationalities (FAF, E. Zingler to Fetter Apr. 7, 1943). It also shows how even a psychological economist as professionally successful as Fetter was increasingly unable to find a sympathetic audience for his views. In his old age, his fellow economists accorded him the utmost respect even as they disregarded his most profound contributions to the science. Surprisingly, though, several decades of controversy and (in his view, at least) misunderstanding of his work did not blunt Fetter’s enthusiasm for economic theory. Despite his disappointment at failing to convince more economists of the virtues of the American psychological school, he doggedly persisted in efforts to refine its contributions and to give them new life (FAF, “The Dead Hand in Economic Theory: Some Uncompleted Reforms and Some Unsolved Problems,” 1940).
EARLY EFFORTS AT REHABILITATION Having said something about the rise and decline of Fetter’s influence, the next step is to chronicle the long history of attempts to rehabilitate it. These efforts were led independently by several generations’ worth of Austrian economists at a series of crucial moments in the history of their tradition, particularly when it too was under attack and in decline. Moreover, their ultimate success runs parallel to the resurgence of the Austrian tradition that gained steam in the 1960s.
Neither Fetter nor his students and colleagues were oblivious to the problems of challenging the dominant strands of economic theory. And as the debates of the early twentieth century on topics such as capital, interest, and rent died down and the Marshall-Taussig model of economic theory became clearly established as the dominant force in US economics, it became increasingly obvious that sustaining the Mengerian, psychological tradition would require a renewed effort. In practice, this meant republishing classic works in economic theory and writing new ones, and this is exactly what Fetter and many of his friends and admirers attempted, beginning especially in the 1920s.
Throughout his career, Fetter received countless requests to republish his works as well as produce new treatments of the theory and history of economics. In particular, a persistent theme in his correspondence from the 1920s onward is the scarcity of his published writings, particularly his journal articles on value, price, and distribution theory (see, for example, FAF, Taussig to Fetter, Nov. 23, 1927; O. Weinberger to Fetter, May 27, 1931; Percy Ford to the editor, Quarterly Journal of Economics, June 7, 1932; G. Haberler to Fetter, Feb. 12, 1932; Joseph Dorfman to Fetter, Dec. 12, 1940; H. S. Piquet to Fetter, Feb. 17, 1943; J. J. Spengler to Fetter, Jan. 30, 1946). An especially common request was for a collection of Fetter’s key papers that would help to resuscitate the subjectivist cause in economic research and teaching, especially in response to the triumph of Marshallian price theory and the monopolistic competition revolution. For example, on March 27, 1928, Royal Meeker wrote Fetter that colleagues recommended that he challenge Irving Fisher’s dominance in interest theory by resuming their debate through a reprint of their early articles (FAF). Fetter agreed that the idea was a worthy one, but the project stalled due to his many other professional obligations and the onset of the Great Depression, which made publishing far more difficult (FAF).A similar fate met a later attempt by Fetter’s former student, Vernon Mund, to produce a collection (FAF, Mund to Fetter, Mar. 27, 1943). Over the years many other people close to Fetter expressed general wishes for a collection of his writings, while still others encouraged him to write a systematic account of economic terminology (FAF J. P. Norton to Fetter, Dec. 12, 1912; J. E. Hamm to Fetter, Aug. 17, 1934) or a history of economic thought (G. A. Steiner to Fetter, July 8, 1937). The sources cited here provide only a small sampling of the requests Fetter received through correspondence, and do not include, for instance, similar requests made to him in person by his friends, colleagues, and students. Fetter was continually on the lookout for help to bring his work back into the public eye, and by 1935, it seemed as if he had found it.
NOEL HALL AND THE LSE ECONOMISTS A significant effort to republish Fetter’s work was undertaken in the mid-1930s by the group of Austrian economists based in London, mainly at the London School of Economics. This group was led by Lionel Robbins and F. A. Hayek at the LSE, along with colleagues from University College London such as Paul Rosenstein-Rodan. The plan was mainly negotiated by another UCL economist, Noel Hall.
Noel Hall, later Sir Noel, was a master’s student of Fetter’s at Princeton in the late 1920s before returning to England, where he earned his PhD and became an influential member of the Robbins-Hayek circle in London. In 1935, Hall traveled to the US to present Fetter with an offer from Robbins and Hayek, “who owe a good deal to your work,” to publish a large collection of his writings relevant to Austrian economics (FAF, Hall to Fetter, April 1935). Fetter quickly agreed, and together they began to draw up a table of contents. The main topics were to be value, rent, interest, and population (FAF, Fetter to Hall, June 4, 1935). This initial project was deemed too long, though, so a somewhat shorter version was agreed upon (FAF, Hall to Fetter, May 9, 1935; Hall to Fetter, June 10, 1935c; Fetter to Hall, June 4, 1935). Hall returned to England with the proposal, yet despite his early enthusiasm, nothing came of the planned volume.
A year later, on September 23, 1936, Fetter wrote to Hall to ask about his progress (FAF), and Hall assured him that despite delays, and even though he was in a “stupid, pathological state” about it, all was well in hand (FAF, Hall to Fetter, Oct. 16, 1936). At this point, however, the project seems to have been dropped. It is not clear exactly why, but personal conflict is the most likely explanation. In late 1935—between contacts with Fetter—Hall quarreled with Robbins over the latter’s plans to found a national institute of economic research in England. Robbins believed Hall had undermined his efforts to fund the institute, and Robbins was furious. Hall had until then considered Robbins a close friend and personal ally, and their dispute deeply disturbed him (Howson 2011, 284–87). They eventually settled their differences, but the damage was done, and “Robbins never trusted Hall again” (Howson 2011, 287). Their working relationship mainly ended, and along with it, the planned Fetter book. Hall attempted to pass it to Paul Rosenstein-Rodan for publication through Allen & Unwin, but it never appeared (FAF, Hall to Fetter, Oct. 16, 1936).
FETTER’S LATER WORK IN SUPPORT OF SUBJECTIVISM Parallel to this and various other failed efforts, Fetter gradually began to realize that if such a project were ever to come to fruition, he would have to handle it himself. From the early 1920s to the late 1940s, ultimately right up to his death in 1949, he attempted to do just this. The controversy mentioned above over his textbook chapters is one example, but he also undertook a series of other original projects intended to clarify and extend his early work, and to place it in historical context.
For example, in spring 1923 Fetter began writing a book on the history of the marginality doctrine. In the summer of the same year, he also wrote the bulk of a textbook for high school students that he set aside but revised again more than twenty years later, again without finishing. And some years later, in 1931, he revised his own university textbook, but likely due to the onset of the Great Depression, the publisher believed it was not a good time to bring out a new edition, and so this project too was halted. Unfortunately, all three of these incomplete manuscripts were destroyed after his death (FAF, “Frank Albert Fetter Listings/Archives Prepared by FWF,” 1951). As a teacher, Fetter always encouraged his students to learn languages besides English, and he encouraged them to pursue their reading in the original wherever possible. In fact, so great was his enthusiasm that over the course of several decades he wrote a three-volume English-German dictionary with a special emphasis on word roots that he hoped would aid his students in navigating terminology. This work too was destroyed (FAF, F. W. Fetter to Livy, Mar. 30, 1949).
In all these projects, Fetter’s choice of topics was driven by developments in economic theory in the 1920s and ’30s. Two trends in particular captured his attention: the development of the doctrine of overhead costs pioneered by John Maurice Clark, and the monopolistic competition revolution inspired by Edward Chamberlin and Joan Robinson (FAF, “Overhead Costs,” n.d.; “Duopoly Theory versus Antitrust Policy,” 1941). Both had their roots in the work of Alfred Marshall, who in turn had been influenced strongly by the classical economics of David Ricardo. As a result, as Fetter criticized the newer theories, he found it necessary to return to their foundations, and thus to also criticize Marshall and the Ricardian tradition. This turned his attention naturally to the history of economic thought.
From his earliest days as a teacher, Fetter had lectured on the history of distribution theory, and toward the end of his career, he began to think about a more ambitious treatment of the subject. In 1937, he started seriously to consider writing a book on economic terminology, a favorite subject of his (FAF, Fetter to Robert T. Crane, Jan. 23, 1937). It was not until 1941, though, that he was able to draft a detailed book proposal and outline of the work, tentatively titled “The Language of Economics, with Special Regard to Ambiguities and Resulting Fallacies.” The aim of the volume was a historical survey of major economic terms and of the errors in reasoning and policy that resulted from their ambiguity, inconsistency, and abuse. However, he offered the proposal to publishers without success. The Rockefeller Foundation, which had been a major source of funding for economic research in the interwar period, declined on the grounds that it simply did not have the money. Fetter was discouraged and announced his intention to work on other projects (FAF, Fetter to Joseph Willits, 1941).
He then shifted his attention to a different idea, a book on the development of economic thought after 1850, and especially the controversies over value, price, and distribution theory, in which he had taken a leading role. The initial volume he suggested was to be a collection of his most influential and rare papers on economic theory, along with several new contributions to give the project an overall unity (FAF, “The Revision of Economic Theory,” Mar. 23, 1943). This time Fetter was more successful with his proposal, and in early 1943 he arranged to publish the manuscript, which he had titled “The Revision of Economic Theory,” with Princeton University Press (FAF, D. C. Smith to Fetter, Apr. 6, 1943).
Fetter started to put the collection together, but as he worked, he began to alter his vision for the project (FAF, Smith to Fetter, Aug. 18, 1943; see also FAF, B. M. Anderson to Fetter, Mar. 12, 1945). The new manuscript was to include a greater amount of historical material relating to the development of economic theory in the classical period, beginning with Adam Smith. The plan was to use this brief survey as a foundation for discussing the subjectivist neoclassical period, which was to be the main focus. Fetter wanted especially to emphasize the valuable contributions of American economists in the eighteenth and nineteenth centuries, which he thought had been unfairly neglected in the history of economic thought. The more he worked, the more he felt he needed to write about the classical period. He continued to work on this project until his death in March 1949, by which time his ideas, and those of the other psychological economists, had all but disappeared from economics.Fetter’s later projects involving the history of economic thought are discussed in detail in McCaffrey (forthcoming).
MISES’S PRESERVATION OF FETTER’S WORK The year 1949 is a crucial one in the history of Austrian economics. In September of that year, a few months after Fetter’s death, Ludwig von Mises published Human Action, which preserved and extended Mengerian economic theory and thereby laid the groundwork for the revival of Austrian economics in the following decades. It was through Mises that Fetter’s reputation survived.
Their published works give no indication that they knew each other, but the archival records reveal that Mises and Fetter had been personally acquainted since at least the 1920s.They may have met even earlier during one of Fetter’s visits to Vienna before the First World War. For example, Mises visited Fetter at his home in Princeton in 1926 while on a visit to the United States to survey its economic conditions. Mises was at this time fascinated by business cycle research (Hülsmann 2007, 573–77), and it is not a coincidence that a few months later Fetter published his last extensive study of the problem of interest rates, a paper that later scholars such as Gerry O’Driscoll argue is very Austrian in its approach to interest and business cycles (Fetter 1927; O’Driscoll 1980).
Some years later, Mises, then in Geneva, wrote to Fetter to express his admiration for his work. Mises was at the time drafting Nationalökonomie, the German-language predecessor to Human Action, and he explained that “[i]n these last months I have reread your contributions on the theory of interest. It is my firm opinion that they are more important than any other contribution on the subject since Böhm-Bawerk” (FAF, Mises to Fetter, Feb. 5, 1938). Mises adopted Fetter’s pure time preference theory of interest in his treatises (Mises 1998). Nor was this the only way in which Mises relied on Fetter’s work: he cites him on problems relating to capital, rent, and the democracy of the market (Mises 1998, 262, 631, 271, respectively). Fetter is also remembered fondly in several of Mises’s public writings and speeches as an outstanding teacher without serious peers in the rising generation of economists (Mises 2011; 24; 1974, 172).
In addition to academics, Fetter’s work was also respected by liberal public intellectuals of the 1930s and ’40s, who saw in him a fellow supporter of free enterprise. He was on good terms, for instance, with John T. Flynn, Garet Garrett, F. A. Harper, and Henry Hazlitt (e.g., FAF, Flynn to Fetter, Aug. 29, 1934; Garrett to Fetter, Mar. 30, 1935; Harper to Fetter, July 17, 1945; Hazlitt to Fetter Aug. 26, 1946).At this point, Fetter’s work as a public intellectual mainly concerned his opposition to monopoly and special privilege, including New Deal policies, and contained little of his earlier progressive views. These later policy crusades (for such they were in his eyes) likely played a role in diminishing Fetter’s importance among economists. However, this is not to imply that Fetter’s pro–market stance was solely to blame: his refusal to compromise at all on monopoly policy, especially on the issue of price discrimination, was a notable factor also. Hazlitt listed Fetter’s textbooks among the classics of economics, and in his popular writings questioned why economists like Fetter were sidelined from public discussion (Hazlitt 1956, 70; 2011, 772).Fetter may have been the person who introduced Hazlitt’s writing to Mises (McCaffrey 2019, 479).
ROTHBARD’S TWENTY-YEAR FIGHT FOR FETTER It was in the references to Mises’s Human Action that Fetter’s name was discovered by Murray Rothbard, who took an immediate interest and drew extensively on his work in Man, Economy, and State. In fact, Rothbard regarded his own work as filling a fifty-year gap since the publication of the early systematic treatises by Fetter and the other psychological economists (Rothbard 2009, li–liii). His price and distribution theory in particular was thoroughly Fetterian. In addition to carrying forward the pure time preference theory of interest as Mises had done, Rothbard also thoroughly integrated Fetter’s theory of rent into a general analysis of production and distribution (Rothbard 2009, 367–452, 453–508).
It is not an exaggeration to say that Rothbard recognized Fetter’s importance more than any other economist besides Mises, and it was for this reason that he undertook to rehabilitate Fetter by making his work more widely available in its original form.According to Walter Grinder, Rothbard considered Fetter the second most important economist in the Austrian tradition after Mises (W. E. Grinder, personal communication, Jan. 31, 2018). Integrating Fetter’s ideas was not enough; Rothbard believed they deserved renewed attention in their own right, even though, in some cases, he disagreed with them. The most effective way to accomplish this goal was to gather Fetter’s papers on distribution theory into one convenient collection that would represent a kind of treatise in its own right. As Rothbard explained to his friend and supporter Richard C. Cornuelle,
[Fetter’s] contributions … to interest theory were enormous, he being the first all-out time-preference economist, and he also contributed a great deal to rent theory. His rent theory I believe to be superior to Mises, who is still under classical influence in this respect, and Fetter’s rent theory permeates my book. Fetter died several years ago, and needs to be resurrected; his journal articles attacking all forms of productivity theory of interest are brilliant. To resurrect Fetter would be a particularly effective part of the neo-Austrian revival under way. (Rothbard 1955a; emphasis added)
What Rothbard did not know was that this exact idea, right down to the table of contents, had already been proposed many times in the past, including by other Austrians. His remarks also help undermine another misconception about the history of the Austrian tradition: that its revival dates to 1974, to the conference held in South Royalton, Vermont, and the awarding of the Nobel Memorial Prize to F. A. Hayek later in the same year. As Rothbard points out, thanks to Mises, the Austrian revival was already getting underway in the 1950s. It would continue to grow throughout the 1960s, culminating in South Royalton rather than beginning with it (see also Salerno 2002).In another letter, Rothbard similarly remarked that, “I think a resurrection of the now practically–forgotten Fetter would give a great spur to the Austrian Renaissance now under way” (Rothbard 1955b).
In any case, the final book was not an insignificant side project for Rothbard, but the fruit of more than twenty years of effort. His correspondence reveals that he had the idea for the book, and nearly the same title, in 1955—only a few years after Fetter’s death—while he was in the midst of writing Man, Economy, and State. He first proposed the idea to Cornuelle, who was then helping to support Rothbard financially through Cornuelle’s work at the Volker Fund (MNR, Rothbard to Cornuelle, Aug. 31, 1955), though nothing came of the project during this early period (MNR, Rothbard to Cornuelle, Jan. 8, 1956). While he waited for his own project to materialize, Rothbard recommended including Fetter’s work in similar books such as Stephen Littlechild’s reader, Austrian Economics (MNR, Rothbard to Louis Spadaro, Feb. 6, 1977; Littlechild 1990).
Rothbard shopped his book proposal around for many years with a variety of potential publishers. Augustus M. Kelley considered it, for example, probably because the house had also republished Fetter’s book on basing-point monopoly (Fetter [1931] 1971), but Rothbard withdrew the proposal, apparently before a decision had been reached, to publish it elsewhere (MNR, Rothbard to Augustus M. Kelley, July 2, 1975). Eventually the book appeared through the support of the Institute for Humane Studies as a part of the Studies in Economic Theory series edited by Lawrence S. Moss (Fetter 1977). The official publisher of the book, Sheed Andrews and McMeel, was a Catholic publisher, and was far more at home printing the works of Ronald Knox and G. K. Chesterton than the economic theories of an American Quaker.I am grateful to Walter Grinder for pointing out to me the publisher’s Catholic roots.
The final title was Capital, Interest, and Rent: Essays in the Theory of Distribution. As this indicates, the contents revolve around the central theme of distribution, with special emphasis on capital, interest, and rent. In the preface, Rothbard praised Fetter’s “challenging and original” theories and the “brilliance and consistency of his integrated theory of distribution,” while lamenting “the neglect of Fetter in current histories of economic thought, even by those that are Austrian oriented.” Rothbard also included a lengthy introduction in which he explored the individual papers in detail, pointing out their particular achievements as well as mentioning places where he believed Fetter’s arguments went astray (Rothbard 1977).
Rothbard also strongly emphasized Fetter’s consistency and refusal to compromise:
It may be that the hallmark of Frank A. Fetter’s approach to economic theory was his “radicalism”—his willingness to discard the entire baggage of lingering Ricardianism. In distribution theory his most important contributions are still too radical to be accepted into the corpus of economic analysis. These are: (1) his eradication of all productivity elements from the theory of interest and his development of a pure time-preference, or capitalization, theory and (2) his eradication of everything pertaining to land, whether it be scarcity or some sort of margin over cost, in the theory of rent, in favor of rent as the “renting out” of a durable good to earn an income per unit time. Guided by Alfred Marshall and by eventual retreats toward the older view by Böhm-Bawerk and Fisher, microeconomic theory has chosen a more conservative route. (Rothbard 1977, 23; emphasis in original)
He concluded that, “microeconomic analysis has a considerable way to go to catch up to the insight that we find in Fetter’s writings in the first decade and a half of this century” (Rothbard 1977, 1).
Israel Kirzner expressed much the same opinion in a glowing review of the collection:
Fetter carried forward the radical reformulation of economic theory which had begun with the marginal utility revolution of the 1870’s, but which, at the turn of the century, was still far from being complete. Along with the new insights learned from the marginal utility theorists there remained pervasive and incongruous traces of earlier misunderstandings. These were particularly troublesome in the area of distribution theory, in the treatment of rent theory, interest theory, the concept of capital. Fetter attacked these problems with keenness of insight, with profound clarity of understanding, and with a delightfully lucid literary style…. Not only can the modern reader learn a great deal of the history of modern economics from this volume; these papers also demonstrate how economic theorizing can be engaged in by a master. It is a rare pleasure, these days, to encounter economic reasoning so elegantly presented, so powerfully yet lucidly argued. (Kirzner 1980, 8)Kirzner also generously remarks that “[t]he Introduction is a gem in its own right, giving us Murray N. Rothbard, the economist, at his very best. Careful and wide scholarship, perceptive interpretation and keen criticism of Fetter’s contributions, characterize this brilliant introductory essay” (Kirzner 1980, 8).
Given that the collection focuses on fundamental questions of economic theory, and that it does so from an essentially Austrian perspective, it should be considered just as important as the other key collections and research handbooks published in the mid-1970s (several of them in the same book series) that helped give expression to then emerging strands of Austrian research. In fact, the Fetter collection filled some important gaps left by those other collections, which focused on methodological and philosophical issues and on applied topics without exploring much of the core of economic theory: value, price, and distribution (e.g., Dolan 1976; Spadaro 1978).
However, due to its specialized nature, the book sold in limited numbers, and was mainly appreciated by the younger generation of academic economists who had discovered the Austrian tradition in the 1960s and 1970s. One way or another, though, the job was done, and Fetter’s work was once more in a position to influence new generations of economists. And that is exactly what it has done, slowly but surely, for nearly fifty years.
THE FETTERIAN REVIVAL Rehabilitating Fetter depends crucially on the availability of primary and secondary reference material for scholars to use in evaluating his ideas. Fortunately, there are now several studies of Fetter’s life and work, though only some are readily available. The most concise is Rothbard’s entry on Fetter in the New Palgrave Dictionary of Economics (Rothbard 1987a).Fetter is also featured in Rothbard’s New Palgrave entry for “Time Preference” (Rothbard 1987b). Jeffrey Herbener surveys Fetter’s contributions in a larger and more detailed account that includes discussions of lesser-known topics in his work such as his views on money and on welfare economics (Herbener 1999). The most comprehensive source is a PhD dissertation by John A. Coughlan on “The Contributions of Frank Albert Fetter (1863–1949) to the Development of Economic Theory” (1965). It is an invaluable source of information about his ideas and professional activities, and devotes considerable space to Fetter’s work on monopolistic combinations. It also includes a bibliography of his published writings compiled with the assistance of his son, Frank Whitson Fetter.Rothbard later included this bibliography in his collection. Though a tremendous achievement, the bibliography overlooks a variety of Fetter’s minor publications, and does not include his unpublished work or the various reprints and collections that have appeared since his death. Although expansive, the dissertation is remarkable for being entirely descriptive: Fetter’s theories and debates are discussed in detail, yet Coughlan makes no attempt to evaluate them independently. In addition to these specialized sources, Fetter’s work is also treated in broader studies of the history of economic thought in America by Wesley Claire Mitchell (1969) and Joseph Dorfman (1949).
Understandably, today Fetter’s work is most prominent in economic research in and around the modern Austrian tradition (McCaffrey 2019). Here, he plays a large role in debates about familiar topics such as capital, interest, and rent (Lewin 1997, 2008; Lynch 2010; Herbener 2011, 2013; Topan and Păun 2013). However, this scholarship is being complemented by studies on entrepreneurship (Salerno 2008; Foss and Klein 2012, 48–50; McCaffrey 2016), the theory of the firm (Lewin and Phelan 1999, 2002), business cycles (O’Driscoll 1980), and monopoly (Salerno 2003, 2004).Another more bizarre source on monopoly is the awkwardly titled Three American Economics Professors Battle against Monopoly and Pricing Practices: Ripley, Fetter and Commons: “Three for the People” (Schneider 1998). Although a good-natured attempt to discuss the role of American economists in the monopoly cases of the 1920s and ’30s, the book is unfortunately an incoherent mess, and is, in truth, a vanity press publication.
Outside the Austrian tradition, Fetter’s work on capital is receiving renewed attention (Hodgson 2008), as well as his concept of consumer sovereignty (Desmarais-Tremblay 2020). Other scholars are investigating Fetter’s progressive liberalism and his involvement with important figures of the Progressive Era (McCaffrey 2019; Leonard 2016, 164–65; Samuels 1985), factors which set him apart from many past and present Austrians.Fetter’s work on population has been recognized as ahead of its time despite, or perhaps because of, its progressive, pessimistic, semi-Malthusian character. See his presidential address to the American Economic Association, which has also been reprinted in the Population and Development Review (Fetter 1999). There are also dedicated discussions of Fetter’s interactions with different schools of economic thought (Hodgson 2008; McCaffrey 2019). The Fetter archives at Indiana University make new work in these and many other fields possible, as will the continued publication of his works by the Ludwig von Mises Institute. Lastly, the author is currently preparing a variety of Fetter’s obscure, lost, or unpublished writings for publication.
Fetter would no doubt be enthusiastic about this renewed appreciation of his life’s work. Nevertheless, he was wary about the pitfalls of an uncritical approach to economics and to the history of economic thought. He was especially concerned that his own views had been misrepresented or pigeonholed as derivative of older thinkers:
[A]lthough all my years of systematic economic study were spent entirely under teachers of the German historical school, I was early tagged as an adherent of its foremost antagonist, “the Austrian school,” because of my recognition of the substantial contributions of that school. For the same reason, I was frequently classified as a faithful disciple of John Bates Clark, and that, also, neatly disposed of the matter. Meanwhile, I was vigorously dissenting from some of the views of both friends in theory. Later, the Austrian label was again more frequently applied to me, alternating with “neo-classical,” after that term had taken on a more confused meaning. I have even been called an “institutionalist”—a richly suggestive title which I would gladly accept if allowed to define it as I would like to. I have never been consciously a partisan adherent of any school or sect of economic theory, and have earnestly striven to prevent either pride of personal opinion or a mistaken sense of loyalty to the ideas of any writer or school from dimming my eyes to new ways to truth. I have continued to believe that sharp differences of opinion among economists on intellectual issues is consistent with mutual respect and lasting friendship, and that in such matters the one loyalty is to the search for truth, not to some theoretical hero, living or dead, or to some cult, past or present. (FAF, “The Development of Economic Theory from Adam Smith to John Stuart Mill, n.d.)
Given his own stance on labels and schools of thought, it seems likely that Fetter would approve of the way his works have been treated by contemporary Austrian economists, namely, as sources of great insight, but also as a basis for debate and criticism rather than objects of blind devotion. In that sense, the Austrian rehabilitation of Fetter has given him the fair treatment that he sought in vain throughout his career.
Development of Economic Theory from Adam Smith to John Stuart Mill
Fetter should have the last word on his own rehabilitation. I have already mentioned his last major project, a book on the history of economic thought. At the time of his death, Fetter had completed only about half of this study, namely, the part dealing with classical economics. Nevertheless, it is an impressive work in its own right, a full-length volume titled “Development of Economic Theory from Adam Smith to John Stuart Mill.” It was Fetter’s swan song: one last broadside against the Ricardian tradition and in favor of Mengerian subjectivism. In fact, at the time it was written, it was really the only effort by an economist working in the Austrian tradition to systematically study the history of economic thought from that perspective. And although incomplete, it is full of Fetter’s characteristic wit and insight. It will soon be published for the first time, and will, hopefully, provide the basis for renewed attention to Fetter as an economist.
One point of particular interest is that the book at last gives us an idea of Fetter’s broader view of the history of economic thought. In the first chapter, he explains the history of economics as a series of reactions and revolutions among competing theories of political economy. Each generation proposes a new political economy, which eventually becomes the old political economy before being overturned by some even newer doctrine. Yet Fetter did not subscribe to the Whig theory of history in economics. He recognized that these revolutions can be and often are disastrous for the progress of knowledge, and sadly, the later decades of his life gave him ample firsthand experience of how fleeting and incomplete was the revolution inspired by Menger, Jevons, and Clark. Most economists, indeed, missed this at the time, but Fetter’s dogged support of the subjective theory of value allowed him to see what others overlooked. In this sense, this paper hopes not only to rehabilitate Fetter, but also his view of economics as one of constant struggle and competition.
CONCLUSION In a sense, the history of economics is a history of rehabilitations. It is tragic that Fetter and others were unable in his lifetime, despite their best efforts, to preserve the progress that had been made in economic theory. Yet the careful scholarship and energy of Mises, Rothbard, and their students means that, however delayed, Fetter’s rehabilitation is being brought to fruition, and his work is becoming foundational for a new generation of scholars. This revival, slow and halting as it has been, runs parallel to, and is a crucial part of, the renaissance of the Austrian tradition.
In the 1920s, Wesley Clair Mitchell confidently remarked that Fetter’s ideas had up to that point provided a basis for “critical evaluation which has been going on for two decades, and which will doubtless continue for years to come” (Fisher et al. 1927). If there is any justice in the history of economics, Mitchell’s optimism will be justified in the twenty-first century in ways that it was not in the twentieth.
ABSTRACT: The “new development economics” (also called behavioral development economics) consists of microeconomic experimentation based on behavioral economics and randomized controlled trials. This approach would illuminate the close relationships between preferences, culture, and institutions and point to new political opportunities. This paper describes and analyzes the new development economics’s main components and argues that the new development economics is just like the old development economics in terms of its central assumptions, objectives, and recommendations. Despite the growing recognition that social, cultural, and institutional factors profoundly affect decision-making, old and new development economists generally lean toward the extreme reductionism of the neoclassical paradigm. It is observed that research on the essence of economic development has been neglected or treated inadequately in the school’s literature. It is suggested that the findings of the Austrian theory of dynamic efficiency, based on human action’s creative and entrepreneurial feature, may allow the development economics to overcome its analytical challenges.
JEL Classification: B41, B53, O11, O12, L26, P14
Victor I. Espinosa (victor.espinosa@uautonoma.cl) is Professor of Economics at the Department of Business Administration, Universidad Autónoma de Chile, Providencia 7500912, Chile. Óscar R. Carreiro (oscarcarreiro@ufm.es) is Professor of Economics at the Department of Entrepreneurship, Universidad Francisco Marroquín, Madrid 28033, Spain. Acknowledgement: The author would like to thank Jesús Huerta de Soto and Philipp Bagus, and the two anonymous reviewers for their constructive comments and suggestions.
The progress of underdeveloped countries depends on the supply of capital available to build the necessary infrastructure for industrialization and the rapid modernization of the economy. The emerging countries themselves cannot generate the required capital because of the poverty trap, which inexorably condemns them to low incomes. The less developed world inhibits entrepreneurial prospects, restricting local markets and strengthening the poverty trap. International trade is inefficient and often detrimental to emerging countries’ advancement, as it fosters a widening income gap with rich countries. Foreign aid is crucial to escape from extreme material deprivation and ascend the ladder of economic growth. Government interventions play a crucial role in carrying out the needed changes and achieving the pathway to higher levels of equality and prosperity.
These ideas are the core theoretical framework of old development economics, which has become the dominant political and public discourse (Arndt 1987; Meier 1984, 2005; Boettke and Horwitz 2005; Boianovsky 2018; and Alacevich 2018). However, the scientific validity of old development economics has been widely questioned by some heterodox development economists (see, for instance, Bauer and Yamey 1957; Bauer 1976, 2000; Easterly 2014; and Espinosa 2020):
If the poverty trap is valid, how does humanity not continue to live in caves?Given that all the currently rich countries were once poor, how was capital accumulation able to develop?If trade increases income inequality between countries, how can the rapid development of emerging economies such as Ireland, Poland, Estonia, Israel, Hong Kong, and Singapore be explained?If international trade is harmful, why are the wealthiest countries the most open to international trade?If foreign aid is vital for economic development, how did the currently rich countries develop without such aid?If global economic planning plays a crucial role in the path to higher equality and prosperity levels, why are the wealthiest countries in the world precisely those with the most significant economic freedom? Although there is a consensus that development supposedly means moving from one type of economy to a more advanced one, the inconclusiveness of the leading old development theories has shown the field’s “inability to adjust the demands of the main tasks of the day, that is, the elaboration of policies that favor the development in the least developed countries” (Alacevich and Boianovsky 2018, 2). As Romer (2009, 126) discerns, development economics must review its fundamentals on “how to contribute to better policy in developing countries … at a time when many economists are skeptical.”
In the eyes of a new generation of development economists, old development economics’s efforts, albeit necessary, showed that its macroeconomic approach does not come to any relevant conclusions about the poor’s economic lives (Coyne and Boettke 2006; Banerjee and Duflo 2011; Coyne 2013). Thus, it was concluded that the central focus of research and teaching in development economics should be at the microeconomic level of social, cultural, and institutional factors that help explain real-life human behavior. The new development economics (NDE), also called behavioral development economics (BDE), analyzes underdevelopment problems using psychological models of quasi-rational decision-making and preference formation, rather than the homo oeconomicus models (Thaler 2000; Demeritt and Hoff 2018). These economists consider randomized controlled trials (RCTs) in experimentation as the best way to advise governments on policy design in all its details to reduce poverty.
This paper argues that the old and new development economics share the same main assumptions, objectives, and recommendations. Despite the growing recognition that social, cultural, and institutional factors profoundly affect decision-making, old and new development economists generally prefer the neoclassical approach of extreme reductionism. The research on the essence of economic development has been neglected or treated inadequately in the development economic literature. This approach does not recognize economic development as the by-product of achieving social cooperation and coordination driven by human action under the division of labor. Consequently, the old and new development economics analysis is narrowed to testing the superficial problems of economic underdevelopment. The paper proposes that the Austrian theory of dynamic efficiency, based on the creative and entrepreneurial potential of human action, would be adopted as a way for the new development economics to overcome the analytical challenges of its macroeconomic approach. More specifically, it is recommended that dynamic flesh-and-blood entrepreneurship be placed at the core of development theory, which would redesign its objectives of policy analysis and institutional change in underdeveloped economies.
The paper proceeds as follows. The first two sections explain the objectives and tenets of the “old” development economics and the “new” development economics’s theoretical core, respectively. Then, the “Austrian” theory of dynamic efficiency is presented as a solution to the analytical challenges of development economics. The final section discusses the future of the discipline.
THE CRISIS OF DEVELOPMENT ECONOMICS In the 1940s, 1950s, and 1960s, economic thinking about economic development was confined mainly to the United Nations’s (UN) international organizations. At the same time, some pioneering work began to emerge in this field, including Rosenstein-Rodan (1943, 1944, 1961a, and 1961b), Nurkse (1952, 1953), Prebisch (1950), Myrdal (1956, 1957, and 1968), Singer (1949, 1950), Lewis (1954, 1966), and Hirschman (1958). These books and papers “crystallized what, over the next two decades, became the conventional wisdom about economic development” (Arndt 1987, 49).
The “old” development economics relied on dual models, in which a traditional sector, mainly agricultural, was contrasted with a modern industrial sector. According to development pioneers, poverty was the result of vicious circles caused by the interaction of various economic phenomena on the supply side (low per capita income, low propensity to save, insufficient capital, and low productivity) and on the demand side (low purchasing power, insufficient market size in the modern sector, lack of investment, and low average productivity). They concluded that the free market did not lead to the desired pattern of economic development. For this reason, the state ought to direct the modernization process by diverting resources from traditional and “backward” activities to selected modern activities. To break the vicious circles, they proposed increasing the size of the market (to take advantage of economies of scale), channel existing resources into the modern sector, and generate more incentives for saving, such as controls on demand for consumer goods.
The old development economics’s backbone was the Harrod-Domar model, strongly influenced by John Maynard Keynes (Boianovsky 2018). According to the Harrod-Domar model, GDP depends directly on the investment ratio and inversely on the capital-output ratio. Two groups of theories that emphasized the state’s role in initiating and coordinating a massive investment effort in the industry (big push) were developed from the Harrod-Domar model: the theories of balanced growth and unbalanced growth.
On the one hand, balanced growth results from an equitable distribution of investment among the different consumer-goods sectors, which can then take advantage of the interdependencies between them to accelerate growth. On the other hand, unbalanced growth results from the concentration of investment in those industries believed to be more apt to promote growth in other sectors. These sectors are the ones with the greatest forward-chaining (in consumer goods industries) and backward-chaining (in capital goods industries) effects.
Thus, two of the key characteristics of the “old” development economics can be highlighted: 1) the recourse to central planning in the selection of the most productive “modern” activities; 2) the resortion to intervention in the economy to coordinate the diversion of resources toward these activities, either by trying to promote most of them in a balanced way or by focusing on those sectors believed to have tremendous growth potential.
Prominently, Rosenstein-Rodan (1943) defined the theoretical and political issues that became the core of the new discipline of development economics in the postwar years.Paul Rosenstein-Rodan (1902–85) attended Ludwig von Mises’s private seminar at the Vienna Chamber of Commerce, which was also attended by Fritz Machlup, Oskar Morgenstern, Gottfried von Haberler, Alfred Schutz, Richard von Strigl, Eric Voegelin, and many other intellectuals from all over Europe. However, Jörg Guido Hülsmann (2007, 161) explains that Rosenstein-Rodan was “shaped by the Wieserian mold before setting off on [his] intellectual paths. Largely ignorant of [Carl] Menger’s Principles (out of print since the 1880s), [he was] trained in the spirit of the neoclassical synthesis.” First, he emphasized the impact of overpopulation on the low productivity levels of developing countries. Second, he discussed the institutional and cultural elements that make it difficult for a developing country to industrialize. Third, he argued that capital accumulation and industrialization are essential to eliminating poverty but that it is difficult for entrepreneurs to establish new factories due to capital shortage in developing countries. Fourth, he highlighted the need for global planning to overcome coordination problems and promote economic development. Without the government’s increase in “effective demand,” investment opportunities would stall, and poverty would be perpetuated indefinitely. In sum, Rosenstein-Rodan laid the foundations of the poverty trap theory: the idea that poverty is an insurmountable obstacle that can only be overcome with political intervention and a big push.
Rosenstein-Rodan’s influence was manifold and important. First, Nurkse (1952) formalized the poverty trap theory due to supply and demand events. On the demand side, if incomes are low, the market’s size is too small to stimulate private investment. Shortage of investment means low productivity and continued low income. On the supply side, if incomes are low, consumption cannot be diverted toward capital formation and accumulation—shortage of capital results in low productivity, which perpetuates low incomes. Thus, the vicious circle is complete: a country is poor because it was too poor to boost entrepreneurial investment.
Second, Rosenstein-Rodan’s poverty trap thesis suggested a widening inequality gap between developed (rich) and underdeveloped (poor) countries, based on enormous differences in these two distinct groups’ per capita incomes (Prebisch 1950). Therefore, emerging countries should somehow increase national investment.
Third, if tax revenues are insignificant, developing countries’ governments will not perform economic planning accurately. How to get the necessary capital in developing countries? Lewis (1954), based on the Harrod-Domar model, proposed an unlimited supply model, where policies aimed at increasing aggregate rates of saving and investment help overcome the poverty trap. If domestic saving is very low, it should be complemented by external savings in foreign aid.Foreign aid (official development assistance, ODA) refers to “intergovernmental grants and subsidized loans in cash or kind…. It does not refer to external loans raised by governments abroad on commercial terms, nor to private foreign investment, nor to the activities of voluntary organizations” (Bauer 1976, 95). Thus, international organizations should quantify the aid for each country, and with this money, the governments of less developed countries will promote industrialization and self-sustaining development (Hirschman 1958). Finally, global planning is a “heroic” attempt to overcome “cultural stagnation or regression” of the poverty trap (Myrdal 1956, 65).
Economists of the early development theory shared a commitment to planning and the conviction that economic problems would yield to the actions of benevolent states endowed with sufficient supplies of capital and armed with good economic analysis (Leys 1996). They designed development plans for newly independent countries and the not yet independent African colonies based on raising rural productivity and transferring underutilized labor out of agriculture into industry. However, the hope of achieving economic growth through policies based on development theory soon began to unravel: “By the end of the 1950s, … the original optimism that this approach would yield rapid results had begun to evaporate, and the limitations of development economics as a theory of development were beginning to be exposed” (Leys 1996, 8). Dissatisfaction with the development policies’ results led to the rise of new theories based on the Prebisch-Singer thesis, advanced independently by Raúl Prebisch and Hans Singer in the late 1940s.
The Prebisch-Singer thesis is that over time poor countries will have to export more of their primary commodities to maintain their levels of imports from the rich countries. This is because prices in advanced economies rise more quickly than those in more backward ones. Differences in income elasticities of demand strengthen this effect: demand for finished goods rises with income, but demand for primary goods varies less with income. Therefore, underdevelopment results from the prevalent economic structure and the international division of labor.
The Prebisch-Singer thesis is the backbone of two different development theories: structuralism and dependency (see, for instance, Toye and Toye 2003). Structuralists argue that the only way poor countries can develop is through state intervention in economic performance. Because trade is reduced by the erection of all kinds of political barriers and an overvaluation of the domestic exchange rate, the production of domestic substitutes of formerly imported industrial products is encouraged. Poor countries have to push industrialization and have to reduce their dependency on trade with advanced economies. The logic of the strategy rests on the “infant industry argument,” which states that young industries initially do not have the economies of scale and experience to compete with foreign competitors and thus need to be protected until they can compete in the free market.
Dependency theory is a more radical follow-up of structuralism. Dependency theorists also think that underdevelopment is mainly caused by the peripheral position of the affected countries in the world economy. However, they believe that the only way out of dependency is to search for autarky and create a socialist economy.
This belief explains why economists such as Singer warn that poverty is a consequence of colonialism and imperialist capitalism. While international trade is pernicious to developing countries, “the establishment of a socialist planned economy is an essential condition for attaining economic and social progress in underdeveloped countries” (Baran 1957, 416).
Unfortunately, as John Rapley mentions, the implementation of economic measures based on structuralism and dependency also led to disappointing results:
[T]he difficult truth was that in many places, economic growth barely kept pace with population growth and inflation, and progress was much slower than had been hoped. In real per capita terms, a significant portion of humanity ended the twentieth century poorer than when it welcomed political independence. (Rapley 2007, 57)
Despite its poor results and intense debates about its scientific validity, the public policy recommendations of the “old” development economics are at the heart of current United Nations development programs (Edwards 2015; and Toye 2018). Consider, for instance, the case of Jeffrey Sachs, director of the UN Millennium Project and renowned economist at Columbia University, who conceives breaking the poverty trap as experts’ fundamental objective. As Sachs (2015, 105) states,
[T]he underlying condition [of underdevelopment] could be what I call a poverty trap: when the country is too poor to make the basic investments it needs to escape extreme material deprivation and climb the ladder of economic growth.
The poverty trap involves a distinction between countries, groups, or individuals, rich and poor, not only in terms of their “country’s average level of income but its distribution of income” (Sachs 2015, 55). Accordingly, the government should plan the distribution of income to propel countries toward higher economic equality and success levels.
Foreign aid plays an essential role in Sachs’s proposal “to help a poor country make the crucial early investments needed so that the economy can soon stand on its own and begin climbing the development ladder” (Sachs 2015, 172). Foreign aid would push the capital stock elements (i.e., infrastructure, human capital, public administration) toward self-sustaining economic growth. As Sachs (2015, 175) argues, it should make a substantial difference when applied on a “professional basis grounded in an accurate differential diagnosis of the needs of a low-income country.” The practical steps to reach the UN millennium development goals (MDG) in each country can and should be diagnosed, planned, and implemented with the proper focus and actions, combined with proper support from the international community. That is why the United Nations calls for adequately generous increases in foreign aid. It is the raise of a mínimum of 0.7 percent of GDP would have to bring the level of UN support to at least 10 percent of the recipient developing countries’ GDP. With this aid, experts could design policies in all their details to escape the poverty trap and the widening gap (United Nations 2005).
Nevertheless, the United Nations (2015, 8) shows that although “significant achievements” have been made on many of the MDG targets worldwide, “progress has been uneven” across regions and countries, leaving significant gaps. Millions of people “are being left behind,” especially the poorest and those disadvantaged because of their sex, age, disability, ethnicity, or geographic location. Accordingly, authors like William Easterly (2009) and Christopher Coyne (2013) suggest that “old” development economics is in crisis because global planning even worsened developing countries’ economies, notably in Latin America and sub-Saharan Africa. Easterly (2002, 88) believes that the record of the “old” development economics is one of failure: “The efforts that we as development economists, aid donors, and policymakers have made have not worked.”
THE NEW DEVELOPMENT ECONOMICS In the 1990s and 2000s, a new way of conceiving development interventions appeared as a response to the failure of what Easterly (2014) calls “big push reasoning,” the legend that the poorest countries are stuck in a poverty trap from which they cannot emerge without an aid-financed big push. This reaction included academic economists with a distrust for big plans to eradicate poverty, and its focus, instead, was on the use of experiments to determine smaller interventions for the solution of specific problems. As an example of this new practical scientific approach, Easterly mentions the work of Bouguen et al. (2019) about the effects on school absenteeism of programs that administered deworming drugs to school kids.
The main tool employed in Bouguen et al. (2019) was the randomized control trial (RCT), which may be seen as one of the characteristic features of this new development economics, also called behavioral development economics (Rodrik 2009). An RCT is a trial in which subjects are randomly assigned to one of two groups: one receiving the intervention that is being tested (the experimental group), and the other receiving an alternative conventional treatment (the comparison group or control).RCTs come from the natural sciences, particularly “evidence-based medicine,” where they are used to evaluate the statistical effects of different types of drugs and treatments (Sackett et al. 1996). During the 1990s, this “gold standard technique” was imported into development economics as an “evidence-based policy approach” to investigate cases of everyday life (Pawson 2006; and Banerjee et al. 2017). The two groups are then followed up with to see if there are any differences in their outcomes. The trial results and subsequent analysis are used to assess the effectiveness of the intervention, which is the extent to which treatment, procedure, or service does patients more good than harm. RCTs are believed to be the most stringent way of determining whether a cause-effect relation exists between the intervention and the outcome (Kendall 2003).
The employment of RCTs in development economics is advocating mainly by the efforts of the Poverty Action Lab (J-PAL), a global research center founded in 2003 by Abhijit Banerjee, Esther Duflo, and Sendhil Mullainathan to reduce poverty by ensuring that policy is informed by scientific evidence. The J-PAL was established to support randomized evaluations measuring interventions against poverty in areas such as health, agriculture, education, or governance. Advocates of RCTs argue that they serve to identify both the causes of poverty and the incentives needed to escape the poverty trap. They believe that this method will encourage more efficient government interventions to foster economic development.
For economists like Banerjee, the use of RCTs represents a departure from the old way of thinking in development economics, since the analysis of underdeveloped economies concerns “an enormously complex set of different strategies, and not a single button on the machine to be pushed or not” (Banerjee 2007, 142). Mathematical economics neglects the ultimate foundations of what happens in poor countries’ economies and institutions, so that “development experts are still thinking in machine mode: they are looking for the right button to push” (160). Thus, Banerjee and other economists, chiefly from the J-PAL, propose RCTs to verify foreign aid programs’ effectiveness. RCTs improve the impact evaluation of social programs, because they “[force] us to venture inside the machine” (162).
One curious result of the RCTs’ rise is that the new development economics is moving away from pure economic theory and the big questions about the essence of economic phenomena. RCT experts often reject praxeological theory because it would not help with deciding the details of government policies. They conceive the economist as a kind of plumber focused on designing and predicting the results of several market interventions (Banerjee 2005; and Duflo 2017). As Banerjee (2007, 115) writes, “[T]he beauty of randomized evaluation is that the results are what they are: we compare the outcomes in the treatment with the outcome in the control group, see whether they are different, and if so by how much.”
Banerjee (2007) suggests that RCTs are the best and most direct way of knowing which foreign aid program works and which does not. Although a single experiment does not provide a final answer on any intervention’s universal validity, a series of hundreds or thousands of experiments could reinforce more government interventions at the margin. As Stephan Dercon (2018) comments,
[E]verything has to be inductive and experimental for the New Development Economics. Lots of little solutions will move us forward. They have no big theory of what causes low growth, no big questions, just “a technocratic agenda of fixing small market failures”. Getting institutions right is not crucial.
Experts will recommend the cheapest policy strategies among thousands of prescriptions, like a doctor prescribing aspirin for a headache. Thus, Behavioral development economics’s lack of interest in theoretical thinking and its focus on experimentation for the assessment and evaluation of policies has been criticized because theory is needed to understand the causal relations that may lead to economic growth and development. For example, Deaton says that “we are unlikely to banish poverty in the modern world by trials alone unless those trials are guided by and contribute to theoretical understanding” (2010, 452). Rodrik (2009, 42) adds that “pragmatism does not imply the absence of theory. The only meaningful way in which one can sift through the evidence—or indeed know what kind of evidence to look for—is through the prism provided by clearly articulated theoretical frames.” And Kumar (2016, 84) thinks that “understanding the causal processes underlying responses to a tested intervention could help extrapolate to a different but related policy, and a structurally distinct context.”
The detachment from grand theory and the big economic questions is relevant because it may lead, inadvertently, to the preservation of old theoretical assumptions and the repetition of previous failed recommendations and policies. We could argue that the new development economics does not represent a radical departure from the old development economics but is its continuation.
One element of the new development economics that reflects continuity with the old is the faith put in government intervention. Generally speaking, in the work of the “randomists” (the new development economists), there is little questioning of the need for government intervention or justification. For example, when Banerjee and Duflo consider the case of government intervention in education, they state one (questionable) ethical argument: “A civilized society cannot allow a child’s right to a normal childhood and a decent education to be held hostage to a parent’s whims or greed.” From this, they directly proceed to justify conditional cash transfers: in states with limited capacity for enforcing compulsory education, the government “must make it financially worthwhile for parents to send their children to school” (Banerjee and Duflo 2011, 77).
Banerjee and Duflo (2011, 216) state that “governments are necessary, to provide basic common goods and enforce the rules and norms that the market requires to function.” It is not clear how such a statement could be demonstrated with hard scientific evidence by conducting RCTs, but they do not try to do this. They just accept this theoretical assumption and justify it with a brief illustration of a free market in driver’s licenses. Consider, for instance, Hoppe (1989), Frey and Eichenberg (1999), Block (2003), Bastos (2005), Risse (2011), Kode (2013), and Risse and Stollenwerk (2018), who suggest that the need for governments to provide public goods is not such an obvious and indisputable principle. Indeed, Kode (2013, 5) states that “while a strong state is often seen as necessary, a close look at the empirical reality on the ground calls into question the state’s role as a necessary precondition for security, peace, development, and more broadly, the provision of public goods.”
The first theoretical principle underlying the faith in government intervention is the idea of poverty traps, which also shows the continuity between the “old” and the “new” development economics. When Banerjee and Duflo (2011, 21–24) discuss the idea of poverty traps, it seems that they think that “the existence of a specific poverty trap” is a possibility that has to be empirically assessed on a case-by-case basis. But later they talk about many poverty traps for whose existence they do not have definitive or impressive empirical evidence but which they accept on the ground of theoretical assumptions. Thus, they believe in the existence of a nutrition-based poverty trap in terms of the quality of food or a shortage of micronutrients (43–44); they believe that health can be a source of several different traps (46–52); they believe in the existence of a savings trap created by behavioral and technological conditions (177–79); and they believe in a vicious circle where small size firms are stuck at a small size (190–201).
Consider, for instance, the latest poverty trap.. According to Banerjee and Duflo, there is a level of investment that must be reached to make serious money. If an entrepreneur invests little, he makes little money and remains too poor to invest much more. If an entrepreneur invests enough to reach the critical point, he becomes rich, invests more, and becomes even richer. The problem is that in a poor country most people do not have that option. No one will lend these small entrepreneurs enough money. Moreover, getting there might also require management and other skills that they do not have and cannot afford to buy. They are stuck at a small size. The entirety of this argument accords with the old development theory.
The only difference is that economists like Rosenstein-Rodan, Lewis, and Rostow had a macroeconomic approach while the randomists have a microeconomic approach. The rest is the same. Moreover, the solution proposed by Banerjee and Duflo is an old one also: to establish a virtuous circle, stable and higher wages are needed. This would give workers the financial resources, the mental space, and the necessary optimism to invest in their children and save more. With those savings and the increased access to credit that a steady job brings, the most talented among them would eventually be able to start businesses large enough to, in turn, hire other people. Besides the creation of government jobs, Banerjee and Duflo (2011, 208) think that
there may be a case for using some governmental resources to help create enough large businesses by providing loan guarantees to medium size ventures…. The way out of poverty is not one more shed with some cows in it, but a son with a secure job in the army.
The second principle that shows the continuity between the “old” and the ”new” development economics is the NDE’s top-down planning approach. Even though the randomists talk about decentralization and increasing people’s involvement and participation in development strategies, Banerjee and Duflo (2011, 222–23) believe in giving power to the people but not all the power:
If the rules make such a difference, then it becomes very important who gets to make them. If the village is left to its own devices, it seems likely that rulemaking would be captured by the elite. It might therefore be better for the decentralization to be designed by a centralized authority, with the interest of the less advantaged or less powerful in mind.
This kind of enlightened despotism comes from the behavioral economics of the randomists. Poor people make all kinds of bad choices, but they can be led to make better choices with the enlightened help of technocratic experts. For example, according to Banerjee and Duflo, poor people behave as if they thought that any change significant enough to be worth sacrificing for will take too long. Instead of spending enough money on healthy food, “they spend their money on unhealthy but tastier food or cheap luxuries like television sets” (Banerjee and Duflo 2011, 39–42). Poor people do “not save, in part, because they lack self-control” (174–79). Although poor people choose to have large families, , what leads them “to make these choices are factors outside their immediate control like social pressures” and even the lack of availability of contraception does not seem to be a big constraint (112). In establishing the right set of incentives, the expert’s role is to threaten people’s bad choices so that they can make good choices. This involves “giving away goods and services” for free or even rewarding people for doing things that are good for them (239).
This attitude represents an example of what James C. Scott (1998) calls “high modernism,” an ideology instrumental in the modernization period of the old development economics that was grounded in the belief that a scientific, technically trained elite could take responsibility for social planning. According to Scott, the twentieth century’s major development disasters derived from a toxic combination of epistemic arrogance and authoritarian power, including excessive confidence in the ability of “scientific management” to order and organize human activity. The new development economics would represent a softer version of the high modernism with a smaller-scale focus.
The last source of continuity between the “old” and “new” development economics is their shared view of costs and benefits. From an Austrian perspective, costs and benefits are not objective, since they are the result of individual choices. Costs and benefits are subjective, because they are the result of ex ante anticipation of foregone opportunities. If an agent thinks that the value of the achieved end is higher than the value of the foregone opportunities (costs), then the agent has obtained a subjective profit (benefits). Profits and losses show whether there has been a correct use of scarce resources, and guide people to the achievement of everhigher valued ends.
In contrast, the randomists analyze costs and benefits as something objective and measurable. They try to evaluate public policies based on their effects over a specific set of objective and measurable characteristics. Despite all their good intentions, they have not abandoned the analysis of underdeveloped economies as machines with buttons to be pushed. These machines have more than one button and they believe that RCTs are the only way to know which one to push.
In summary, losing sight of the big-picture questions means that, in the end, the practitioners of the new development economics ultimately make the same recommendations as the old development economics. Development economists often assume the existence of a poverty trap but fail to explain its ultimate foundations. It may be a relevant reason why theoretical thought is still important: to avoid repeating old mistakes. For this reason, it is argued that Austrian theory—its perspectives on the entrepreneurial essence of the dynamic market process, the role of the structure of production, and the importance of evolving institutions in economic performance—can overcome the new development economics’s theoretical insufficiencies.
The Austrians’ uniqueness lies in their “analytical contributions to our understanding of the epistemic-cognitive properties of alternative institutional arrangements” (Boettke 2002, 265). These contributions lead to the recognition of the uncertainty inherent in all economic decisions and of the entrepreneurial nature of the market process as the essence of economic phenomena. The Austrian theoretical framework would help “new” development economists identify the essence of underdevelopment, in addition to bringing their empirical constructions closer to real-life dynamics.
ENTREPRENEURSHIP, DYNAMIC EFFICIENCY, AND DEVELOPMENT This section explains how Austrian economics improves the old and new development economics approach to understanding the essence of economic phenomena. Austrian theory explains that market phenomena are governed by defined chains of cause and effect, which constitute and generate a defined process that reflects entrepreneurial decisions. It argues that economic development objectives are best achieved by strengthening entrepreneurship through an institutional environment conducive to private property. This statement requires clarifying how this perspective challenges the wisdom of old and new development economics and leads to better historical analysis and qualitative predictions (pattern prediction). By encouraging a broader perspective, the application of Austrian economics would be a step forward in recognizing the dynamics of underdeveloped economies.
Although poverty has been the “natural” condition of human beings, entrepreneurship’s dynamic efficiency has contributed to overcoming it. Entrepreneurship entails the ability of individuals to perceive hitherto unsuspected opportunities for profit and the willingness to take advantage of them.Human action is linked to entrepreneurial behavior. Entrepreneurship etymologically comes from the Latin verb in prehendo-endi-ensum, which means “discover, perceive, identify, carry out.” This meaning is indicative of systematic steps in perceiving profit opportunities, which sheer ignorance could tend to dissipate. Indeed, the Real Academia Española (Royal Spanish Academy) (2020) defines enterprise as an “action that involves difficulties and whose execution requires decision and effort.” It is also the “intent or design to do something,” that is, to perform an action. An entrepreneur is one who “commits to resolution actions” as something “proper to people.” Italics are mine. In the tradition of Carl Menger, Ludwig von Mises, Friedrich Hayek, Israel Kirzner, and Murray N. Rothbard, entrepreneurship is also connected to private property. Without private property, entrepreneurs cannot take advantage of perceived profitable opportunities. For more on this, see Salerno (2008); Huerta de Soto (2010); and Klein and Bylund (2014). The translation is own. What economic theory finds in the entrepreneur is valid for all human beings, regardless of people’s role in society. As Ludwig von Mises argues, “in any real and living economy, every actor is always an entrepreneur” (1966, 253). The flesh-and-blood entrepreneur is the driving force behind the entire market process, which is often neglected in the “old” and “new” development economics literature. In other words, the analysis of entrepreneurship as the engine of economic phenomena contributes novel findings on how the dynamic process of development works:
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Entrepreneurship is the essence of economic development.
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The poverty trap is only valid in an institutional environment adverse to entrepreneurship.
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The replacement of entrepreneurship by top-down economic planning inhibits economic development.
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Costs and benefits are subjective, therefore, it is impossible to coordinate individual action plans through top-down economic planning.
The role of development policy is to reduce the political barriers to entrepreneurship.
Israel Kirzner identifies the entrepreneur’s alertness as the core of economic development. The scope of entrepreneurial alertness “refers not to the ability to see what exists, but to the necessarily speculative ability to see into the future. In particular, such metaphorical alertness may consist in the vision to create something in the future” (Kirzner 1985, 7). Alertness implies human action that reshapes the entire map of individuals’ ends and means as they act in their contexts. Alertness allows the entrepreneur to notice new profit opportunities to improve his condition, that is, creativity does not need prior means. Alertness creates an idea in the entrepreneur’s mind, but his human action guided by that idea requires assets to achieve ends. He can speculate ex ante about his action’s effectiveness, but the outcome of his alertness can only be verified ex post. Alertness also involves serendipity, the ability to realize opportunities that arise by surprise, without being deliberately sought, and act accordingly.
Entrepreneurial knowledge is subjective, because it cannot be represented formally; the individual acquires it through practice (Huerta de Soto 2009). Knowledge is scattered in the minds of all individuals, who create it as they seek their ends in unique historical conditions. Entrepreneurs learn how to perform specific actions (know-how) and acquire practical behavior patterns. These actions allow entrepreneurs to articulate their knowledge and improve alertness through a dynamic process of “learning by seeing” and “learning by doing.” It is the eureka flash in terms of subjective interpretation through daily experiences and expectations. However, the power of individuals’ minds is limited, since they are not omniscient, omnipotent, or omnipresent, and this causes the dynamic process of social cooperation, well known as the market. As Mises (1966, 259) writes, “the market process is the adjustment of the individual actions of the various members of the market society to the requirements of cooperation.”
The price system is the method of communicating entrepreneurial information through the market process, i.e., all the exchange ratios built on the relative scarcity of the goods and services subjectively valued by each actor as a seller or consumer, participating in the market or abstaining from doing so. The rise of market prices requires the presence of private property, which enables subjective assessments of voluntary exchanges. Market prices are indeed historical relationships of exchange that help human minds perform a rational economic calculation: the estimation in monetary units of the possible outcomes of different courses of action. Economic calculations are reflected in profit-and-loss accounting and expectations, which guide entrepreneurs on what to produce, how to produce, and in what quantity (Salerno 1990). Although the control of production is the task of entrepreneurs, consumers are the sovereigns who can enrich the poor and impoverish the rich. Entrepreneurs propose goods and services in the market, but consumers have the freedom to choose the best or the cheapest ones for themselves.
Knowledge of market prices and the ability and willingness to use this knowledge is indispensable in finding the most economical uses of available resources. This dynamic process develops the productivity of resources and tends to increase incomes, enabling the accumulation of additional resources. Thus, the market process fosters social coordination. Entrepreneurs tend to discipline their behavior in line with consumers’ needs. A final state of equilibrium (when all profit opportunities are given) is never reached; these coordination trends generate new discoordination to be perceived and adjusted by entrepreneurs. The insight of entrepreneurs in serving consumers is what steadily tests their reputation in the market. Because entrepreneurs may only prosper if they continually adjust their intellect to satisfy others’ needs, the entrepreneurial coordination process is dynamically efficient (Kirzner 1997, 2017). Given that the economic calculation is subjective, it is impossible to coordinate individual action plans through top-down economic planning (Huerta de Soto 2010).
The material development of a society is greatly assisted when the qualities of entrepreneurs, such as a long-term vision in adopting ideas and taking risks, are present to a high degree. Entrepreneurs seek to reduce as much as possible those time barriers that separate them from achieving their goals (Kirzner 2009). The entrepreneur tends to pursue potential profit opportunities in the long term when he considers that the goals to achieve are higher than those he could reach in the short term. If the entrepreneur perceives a more worthwhile goal in the future, he will transfer part of his present consumption toward a higher expected level of future consumption. In other words, saving is an essential requirement to accumulate capital and produce capital goods, all the goods or services that the actor believes subjectively necessary to produce other goods or services.
The structure of production consists of a series of stages that require time, from entrepreneurial alertness to a profit opportunity, the acquisition of capital goods (i.e., land, labor, capital, and technology), and the combination of them through successive stages until the final consumer goods are obtained. Moreover, capital goods are heterogeneous and have multispecific uses, both because of their physical dimensions and the different plans they can satisfy (Foss et al. 2007). The general outcome of an increasing level of capital is a more capital-intensive method of production. Prior savings allow the creation of more and better goods offered at a lower price for people, increasing consumption per capita.
The dynamic process of intertemporal coordination is influenced by the price of time, better known as the interest rate, mainly composed of society’s time preference, the default risk premium, and the expected change in money’s purchasing power.Hülsmann (2002) argues that the originary interest rate depends on the subjective assessment between individuals’ ends and means, which determines how market participants choose between production alternatives with different time frames and expected profit and productivity. When the originary interest rates are manifested, the production structure and the interest rate are determined. The interest rate guides entrepreneurs toward the stages of the production process that are relatively more profitable. When people increase their level of savings, the supply of loanable funds rises and the interest rate falls. This event makes entrepreneurial projects relatively more profitable in the formative stages, farther from final consumption: investment in capital goods grows (Manish and Powell 2014). Saving fosters economic development, because the incentives of entrepreneurs (investing in projects of greater complexity and maturation time) tend to coordinate with the goals of consumers (consume more in the future).If the interest rate is altered artificially, an intertemporal discoordination is generated between entrepreneurs and consumers, which drives recurring boom-and-bust cycles (Garrison 2001; Huerta de Soto 2006).
International trade also improves dynamic efficiency, because it contributes to the technological and cultural exchange between countries, which tend to move from subsistence to exchange in new markets. Free trade and population growth strengthen the division of knowledge and labor. If everyone dedicates their efforts to what they consider subjectively more efficient and exchanges with others in domestic free trade, the same rule applies in the international market (Manish and Powell 2015). The most prosperous regions and sectors are those that have established business contacts with the most advanced countries. In contrast, the most impoverished and backward populations are generally those with little or no foreign trade.
Accordingly, economic development is better understood as the widening range of entrepreneurial alternatives open to individuals, which implies “the accumulation of available solutions to human problems” (Beinhocker and Hanauer 2014, 4). Increasing well-being in underdeveloped economies depends on the freedom to exercise entrepreneurship in a virtuous process of technological change to meet the increasingly complex demands of individuals. There are no frontiers for economic development, because there are no limits to creating new alternatives for people.Beinhocker and Hanaeur (2014, 4) suggest that “these solutions run from the prosaic (crunchier potato chips) to the profound (cures for deadly diseases). Ultimately, the measure of the wealth of a society is the range of human problems it has solved and how available it has made those solutions to its people. Every item in a modern retail store can be thought of as a solution to a different kind of problem—how to eat, dress, entertain, make homes more comfortable, and so on. The more and better the solutions available to us, the more prosperity we have.” For more details on the link between entrepreneurship and technological improvement, see Holcombe (1998, 2009). Hence, development is not a unique and absolute value for all people. It is a subjective appreciation that depends on individuals’ ends and means in the context of their action plans.
The essential difference between prosperous and poor societies lies in the former having a more robust network of entrepreneurial capital invested than the latter. A more capital-intensive production gives rise to better and more accessible technologies to solve the people’s needs (e.g., industry, transportation, education, health, social security, or environment). Technological progress boosts the efficiency of workers and thus their level of income. As entrepreneurship drives the extension and deepening of the division of knowledge (or division of labor), the progressive division and subdivision of the production stages proceeds horizontally and vertically. In short, entrepreneurial alertness plus investment in capital goods are the key elements inimproving people’s well-being.
The poverty trap is only valid in an institutional environment adverse to entrepreneurship. Indeed, the rise of evolutionary social institutions, such as language, morality, private property rights, law, money, and culture, explains the creative and coordinating feature of entrepreneurship to produce more and better solutions to human problems and reduce transaction costs and uncertainty.There is a widespread myth that attributes the rapid economic growth of Asian tigers (i.e., Japan, Taiwan, South Korea, Hong Kong, and Singapore) to government development planning. In those cases, governments used their power, authority, and fiscal incentives to strengthen private property and stimulate increasingly capital-intensive production. The prosperity of these countries is best explained by their economic freedom backed by a probusiness state and not a predatory state. For more details on this, see Yu (2000); and Powell (2005). As Acemoglu et al. (2019) put it, development requires “inclusive institutions” based on the enforcement of private property rights and competitive markets that create broad-based incentives and opportunities in society. By contrast, “extractive institutions” lack these properties and impoverish society.
Notably, “extractive institutions” explain economic and technological underdevelopment through significant political barriers to the free exercise of entrepreneurship. Coerced people perceive that they may have a better chance of achieving their goals if they use their creativity to influence political decision-making: this is the “corruption effect,” that is, unproductive or destructive entrepreneurial behavior.Entrepreneurship takes place independently of the institutional environment, which can only influence the available types of profit opportunities. In an intervened market, private property institutions and the profit and loss system are damaged or substituted by political power decisions. See Boettke and Subrick (2003); and Boettke, Coyne, and Leeson (2008). Nonproductive entrepreneurship occurs when actors perceive that it is more profitable to seek government privileges than to serve consumers. Concerning nonproductive entrepreneurship, see Acemoglu and Robinson (2019). Indeed, political and cultural institutions significantly shape the source of these barriers, which include low maintenance of law and order, instability in political and economic institutions, unstable monetary conditions, and confiscatory policies through high levels of taxes and regulation (Boettke and Coyne 2003; Leeson and Boettke 2009; March, Martin, and Redford 2016; Espinosa, Wang, and Zhu 2020; Espinosa 2021). Thus, the replacement of entrepreneurship by top-down economic planning inhibits economic development. These situations affect people’s ability and willingness to look beyond the immediate present and take a long-term view.
Some regulations, such as labor legislation, price controls, tax levels, banking laws, and licensing requests, among others, restrict potential competition. If the regulation policy becomes more widespread, the government will tend to favor entrepreneurs who are already installed in the market to the detriment of society (Ikeda 2015). Thus, entrepreneurship’s political barriers promote economic power concentration, leading to corruption, distortion of price signals, and waste of resources. To have a monopoly, entry barriers are needed so that most people do not have opportunities or incentives to innovate or create companies. The most effective monopolies are those created by government regulations: entry barriers make it difficult or unfeasible for new competitors to emerge, and corruption is strengthened through rent seeking (Cachanosky 2020). Therefore, the diffusion of decision-making is reduced and the range of alternatives open to people is narrowed. This is the exact opposite of the broad-based incentives and opportunities required to create prosperity.
Competition without barriers to entry fosters creative and coordinating behaviors in both incumbent entrepreneurs and potential players. Hence the role of development policy is to reduce the political barriers to entrepreneurship. Economic development, that is, the widening range of alternatives open to the people, is only possible when the right to private property is respected in an organized society with contractual ties and when assault on private property and breach of contracts are penalized. In sum, the government can support the expansion of access to new alternatives by eliminating privileges and political barriers to entrepreneurial entry.
CONCLUDING REMARKS Despite appearances, the old and new development economics share the same main assumptions, objectives, and recommendations. More specifically, the core of old and new development literature includes: 1) the poverty trap theory, 2) the indispensability of top-down planning of the economic life of the poor to overcome the poverty trap, and 3) the objective conception of costs and benefits to support political interventionism in underdeveloped countries.
This paper argues that neoclassical reductionism causes the old and new development economics to fail to recognize the essence of poverty, corruption, and underdevelopment: political barriers to human beings’ innate creative and entrepreneurial ability to solve human problems. It reveals how the Austrian theory of entrepreneurship provides the essential theoretical framework to overcome the new development economics’s challenges. It is interesting to note that placing the entrepreneur at the heart of economic analysis allows development to be understood as the widening range of alternatives open to people. This objective serves as a pattern in the analysis of policies and institutional change. Thus, economic development objectives are best achieved by strengthening entrepreneurship through an institutional environment conducive to private property. Higher confiscation risks in the market process tend to inhibit the creative and coordinating feature of entrepreneurship. As long as there are political barriers, there will be poverty.
These arguments add more theoretical substance to the recently renewed concern in development economics circles about the impact of weak property rights on economic development. A theory built on dynamic flesh-and-blood entrepreneurship provides quantitative tools with more powerful meaning for further research on economic history and public policy in underdeveloped economies.
Per Bylund is Associate Professor of Entrepreneurship at Oklahoma State University. He discusses three of his current book projects, all touching on various aspects of the Austrian School and its continued importance.
Mentioned in the Episode and Other Links of Interest: Per Bylund’s page at Oklahoma State UniversityThe Mises Institute’s description of Per Bylund’s upcoming primer on Austrian EconomicsBob’s debate with David Friedman on economic methodBob Murphy Show episode on intelligent designBob’s article critiquing Eugene Fama’s denial of the housing bubble For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on Apple Podcasts, Google Podcasts, Stitcher, Spotify, and via RSS.
Featuring Joseph Becker, Felicia Jones, Karras Lambert, and David McClain. Recorded at the Mises Institute in Auburn, Alabama, on 24 July 2021.
Fellowships in Residence at the Mises Institute in Auburn, Alabama, are available to graduate students and post-docs interested in scientific research in the Austrian school and libertarian political economy. For more information, visit Mises.org/fellows.
The Mises Institute’s Master of Arts in Austrian Economics is the first graduate program in the United States dedicated exclusively to the teaching of economics as expounded in the works and great treatises of Ludwig von Mises and Murray N. Rothbard. The goal of the program is to assist students in mastering the principles of this great body of work and putting these principles to use in their chosen endeavors. For more information, visit Mises.org/edu.
Featuring Lucas Engelhardt, David Gordon, Jeffrey Herbener, Peter Klein, Jonathan Newman, Ritenour, and Joseph Salerno. Recorded at the Mises Institute in Auburn, Alabama, on 23 July 2021.
Featuring Per Bylund, Tom DiLorenzo, Sandy Klein, Patrick Newman, Tim Terrell, and Mark Thornton. Recorded at the Mises Institute in Auburn, Alabama, on 23 July 2021.
Download the slides from this lecture at Mises.org/MU21_PPT_31.
Recorded at the Mises Institute in Auburn, Alabama, on 22 July 2021.
Download the slides from this lecture at Mises.org/MU21_PPT_22.
Recorded at the Mises Institute in Auburn, Alabama, on 21 July 2021.
Download the slides from this lecture at Mises.org/MU21_PPT_13.
Recorded at the Mises Institute in Auburn, Alabama, on 20 July 2021.
Download the slides from this lecture at Mises.org/MU21_PPT_15.
Recorded at the Mises Institute in Auburn, Alabama, on 20 July 2021.
Recorded at the Mises Institute in Auburn, Alabama, on 20 July 2021. Download the slides from this lecture at Mises.org/MU21_PPT_11.
Download the slides from this lecture at Mises.org/MU21_PPT_16.
Recorded at the Mises Institute in Auburn, Alabama, on 20 July 2021.
Download the slides from this lecture at Mises.org/MU21_PPT_14.
Recorded at the Mises Institute in Auburn, Alabama, on 20 July 2021.
Entrepreneurship is a general feature of the market economy.
Download the slides from this lecture at Mises.org/MU21_PPT_04.
Recorded at the Mises Institute in Auburn, Alabama, on 19 July 2021.
Download the slides from this lecture at Mises.org/MU21_PPT_06.
Recorded at the Mises Institute in Auburn, Alabama, on 19 July 2021.
"The free market and the division of labor does not promote hyper-atomized individuals. It creates social harmony and community." Download the slides from this lecture at Mises.org/MU21_PPT_05.
Recorded at the Mises Institute in Auburn, Alabama, on 19 July 2021.
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.
Listed below are links to the readings that all students are encouraged to complete before attending Virtual Mises University.
All materials are available on Mises.org free of charge, and most readings are available in multiple formats (e.g., PDF, ePub, HTML, audio).
Suggested Reading Anatomy of the State by Murray N. Rothbard
The Philosophical Origins of Austrian Economics by David Gordon
Praxeology and Understanding by George A. Selgin
Profit and Loss by Ludwig von Mises
I, Pencil by Leonard Read
What Has Government Done to Our Money? by Murray N. Rothbard, pp. 1-87
From The Austrian Theory of the Trade Cycle and Other Essays, edited by Richard M. Ebeling:
"Introduction: The Austrian Theory in Perspective" by Roger W. Garrison, pp. 7-35"Economic Depressions: Their Cause and Cure" by Murray N. Rothbard, pp. 65-91"Can We Still Avoid Inflation?" Friedrich A. Hayek, pp. 93-120 From Economics in One Lesson by Henry Hazlitt:
"The Lesson," pp. 3-7"The Broken Window," pp. 11-16 From Economic Freedom and Interventionism by Ludwig von Mises
"The Elite Under Capitalism""The Individual in Society" From An Introduction to Austrian Economics by Thomas C. Taylor:
"Introduction," pp. 7-21"The Subjective Theory of Value," pp. 40-62 From Planning for Freedom by Ludwig von Mises:
"Planning for Freedom," pp. 1-17"Middle of the Road Policy Leads to Socialism," pp. 18-35 "Fundamentals of Value and Price" by Murray N. Rothbard (in The Rothbard Reader, pp. 89-126)
"Economic Calculation" by Ludwig von Mises (in Socialism: An Economic and Sociological Analysis, pp. 113-122)
"The Meaning of Competition" by F. A. Hayek
Optional Reading Penthouse Interviews Murray Rothbard
ABSTRACT: This retrospective, covering half a century, is a personal history of modern libertarianism. It provides some historical perspective on the growth of libertarianism and its impact on society, especially for those who were born into an existing libertarian movement, including political and academic paths. As outsiders, Austrians and libertarians can expect more than their share of difficult times and roadblocks, although that situation has improved over time. It also shows the limitations of the political path to liberty and the importance of the Austrian view that society changes via emphasis on sound economic science, its practicality, and its subsequent impact on ideology. Finally, it conveys the importance of solving practical problems and puzzles via the thin, radical version of libertarianism.
Keywords: libertarianism, libertarian party, mises institute, lew rockwell, murray rothbard, austrian economics, auburn university
Mark Thornton (mthornton@mises.org) is Senior Fellow at the Mises Institute. The author would like to thank I. Harry David, Robert B. Ekelund, Jr., and Joseph T. Salerno for helpful commentary. This article is dedicated to Llewellyn H. Rockwell, Jr.
This paper was first published in Studia Humana, vol. 9, no. 2 (2020), pp. 100–109. Reprinted with no changes as permitted under the original CC: BY-NC-ND license.
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INTRODUCTION This personal retrospective, covering half a century, is an extremely thin slice of the history of modern libertarianism. Its purpose is to provide some historical perspective on the growth of libertarianism and its impact on society, especially for those who were born into an existing libertarian movement. As outsiders, Austrians and libertarians can expect more than their share of difficult times and roadblocks, although that situation has improved over time. If you attempt to make a career in these academic areas, you should view it more as a vocation than as a profession (Salerno 2019). It also shows the limitations of the political path to liberty and the importance of the Austrian view that society changes via emphasis on sound economic science, its practicality, and its subsequent impact on ideology. Finally, I hope it conveys the importance of solving practical problems and puzzles via the thin, radical version of libertarianism, rather than the thick and compromised versions.See Walter Block and Kenn Williamson’s (2017) case that thin libertarianism is libertarianism and thick libertarianism is not.
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IN THE BEGINNING In 1970 libertarianism did not exist as a coherent term meaning opposition to government coercion. Murray Rothbard (1926–95) would often lament that many of the good terms, such as liberalism and capitalism, had been hijacked by the bad guys. However, it turns out that the term libertarian is one of the few stolen by the good guys from the bad guys.The word libertarian was first used to describe a variety of socialists (Wikipedia 2020).
At this time there was no significant libertarian social movement or political party to represent libertarianism. Although I was moving toward this political view by the age of eight, I would not hear the word for more than another decade.
The only institutional forms of libertarianism were the Foundation for Economic Education, which was founded in 1946 by Leonard Read, Robert LeFevre’s Freedom School, which began in 1956, and the Institute for Humane Studies, founded by F. A. Harper in 1961. The National Libertarian Party in the United States began in 1972, and the Center for Libertarian Studies was founded by Burt Blumert and Murray Rothbard in 1976. However, I never heard of any of these organizations until the early 1980s.
I began listening to an alternative-rock AM radio station at age thirteen. You could only get its signal at night. The program that I listened to was sponsored by the John Birch Society. Its advertisements were long, thoughtful commentaries on events of the day. I rarely disagreed with its views, but I think it avoided airing its most controversial viewpoints. I guess I was a thirteen-year-old Bircher.
- THE WORD LIBERTARIAN Even though my political views were libertarian by the time I was eighteen years old (Thornton 2002), the encounter between me (on the one hand) and the concept and term of libertarianism (on the other) was still a couple of years away. During my sophomore year at St. Bonaventure University, I declared my major to be economics, acquainted myself with the writings of Milton Friedman, and saw the television advertisement for the Libertarian Party’s presidential candidate, Ed Clark.
I was really excited about having a term for my political views and knowing that others out there that held similar views. Some people took a dimmer view of my new political home base. Only a couple of my professors were market oriented, and apparently only one, Scott Sumner, had ever heard of the Austrian school of economics. Even though the Austrian school was minuscule then, I knew that it had been very important in the past and I suspected it still had a lot to offer. Unfortunately, my history-of-economic-thought professor assigned Joseph Schumpeter’s Ten Great Economists: From Marx to Keynes, and the only chapter that we did not cover was the one on Carl Menger, the founder of the Austrian school. We did cover the chapter on Joseph Schumpeter’s professor Eugen von Böhm-Bawerk, but my professor did not discuss the connection to the Austrian school.
The topic I was most interested in was the Austrian business cycle theory, and I was very excited when a special course on business cycles was added in my junior year. The elderly professor who taught the course told us that he was retiring and they needed to put him in some classes, so they resurrected this course from the old curriculum. On day one he told us that Keynesian economics had cured the business cycle, so the course was no longer needed. How he could say such a thing given that the economy was in the worst shape since the Great Depression was beyond my comprehension. Maybe that was why he was being retired. The class and the textbook covered nine business cycle theories, and the Austrian theory was never mentioned—not even in the index!
I decided that I would be a guerrilla student activist. My main outlet was to discuss libertarian ideas and government failure with my friends and my professors in my economics, history, philosophy, and political science classes. I also pinned libertarian pamphlets around campus on billboards.
One day, I found a note attached to my dorm-room door asking for a meeting. It was from the dorm monitor, a position I did not even know existed. It turns out the monitor was the most feared man on campus. He was a former US Marines officer turned Franciscan friar—that is, a monk. He taught calculus and went to class in only his brown robe and leather sandals even if there was two feet of snow on the ground. I was frightened to death, and my roommates and friends would howl in laughter about my predicament.
It turns out that he had discovered my guerrilla activism. He recommended that I stop it because I might be considered either insane or a criminal. It was such a relief! The confusion over the meaning of libertarianism at this time was rampant—anything from communism, to libertinism, to the John Birch Society belief system was suspected—and I eventually developed a good, disarming explanation of what the term really meant.
I mention all this to note, importantly, that these were very dark early days for liberty and libertarianism. The United States had been taken off the gold standard; had experienced Watergate, the Vietnam War, gas lines, and the Great Stagflation (1971–82); and was currently mired in an economic depression. So, however despondent one might become about the libertarian moment now, remember that much progress has been made and that a massive amount of knowledge about libertarianism and the Austrian school is readily available to fuel future progress, thanks largely to Lew Rockwell and the donors to the Mises Institute.
As Murray Rothbard would remind me several times, he was always a pessimist in the short run but an optimist in the long run. Remember, we measure libertarian progress in terms of ideology, not votes, and there is no question that ideological progress of significant proportions has occurred. Most Austrian economists support the idea that ideological change is what causes social change (Stringham and Hummel 2010).
The next semester, improvements started to take place. I took a course on international economics from a new professor, Scott Sumner, an ABD from the University of Chicago. He was a free market economist, and his course could have been renamed Why Arguments for Protectionism Are Stupid. One day before an exam, I went to his office hours to ask a technical question. After we were done with my question, I noticed he had a copy of Human Action on his bookshelf.I did not know this at the time, but this book was very important for the development of modern economic theory (Salerno 1999). I asked him about it, and he said his grandfather had given it to him and it was not part of the University of Chicago curriculum.
I later asked him if he would do a directed-readings class for me on Mises’s book The Theory of Money and Credit, and he agreed. I think I had bought the book on sale from Laissez Faire Books or Liberty Fund. My performance in trying to understand Mises was less than optimal, but Scott knew Mises’s work on business cycles and that kept me on track. I really did not think much about Scott again until 2012, some thirty years later, when I learned that he was ranked fifteenth on Foreign Policy’s influential list of the top hundred global thinkers. Sumner was tied with Federal Reserve chair Ben Bernanke! I was astonished, but with a little research I confirmed it was the same Scott Sumner. His ideas were circulated through his blog, Money Illusion. Apparently, academia was losing its stranglehold on the flow of ideas. Scott’s ideas were related to nominal-GDP targeting where the central bank uses monetary policy to achieve an annual increase in nominal GDP, of say for example 5 percent.
Bolstered by the historic performance of Ed Clark’s presidential campaign in 1980, I decided to join the political fight, which seemed at the time the most direct path to liberty. I also wanted to learn more about Austrian economics. I joined the Libertarian Party and started doing volunteer work, such as getting signatures that would permit Libertarian Party candidates to get on the ballot. I eventually realized that the combination of ignorance and politics would make the political route to freedom a difficult one.
In terms of ignorance, the vast majority of people had never heard of the Libertarian Party, and of those who had heard of it, most did not know what it really meant. In terms of politics, the one thing that Democrats and Republican could almost completely agree on was keeping third parties off the ballot by making the number of signatures prohibitively high for small nonprofit organizations—that is, third parties. The combination of these two factors would be toxic to the party’s success and growth.
- GRADUATE SCHOOL Note that libertarianism at this time was 99 percent based on the idea of limited government, where government would consist of police, courts, and national defense and maybe some local government activities. The idea was to borrow some ideas of the Founding Fathers to assuage people’s fears of society breaking down into chaos. The vast majority of libertarians were minarchists and constitutionalists who supported the ideal of the night-watchman state, an idea popularized by philosopher Robert Nozick in his 1974 book Anarchy, State, and Utopia. This was the idea that government should be viewed as a necessary evil. For the minority, the anarcho-capitalists, it was merely a tactic—a way to make political progress. I include myself in the latter group.
I also started applying to graduate schools, I think eleven in all, including New York University’s and George Mason University’s PhD programs in economics and Auburn University’s master’s program in economics. The rest were MBA programs. I was accepted to all these programs, but I chose Auburn because of its low cost and because I had already met Auburn University economist Roger Garrison at an Institute for Humane Studies summer conference in Kentucky. I had also researched the Auburn faculty’s publications, and the faculty all seemed to be writing interesting and practical academic papers, even some on Austrian economics. I was told it was in the top-three master’s-only programs in the country. Things were looking up when I was granted funding as well.
Things did not go well upon arriving at Auburn University. During my first week, one of the professors, upon learning of my interest in Austrian economics, said that Austrian economics is a historical fact but dead as a school of economic thought. He said that there were virtually no Austrian economists working at doctorate-granting universities and even if there was one and you wrote an Austrian dissertation, you would never find a decent job.
However, the next term the esteemed Leland B. Yeager joined the faculty at Auburn University from the University of Virginia. Yeager was a macroeconomist but was also noteworthy in international economics and economic philosophy. Garrison taught first graduate macroeconomics course, and Yeager was scheduled to teach the second and third macro courses. I was told he was a fellow traveler of the Austrian school and that he was translating one of Ludwig von Mises’s books. At the time, I was reading Murray N. Rothbard’s America’s Great Depression, a book that had a profound effect on me and my understanding of Austrian business cycle theory as well as the Great Depression in the United States.
I was very excited I could possibly write my master’s thesis on the Great Stagflation of the 1970s using Rothbard’s book as a template under the supervision of Garrison and Yeager. I knew Garrison liked the Austrian business cycle theory, but when I broached the topic with Yeager, he responded that the theory was a “grizzly embarrassment.” I was distraught and without a thesis subject heading into the third term. You write your thesis in the fourth term. I thought of dropping out of the graduate program and made the decision to do so, only to quickly reverse that decision. I got past my first year of graduate school.Otherwise, Yeager was wonderful, and I took four of his courses and participated with him in seminars and festive occasions.
I think it was shortly thereafter that Roger Garrison called me into his office and sat me down. He told me that that Lew Rockwell was moving the Ludwig von Mises Institute to Auburn University and would be bringing Austrians from around the world to give seminars, publishing books and newsletters, and supporting the economics department’s new doctoral program. Rockwell would be giving me a full scholarship for my next year in graduate school.
This all sounded too good to be true. I had never heard of Rockwell or the Mises Institute and not a word about a new doctoral program. I was naturally very skeptical, as Garrison was a well-known prankster and provocateur. He must have seen the disbelief in my eyes because he pointed to a large box to my right and behind my chair. He said that Rockwell had sent it and that I should take a book from it. I reached in and pulled out a copy of Rothbard’s Man, Economy, and State, one of the largest economics books I had ever seen. The only Rothbard book I had was Power and Market, and when Garrison said it was originally supposed to be part of Man, Economy, and State, I had no idea what to think. I left Garrison’s office stunned with disbelief (Salerno 2002).
The Mises Institute showed up in the summer of 1983. It consisted of Lew and Mardi Rockwell, some boxes of pamphlets, and its technology: an electric typewriter. They moved into a tiny office in Thach Hall on Auburn University’s campus. It was attached to a small conference room and actually in a very prominent location in the College of Business. Pat Barnett soon joined them, and Lew got to work, with Murray Rothbard running the academic affairs from afar. They were attempting to bring the world true economics and true libertarianism. What the Rockwell, Rothbard, Burt Blumert, and Ron Paul foursome have done is build an enormous worldwide libertarian movement. It all is now centered at the Mises Institute (Rockwell 2018).
As the luckiest person in the world, I have had the privilege of seeing Lew and his colleagues build the Mises Institute into a worldwide powerhouse in the realm of ideas. He built the institutional framework, including Mises.org, that has helped support thousands of teachers and maybe millions of students. There are too many details of this tremendous success story to provide in this essay, but it is critical to highlight here that Lew provided the structural home for true economics and true libertarian political theory.
- MY POLITICAL CAREER Shortly after I arrived in Auburn, I saw the Libertarian Party candidate for governor of Alabama being interviewed on a local TV station. I had never seen a Libertarian politician on television in my hometown of Geneva, New York, so I was pleasantly surprised.
However, I was also overwhelmed by moving to a new city and state and the tougher workload of graduate school. Fortunately, the citizens, students, and professors were all friendly to me. Walking down sidewalks on campus and even around town, total strangers would say hey as an informal greeting. Graduate work was nothing like college. You had to do the readings, you had to do the assignments, and of course you had to come to class under all circumstances. Exams were competitive and often graded on a curve, and a final grade of C was considered failing.
There was simply no time for politics until the end of the spring term. Sometime after my exams were over, I contacted the party’s national office and it put me in contact with state headquarters. When I contacted one of the top officers of the state party, he invited me to the next executive-committee meeting in Birmingham—about a two-hour drive—the following Sunday.
I asked myself: an executive-committee meeting on a Sunday at someone’s house? The meeting found me sitting on the floor listening to people talking about bylaws and Robert’s Rules, but there was no political action until late in the meeting, when several votes were taken about officers and candidates for political office. I thought I was going to be there all night, but fortunately every vote had no candidate or a single candidate, so things went quickly.
Leaving the meeting on time to return to Auburn before dark, I found myself elected as state representative for District 3 (thirteen counties and 750,000 citizens in east-central Alabama). More puzzling, I was elected to be the party’s candidate for the district’s Alabama House of Representatives seat. As a six-foot, four-inch Yankee, I stuck out like a sore thumb, plus on election day I would only be twenty-four and therefore ineligible for the job.
I would soon learn who my opponent was. Alabama was a solid Democratic state, and the Republican Party was not running a candidate (things have obviously changed). The Democratic candidate was Bill Nichols, who had been in Congress for twenty-two years, was a football hero at Auburn University, was a vice president of the most important textile factory in the district (an industry that has now abandoned the district), and was crippled on D-Day on the beaches of Normandy and therefore a war hero.
Fortunately, I could turn to Lew Rockwell, who had some political experience, as an unofficial advisor. He said that given that the probability of winning was zero and given the demands of graduate school, I should run an educational campaign or nothing at all. I decided to give the educational campaign a try. On Sunday afternoons I would write fundraising letters once a month and letters to the editors of the state’s newspapers each week. It would be about six hours before everything was enveloped and stamped. The campaign distributed pens, t-shirts, and posters, mostly to Auburn students. I feel like I was successful in getting a very large number of people to learn what libertarianism was, and I got 4 percent of the votes. I also met Jimmy Wales, the founder of Wikipedia, who helped out with the campaign.
This campaign was also successful in getting David Bergman, the 1984 Libertarian Party candidate for president to visit Auburn University and give a speech to students and faculty. That was followed by Ron Paul in 1988, Andre Marrou in 1992, and Harry Browne in 1996 and 2000. These events were well attended by students and often generated interviews in the student newspaper. I was also the faculty advisor to the Auburn University Libertarian Club for many years.
My mother died unexpectedly in 1987, and given that I was editor of the Austrian Economics Newsletter, I decided to buckle down and finish my dissertation. No more politics. Then one day, the state-party chairman paid me a surprise visit and begged me to run for Congress. I told him under no circumstance would I do it and gave my reasons. He then suggested I be a line holder and run for constable, which had no duties. I agreed just to get him out of my office.
I did not think I thought about the campaign until months later, when I was rudely awakened early on a Sunday morning. It was the politics editor of the local paper. “Is this Mark Thornton, Libertarian candidate for constable in Lee County?” My response was yes. “Did you know that you are running unopposed and that you will be the first Libertarian Party candidate ever elected in Alabama?” I lied and said, “Yes, of course.” His next question was “What is your campaign platform?” I responded that I would abolish the office. That brief interview was apparently enough for his article, which was picked up by the Associated Press and newspapers across the state. I did interviews with all the major newspapers in the state and several smaller ones. My little ten-to fifteen-minute phone calls took no money and little effort, but generated more publicity than any campaign in the state party’s history. The fact that I had lied made me realize I was becoming a politician. I knew that I never actually had the power to dissolve the office.
Then 1995 rolled around, and my effort to stay out of politics took a big blow. My libertarian friend on the Birmingham city council called me and told me he was running for US Senate as a Republican and that he wanted me to run for vice chairman of the Alabama Libertarian Party to prevent it from running a candidate for Senate. He said it would be a one-day effort, the position carried no active duties, and I could step down later. I agreed.
The convention was a real ruckus. I was elected vice chairman as planned. However, the elected chair did not want to waste the ballot access the party had earned, so he forced through a candidate for US Senate; mission not accomplished. Worse yet, just as I arrived home, the telephone rang. It was the chairman, who stated that he and the candidate for US Senate had resigned. At that point he informed me that my only duty was activated. I would take over as chairman, and, with no volunteers coming forward, I would also have to take over as the candidate for US Senate as my friend did not get the Republican nomination.
I designed the campaign to be hard-hitting and educational. I never once said that any government function was necessary. I knew more people by now, in and out of libertarian circles. I restricted my campaign time to weekends, Wednesday afternoons, and scheduled interviews and events. I built what I think was one of the first campaign websites and designed and purchased t-shirts and large road signs. I even produced thirty- and sixty-second radio ads, which I peddled to small rural stations, hoping to get requests for interviews. It worked. I would often be on the air longer than the ad time I purchased! I got the endorsement of the Reform Party, Gun Owners of America, and some local groups, and I almost got the Constitution Party’s endorsement until the chairman, Howard Phillips, violated a core belief of his party in order to deny me the endorsement. I came in third place with over 4 percent of the vote.
Then one day not long after the election, the sitting governor of Alabama, Fob James, came to Auburn University, his alma mater, where he had studied engineering and had been a star football player. He was going to give a speech at the brown-bag seminar that I had been running for several years. In his speech he strongly supported the gold standard. After his speech was over, he said: “Now where is that libertarian fellow who ran for Senate?” Sitting next to him, I raised my hand and said: “Governor, welcome to my seminar.” The place roared with laughter. Then the governor said that he and his wife had seen me on TV and that he liked what I said and how I said it.
A few day later I was offered the position of assistant superintendent of banking and was told that I would actually be working for the governor’s office and investigating all aspects of state government. After leaving this office, I worked briefly for the Alabama attorney general Bill Pryor. Describing those experiences would unnecessarily lengthen this essay, and I am working on a book on that subject that will explain it in detail.
- DISSERTATION My best professor, Robert B. Ekelund Jr., posed a titillating question in class one day. What does prohibition do to the quality of alcohol? I raised my hand and said it would decrease it, and my fellow graduate students agreed. He said no, it would increase it. We were told it was a question on the preliminary exams of the economics department at the University of Chicago. He explained that smugglers would buy expensive whiskey and cross the Detroit River into the United States. Given the high risk, it paid better to make the attempt with high-quality whiskeys and scotches, which commanded a much better price. I knew there was something wrong with the answer and felt like if I could solve it, I might have a dissertation topic.
Eventually I found data that tracked the potency of cannabis—that is, marijuana—and showed that it had increased in line with the money spent on the War on Drugs. Now all I would need was a theory. I remembered an argument in University Economics, the famous textbook by Armen Alchian and William Allen, called “shipping the good apples out.” The argument is that the fixed cost of shipping lowers the relative price of higher-quality apples to distant consumers and leads to an outflow of high-quality apples.
I reasoned that the risk of smuggling illegal drugs into the United States increased the total cost of transportation and risk by a tremendous amount and that this reduced the relative price of higher-potency cannabis versus lower-potency cannabis. In layman’s terms, you get more bang for the buck.
This changed the incentive of smugglers to smuggle higher-potency cannabis, and that in turn altered the incentives of growers to grow higher-potency cannabis in terms of the active ingredient, THC. The smuggled product would be stripped of all of its non-essential attributes and pressed into bricks for shipment. No stems, no seeds, just the medicinal part that has an intoxicating effect, and also no pleasantries like the rolled paper cigarettes with filters like we find in the legal tobacco market. Growers would eventually be able to genetically engineer cannabis to increase THC levels at the expense of CBD. This would change the cultural question “Do you want to get high?” to “Do you want to get stoned?”
I wrote my first paper on the subject, “The Potency of Illegal Drugs,” in the mid-1980s and shared it with several friends and colleagues. In 1986 Richard Cowan dubbed my results “the iron law of prohibition.” I outlined my dissertation on 3′′ x 5′′ cards but could not start my dissertation until after passing all my classes and all my preliminary examinations.
Still, I remained excited at the prospect of a dissertation that was a simple application of basic economic theory, that would be tested not with econometrics, because of a lack of data, but rather by looking back at the history of alcohol prohibition (1920–33) and at other illegal drugs. Plus, it seemed that the main logical argument was that the more you tried to prohibit drugs, the worse the results would be. No need for a cost-benefit analysis because there were no benefits, just costs. There was no trade-off. There was no need for value judgment. Thus I would be staying within the confines of Austrian economics and I would be striking a direct hit for libertarian political economy, against the dreaded War on Drugs.
Eventually, I took my outline for a traditional-format economics dissertation to Professor John Jackson, a man who seemed to know everything. He also seemed to work well with the entire faculty and was very well respected by everyone. He asked who I wanted as readers on my committee. I responded that I wanted Richard Ault and Leland Yeager. Richard Ault was the best microeconomist on a faculty of mostly good microeconomists. Leland Yeager was known more as a macroeconomist, but he actually knew everything, including libertarian political theory. These two men were libertarian from a practical or utilitarian perspective. These three professors were known for being helpful with students, and they deserve a great deal of credit for the success of my dissertation.
In the early stages of the dissertation, I was called in and asked to drop the subject and format of my dissertation. Instead of a dissertation on the economics of prohibition written in the traditional book format, it would instead be on the economics of the 1920s and written in the new three-essay format. It would consist of an essay on the tax cuts of the 1920s that I already had written, an essay on income distribution in the 1920s that I had already done a good deal of work on, and an essay on alcohol prohibition in the 1920s that I had started working on as a chapter of my original dissertation. The committee justified the change by noting correctly that I could finish it quicker and get three papers submitted to academic journals, and it would be better for my job-market prospects once I finished.
I saw the merits of their arguments and complied, but I was crushed that what I thought was a second great dissertation idea was being discarded. I only realized many years later that that dissertation would have been a dangerous one during the pinnacle of Reagan and Bush’s War on Drugs. It would have been dangerous for me and my job prospects—and, in terms of things like budgets and grants, the department, the college, and the university.
I assembled an abstract and the work I had completed on the three essays of my proposed dissertation, submitted the result to my committee, and scheduled a time to present my proposal. The presentation took about fifteen minutes and was pretty straightforward. I was excused from the room and asked to sit outside the seminar room so that the committee could discuss the proposal. This discussion seemed to take forever, but the committee finally emerged about forty minutes later. They had rejected my proposal, and they said that I was to proceed on my original proposal on the economics of prohibition!
Many months later, after about six iterations of all of the chapters, an outside reader was appointed and a final oral exam was scheduled. The outside reader had many excellent questions and suggestions, including the suggestion that the entire dissertation should be edited again before being submitted for publication by an academic publisher. I had never thought about doing that, but about eighteen months later it was published by the University of Utah Press and would become one of their best-sellers. I went on to write many articles on this subject, both academic and popular.
- ACADEMIC CAREER All this time I was the editor or coeditor of the Austrian Economics Newsletter under the stewardship of Murray Rothbard. He emphasized to me that the publication should emphasize things that were controversial within Austrian ranks and not Austrian economics compromised by mainstream economics and that the publication was rapidly losing its comparative advantage in the presentation of news about Austrian economics.
He also prodded me to write on the economics of antebellum slavery after I took the Austrian stance in an impromptu debate with Robert Higgs at a Mises University conference in which Higgs took the Fogel and Engerman view that capitalism kept slavery profitable, during a question-and-answer session. This resulted in me supervising a master’s thesis and dissertation and publishing several academic journal articles in which my coauthors and I showed that it was government intervention that kept slavery economically viable, not capitalism per se.
Reading books about the Civil War had been a hobby of mine, and I included a footnote in my dissertation that the Union blockade was like the War on Drugs in that it radically changed the type of goods that were smuggled. That suggestion would ultimately lead to several academic articles and a book published with Robert B. Ekelund Jr. We showed that the intervention in the economy by the Confederate government was the reason they lost the war.
In the interest of time and space, I will just mention that I have been writing about Richard Cantillon, the first economic theorist and a proto-Austrian (Deist 2019), for over twenty years, including doing a modern retranslation of his Essay with Chantel Saucier. I have also written many articles on how Austrian economists have done much better than mainstream economics at predicting economic crises and articles on the skyscraper curse, which culminated in the publication of a book in 2018 that predicted an economic crisis in 2020.
- CONCLUSION When you see the lowly beginnings of libertarianism in America, with the Austrian school of economics on the brink of extinction, it is hard to believe how much progress has been made. The progress has occurred around the globe. I had never heard the word libertarian until I was an adult, and my discovery of the word led me to discover the Austrian school, which was otherwise not in my college curriculum.
Having the good fortune to graduate from college during the depression of 1982, I moved to Auburn, Alabama, which, in addition to the scholars already mentioned, led me to scholars such as Randy Beard, Don Bellante, Mark Jackson, Bob Hébert, Randy Holcombe, Dave Laband, Dave Kaserman, John Sophocleus, Bob Tollison, and many more. Then, with the arrival of the Mises Institute, I was exposed to several Nobel Prize winners and most of the prominent people in the Austrian school, including especially my colleague Joe Salerno—not to mention all the great students I have had the pleasure of mentoring. These people have taught me the value of practical solutions to social problems and the importance of solving social puzzles. These solutions not only help people, they demonstrate the power of good economics and the free market.
Based on my experience in political campaigns, which are seemingly the most direct path to liberty, I think most of them are of limited value, with the important exception of dealing directly with the general public and engaging in the battle of ideas, especially Ron Paul’s campaigns. At some point in the future, possibly the near future, such engagements will bear fruit.
Walter Block is a giant in the libertarian movement. He explains how he discovered this philosophy and why it will be difficult to advance liberty.
Mentioned in the Episode and Other Links of Interest: The YouTube version of this interviewWalter’s (co-authored) 2019 article on sociobiology and libertyWalter’s book Defending the Undefendable For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on Apple Podcasts, Stitcher, Spotify, and via RSS.
Listed below is information on accommodations, shuttle between airports and Auburn, and links to the readings that all students must complete before attending Mises University.
All materials are available on Mises.org free of charge, and most readings are available in multiple formats (e.g., PDF, ePub, HTML, audio).
Required Reading Anatomy of the State by Murray N. Rothbard
The Philosophical Origins of Austrian Economics by David Gordon
Praxeology and Understanding by George A. Selgin
Profit and Loss by Ludwig von Mises
I, Pencil by Leonard Read
What Has Government Done to Our Money? by Murray N. Rothbard, pp. 1-87
From The Austrian Theory of the Trade Cycle and Other Essays, edited by Richard M. Ebeling:
"Introduction: The Austrian Theory in Perspective" by Roger W. Garrison, pp. 7-35"Economic Depressions: Their Cause and Cure" by Murray N. Rothbard, pp. 65-91"Can We Still Avoid Inflation?" Friedrich A. Hayek, pp. 93-120 From Economics in One Lesson by Henry Hazlitt:
"The Lesson," pp. 3-7"The Broken Window," pp. 11-16 From Economic Freedom and Interventionism by Ludwig von Mises
"The Elite Under Capitalism""The Individual in Society" From An Introduction to Austrian Economics by Thomas C. Taylor:
"Introduction," pp. 7-21"The Subjective Theory of Value," pp. 40-62 From Planning for Freedom by Ludwig von Mises:
"Planning for Freedom," pp. 1-17"Middle of the Road Policy Leads to Socialism," pp. 18-35 "Fundamentals of Value and Price" by Murray N. Rothbard (in The Rothbard Reader, pp. 89-126)
"Economic Calculation" by Ludwig von Mises (in Socialism: An Economic and Sociological Analysis, pp. 113-122)
"The Meaning of Competition" by F. A. Hayek
Optional Reading Penthouse Interviews Murray Rothbard
Final Exam Mündliche Prüfung is an optional exam for students who would like to have their knowledge tested at the end of the conference. The exam is open only to students. Preliminary written testing on Thursday determines who is qualified to take the final exam on Saturday. Questions consist of general knowledge learned from required readings and plenary lectures. Results of the preliminary testing will be posted on the bulletin board in the outdoor dining area by Friday morning. If you pass the preliminary exam, you will then email a list of classes you attended or will attend this week (not including plenary sessions) to felicia@mises.org by Friday at 4:00 p.m. On Saturday, a faculty jury will engage each of the preliminary passing examinees in a 10-minute question-and-answer session based on the readings and lectures each has attended. At graduation, those who pass the oral exams will receive a graded certificate. Each faculty panel will select two students as the leading candidates from its examinations. These six finalists will then undergo a deeper examination by the entire faculty. The third and second highest scorers will receive the Kenneth Garschina Prize of $1,500 and $750 respectively. The student who emerges from the oral examinations (the Mündliche Prüfung) with the best record, as chosen by the examining committee, will be awarded the Douglas E. French Scholarship Prize of $2,500.
Accommodations, Airport Shuttle, Meals, Attire, Directions, and More Students Scholarships: Student scholarships include all sessions, refreshment breaks, social hours, and meals beginning with dinner on Sunday, July 24 and ending with dinner on Saturday, July 30, and accommodations at Auburn University Hotel with arrival Sunday July 24 and departure Sunday July 31.
Conference Registration: Registration will be at the Mises Institute, 518 W Magnolia Avenue in Auburn on Sunday, July 24 anytime between 5:00 - 7:00 p.m. central time. Registration is a very quick process of picking up your name tag. The Massey and Ward Libraries of the Mises Institute will be open for research and browsing at 4:00 p.m. on Sunday, July 24. The Institute is within walking distance of the hotel, less than a mile. The conference closes with dinner and an awards ceremony late afternoon on Saturday, July 30. Most people will depart the hotel Sunday, July 31. If you are a finalist in the optional Mises U exam, you must be present at the closing dinner to accept your award. (See Awards section.)
Attire: Sunday and Saturday are casual attire (no tank tops, short-shorts, etc. Jeans, walking shorts, and nice t-shirts are fine). Monday-Friday is business casual. The weather will be very hot and humid, but we highly recommend you bring a light jacket as the air conditioning in the classrooms can be very cool. For the group photo on Tuesday, please wear a collared shirt if possible—like a golf shirt or similar, with no large logos on it. Be sure to bring an umbrella or rain jacket!
Parking and Directions: Driving directions to the Mises Institute are here. Auburn University Hotel is located at 241 S College Street in Auburn. Restaurants and general Auburn area info is here. The Tiger Transit bus line that may be useful is here. The parking lot of the hotel is under construction, but there is free parking across the street in the Auburn University parking deck. Parking is free at the Mises Institute, but limited. There will be printed schedules at the hotel when you arrive, with walking directions as well as shuttle times from the hotel to the Mises Institute.
Airport and Shuttles: Most people coming to Auburn fly into the Atlanta, Georgia airport. Students are responsible for making and paying for reservations between Auburn and the airport. Groome Transportation provides shuttle service only from Atlanta airport. Tiger Taxi Shuttles can be reserved from Atlanta, Birmingham, Montgomery, or Columbus, Georgia airports to Auburn. Your drop off and pick up location will be Auburn University Hotel and Conference Center, 241 S College Street. Atlanta airport is on eastern time, one hour ahead of Auburn, which is on central time. The trip from Atlanta to Auburn takes about 1 hour and 45 minutes.
Mises Bookstore: Titles for sale at Mises.org/Store will be available for purchase during the conference. Faculty will be happy to autograph their books. Please ask the cashier about student discounts on certain titles.
Visiting Scholars Manual: Attendance at Mises University indicates your acceptance of the terms outlined in the Mises Institute Visiting Scholars Manual.
Dietary Restrictions: Please email our event coordinator Rachael Barefield (rachael@mises.org), before July 6 to reserve vegetarian or gluten free meals (the only alternative dietary options).
Guests: Only scholarship students may attend Mises U sessions, meals, and social hours. Exceptions are pre-approved guests of Faculty to attend the final dinner Saturday night.
Other Info: You are welcome to receive mail at the Institute to your attention: Mises Institute, 518 W Magnolia Avenue, Auburn, Alabama 36832. The packages will be held for you at the Mises front desk. International calling cards can be purchased at the front desk of the Institute for long-distance calls on telephones at the Institute. There are a number of computers and printers at the Institute for your use in research and to check email. You are welcome to bring your laptop as there is complimentary wireless access throughout the building. International students should bring a converter for 110 V.
Questions: Please contact Felicia Jones (felicia@mises.org).
Professor Jonathan Newman joins the show for a look at America's Great Depression, Rothbard's classic explanation of a terrible period in US history. This book provides one of the best short surveys of Austrian business cycle theory, along with deep history surrounding the inflationary run-up of the 1920s and the disastrous mistakes made by the "laissez-faire" Hoover administration in the 1930s. Any serious student of booms and busts needs to read this cautionary tale, as does anyone worried about unconstrained monetary policy in the wake of Covid-19 lockdowns. It can happen here, and it can happen again, if Rothbard's counsel goes unheard.
Find the online version of the book at Mises.org/GreatDepression Receive a discount on America's Great Depression in the Mises Bookstore with code HAPOD15%
Professor Janek Wasserman's book The Marginal Revolutionaries: How Austrian Economists Fought the War of Ideas, is an entertaining and fascinating account of key players and events in the evolution of Austrian school economics. Jeff Deist details the good, bad, and ugly of the book, written by a left-progressive historian from a critical perspective.
Read Jeff Deist's review at Mises.org/DeistWasserman
Read David Gordon's review at Mises.org/GordonWasserman
Find Hülsmann's biography of Mises at Mises.org/LastKnight
Read Mises on the history of the Austrian school at Mises.org/MisesHistory
Abstract: This article develops a typology for making sense of the numerous strands of Austrian (and Austrian-related) economics and demonstrates how this typology can guide organizational entrepreneurship scholars wishing to ground their research in Austrian thought. In the process, not only are existing insights from the history of Austrian economic thought rediscovered, but clearer light is also shed on important perspectives from that tradition that have received less attention in entrepreneurship research. Based on the Austrian concept of entrepreneurial production and its relationship with the core concepts of knowledge and change, the typology yields four perspectives—equilibration, punctuated equilibrium, disequilibration, and punctuated disequilibrium. These perspectives’ different paradigms as used in organizational research are explored, along with their ontological, epistemological, and methodological assumptions. The typology is illustrated with selected empirical examples from organizational research to spotlight the types of questions that contemporary scholars may appropriately ask and answer from each perspective.
JEL Classification: B53, D24, D50, D81, L26, M10 Sara R. S. T. A. Elias (selias@uvic.ca) is an assistant professor of entrepreneurship at the University of Victoria’s Peter B. Gustavson School of Business and a research associate of the Center for Psychosocial Organization Studies.
Todd H. Chiles (chilest@missouri.edu) is a senior research fellow at the Center for the Study of Complexity, Creation and Change and an emeritus professor at the University of Missouri’s Trulaske College of Business.
Qian Li (qian.li.5@cass.city.ac.uk) is a PhD candidate at the Cass Business School, City, University of London.
Fernando A. Monteiro C. D’Andrea (fernando.dandrea@okstate.edu) is a PhD student in entrepreneurship at the Spears School of Business, Oklahoma State University.
The authors thank Joseph T. Salerno and two anonymous reviewers who helped them sharpen their thinking and refine their arguments, as well as the special issue guest editor, Per Bylund, for his encouragement and thoughtful guidance throughout the review process.
INTRODUCTION Austrian economics, which will celebrate its sesquicentennial in 2021, has long had a seat at the table of the history of economic ideas (Ekelund and Hébert 2014), and its proponents have played a particularly important role in building the economic foundations of entrepreneurship (Hébert and Link 2006). More recently, it has become a central pillar of organizational entrepreneurship research, featured in theoretical (Cheah 1990; Chiles, Tuggle, et al. 2010; Dew, Velamuri, and Venkataraman 2004; Mathews 2010; McMullen and Shepherd 2006), empirical (Chiles, Meyer, and Hench 2004; Chiles et al. 2013; Dean and Meyer 1996; Dolmans et al. 2014; Keyhani and Lévesque 2016; Shane 1996 2000), and programmatic (Chiles, Bluedorn, and Gupta 2007; Chiles, Vultee, et al. 2010; Foss and Klein 2012; Shane and Venkataraman 2000) work. As a school of economic thought to which many have contributed over a century and a half, Austrian economics is not a monolithic bloc; rather, it comprises a number of distinct strands or perspectives (McMullen and Shepherd 2006)—each with a unique ability to help scholars understand certain phenomena. Many organizational entrepreneurship scholars, however, appear to be unaware of this intellectual heterogeneity, leading some to unwittingly commingle concepts from different perspectives, unknowingly shoehorn ideas from one perspective into another, or simply ignore other perspectives altogether (Chiles, Bluedorn, and Gupta 2007). Consequently, the organizational entrepreneurship literature that draws from the Austrian tradition often contains inconsistencies and gaps.
This article takes a step toward addressing these problems by developing a typology that builds on Chiles, Vultee, et al. (2010) to make sense of the numerous strands of Austrian and Austrian-related economics, with a particular focus not on how the Austrian literature itself has developed, but on how it has inspired organizational research. Consistent with the wider organization studies literature, this article takes a broad view of Austrian economics to include not only its core thinkers (F. A. Hayek, Israel M. Kirzner, Ludwig M. Lachmann, Carl Menger, Ludwig von Mises, Murray N. Rothbard), but also closely related scholars such as Joseph A. SchumpeterAlthough few (perhaps no) Austrian economists would count Schumpeter among their ranks, most organizational scholars would. Indeed, organizational scholars tend to see Schumpeter as “the preeminent Austrian economist” (see Chiles, Bluedorn, and Gupta 2007, 488). This view of Schumpeter as an Austrian economist probably obtains from his close ties to the Austrian school (e.g., Böhm-Bawerk supervised his dissertation, Wieser had a significant intellectual influence on him and vice versa; see Powell, Rahman, and Starbuck 2010) and his pursuit of Austrian themes (Vaughn 1994). For more on Schumpeter and his relationship to Austrian economics, see Ekelund and Hébert (2014), who cover Schumpeter in their chapter on “Austrian Economics.” and G.L.S. Shackle.Shackle studied Austrian economics under Hayek and completed his dissertation under his supervision (Harcourt 1981, 139–40), albeit on a Keynesian topic. Consequently, some consider Shackle a post-Keynesian with Austrian school influences. Shackle later explored issues raised by Mises about the fundamentally indeterminate nature of a social science of human action, developed innovative subjectivist theory that engaged Austrian ideas and laid the groundwork for further Austrian research, and served as an ally to Austrian economists interested in radical subjectivism (Vaughn 1994, 75, 104, 118). In a 1978 interview, Lachmann was asked what relationship he saw between Shackle’s work and that of the Austrian school. His response: “I can think of no one more distinguished or important to the fundamental Austrian ideas than Shackle … I regard Shackle as, in fact, an Austrian” (Lachmann 1978). So too have organizational entrepreneurship scholars who draw on Austrian radical subjectivism (Chiles et al. 2013; Chiles, Tuggle, et al., 2010; Chiles, Vultee, et al. 2010; McMullen 2010). Based on the Austrian school’s emphasis on the entrepreneurial organizing of production in service of the consumer, and the relationship between production and the core Austrian concepts of knowledge and change, the typology elaborated here yields four distinct perspectives: two firmly rooted in states of equilibrium (equilibration and punctuated equilibrium)The concept(s) of equilibrium in the Austrian tradition differs substantially from what is commonly seen in mainstream economics—and is usually taken for granted by organizational scholars—either in the general or the partial equilibrium tradition. Unless otherwise noted, the word equilibrium in this paper refers to the Austrian concept of the Wicksteedian state of rest (WSR), which, along with other Austrian ideas, is explained below in the section entitled “Core Concepts in Austrian Economics.” and two that break sharply with the first perspective (disequilibration and punctuated disequilibrium). The goal is to help scholars pursue Austrian-inspired organizational entrepreneurship research in a more mindful and informed manner by providing not only an organizing scheme to make sense of the various strands of Austrian economics, but also a nuanced understanding of how each of those strands maps onto different ontological, epistemological, and methodological assumptions.
This is important because different strands of Austrian economics are undergirded by different philosophical assumptions, which play a powerful role in how we see and study entrepreneurial phenomena (Chiles, Vultee, et al. 2010; McMullen and Shepherd 2006). Indeed, different paradigms are appropriate for understanding particular phenomena and pursuing certain lines of inquiry—and not others (Burrell and Morgan 1979). Thus, the aim is to sensitize organizational entrepreneurship scholars wishing to ground their work in Austrian thought to the importance of the different ontological, epistemological, and methodological assumptions within this school as used in organizational research.
This article goes beyond previous efforts by organizational entrepreneurship scholars to make sense of Austrian ideas. For example, Pittaway (2005) summarized the philosophical assumptions of a wide range of economic approaches to organizational entrepreneurship, including Austrian economics, but treated the Austrian school as a monolith. Jeffery S. McMullen and Dean A. Shepherd (2006) focused on the philosophical assumptions of Frank H. Knight, Kirzner, and Schumpeter but did not develop an overarching typology. Chiles, Vultee, et al. (2010) explored the philosophical and methodological assumptions of neoclassical and Austrian economics approaches to organizational entrepreneurship. Although they distinguished different strands of Austrian thought, they used a single, generic objective-subjective dimension to structure their arguments, an approach criticized by some scholars (Cunliffe 2011). Although drawing inspiration from Chiles, Vultee, et al. (2010), for example, in how the typology’s perspectives were titled, this work, by contrast, builds upon the fundamental Austrian idea of production as guided by the entrepreneur (Lachmann 1976; Mises [1949] 1998; Rothbard [1962, 1970] 2009) and its relationship with the core concepts of knowledge (convergent/divergent) and change (continuous/discontinuous). Further, this work explores different Austrian constructs of equilibrium to understand markets as dynamic, real-world processes, thus providing a more comprehensive view; it does so in order to develop a typology that links each type to the broader philosophical and methodological assumptions of organizational research commonly conducted using that perspective. This typology contributes to the field of organizational entrepreneurship by not only allowing scholars to make sense of a wide range of entrepreneurial phenomena, but also guiding them to the best approach in studying the particular phenomena of interest to them.
In sum, the aim of this work is to provide guidance to organizational entrepreneurship scholars wishing to ground their research in Austrian thought. It does so by first reviewing the core concepts of equilibrium, knowledge, and change within the Austrian school of economics and explaining how these concepts have been used to develop a typology that makes sense of the numerous perspectives within this school. Next, it is shown how the typology’s perspectives are all rooted in different sets of philosophical and methodological assumptions, and why this matters to Austrian-inspired organizational entrepreneurship research. In addition, the typology is illustrated using selected empirical examples drawn from the organization studies literature—all comprising an industry level of analysis—in order to spotlight the types of questions that entrepreneurship scholars can appropriately ask and answer from each perspective. The nature of the entrepreneur and of opportunities is also discussed in relation to each perspective, with the aim of helping organizational entrepreneurship scholars locate and choose the most appropriate perspective for their research efforts. Finally, organizational entrepreneurship researchers are provided with potential research questions that are illustrative of the types of phenomena with which each Austrian perspective is concerned.
A TYPOLOGY FOR CLASSIFYING AUSTRIAN IDEAS IN ORGANIZATIONAL ENTREPRENEURSHIP RESEARCH Typologies allow scholars to order and make sense of phenomena by arranging information into distinct and somewhat homogeneous groups. The categorization of information and patterns is essential to advance social theory and research, because classifying knowledge into homogeneous categories allows us to find differences between phenomena and to, ultimately, understand existing commonalities (Meyer, Tsui, and Hinings 1993). Each of the four quadrants of the typology presented here is rooted in specific philosophical assumptions that correspond to particular insights and ideas in which one can base future research in entrepreneurship. As such, each quadrant provides a focused way for organizational scholars to use an Austrian economics lens to make sense of entrepreneurship phenomena. These four quadrants correspond to three different paradigms, which denote different views of reality (Morgan 1980). Following Robert K. Merton (2004, 267), the term paradigm is used “to refer to exemplars of codified basic and often tacit assumptions, problem sets, key concepts, logic or procedure, and selectively accumulated knowledge that guide inquiry in all scientific fields.” In other words, paradigms are viewed as worldviews rooted in basic sets of beliefs that guide action (Creswell 2007). As Thomas Kuhn (1970) argued, paradigms have both intellectual and social purposes. First, they guide researchers to new definitions and questions about phenomena and, second, they “form structures within which their members can share a sense of purpose and engage in day-to-day practices of collaboration, collegiality, and ‘progress’” (Lindlof and Taylor 2011, 33).
In research, paradigms allow scholars to develop high-quality research designs by providing them with a set of philosophical assumptions regarding “the nature of reality (ontology), how the researcher knows what she or he knows (epistemology), the role of values in the research (axiology), the language of research (rhetoric), and the methods used in the process (methodology)” (Creswell 2007, 16). These philosophical stances shape the phenomena studied, the types of problems and questions posed, the particular approaches to data collection/generation and analysis, as well as the type of language used to describe and disseminate information (Creswell 2007). In this paper, the ontology, epistemology, and methodology of each paradigm are explored as a means to improve clarity regarding—and ultimately provide guidance on—how Austrian economics can be used as a lens to understand entrepreneurship phenomena.
CORE CONCEPTS IN AUSTRIAN ECONOMICS At the essence of the Austrian school of economics is praxeology, a term developed by Mises ([1949] 1998). Praxeology refers to the science of human action, i.e., the conscious actions taken by individuals toward a chosen goal. As such, it “rests on the fundamental axiom that individual human beings act” (Rothbard 1997, 58), with action consisting of the processes by which one selects a particular alternative over another by using specific means to pursue desired ends (Vaughn 1994). Fundamental to an understanding of human action is the notion that an individual’s actions take place over time (Mises [1949] 1998) and that his/her choices are rooted in knowledge that is only known to that individual (Hayek 1945). In the realm of entrepreneurship, Austrian economics treats the individual (i.e., the entrepreneur) as an organizer of production processes (Bylund 2016; Lachmann 1976; see also Mises [1949] 1998; Rothbard [1962, 1970] 2009). It is in production processes subject to unexpected change—which by their nature require individuals to combine and continually recombine resources— that “we find the real function of the entrepreneur” (Lachmann 1956, 13). Consistent with Austrian precepts, such processes take time to play out and are bounded by the entrepreneur’s limited knowledge (or ignorance).
Because Austrian economics places entrepreneurs at the very core of the market process, it is commonly referred to as the economics of time and ignorance (Vaughn 1994, 134)—a term that derives from John Maynard Keynes’s (1964, 155) “dark forces of time and ignorance,” which point out “the importance of the basic problems with which real time confronts individual actors” (O’Driscoll and Rizzo 1996, xiv). Although Keynes was quite far from being an Austrian, as a neoclassical economist he did use subjectivist elements in his economic analyses. The Austrian school of economics is rooted in dynamic subjectivism, as opposed to the static subjectivism of neoclassical economics. Unlike static subjectivism, dynamic subjectivism recognizes creativity and the uncertain nature of human action that unfolds through processes of change (Vaughn 1994). To study this dynamism, Austrian scholars have developed different ways of thinking about equilibrium.
Equilibrium
The Austrian school recognizes the market as a dynamic process that is always in disequilibrium. Thus, contrary to mainstream views, it does not use a single theoretical idea of static equilibrium; rather, it uses different dynamic equilibrium-like constructs to understand and deal with market dynamism. Recent work by Per Bylund (2019) recognizes this flawed use of static equilibrium in Austrian theorizing while problematizing Kirzner. Three of these Austrian equilibrium-like constructs are purely theoretical: (1) The evenly rotating economy, or ERE (Rothbard [1962, 1970] 2009), an imaginary construction where changes in preference and satisfaction are held constant while human action persists but merely as repetitive routine (Packard 2019, 6). (2) The final state of rest, or FSR, toward which all action is “pulled” and where there would be no action because all dissatisfaction would disappear; this state, however, “is constantly changing, as preferences, knowledge, technology, and expectations shift over time” and is thus never reached (Mises [1949] 1998; Packard 2019, 5). (3) The “Nirvana state of rest,” or NSR, in which all action becomes unnecessary because “no future knowledge, technology, or resources can attain a higher state of well-being; all possible improvements (forevermore) have been exploited, and we are at a true optimal state” (Packard 2019, 9). These equilibrium constructs, which are hypothetical, are theoretically similar to the mainstream concept of equilibrium (i.e., absence of new production and lack of change in the subjective valuations of market participants), which is, by definition, static. Austrian ideas about equilibrium, which are rooted in very different underlying assumptions, are fundamentally based on a market process that constantly reaches some kind of temporary equilibrium but that is dynamic in nature. Being hypothetical, these constructs serve only for economic reasoning and thus are not helpful to this discussion.
Two additional equilibrium constructs that appear in Austrian theorizing and that are more closely related to this discussion because they are grounded in the real world are: (1) the plain state of rest, or PSR, and (2) the fully arbitraged state of rest, or Wicksteedian state of rest, WSR (Packard 2019; Salerno 1994). The first state, the PSR, is reached every single time an exchange takes place, when all parties in a transaction momentarily exhaust the possible gains from trade. It is a momentary equilibrium that persists so long as “the prevailing state of valuations of the marginal pairs in each market remain constant” (Salerno 1994, 97–98). It is reached in a given market, at a given time, when all trades have been temporarily satisfied. At that particular time, all buyers and sellers have carried out the transactions that they deemed satisfactory at the current prices, to the point when everyone in the market is satisfied with the current situation and sees no reason to pursue further exchanges (Mises [1949] 1998, 245–251).In some specific empirical cases, there may be a theoretical difference between initial price paid or agreed upon by parties and the actual PSR (two-party market-clearing) price. However, this analysis falls outside the scope of this paper and thus does not affect our argument. The second state, the WSR, is more general; it is based on Wicksteed’s idea of the fruit market, in which the stocks of perishable goods and consumer valuations remain fixed for a given, foreseeable duration. It was reintroduced in Austrian circles by Joseph T. Salerno (1994) as a state between the FSR and the PSR. A WSR is reached “when preferences, supplies, and available parties to trade remain constant over some period of time” (Packard 2019, 6). This state lasts for as long as the prices for all goods in a given market remain stable; “[f]or the rest of the market day, each successive set of transactions takes place at equilibrium prices and thus generates a momentary WSR until the arrival of the next group of buyers on the scene” (Salerno 1994, 100).
Unlike in a PSR, where prices may change moment after moment, in a WSR, the different market criteria are stable enough to keep an equilibrated price and to get rid of arbitrage opportunities for a given period of time in a given place. An example of a situation close to a WSR is supermarket prices, which remain stable even after numerous transactions and end up facilitating exchanges because of price stability. This price stability is the basic idea behind general equilibrium. Figure 1 shows different understandings of equilibrium in terms of Austrian equilibrium constructs, real-world market equilibria, and mainstream equilibrium constructs.
Figure 1. Different Understandings of Equilibrium: Comparisons and Rough Equivalences
Significantly, the equivalences in figure 1 between Austrian and mainstream equilibrium constructs are neither perfect nor possible. The reason for this is that, for example, neoclassical economics does not aim to explain market prices, but rather hypothetical prices (as in full information, Nash equilibrium, perfect competition, etc.). As has been seen, the Austrian approach differs substantially from the neoclassical one in that it seeks to explain real-world prices (Klein 2008; Manish 2014). The aim with figure 1 is simply to facilitate understanding of Austrian ideas by comparing them to real-world market equilibria and mainstream equilibrium constructs.
In short, in discussions of entrepreneurship and production, Austrian economics recognizes two variants of real-world equilibrium—the PSR and WSR. The typology presented here is grounded in the latter, because entrepreneurial action starts at a point close to the WSR, eventually moving markets either closer or farther away from equilibrium. Furthermore, according to proponents of the Austrian school, “economics should be about how humans pursue their projects and plans over time, and with limited knowledge of present conditions and with pervasive uncertainty about the future” (Vaughn 1994, 4; see also Lachmann 1976 and Rothbard [1962, 1970] 2009). Thus, Austrians also recognize that equilibrium situations occur based on two important concepts: ignorance (or limited knowledge of the parts involved) and time (or the passage of time required for production to yield consumer goods—a process that relates to change). Discussed in the next two subsections are the typology’s dimensions—two core concepts that are central to the entrepreneurial organizing of production: knowledge (as convergent or divergent) and change (as continuous or discontinuous).
Knowledge
While neoclassical economists tend to assume perfect and homogeneous knowledge in the processes of decision-making and acting, Austrian economists view knowledge as imperfect, heterogeneous, complex, disaggregated, and dispersed (Vaughn 1994), as well as tacit and local (Hayek 1945). This conception of knowledge lets us understand why for Austrians human action will always result in unintended and uncertain outcomes. Uncertainty is one of the basic tenets of Austrian economics and is also a corollary of ignorance (O’Driscoll and Rizzo 1996). Thus, an understanding of ignorance, or limitation of knowledge, is crucial in Austrian thought.
Hayek, in his seminal paper “The Use of Knowledge in Society,” developed an understanding of knowledge not in terms of general laws, but rather “the particular circumstances of time and place” (Hayek 1945, 521). Later he further broadened understanding of knowledge in economic analyses by characterizing knowledge as “private, empirical, often tacit, not all gained through price signals, and often the source of surprise” (O’Driscoll and Rizzo 1996, 102). Hayek’s characterization of knowledge as tacit was based on Michael Polanyi’s ideas (Gourlay 2006). For Polanyi, knowledge has a fundamental and indispensable tacit component, even so-called scientific knowledge. Indeed, he suggests “that into every act of knowing there enters a passionate contribution of the person knowing what is being known, and that this coefficient is no mere imperfection but a vital component of his knowledge” (Polanyi 1958, viii). Despite Hayek’s attempts to expand our understanding of knowledge, the definition of this concept remains rather vague. For instance, although Hayek (1945) argued that knowledge is a function of the “man on the spot” and that fragmented and tacit knowledge is coordinated through the market process (Gloria-Palermo 1999), he did not make explicit what knowledge actually is. This has provided scholars within the Austrian school with the freedom to develop their interpretations of the concept, as can be seen in the knowledge arguments made by Kirzner, Schumpeter, and Lachmann.
More specifically, Kirzner (2005) distinguishes action knowledge from information knowledge. While action knowledge refers to the knowledge that shapes actions, information knowledge is what allows entrepreneurs to grasp opportunities. As Kirzner (2005, 80) notes, “The one who grasped the opportunity was, presumably through his alertness.” For Kirzner (2005), it is alertness that transfers information knowledge into action knowledge and, given the economic role of advertising and learning, information knowledge tends to be convergent. For Schumpeter, unique and idiosyncratic knowledge arises from technological breakthroughs (Sarkar et al. 2006). Innovation entails new knowledge, which is imitated or modified by the swarm of new market entrants who are incentivized by the monopolistic profits generated by innovators. This eventually results in knowledge, manifested as innovation, moving toward convergence (see Packard and Bylund 2018). Finally, Lachmann’s interpretation of knowledge contrasts starkly with Kirzner’s and Schumpeter’s. Lachmann considers knowledge as both interpretations of past experience and expectations of future action (Gloria-Palermo 1999). As such, knowledge is continually changing because of the “continual interpretation and re-interpretation of experience” and the “continual forming and re-forming of expectations,” which “makes accurate prediction of the future not merely difficult but largely impossible” (Chiles, Bluedorn, and Gupta 2007, 483). Thus, for Lachmann, knowledge is divergent given that the idiosyncratic knowledge possessed by individuals is not easily reconciled and that these individuals have the ability to create, in their minds, divergent expectations of the future.
In short, for some Austrians, such as Hayek and Kirzner, the market process allows for the coordination of fragmented and tacit knowledge (Gloria-Palermo 1999). For others, such as Lachmann, when one incorporates past knowledge and future expectations, which are subjective, the result is knowledge divergence that prevents plan coordination (Chiles, Bluedorn, and Gupta 2007). This shows that within the broad tradition of the Austrian school of economics there are two opposing views of knowledge and how it changes over time. Based on these two opposing views, this article breaks the knowledge dimension down into a convergence-divergence dichotomy, represented horizontally in the typology.
Change
When Austrians acknowledge the temporal dimension of market processes, they implicitly accept the existence of change. Indeed, as shown above, change and knowledge are natural bedfellows in the market process: change can either lead to a convergence or divergence of knowledge. Thus, knowledge is not a static concept, but one that changes over time. Such changes in knowledge are the result of the human experience of time and, ultimately, of learning (Hayek 1945; Vaughn 1994). Change, which is a constant in a world composed of humans acting upon their plans, has been described as either a continuous or discontinuous process. Continuous change, or first-order change, occurs in stable systems that do not suffer abrupt modification. This type of change, as Haridimos Tsoukas and Robert Chia (2002, 567) have argued, is “the reweaving of actors’ webs of beliefs and habits of action to accommodate new experiences obtained through interactions.” Using the metaphor of the acrobat on a high wire, they explain that stability is maintained by continuously correcting one’s imbalance (Tsoukas and Chia 2002). In Austrian economics, this relates to Kirzner’s (1973) view of a world in continuous change directed to a FSR, always coming to different PSRs and moving toward a WSR.
On the other hand, discontinuous change, or second-order change, entails abrupt shifts in the state of the existing system, resulting in the inexistence of equilibrium on the horizon. For instance, Shackle suggests that market processes go through abrupt and unexpected change in what he calls a kaleidic society—one “in which sooner or later unexpected change is bound to upset existing patterns” (Lachmann 1976, 54); this is a society “interspersing its moments or intervals of order, assurance and beauty with sudden disintegration and a cascade into a new pattern” (Shackle 1972, 76). Further, Schumpeter views change as a process of creative destruction in which entrepreneurs create new resource combinations in a discontinuous manner (Schumpeter 1934) and in response to changes in technical knowledge (Schumpeter 1942; Shane 1996). Thus, for authors such as Schumpeter and Shackle, change takes place in a discontinuous manner rather than in a continuous way, as argued by Mises and Kirzner (see D’Andrea and Mazzoni 2019). Based on these two differing views, the change dimension can be broken down into a continuous-discontinuous dichotomy, represented vertically in the typology.
A TYPOLOGY BASED ON KNOWLEDGE AND CHANGE The typology presented in this article illustrates four different perspectives within the Austrian school of economics broadly understood. Although four different perspectives are proposed, only three different paradigms—each with its specific ontological, epistemological, and methodological assumptions—underlie these perspectives. As explained above, ontology refers to the nature of reality, epistemology asks how the researcher knows what s/ he knows, and methodology describes the methods used in the research process (Creswell 2007). The assumptions stemming from each one of the perspectives presented in this typology are based on a combination of insights relating to alternative paradigms guiding research, as suggested by Guba and Lincoln (2005) and Chiles, Vultee, et al. (2010). The names of the perspectives represented in this typology are based on the forces that propel the market process: equilibration, disequilibration, punctuated equilibrium, and punctuated disequilibrium. For example, the convergence of knowledge will tend to generate a convergence of action from both entrepreneurs and consumers and, consequently, a tendency toward equilibrium; conversely, when knowledge is divergent, there will be a tendency toward disequilibrium. Figure 2 depicts the typology, with its two dimensions of knowledge and change and its four perspectives. It includes the major Austrian economists who are associated with— and inspire organizational work within—each perspective, as well as information regarding the type of paradigm, ontology, epistemology, methodology, research exemplar, and entrepreneurship authors specific to each different perspective. Below the typology’s four perspectives are explained in greater depth.
Figure 2. A Typology of Four Austrian Perspectives for Entrepreneurship Research: Key Austrian Economists, Paradigm, Ontology, Epistemology, Methodology, Empirical Examples, and Entrepreneurship Authors
Equilibration
In this perspective, the entrepreneur is described as an equilibrator who drives the market process “towards the hypothetical state of equilibrium” (Kirzner 2009, 145), the FSR or the ERE, as explained above. In fact, entrepreneurs and their decisions and actions are viewed as playing a critical role in equilibrating market movements. As such, entrepreneurship is about how entrepreneurs’ decisions disturb the existing market order—a process that emerges from entrepreneurs’ alertness (Kirzner 2009)—and drive the market closer and closer to the ERE. Thus, driving the market process are alert entrepreneurs who continually discover preexisting opportunities according to “their subjective interpretation of past experience” (Chiles, Vultee, et al. 2010, 140)—opportunities that exist “out there” and that are merely “waiting to be noticed” (Kirzner 1973, 74). As a result of the exploitation of these opportunities and the forces of equilibration (Kirzner 1997), markets have a general and natural tendency to gravitate toward a state of equilibrium (Chiles, Bluedorn, and Gupta 2007). However, this state is never reached, as this would entail the unrealistic case of having no opportunities and no competition (Kirzner 1973 1997). Instead, the WSR keeps changing moment after moment for the various economic goods in the different geographical markets. Thus, in the equilibration perspective, entrepreneurs continually discover preexisting opportunities that they then exploit, allowing them to “correct market inefficiencies” and “coordinate dispersed knowledge” (Chiles, Vultee, et al. 2010, 142), driving markets closer and closer to the WSR. This perspective is characterized by continuous change and convergent knowledge. Key Austrian economists taking an equilibration perspective include Böhm-Bawerk, Hayek, Kirzner, Menger, Mises, Rothbard and Wieser.
The equilibration perspective is rooted in a postpositivist paradigm. Significantly, although Austrian economics uses axioms and logical deduction, it does not embrace postpositivism to generate theoretical insights. Yet organizational work that draws from equilibration’s key Austrian thinkers is generally grounded in this paradigm, thus taking a scientific approach to research; as such, it tends to be reductionist, logical, deterministically based on a priori theories, with an emphasis on data collection and cause-effect oriented (see Creswell 2007). In practice, postpositivist scholars pursue research in a series of logically related steps by using rigorous methods of data collection and analysis while allowing for multiple levels of data analysis and using validation approaches. Additionally, they do not believe in a single reality; rather, they are on the lookout for participants’ multiple perspectives (Creswell 2007). Specifically, entrepreneurship research based on a postpositivist paradigm is characterized by a realist ontology, relating to fairly objectivist philosophical assumptions (Chiles, Vultee, et al. 2010); a modified dualist/objectivist epistemology, in which findings are considered to be probably true (Guba and Lincoln 2005); and a mostly quantitative/statistical/variance methodology, although it may include some qualitative methods (Chiles, Vultee, et al. 2010; Guba and Lincoln 2005).
An example of an empirical study taking an equilibration perspective is Asaba and Lieberman (1999). In their study of the Japanese soft drink industry, the authors explore the underlying causes and mechanisms relating to increased behavior similarity among competing firms. In the Japanese soft drink industry, new products are quickly followed by imitations from competitors. This mimicking behavior leads to increased behavior similarity and to markets gravitating toward a state of equilibrium. Another example consistent with the equilibration perspective is Meyer, Brooks, and Goes (1990, 98) during the period of “The 1960s: Evolution Via Institutional Isomorphism.” In their historical analysis of the San Francisco Bay area hospital industry, the authors found that during the 1960s this industry was characterized by incremental, or continuous, change resulting in the homogenization of the industry. Other works that fall within the equilibration perspective include Shane (Shane 2000, 2012), Shane and Venkataraman (2000), Dew, Velamuri, and Venkataraman (2004), McMullen and Shepherd (2006), Kor, Mahoney, and Michael (2007), Loasby (2007), Harper and Endres (2010), and Valliere (2013).
Punctuated Equilibrium
Schumpeter, with his notion of creative destruction, is the key economist taking a punctuated equilibrium perspective. Creative destruction refers to a dynamic process in which new entrants introduce superior new technologies to the market, making existing technologies obsolete and forcing incumbents to exit the market (Pe’er and Vertinsky 2008). The monopolistic profits that new entrants may realize serve as an incentive for innovation, attracting more players to the market; in turn, this results in economic rents eventually being competed away and in the market returning to equilibrium until another innovation occurs (Packard and Bylund 2018; Schumpeter 1934). This process comprises two distinctive features. First, innovation results in markets shifting through brief and violent upheavals from one equilibrium state to another (Chiles, Vultee, et al. 2010), suggesting the occurrence of discontinuous change. Second, a new wave of entrepreneurs is able to enter the market and compete rents away, implying that innovative technology and knowledge are ultimately shared and coordinated through the market process (McMullen and Shepherd 2006). For these reasons, the punctuated equilibrium perspective is characterized by discontinuous change and convergent knowledge. Importantly, this is a theoretical construction; in practice, Schumpeterian shocks spread to the market through the production process and could take a relatively long time to do so. Before the shock, the market tends toward equilibrium and is approaching a WSR; when the shock arrives, it profoundly modifies the capital structure (i.e., capital and prices will be reallocated and readjusted as in Lachmann 1976; Rothbard [1962, 1970] 2009) and the formerly existing foreseeable WSR gives way to a completely different WSR. As such, the shock diverts the WSR somewhere very different from where it was thought to be going before. Although not using the terms equilibration and punctuated equilibrium, previous work has demonstrated that in real-world markets both perspectives are necessary to economic development and that they tend to coexist (e.g., D’Andrea and Mazzoni 2019; Packard and Bylund 2018). This helps explain why in this typology some entrepreneurship work appears in both the equilibration and punctuated equilibrium perspectives.
Organizational research conducted within this perspective is often rooted in a critical realist paradigm. Critical realists believe that there is a world that exists independently of human consciousness, with knowledge about this world of events being socially constructed (Denzin and Lincoln 2005). Furthermore, critical realists are interested in not only explaining but also changing the world. To that end, they seek to identify, reflect on, and change the structures underlying human action (Alvesson and Sköldberg 2009). In regard to entrepreneurship, this means that the entrepreneur can actively respond to and shape the world (Chiles, Vultee, et al. 2010)—a perspective that is characterized by a realist ontology grounded in a “real” reality that one can only apprehend in an imperfect and probabilistic manner (Chiles, Vultee, et al. 2010; Guba and Lincoln 2005). Additionally, this paradigm is typified by a modified dualist/objectivist epistemology in which findings are considered to be probably true (Guba and Lincoln 2005) and by a mostly quantitative/statistical/variance methodology, although it may include some qualitative methods (Chiles, Vultee, et al. 2010; Guba and Lincoln 2005). Although the critical realist paradigm appears to be similar to the postpositivist paradigm, it is important to note that the latter is characterized as more objectivist than the former (Chiles, Vultee, et al. 2010).
Anderson and Tushman’s (1990) longitudinal study of the U.S. cement, glass, and minicomputer industries is consistent with the perspective of punctuated equilibrium. Not only do the authors mention Schumpeter in their opening paragraph, they also frame their study in a way that is consistent with Schumpeter’s view of change. Particularly, the authors “empirically explore when and how dominant designs emerge from technological discontinuities” (Anderson and Tushman 1990, 604) to illustrate that technological discontinuities, or disrupting innovations, trigger periods of upheaval that are followed by a period of order, which in turn is disrupted by a new technological discontinuity. Another empirical example is Meyer, Brooks, and Goes’s (1990, 101) discussion of the period of “The 1980s: Industry Revolution.” In their historical analysis of the San Francisco Bay area hospital industry, the authors found that, during the 1980s, this industry was characterized by discontinuous changes leading to restructuration, reconstitution, and adaptation. Lastly, other entrepreneurship works that fall within the punctuated equilibrium perspective include Guth and Ginsberg (1990), Shane (1996, 2012), Shane and Venkataraman (2000), Dew, Velamuri, and Venkataraman (2004), Venkataraman (2004), McMullen and Shepherd (2006), Kor, Mahoney, and Michael (2007), Loasby (2007), and Valliere (2013).
Disequilibration and Punctuated Disequilibrium
Lachmann and Shackle are the key economists of disequilibration and punctuated disequilibrium, respectively. Their assumptions are similar in that their view of the world is rooted in the same paradigm. For this reason, they are often grouped under the “Lachmann-Shackle position.” As Walter E. Grinder (1977, 20) explains,
The Lachmann-Shackle position that forces of divergence tend to outweigh forces of convergence makes a general market equilibrium unlikely. According to Lachmann, the strength of the forces of convergence depends almost entirely on the activities of entrepreneurs. If entrepreneurs take advantage of the price-cost discrepancies attending changing circumstances, the entrepreneurial function of using resources in search of profit (the process of innovation and imitation) will, as most Austrian economists agree, lead to a convergence of the plans of individuals in markets. However, because change is ever present and unpredictable, individuals have different expectations about the character and extent of change. It is this factor more than any other that precludes anything approaching a macroeconomic general equilibrium in the uncertain world of market activity.
The Lachmann-Shackle position is rooted in radical subjectivism—an approach that recognizes entrepreneurs’ divergent interpretations of complex phenomena and, thus, their divergent knowledge. In this disequilibrium-based approach, divergent knowledge eventually results in increasingly heterogeneous markets as entrepreneurs’ plans and actions collide, forcing them to revise and change their subjective future expectations and knowledge (Chiles, Vultee, et al. 2010). Although Lachmann and Shackle have a similar take on knowledge divergence, they do differ in their approach to change. In disequilibration, change in the market process has a continuous nature. For instance, Lachmann is known for advocating disequilibrium processes in a world of continuous change and reorganization (Harper and Endres 2010; Lachmann 1956).Lachmann acknowledged the operation of both equilibrating and disequilibrating forces in market processes (see, e.g., Lachmann 1986). His early work in capital theory gave the distinct impression that equilibrating forces dominated (Barbieri 2017; Lewin 1997), while his later work, which was more radically subjective, emphasized or at least logically implied the dominance of disequilibrating forces Barbieri (2017) dubs this evolution of Lachmann’s thought Lachmann I and Lachmann II, respectively. Our placement of, and emphasis on, Lachmann in the disequilibration quadrant of the proposed typology accords with Lachmann II. Although organizational entrepreneurship scholars pursuing Austrian radical subjectivism have embraced this Lachmann II interpretation (Chiles, Vultee, et al., 2010), they have also observed in Lachmann’s later work “a two-stage process, in which early market equilibration, attributable to close imitation of innovators’ products, eventually yields to market disequilibration, attributable to secondary innovations that differentiate rivals’ products” (Chiles, Vultee, et al., 2010, 159).(Barbieri 2017; Boehm et al. 2000; Chiles, Vultee, et al., 2010; Lewin 2001, 2007). In punctuated disequilibrium, market processes change in a kaleidic manner; that is, markets shift, or change, abruptly from one disequilibrium phase to another (Chiles, Vultee, et al. 2010; Shackle 1967). Thus, while the disequilibration perspective involves continuous change and divergent knowledge, the punctuated disequilibrium perspective entails discontinuous change and divergent knowledge. Furthermore, in both disequilibration and punctuated disequilibrium entrepreneurial actions drive the market away from the WSR; however, in punctuated disequilibrium this process occurs in abrupt punctuations. Reminiscent of Schumpeterian shocks, an action or event, or a set of actions and events, abruptly punctuates the disequilibrium market, kaleidically shifting it from one disequilibrium phase to another.
Organizational research conducted within the disequilibration and punctuated disequilibrium perspectives is often grounded in a social constructivist/interpretivist view of the world—i.e., they are both rooted in the same paradigm. In this paradigm, researchers search for an understanding of the world surrounding them by gathering subjective and intersubjective meanings of experience (Creswell 2007; Morgan 1980). Such meanings are thus complex, multiple, and varied (Creswell 2007). Indeed, researchers may even find that different individuals will have different perspectives of phenomena, leading to evidence of multiple realities (Creswell 2007; Morgan 1980). The term social constructivism refers to the idea that meanings are formed by interacting with others (Creswell 2007). In practice, social constructivist/interpretivist researchers ask general and broad questions that lead participants to build the meaning of phenomena through discussions or interactions with others. This allows researchers to address ongoing and dynamic processes of social interaction while focusing on context to understand the cultural and historical settings of participants and phenomena (Creswell 2007). Additionally, social constructivists/ interpretivists recognize that their own historical, personal, and cultural experiences shape their interpretations. Thus, the goal of these researchers is to make sense of, or interpret, the meanings the world has to different individuals based on their own backgrounds (Creswell 2007; Morgan 1980). This is why social constructivism and interpretivism are often combined (Creswell 2007).
Entrepreneurship research based on a social constructivist/interpretivist paradigm is characterized by a relativist ontology (Chiles, Vultee, et al. 2010), referring to “local and specific co-constructed realities” (Guba and Lincoln 2005, 195); a transactional/subjectivist epistemology, meaning that findings are co-created; and a process/ hermeneutical/dialectical methodology (Chiles, Vultee, et al. 2010; Guba and Lincoln 2005). Scholars taking a social constructivist/ interpretivist approach attempt to preserve the interpretations of those under study as well as their own, even if they are different or contradictory. This may lead to different perspectives, or multiple realities, which paves the way for a holistic understanding of the phenomenon under study (Stake 1995).
A research example that is consistent with the disequilibration perspective of Austrian economics is Hambrick et al. (2005). In their empirical study of the U.S. steel industry, the authors challenge the traditional view of institutional theory as argued by DiMaggio and Powell (1983) by suggesting that organizations do not become increasingly similar over time due to isomorphic pressures. Rather, they become less similar due to several macrosocial trends that the original authors did not anticipate (Hambrick et al. 2005). The way these authors frame their study is consistent with a disequilibration perspective, in which continuous change throughout time results in knowledge divergence and, consequently, a movement away from the WSR. Moreover, diversity is an indicator of disequilibrium (e.g., Kirzner 1973); thus, increasing diversity is an indicator of disequilibration. Another empirical example taking a disequilibration perspective is Meyer, Brooks, and Goes’s (1990, 100) discussion of the period of “The 1970s: Organizational Adaptation.” In their historical analysis of the San Francisco Bay area hospital industry, the authors found that during that period this industry was primarily characterized by incremental change and adaptation in different directions, leading to increasing interorganizational diversity. Lastly, other work in entrepreneurship that falls within the disequilibration perspective of the typology includes Dew, Velamuri, and Venkataraman (2004), Greenwood and Suddaby (2006), Chiles, Bluedorn, and Gupta (2007), Loasby (2007), Foss and Ishikawa (2007), Kor, Mahoney, and Michael (2007), Chiles, Tuggle, et al. (2010), Harper and Endres (2010), Mathews (2010), and Dolmans et al. (2014).
Chiles, Meyer, and Hench (2004) is an example of research that is consistent with the punctuated disequilibrium perspective. Their study of the musical theaters of Branson, Missouri, found that new organizational collectives evolve in a perpetual state of disequilibrium through an extended series of punctuation events, each of which ushers in a new disequilibrium phase qualitatively different from the one before. Such findings, the authors argued, “support a ‘punctuated disequilibrium’ view of change” (514, emphasis in original). Another empirical example of the same perspective is Chiles, Vultee, et al. (2010). Analyzing the Japanese beer industry, the authors concluded that this industry is characterized by disequilibrium market processes, continual disruption, and increasing heterogeneity. The authors’ analysis also provides an illustration of one methodological approach (hermeneutics; see Lachmann 1991) that can be used to study entrepreneurial phenomena from a radical subjectivist perspective. Lastly, other work in entrepreneurship that falls within the punctuated disequilibrium perspective of the typology include Chiles, Tuggle, et al. (2010) and Chiles et al. (2013).
FUTURE RESEARCH USING THE TYPOLOGY Keeping in mind the broad philosophical assumptions relating to each of the typology’s perspectives, let us now take a closer look at the different accounts of the nature of the entrepreneur and the nature of opportunities by the major Austrian economists within each perspective (see figure 3 for a summary). An overview of these is provided next as a basis for developing possible research questions (shown in figure 4) that scholars may find of interest in future research and that are appropriate for each perspective. Because this work is building on the work of Chiles, Vultee, et al. (2010), some of the research questions developed by these authors have been included intentionally, appropriately placed and organized within the typology’s four perspectives.
Figure 3. A Typology of Four Austrian Perspectives for Entrepreneurship Research: The Nature of the Entrepreneur and Opportunities
Figure 4. A Typology of Four Austrian Perspectives for Entrepreneurship Research: Potential Research Questions
Equilibration
Scholars taking an equilibration perspective view the entrepreneur as an imaginative and bold individual who is alert to opportunities (Kirzner 1997). By discovering and taking advantage of opportunities, the entrepreneur drives the market toward equilibrium, reducing Hayekian problems of dispersed knowledge through the coordination of diverse plans (Jakee and Spong 2003). In this perspective, as time passes, the WSR nears and nears in the various markets. Scholars using an equilibration perspective view the entrepreneur as an arbitrageur/middleman who buys or sells hoping to make a profit; thus s/he is someone who need not be a producer or an innovator, or even own capital (Foss and Klein 2010; Rothbard [1962, 1970] 2009). Lastly, the entrepreneur is an agent of change who profits by taking advantage of opportunities while acting in the interest of the consumer (Mises [1949] 1998). Austrian economists within the equilibration perspective view opportunities as preexistent in the market and as waiting to be discovered. Entrepreneurs discover such opportunities based on their own interpretations of past experiences (see Chiles, Vultee, et al. 2010).
Taking into consideration the aforementioned assumptions and information regarding the nature of change, knowledge, opportunities, and the entrepreneur, scholars wishing to pursue research using an equilibration perspective may consider asking questions such as (1) How do entrepreneurs continually discover existing opportunities?, (2) How do entrepreneurs continually correct market errors (due to market ignorance and dispersed knowledge)?, and (3) How do entrepreneurs ultimately drive markets from a disequilibrium state toward the WSR?
Punctuated Equilibrium
Proponents of this perspective view the entrepreneur as an innovator who disrupts business routines and market equilibria through opportunity exploitation (Jakee and Spong 2003). As such, the entrepreneur is not passive—s/he creates a world that is different from the one s/he finds—meaning that the entrepreneur is, in fact, a “creator” (Foss and Klein 2020; Kirzner 2009). However, it is important to note that although the entrepreneur is a creator and an innovator, s/he does not necessarily need to be an inventor or a capitalist (Schumpeter 1934). Additionally, the entrepreneur is different from a manager in that while managers perform routine activities, entrepreneurs rely less on tradition. In fact, entrepreneurs break with the old to create something new—a process known as creative destruction (Schumpeter 1934). Entrepreneurs exploit preexisting opportunities that are widely known and that are a result of scientists’ inventions (Chiles, Vultee, et al. 2010). In order to exploit such opportunities, entrepreneurs periodically carry out new resource combinations through their will and action (Bylund 2016; Foss and Klein 2012; Schumpeter 1934). This results in markets evolving “from one long period of equilibrium through brief upheaval to another such equilibrium” (Chiles, Vultee, et al. 2010, 140). From an Austrian equilibrium perspective, such entrepreneurial actions interrupt the path toward a WSR, thus suggesting a different, much more distant WSR toward which markets will tend once the rearrangement of production processes starts.
Taking into consideration the aforementioned assumptions and information regarding the nature of change, knowledge, opportunities, and the entrepreneur, scholars wishing to pursue research using a punctuated equilibrium perspective may consider asking questions such as (1) How do entrepreneurs disrupt markets, driving them from one equilibrium state to another?, (2) How do entrepreneurs combine existing resources in novel ways that allow them to exploit new opportunities resulting from technological change?, and (3) How do entrepreneurs take advantage of the inexistence of direct competition that follows the introduction of disruptive innovations?
Disequilibration
Scholars taking a disequilibration perspective view entrepreneurs as capable of reducing chaos to order through their creative intelligence (Harper and Endres 2010). In a world of continuous change, entrepreneurs act because they “prefer to anticipate tomorrow’s changes today rather than adjust themselves to those recorded in the latest message received” (Lachmann 1956, 22). They do so by forming combinations of heterogeneous capital resources in their plans and regrouping resources when their plans are revised, a process that ultimately has a disequilibrating effect on the market. Overall, the function of the entrepreneur is to address a world of unexpected change, as well as “to turn failure into success and to benefit from the discomfiture of others” (Lachmann 1956, 18). Opportunities are created and continually recreated through entrepreneurs’ creative imaginations, and they are realized through the combination and continuous recombination of capital resources (Chiles et al. 2013). Entrepreneurs’ actions cause markets to move away from the previously seen WSR step by step, thus reducing market order.
Taking into consideration all of the aforementioned assumptions and information regarding the nature of change, knowledge, opportunities, and the entrepreneur, scholars wishing to pursue research using a disequilibration perspective may consider asking questions such as (1) How do entrepreneurs continually create new opportunities?, (2) How do competitors in a market react to entrepreneurs’ disequilibrating actions?, and (3) How do entrepreneurs’ combinations of heterogeneous capital resources and regroupings of resources have a disequilibrating effect on the market?
Punctuated Disequilibrium
Under a punctuated disequilibrium perspective, the entrepreneur spots, creates, and exploits new opportunities. S/he is a decision-maker and a risk bearer under conditions of uncertainty (Batstone and Pheby 1996). And although the entrepreneur is ignorant of the future (Hill 2004), s/he possesses an imaginative capacity to ponder future possibilities (Ripsas 1998). Based on subjective expectations of imagined future possibilities, entrepreneurs make decisions that allow them to continually create and recreate opportunities (Chiles, Vultee, et al. 2010). Thus, opportunities are neither preexisting nor waiting to be discovered—they are created by the forward-looking mental acts of entrepreneurs (Chiles, Vultee, et al. 2010; Shackle 1979). Envisioning different courses of action leads to a divergence of expectations and, thus, to a kaleidic society—a notion that is vastly different from Hayek’s self-adjusting spontaneous order (Hill 2004). Ultimately, this results in a punctuated disequilibrium in which markets occasionally experience dramatic shifts from one disequilibrium phase to another as a natural part of an ongoing disequilibrium process (Chiles, Vultee, et al. 2010). In this perspective, such dramatic punctuations drive the market away from the WSR, kaleidically shifting it from one disequilibrium phase to another and allowing the entrepreneur responsible for that shift to collect quasi-monopolistic profits for as long as the situation remains.
Taking into consideration the aforementioned assumptions and information regarding the nature of change, knowledge, opportunities, and the entrepreneur, scholars wishing to pursue research using a punctuated disequilibrium perspective may consider asking questions such as (1) How do entrepreneurs proactively reshuffle resources to introduce new solutions in the market?, (2) How do entrepreneurs decide what imagined future(s) to pursue as part of a process that allows them to kaleidically create new opportunities?, and (3) How do entrepreneurs’ actions result in dramatic shifts from one disequilibrium phase to another, driving markets farther from equilibrium?
CONCLUDING THOUGHTS Austrian economists bring an important perspective on the history of economic thought, one that views the world as inherently cognitive and fundamentally dynamic; that is, about knowledge and change—knowledge that is both convergent and divergent, and change that is both continuous and discontinuous. By placing these concepts at the core of their enterprise, these economists have shed considerable light on the “dark forces of time and ignorance.” In acknowledging the concept of equilibrium in the Austrian tradition and building a typology based on the aforementioned two concepts, which are intricately connected to the Austrian concept of entrepreneurial production, the hope is to offer organizational entrepreneurship scholars a useful framework for organizing their thinking and guiding their research—not only into the more familiar equilibrium-based entrepreneurial phenomena, but also the less familiar disequilibrium ones.
As has been argued, Austrian economics comprises a number of distinct strands or perspectives, each with a unique ability to shed light on specific entrepreneurial phenomena. This work seeks to sensitize organizational scholars pursuing Austrian-inspired entrepreneurship research to the intellectual heterogeneity within this school of economic thought and to clarify the nuances of different perspectives within it, providing scholars with a solid foundation from which to build their research efforts. To do so, ideas from existing typologies in the organization studies literature were integrated and reworked to develop a new typology yielding four distinct perspectives: (1) equilibration, (2) punctuated equilibrium, (3) disequilibration, and (4) punctuated disequilibrium. The equilibration and punctuated equilibrium perspectives, which have garnered the lion’s share of scholarly attention, are firmly anchored in a perceived tendency for market actions to be directed toward some equilibrium, represented in Austrian theorizing by the WSR and the tendency toward the ERE. These perspectives have been valuable in moving the organizational entrepreneurship field forward for the last several decades. However, scholars have leaned on them heavily, and this overreliance has blocked progress into a range of disequilibrium phenomena, from entrepreneurs’ forward-looking imaginative acts to their ex nihilo creation and continual recreation of resource combinations to the relatively unstable interactions these acts and actions engender in markets characterized by radical uncertainty, pervasive heterogeneity, and constant disruption. The disequilibration perspective, in which entrepreneurial action drives the market process away from equilibration, has recently started to receive greater attention, opening inquiry into some of these neglected entrepreneurial phenomena. Its place in this typology further legitimates it as an important perspective in entrepreneurship research. The punctuated disequilibrium perspective is just beginning to appear on scholars’ radars and it is hoped that its place in this typology will compel others to explore some of the current “outer reaches” of the entrepreneurship field, helping us understand, for example, how creative entrepreneurial processes kaleidically shift from one disequilibrium phase to another.
More generally, organizational entrepreneurship scholars can use this typology to better understand how different Austrian perspectives are rooted in distinct sets of philosophical and methodological assumptions. Using this typology, scholars can also locate key differences over the nature of the entrepreneur, the nature of opportunities, potential research questions, and selected empirical examples that illustrate the types of phenomena with which each perspective is concerned. Additionally, for each of its four perspectives this typology lists authors whose work can serve as a reference point. This typology is useful and important because it provides organizational entrepreneurship scholars with a foundation to advance inquiry in at least two ways: (1) it helps scholars organize and sharpen their thinking about a particular entrepreneurial phenomenon, and (2) it guides researchers through the research process, allowing them to identify and make sense of the nuances and subtleties of the phenomenon under study, to ask appropriate questions, and to use suitable methodologies.
Scholars pursuing Austrian-based organizational entrepreneurship research might use this typology in the following manner. First, it is recommended that scholars start by reflecting on the nature of the phenomena they wish to study, specifically seeking an understanding of the nature of knowledge, change, opportunities, and of the entrepreneur (see figures 2 and 3). This will allow them to locate the phenomenon at hand within a particular Austrian perspective. As soon as researchers identify the appropriate perspective, they should examine and reflect upon the broader philosophical assumptions relating to the particular perspective (see figure 2). After that, they can develop research questions that are consistent with the perspective and its underlying philosophical assumptions (see figure 4 for examples). Finally, researchers can choose the appropriate methodology, which should also be consistent with the philosophical assumptions of the perspective being used (see figure 2). In the case that the researcher would like to consult previous work using a specific perspective, figure 2 offers lists of works that fall within each perspective.
Although helpful for sharpening our thinking about the numerous strands of Austrian and Austrian-related economics, this typology is not without limitations. First, some scholars criticize typologies for not being a true depiction of reality—that is, for being oversimplistic and for failing to portray the complexity of organizational life (Meyer, Tsui, and Hinings 1993). It is important to keep in mind, however, that the purpose of typologies is not to perfectly replicate reality but rather to provide a foundation from which to advance inquiry. As Gibson Burrell and Gareth Morgan (1979) have argued, typologies are useful in providing us with a heuristic device, rather than with a set of rigid definitions and classifications. In other words, typologies are designed to help sharpen our conceptions and thoughts about the dynamism of reality without getting lost in an absolutism that is not real. Thus, typologies provide scholars with constructs that help organize their thinking, from which they can then identify the nuances and subtleties that differentiate real phenomena from the ideal types. Given the process orientation of the Austrian school, this typology might be of particular interest to those interested in exploring entrepreneurship from a process perspective. It is recommended that future process-oriented scholars use this typology alongside other work exploring distinct worldviews in entrepreneurship scholarship—see, for example, the work of Chiles, Sara R. S. T. A. Elias, and Qian Li (2017)—to carefully consider the philosophical assumptions that undergird their research efforts.
Second, in developing this typology, and as is typical of this type of work, the two dimensions of knowledge and change were classified dichotomously, even though these are complex and nonbinary concepts. This approach thus prioritized parsimony, glossing over the complexity and nuances of these concepts (Doty and Glick 1994; Weick 1979). As Peer C. Fiss (2007, 1193) has argued, many concepts in the field are complex and multidimensional in nature, “requiring more continuous coding.” Future researchers are thus encouraged to explore alternative approaches, for example, by using qualitative comparative analysis (QCA) to develop an “ideal type” (e.g., Fiss 2011) for each key Austrian economist and their impact on organization and entrepreneurship studies.
Third, the two dimensions of knowledge and change provide one way to make sense of the various strands of Austrian and Austrian-related economics. Future scholars might build different typologies by choosing dimensions that may be rooted not only in other Austrian core concepts, but also in key differences between the Austrian school and mainstream economic thought (e.g., methodological individualism, subjectivism, praxeology). Developing new typologies would inherently allow future scholars to shed different light on—and further make sense of—the complexities of Austrian thought more specifically and economic thought more generally, and how the former may inspire organizational research.
Fourth, it is recognized that there are a number of important debates within the Austrian school that were not included in this discussion, such as Mises versus Hayek on the economic problem arising from power centralization (Salerno 1993), Mises versus Schumpeter on the theoretical grounds of economics (Schulak and Unterköfler 2011), and Kirzner versus Rothbard on the nature of the entrepreneur (Rothbard 1974). This typology represents a first step in helping guide the research efforts of organizational entrepreneurship scholars wishing to more firmly ground their research in Austrian thought. As such, it is a basic conceptual tool for holistically making sense of Austrian economics, allowing organizational entrepreneurship scholars to go beyond mere lists of go-to Austrian figures such as Hayek, Schumpeter, and Kirzner. The aforementioned debates provide theoretical detail and nuance that go beyond the initial efforts in this article. Future scholars are encouraged to flesh out this typology by adding the relevant insights from these debates to the appropriate perspective or, conversely, to explore how this typology might inform these debates.
In closing, the hope is that this typology, along with these concluding suggestions, will help organizational scholars pursue Austrian-based entrepreneurship research in a more mindful and informed manner. Doing so will improve our understanding of entrepreneurship.
If people want to dismiss this school of thought, which many seem inclined to do for political (not theoretical) reasons, at least they should do so based on facts and knowledge, not on falsehoods.
Original Article: "Debunking Seven Common Criticisms of Austrian Economics"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
If the hallmark of conventional economics is unrealistic models, the hallmark of Austrian economics is a profound appreciation of the price system. Prices provide us with critical information about the relative scarcity of goods and services.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Original Article: "The Core of Austrian Theory".
Professor Saifedean Ammous, author of The Bitcoin Standard, is in the midst of writing a new textbook titled Principle of Economics. But he's writing it in open-source form: drafting, revising, and sharing the manuscript with his online students as the book is created. And unlike most lousy college economics textbooks, his offering is rooted in Austrian theory and contains numerous references to Menger, Böhm-Bawerk, Mises, Rothbard, and Hoppe. Academia is changing, and the way we learn is ripe for disruption. Dr. Ammous is at the fore of these changes, and you don't want to miss this show.
Download the slides from this lecture at Mises.org/MU20_PPT_23.
Recorded at the Mises Institute in Auburn, Alabama, on 16 July 2020.
Download the slides from this lecture at Mises.org/MU20_PPT_21.
Recorded at the Mises Institute in Auburn, Alabama, on 15 July 2020.
Download the slides from this lecture at Mises.org/MU20_PPT_20.
Recorded at the Mises Institute in Auburn, Alabama, on 15 July 2020.
Download the slides from this lecture at Mises.org/MU21_PPT_12.
Recorded at the Mises Institute in Auburn, Alabama, on 20 July 2021.
Download the slides from this lecture at Mises.org/MU20_PPT_10.
Recorded at the Mises Institute in Auburn, Alabama, on 14 July 2020.
Download the slides from this lecture at Mises.org/MU20_PPT_11.
Recorded at the Mises Institute in Auburn, Alabama, on 14 July 2020.
Download the slides from this lecture at Mises.org/MU20_PPT_12.
Recorded at the Mises Institute in Auburn, Alabama, on 14 July 2020.
Download the slides from this lecture at Mises.org/MU20_PPT_13.
Recorded at the Mises Institute in Auburn, Alabama, on 14 July 2020.
Download the slides from this lecture at Mises.org/MU20_PPT_09.
Recorded at the Mises Institute in Auburn, Alabama, on 14 July 2020.
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.
Download the slides from this lecture at Mises.org/MU20_PPT_05.
Recorded at the Mises Institute in Auburn, Alabama, on 13 July 2020.
Download the slides from this lecture at Mises.org/MU20_PPT_04.
Recorded at the Mises Institute in Auburn, Alabama, on 13 July 2020.
Download the slides from this lecture at Mises.org/MU20_PPT_03.
Recorded at the Mises Institute in Auburn, Alabama, on 13 July 2020.
Today's solo show kicks off our reading of Rothbard's landmark Man, Economy, and State with a look at Chapter 1, "Fundamentals of Human Action." So much of what economics texts get wrong is laid out brilliantly here by Rothbard, who gives readers the basics of action, means/ends, time, ranking, factors of production, and capital in this 77 page master class. The short appendix at the end of the chapter alone is a bombshell—demystifying the correct form for economic analysis, and explaining why psychology is not praxeology. Don't miss this introduction to the book you know you need to read!
Use the code HAPOD for a discount on Man, Economy, and State from our bookstore: Mises.org/BuyMES
Additional Resources Man, Economy, and State: Mises.org/MES
Bob Murphy's Study Guide to Man, Economy, and State: Mises.org/StudyMES
Austrian economist and Mises Institute Fellow Mateusz Machaj discusses two of his books. The first is a technical work explaining how the Austrian structure of production concept can help resolve puzzles in economics. Machaj’s second book analyzes the political philosophy behind the Star Wars prequels. This episode contains deep insights that will inform even advanced students of both economic theory and the Star Wars universe.
Mentioned in the Episode and Other Links of Interest: The YouTube version of this interview: Part 1 on structure of production and Part 2 on Star Wars.Matt’s book on capital theory and his book on Star Wars. #CommissionsEarned (As an Amazon Associate I earn from qualifying purchases.)Bob’s referee reports from Paul Samuelson.Bob’s article explaining “reswitching.”Krugman on potential GDP flip-flop.Mace Windu, vigilante. For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
Rothbard fans, this is the podcast you don't want to miss! Rothbard scholar Patrick Newman joins Jeff Deist to kick off a series of shows featuring Rothbard's landmark treatise Man, Economy, and State. They discuss the history and background behind this important book, how it changed the landscape, and why the concluding chapters titled "Power and Market" proved so controversial at the time–and remain so today! Dr. Newman calls Rothbard's opus "the best book I ever read," and makes a compelling case for lay readers like you to tackle it.
Read the book free of charge in searchable HTML format here.
Use the code HAPOD for a discount on Man, Economy, and State from our bookstore: Mises.org/BuyMES
Additional Resources Dr. Joe Salerno's introduction to Man, Economy, and State: Mises.org/SalernoMES
Man, Economy, and State: Mises.org/MES
Banking and Monetary Policy from the Perspective of Austrian EconomicsAnnette Godart-van der Kroon and Patrik Vonlanthen, eds.Cham, Switzerland: Springer, 2018280 pp.
Joseph T. Salerno (salerno@mises.org) is professor of economics at the Lubin School of Business at Pace University.
The editors are to be heartily congratulated for putting together this book, which covers an impressive range of topics in monetary economics from an explicitly Austrian perspective. Most of the twelve essays are of a very high quality and one will learn much about money and related topics by a careful reading of them. The chapters range from an insightful interpretation of Austrian monetary theory as a rehabilitation and development of classical monetary theory to novel applications of the theory to current issues such as inflation targeting, the consequences of unconventional European Central Bank (ECB) policies, and cryptocurrencies. In addition to its ambitious scope, this book stands out because most essays take an unabashedly Austrian approach to their topic. It is a great pleasure to read a volume on money and banking that so liberally cites Mises, Hayek, and Rothbard. Ironically, the one minor drawback of the book is that it does not contain an index for someone interested in the number and location of text references to these and other Austrian monetary theorists.
Guido Hülsmann presents an excellent overview of Mises’s monetary theory that emphasizes its deep roots in the classical approach to money formulated by Ricardo and the British Currency school. As Hülsmann (p. 26) demonstrates in his essay, Mises “rebuilds classical monetary theory on a completely new and more solid foundation [i.e., the subjective theory of value], thus awakening it out of the slumber into which it had sunken after 1844 and making it relevant again for political decision-making.” Now, this story has been told before, but the subtlety and clarity of Hülsmann’s presentation mark it as an indispensable introduction to Mises’s monetary theory and perfectly suit its position as the opening essay of the book.
The merits of this essay are not purely expositional, however, for Hülsmann makes an important doctrinal discovery. Standard accounts of the transition from the views of the sound money Currency school to what Hülsmann labels the “New Orthodoxy,” based on the previously discredited Banking school, have always focused on the alleged policy failures of the “currency principle” but have been hazy or mute regarding its doctrinal aspects. Who, exactly, was the central figure (or figures) in the recrudescence of the “banking principle”? The latter principle asserts that issuance of fractional reserve bank notes and deposits convertible into specie are indispensable to ensuring economic stability and accommodating economic growth. Hülsmann fills this gap in the literature by identifying the prolific Scottish banker and economist Henry Dunning McLeod as the pioneer of this movement. He argues that Schumpeter, Keynes, and the early L. Albert Hahn all accepted the New Orthodoxy and developed their respective theories of money under McLeod’s influence. Hülsmann makes a very plausible case for McLeod’s key role in overturning classical monetary theory. But his case would be more compelling if he offered textual evidence from Schumpeter, Keynes, et al. to support his argument, because McLeod was lightly regarded by his contemporaries and dismissed as a monetary crank by later writers. In any event, Hülsmann has uncovered a lacuna in the history of monetary thought that at least needs to be addressed by further research.
Brendan Brown’s essay “What Is Wrong with the 2% Inflation Target” presents what I consider the definitive refutation of inflation targeting. Brown approaches his topic by upholding the classical gold standard as the standard by which to evaluate the nature and performance of modern fiat money regimes. In doing so, Brown provides an excellent analysis of the merits of the gold standard. Brown eschews the artificial constructs of aggregate spending flows that contemporary macroeconomists fixate on. Instead, following Mises, Hayek, and Rothbard, he focuses his comparative analysis of monetary regimes on general movements of concrete money prices, which naturally emerge in an economy in which money and goods are inextricably entwined in individual exchanges.
According to Brown, under the gold standard, gold served as high-powered money and was the “pivot” of the monetary system, because it enjoyed a “large stable demand” for use as transactions media, bank reserves, and as an industrial input. Since the supply of gold was determined by market forces, it tended to be relatively fixed and inelastic in the short and medium runs while in the long run responding elastically to changes in its real price (i.e., in terms of the quantity of commodities a gold unit could purchase). Thus, although the “well-pivoted” gold standard confined the movement of overall prices within definite bounds, it provided the necessary flexibility for the scale of money prices to move upward or downward naturally and spontaneously in response to changes in real conditions over short or medium periods. Indeed, it is precisely the accommodation of these natural price fluctuations that for Brown constitutes the essence of sound money and sharply distinguishes it from modern fiat money regimes, which “target” stability of statistical constructs such as the price level, inflation rate, or nominal income. As Brown (p. 87) incisively states:
Under a system where a high-powered money is at the pivot, as in a gold money regime, there is considerable scope for prices to fluctuate under real influences, and in a way, which aids the invisible hands in their job of steering the capitalist economy in an efficient manner. Indeed stable prices over the short and medium-term would indicate a defect in the price-signalling mechanisms of a capitalist economy under sound money.
Brown (pp. 87–88) gives three instances in which sound money facilitates the “natural rhythm of prices.” During a recession, sound money promotes rapid recovery by facilitating the natural tendency of prices to fall below the perceived norm “for the cycle on average[,] caus[ing] consumers and businesses to bring forward spending (so contributing to the business recovery).” Likewise, sound money poses no obstacle to price declines that reflect increases in real incomes caused by spurts of productivity growth. Lastly, a sound-money regime would not conceal and exacerbate the effects of severe (negative) supply shocks emanating from an interruption of energy supplies or crop failures, because prices would rise rapidly above anticipated levels, revealing and smoothly rationing the scarcer commodity supplies in the short run and encouraging consumers to postpone their purchases until prices return to perceived normal levels in the longer run. In all these cases, inflation targeting, if rigidly followed, would suppress the natural rhythm of prices and thereby disrupt the economy by either initiating asset bubbles (the first two cases) or by exacerbating real scarcities (the third case).
Furthermore, Brown (p. 90) argues, under a regime in which the price level or the inflation rate is targeted by the central bank, “the link between money and prices or nominal incomes [becomes] loose and unpredictable.” The monetary pivot is thus “dislodged” and the natural rhythm of prices gives way to price inertia and institutionalism. This means that, at least in the short and medium runs, inflationary expectations become unmoored from monetary fundamentals and a tendency develops for the inflation rate to persist at the level expected. In addition, expectations themselves come to be dominated by real side institutional factors such as the behavior of labor unions or the state of the national budget or trade balance, etc. Of course, in the long run, monetary forces reassert themselves, but in the meantime resources are misallocated, financial markets distorted, and asset bubbles begin to form.
Brown’s essay is also instructive in explaining the historical origins and dissemination of the 2 percent inflation standard. Brown (pp. 99–100) concludes by presenting a bold, populist program—and the challenges thereto—for demolishing the inflation-targeting regime and reestablishing sound money short of the restoration of the classical gold standard:
Reserves at the central bank, like gold, must not pay interest. Obstacles to a vibrant use of cash in the economy should be demolished (…[including] issuance of high denomination notes to satisfy demand for these as medium of exchange). Bank demand for reserves (which would be held voluntarily not as a legal reserve requirement) would be boosted by the curtailing and ideally the abolition of too big to fail, lender of last resort and deposit insurance….The vast balance sheets of the central banks accumulated during the Grand Monetary Experiment would have to be shrunk such that the monetary base would be freely demanded at zero interest rates at the start.
Arkadiusz Sieroń’s “Hayek and Mises on Neutrality of Money: Implications for Monetary Policy” outlines the uniquely Austrian understanding of the nonneutrality of money, which emphasizes the role of Cantillon effects. In particular Sieroń (p. 153) focuses on Mises’s and Hayek’s writings, “as these two authors presented the most far-reaching criticisms of the neutrality of money.” Mainstream macroeconomists, in contrast, argue that although money is nonneutral in the short run, a proportional adjustment of nominal variables to a change in the money supply ensures that the effects on real variables vanish and neutrality of money prevails in the long run. For Mises and Hayek, Cantillon effects, also known as “first-round” or “injection” effects, refer to the fact that the emission of new money into the economy under any monetary regime is inevitably distributed unevenly among economic agents. This initial redistribution of monetary assets among households and firms causes an alteration in the structure of relative demands for different kinds of goods and a consequent change in the pattern of relative prices and the allocation of resources. Furthermore, the prices of some goods—those purchased by the first recipients of the new money—naturally rise before those of others, causing further changes in the relative price structure and, therefore, in the distribution of money incomes and cash balances. By the time this step-by-step process of adjustment to a change in the money supply comes to an end, the entire system of relative prices has been revolutionized, resulting in a permanent change in resource allocation and the distribution of wealth and income. The sequential and time-consuming operation of the monetary adjustment process, during which the array of money prices changes at different times in different proportions (and even directions), is thus an inherent feature of a money economy. As Sieroń (p. 159) trenchantly puts it:
For Hayek, changes in relative prices in response to monetary disturbances are not frictions, lags, or market failures occurring due to price rigidity, incomplete information, or irrational expectations, but the natural and inevitable consequence of monetary impulses. This is because new money enters circulation only through specific channels and some people receive the additional money earlier than others.
In comparing Mises’s and Hayek’s views on neutral money, Sieroń (p. 161) makes another important observation. Mises went “much further than Hayek” in his critique of neutral money, for Mises pointed out that money is nonneutral even if it is supposed that Cantillon effects are absent because every agent’s cash balance is somehow increased in equal proportion. In fact, although Sieroń does not note this, Mises (1971, pp. 140–41) went even further than this and supposed a situation in which the new money is distributed among individual cash balances in such a way that the relative (monetary plus nonmonetary) wealth of all remains unchanged. Mises insisted that in this case the nonneutrality of money also holds. The reason is that as the wealth of individuals increases, their subjective marginal utility rankings of different goods and money will change and alter their relative demands for goods and cash balances. The outcome of this mental experiment is a permanent reconfiguration of relative prices and resource allocation and a lack of proportionality between the change in the money stock and the scale of money prices—the long-run nonneutrality of money, in short.
Sieroń concludes that the Cantillon effect, as conceived by Mises and Hayek, has momentous implications for the ongoing discussion of the efficacy of monetary policy, which has intensified since the financial crisis. In particular, once the injection effect is recognized, monetary policy is exposed as an important cause of business cycles and asset bubbles and their international transmission, as well as a contributing factor to greater income inequality.
Jesús Huerta de Soto brilliantly debunks the fallacious arguments against deflation in his chapter “Anti-deflationist Paranoia.” He recognizes three distinct kinds of deflation and perceptively analyzes their consequences. He points out that one type of deflation stems from an “error of institutional design” in the form of fractional reserve banking. This “institutional deflation” is part of the regular recurrence of expansion and contraction of the money supply that is an inherent feature of a fractional reserve banking system. It is the inevitable outcome of an inflationary boom fueled by previous bank credit expansion that falsifies the interest rate and causes malinvestments and distortion of the production structure. Indeed, this built-in tendency toward deflation is so powerful that the fractional reserve banking system’s “survival depends on a lender of last resort (or central banker).” Beyond preventing a wholesale collapse of the banking system, Huerta de Soto (p. 198) argues,
there is relatively little central banks can do. At most they can keep private banks from failing by providing them with all sorts of loans and assistance. And that is about it. However a process of monetary contraction (i.e., a process of deflation) is inevitable.
Now this assertion that institutional deflation in the sense of an actual contraction of the money supply is an inevitable outcome of a fractional reserve banking system appears to be in conflict with the facts, at least since World War II. Certainly the Fed and other central banks successfully prevented their money supplies from contracting during the 2008 financial crisis with resort to unconventional methods of printing base money, such as zero interest rate policy (ZIRP), quantitative easing (QE), forward guidance, credit easing, etc. Nor did the money supply contract in the US after the dot-com bubble burst in 2000, or even during the severe “double-dip” recession of 1980–82. I may misunderstand the author on this point, and he may be referring to a powerful deflationary tendency that is present in fractional reserve banking and that actually manifested itself when central banks operated only as lenders of last resort. But if this is the case, it would have been instructive for the author to indicate how modern central banks, focused on stabilizing prices or targeting inflation, routinely neutralize institutional deflation and what the consequences of their doing so are.
Huerta de Soto also engages and demolishes the main arguments against the kind of deflation that is caused by increases in productivity induced by capital accumulation and advances in technology. I do, however, have one minor reservation with respect to his rebuttal of the contention that a fall in prices due to an increase in real output that outstrips the increase in the money supply constrains economic growth and leads to a cumulative economic contraction. Huerta de Soto counters the argument by pointing out that a fall in prices will spur entrepreneurs to reduce costs by: 1. renegotiating input prices downward and 2. substituting at the margin relatively cheaper capital goods for laborers, who are now receiving higher real wages, thereby increasing the demand for capital goods and causing laid-off laborers to migrate to capital goods industries (i.e., the Ricardo effect).
If I have understood the argument correctly, it puts the cart before the horse, for it is the increase in saving and investment in capital goods that initiates the process of productivity growth. Increased investment causes workers to shift from the consumer goods to capital goods industries. Eventually this movement increases the supply and lowers the prices of capital goods, making it profitable to implement new and more productive technical methods in the consumer goods industries. Thus, even with nominal wage rates unchanged, costs of production decline as labor productivity increases. The prospective profit margins on consumer goods therefore expand. This stimulates consumer goods firms to increase their supply and the increased competition causes prices naturally to fall. In short, during the process of economic growth initiated by net saving and investment, labor productivity and costs of production fall in advance of or in step with the decline in product prices. Furthermore, laborers shift from industries closer in time to consumers to ones more temporally remote from consumers at the very beginning of the growth process rather than at its end, as Huerta de Soto contends. Thus there is no need to renegotiate nominal wage rates or to lay off workers in response to deflation due to real output growth. But this is a minor emendation to a fine essay.
Due to space constraints I can only give brief notice to several other excellent essays in the book. Two of these essays focus on the nature and consequences of errors in ECB monetary policy. These are “Unintended Consequences of ECB Monetary Policies in Europe,” by Andreas Hoffman and Nicolas Cachanosky, and “The Failure of ECB Monetary Policy from a Mises-Hayek Perspective,” by Gunther Schnabl. The authors of these essays have been pioneers in the application of Austrian business cycle theory to analyzing the international dimensions and transmission of asset bubbles and the ensuing financial crisis. Their essays in this book display deep scholarship and a familiarity with an enormous range of theoretical and empirical literature, both Austrian and mainstream. The significance of their essays lies not merely in identifying the flaws in ECB monetary policy leading up to the financial crisis, but in utilizing innovative theoretical models and masterfully employing data to explain how ECB policy in the aftermath of the crisis has led to a weak and protracted recovery in the euro area. These essays also serve as exemplars for future research on the global transmission of national or supranational central banks’ monetary policy errors.
Two of the essays addressing the Austrian view of cryptocurrency are “The Reconsideration of Hayek’s Idea on the De-nationalization of Money: Taking the Growing Tendency of Digital Currency in Consideration” and “Cryptocurrencies from an Austrian Perspective,” by Chikako Nakayama and Alistair Milne, respectively. These essays are not as tightly formulated as other essays in the book and tend to be wide-ranging reflections upon the linkages between Austrian monetary theory and cryptocurrencies in their various aspects. But they are extremely valuable nonetheless, because they stimulate thought about the problems and potentialities of a radical approach to denationalizing money and implementing a sound, market-based money regime.
This book is indispensable reading for anyone who has a professional or vocational interest in the Austrian approach to money, finance, and business cycles.
We've reached the end of Human Action! Tom Woods joins the podcast to discuss Part Seven, "The Place of Economics in Society," and it's a show you don't want to miss.
Woods and host Jeff Deist enjoy an engaging and far-ranging discussion of the book's place in history, Mises's frustration with economics co-opting the methods of physical sciences, and the public's seeming inability to overcome anticapitalist propaganda. Mises concludes his great treatise with unmatched clarity and wisdom, reminding us why economics belongs at the forefront of society—and why we all should retain our unwavering sense of élan vital.
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Additional Resources The Sociology of the Development of Austrian Economics by Joe Salerno: Mises.org/SalernoHAP
Mises's Élan Vital by Jeff Deist: Mises.org/Elan
Human Action: Mises.org/HumanAction
Bob Murphy's Study Guide to Human Action: Mises.org/Study
We continue our survey of Human Action by finishing up Part Six of the book, Mises's analysis of interventionism—or the so-called "third way" between capitalism and socialism.
Mises exposes how state intervention in the market economy makes us all poorer, even while it claims to act against poverty and inequality on behalf of social justice. That perverse "justice" takes the form of currency manipulation, confiscation of land and capital, protectionism for syndicates and unions, and civilization-destroying total wars. This is a solo episode with Jeff Deist, who enjoys Mises's demolition of the hampered market economy masquerading as laissez-faire capitalism.
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Bob Murphy's Study Guide to Human Action: Mises.org/Study
Professor Peter Klein from Baylor University joins the show to discuss Part Six of Human Action, where Mises presents his exposition of interventionism in all its manifestations. Mises breaks socialism down into Soviet and German versions; the first purely bureaucratic (state ownership) and the second nominally private but state-directed. He gives us a contrasting definition of laissez-faire, the choice of freedom over government omnipotence. Successive chapters take readers through taxation, restrictionism (tariffs, regulations, labor laws), and price controls (goods, wages, interest rates).
Dr. Klein is a fascinating guest with great insights into Mises and "the Hampered Market Economy." This is a conversation you don't want to miss!
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Bob Murphy's Study Guide to Human Action: Mises.org/Study
Ryan McMaken, an economist and editor of Mises.org, joins the show to consider Part Five of Human Action: "Social Cooperation without a Market." This section of the book provides Mises's updated exposition of socialism, the impossible project of substituting 'One Will' for the subjective actions and preferences of everyone in society. Mises gives us the history behind support for socialism, and the enduring appeal of ascribing the best intentions and omniscience to the central state.
Can a socialist system really operate using the division of labor? Can mathematical equations lead us to equilibrium, the final and static price for any good or factor? Can the managerial state make the impossible possible? This is a rewarding discussion of socialism from Mises's brilliant and radical point of view.
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Bob Murphy's Study Guide to Human Action: Mises.org/Study
Professor Mark Thornton and Jeff Deist finish Part Four of Human Action with a look at Chapters 21–24 of the book—a powerful exposition of how social cooperation and market exchange create far more harmony in society than state power. Here Mises explains how we all choose labor or leisure every day, and why wages are not the exploitative pittance socialists imagine. Land and rents have been misconstrued as special factors of production, when in fact market exchange helps us understand their prices just like any other good.
These chapters serve as a nice summation of several themes in the book, and set the stage for considering full socialism in Part Five.
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Dr. Joe Salerno joins the show for a dynamic look at Human Action Part Four, arguably the meatiest part of the book.
Chapters 18, 19, and 20 are where Mises presents the idea of pure time preference, his expanded theory of interest, and the parameters of business cycle theory and malinvestment. Salerno and Jeff Deist consider how time relates to capital; gratitude for society's accumulated wealth; convertibility of capital thanks to stock markets; why holding cash can be productive; originary interest as a ratio, the fallacious classical and Marxist notions of interest, and the boom/bust cycle created by politicians, voters, and bankers who see that inflation "works" for awhile. This is a great discussion of Mises at his best!
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Abstract: This paper offers a synthetic and comparative assessment of the most basic Austrian macroeconomic models, i.e. the models that analyze the static forces determining the equilibrium interest rate and structure of production (monetary disequilibria and business cycles are not part of this investigation). The three models presented here are those of Böhm-Bawerk ([1889] 1959), Hayek (1936, 1941), and Garrison (2001). This review shows that these models are largely inconsistent with each other, but also that at a more general level they share several important characteristics. Finally, a tentative explanation is offered as to why there is no cumulative tradition in the Austrian School in this kind of basic macroeconomic theorizing.
JEL Classification: B13, B25, B53, E14 Key Words: hayekian trianage austrian economics business cycle macroeconomics Renaud Fillieule (renaud.fillieule@univ-lille.fr) is Professor of Sociology at the University of Lille, France, and member of the CLERSÉ research unit (UMR CNRS 8019).
A preliminary version of this paper was presented at the Austrian Economics Research Seminar in Paris, France, May 9, 2017. The author wishes to thank Prof. Hülsmann for this invitation and the attendees for their remarks and suggestions.
INTRODUCTION The Austrian School is best known for its subjectivist approach and for its theories of the market process and the business cycle. This paper focuses upon a less familiar but nevertheless significant topic. Prominent economists of this school have developed, over the century and a half of its existence, a series of basic macroeconomic models. These models are “basic” in the sense that they investigate the most fundamental forces operating in an economic system, leaving aside the complications due to monetary disturbances and to uncertainty. No systematic comparison between them has been provided yet, and this paper seeks to fill this gap. This kind of basic and integrated model analyzes the convergence process of a very simplified economic system towards a macroeconomic equilibrium, and investigates the macro-effects of typical changes such as technical progress, a lower or higher time preference (leading respectively to a larger or smaller saving-investment), or an increase in the number of workers. Monetary disturbances and short-term fluctuations are therefore off topic here. Three models fit these criteria in the published Austrian literature. They were respectively elaborated by (i) Böhm-Bawerk ([1889] 1959), (ii) Hayek (1936, 1941), and (iii) Garrison (2001).Hülsmann (2010) has developed a macroeconomic model that integrates Rothbard’s model of determination of the pure interest rate and the Hayekian structure of production, but it is still a working paper and can therefore not yet be considered as an “official” contender. Fillieule (2005) has expounded a graphical model illustrating the interrelations between various aspects of the economic system, but it lacks a very important element, namely a theory of interest. The first purpose of this paper is to provide a history of the way basic macroeconomic theorizing has been conceived in the Austrian School. The three models will be expounded in turn, with a review covering in each case the convergence process, the final equilibrium characteristics, and the response to typical exogenous changes (Section One). The second purpose is to analyze the relationships between these models and to expose their theoretical inconsistencies (Section Two). The third purpose is to show that, beyond their differences and contradictions, these models have in common a number of significant general features (Section Three). The fourth and last purpose is to seek to explain why—in contrast with the standard neoclassical paradigm since the classic contribution by Solow (1956) and Swan (1956)—no single basic reference model dominates within the Austrian School (Section Four).
- THE AUSTRIAN MODELS: A CHRONOLOGICAL PRESENTATION
This presentation of the three basic macroeconomic models aims at elucidating, as briefly as possible, their framework and internal logic. Many secondary features will be left out, so that the length of the paper remains within reasonable limits. In each case the graphical visualization of the model will be used instead of the mathematical formalization, but the latter also exists.Wicksell ([1893] 1970) developed both the mathematical and the graphical versions of Böhm-Bawerk’s model, Molavi Vasséi (2015) developed the first mathematical formalization of Hayek’s model, and Cachanosky and Padilla (2016) the first mathematical formalization of Garrison’s model.
1.1 Böhm-Bawerk’s Model
Böhm-Bawerk ([1889] 1959) expounds his model in a chapter titled “The Rate of Interest.” However, his theory is not just a theory of interest and turns out to be a genuine macroeconomic model, in which not only the equilibrium interest rate but also the equilibrium wage and period of production are determined. Böhm-Bawerk was a true pioneer in modern macroeconomic analysis, but his exposé was a bit simplistic in that it was based upon a single numerical example. Wicksell ([1893] 1970) quickly replaced this elementary formulation by a general mathematical presentation using differential equations, and also by a convenient graphical display. Much later, Dorfman (1959) improved upon the Wicksellian graphical version of the model.See Fillieule (2015) for a recent and comprehensive graphical account of the model. It must nonetheless be noted that this model has not evolved between its original exposition by Böhm-Bawerk and its subsequent representations. It is exactly the same model, and only its form has been refined over time.
The model rests upon two exogenous data, the quantity of capital K and the number of workers N, and upon an exogenous production function f that relates the total period of production T of the economic system to the quantity qc of consumption goods produced per worker and per year. Figure 1 shows this production function qc = f(T) as a concave curve on the top diagram.Lower cases are used for individual variables, and upper cases for aggregate variables.,Two differences between the production functions respectively used in Böhm-Bawerk’s model and in the well-known Solow-Swan model can be briefly highlighted. First, the Böhm-Bawerkian macroeconomic function of production determines the annual quantity Qc of consumption goods produced, not the total quantity of consumption and capital goods. Second, the argument of this Böhm-Bawerkian function is the period of production T of the economic system, not the quantity of capital K (for a given quantity of labor N). The function f is increasing, which expresses a central tenet of Böhm-Bawerk’s theory of capital, namely that “roundaboutness” is productive: a “well-chosen” more roundabout method of production produces more consumption goods per period, everything else equal (Böhm-Bawerk [1889] 1959, 82–84). In other words, if T increases, then the annual product per worker qc increases. This increase occurs with diminishing returns that Böhm-Bawerk justifies as an “observation... based on experience” (p. 83).These diminishing returns should rather be explained by the fact that there is a fixed factor, namely labor.
Figure 1. Böhm-Bawerk’s model (adapted from Wicksell 1893, p. 122, and Fillieule 2015, p. 309)
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In final equilibrium, two conditions must be fulfilled. The first one is that the whole capital K is invested, no part remaining idle. The second condition is that the capitalists maximize the interest rate (by choosing the appropriate length T for the production process). This optimization condition—maximum interest rate—is visualized on the diagram as the tangency between the production function f and the straight line going through the point (0, w). If the line going through (0, w) rotates clockwise, then the ratio 2/i increases (which implies that the interest rate i falls); if it rotates counterclockwise, then no intersection point appears with the production function f and no corresponding economic system exists. The tangency point therefore represents the highest possible level for the interest rate (equivalently, the lowest possible level for 2/i). The graphical relationship illustrated in Figure 1 between the endogenous variables (i, w, T) is the visual translation of the fundamental equation of the model:
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This equation expresses the distribution of the quantity qc of the annual final product (per worker) between the worker (wage w) and the capitalists (interest ik). The quantity of capital k = (wT/2) invested per worker is viewed by Böhm-Bawerk as the subsistence fund required to carry out the process. If all the production processes started at the same date and simultaneously ended T periods later, then the capital—i.e. subsistence fund—required would be k = (wT) (each worker would “subsist” on wage w during T periods). But production is not organized this way. Rather, it is “synchronized” in the sense that, if the length of the production process is T, then there are T processes occurring simultaneously and at different levels of completion.If a process lasts for three periods, for instance, then a “synchronized” system comprises three simultaneous processes: at the beginning of each period, one process just begins (and will be completed three periods later), another process is half-way (and will be completed two periods later), and the third process nears completion (and will be over at the end of the current period). Thanks to this synchronization, the final product is delivered in each period, instead of waiting for the many periods required to complete a single process. The calculation shows that, with a synchronized production, the subsistence fund required falls from k = (wT) to approximately k = (wT/2). The fund is lower because thanks to the synchronization, a part of the subsistence required to sustain a worker is produced by the processes that reach completion while the process in which this worker participates is still under way. The fundamental equation can be written so that the intercept theorem (Thales’ theorem) applies: this theorem is then used to show that the values (2/i), w, T, and qc(T) are necessarily related in the way illustrated in the diagram in Figure 1 (Wicksell 1893).
The convergence process towards equilibrium is carried out through the actions of the capitalists. The latter aim at maximizing the interest rate while competing to invest their funds. Their actions lead the economic system towards an equilibrium characterized by the values (i, w, T) of the three endogenous variables, namely the interest rate, the real annual wage, and the period of production. The convergence process takes place as follows. Initially, an arbitrary wage prevails. Given this initial wage w0 (w0 < w), the capitalists maximize the interest rate i (in the symmetrical version, the interest rate is given and workers maximize their wage). The maximization of the interest rate is carried out by choosing between the different possible lengths for the structure of production. If the optimal period of production is T0, then the quantity of invested capital is k0 = wT0/2 (per worker) and K0 = NwT0/2 (total). Now, suppose that K0 happens to be below the total available quantity of capital K (exogenous data). The capitalists have some capital left to invest, and they want to invest it to increase their income. So they compete to hire more workers, the demand for labor increases, and the wage therefore rises from w0 to w1. At this higher wage w1, the capitalists once again maximize the interest rate, capital invested once more falls short of the total quantity available, the wage increases again, and so on and so forth. This process keeps on until the wage reaches the equilibrium level w: at this wage, the maximization of the interest rate determines a period of production T such that NwT/2 is just equal to the total quantity of capital K (and this configuration is bound to happen because T necessarily goes up when w does, so NwT/2 increases until it is equal to K). At this point, the whole available capital is invested, and the final equilibrium has been reached.
The two lower diagrams of Figure 1 show how the typical changes are visualized. Technical progress is represented as a counterclockwise rotation of the production function. An increase in the supply of labor N is represented as a downward and leftward shift of the (wT) hyperbola. An increase in the quantity of capital K is represented as a shift of this hyperbola in the other direction. It is then possible to analyze the effects of these typical changes on the equilibrium position and, from there, on the distribution of the final product between capitalists and workers.Böhm-Bawerk (1959 [1889]) thoroughly analyzes the effects of the typical changes on the level of the interest rate, but only cursorily notes the effects on the level of wages (for instance on p. 378). This investigation concludes that technical progress is advantageous both to capitalists and to workers, an increase in the quantity of capital favors workers but not necessarily capitalists, and a rise in the number of workers benefits capitalists but harms workers.Böhm-Bawerk does not take into account here the increasing returns due to the intensification of the division of labor that follows a multiplication of workers. He never mentions these increasing returns in the chapter. He only refers, in the penultimate footnote (1959 [1889], 461, footnote 52), to the diminishing returns on labor brought about by an increasing population. In order for the results to be appropriately interpreted, it should be noted that an individual can be both a worker and a capitalist, even though Böhm-Bawerk seems to implicitly suppose that workers and capitalists are two separate groups of people. Böhm-Bawerk’s model is summarized in Table 1.
Table 1. A summary of Böhm-Bawerk’s model
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1.2 Hayek’s Model
In the early 1930’s, Hayek developed the most famous macroeconomic construct of the Austrian School, namely the representation of the structure of production as a triangle displaying the annual nominal consumption and the smaller and smaller annual investment expended into the higher and higher stages (Hayek [1931] 1935). This illustration was inspired by Jevons (1871), but the latter applied it to a single economic process while Hayek used it as a macroeconomic tool to represent the whole economic system. This Hayekian triangle was quite influential and quickly found its way even among authors not members of the Austrian School, such as Abrams (1934, 25–28) and Durbin (1935, 34) who was then a leading economic expert for the British Labour Party.The author wishes to thank an anonymous referee for these references. It may come as a surprise that this subsection will not at all be devoted to this macroeconomic construct. The first reason is that Hayek did not associate his triangle with a model explaining the determination of the interest rate. This combination was achieved much later by Garrison (1978, 2001) and will be presented in the next subsection. The second reason is that Hayek’s theory of the interest rate (which will be our subject matter here) is incompatible with his triangle, because this theory requires that capital accumulation takes place laterally, while with the triangle capital accumulation takes place longitudinally (see Subsection 2.1).
For these reasons, Hayek’s triangle is left aside for now, and the focus is on his model of the interest rate (Hayek 1936, 1941). Hayek’s model is inspired, not by the theoretical insights elaborated by the Austrian economists since Böhm-Bawerk’s contribution, but rather by the theory of interest developed by the American neoclassical economist Irving Fisher (1930). The main purpose of Hayek with his model is to investigate the question of the determining principle of interest: time preference or productivity? He concludes that productivity is the key factor, but we are not primarily concerned here about this issue. Our focus is on the macroeconomic core of the model, i.e. the convergence towards a macroeconomic equilibrium, the characteristics of this equilibrium, and the study of the effects of typical changes upon the distribution between workers and capitalists.
Figure 2. Hayek’s model (adapted from Hayek 1941, 233). The concave curves are the productivity curves and the dotted curves are the intertemporal indifference curves.
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Hayek (1941) presents his model in a figure inspired by Fisher’s classic intertemporal graph (see Figure 2). The difference with Fisher’s graph is that the vertical axis here measures the final output, not just in the next period, but in each and every future period: at the starting point Q0, for instance, the economic system produces the quantity Q0 of consumption goods in the current period (as shown on the horizontal axis: current output) and also Q0 in each future period (as shown on the vertical axis). The concave curve going through Q0 is the productivity curve, showing the additional output that can be obtained in each future period against the corresponding additional amount of present saving. The convex dotted lines are the intertemporal indifference curves. When the economic system is at the starting point Q0, the actors maximize their intertemporal satisfaction—reach the highest possible indifference curve—by saving ΔS0 and getting ΔQ0 additional final product in each future period. In the next period, the system is at the point Q1, and once again the actors maximize their intertemporal satisfaction, this time through saving ΔS1 and getting ΔQ1 additional final product in each future period. Figure 2 only shows the first step of the convergence process (from Q0 to Q1), but this process goes on period after period, until the system finally reaches the equilibrium point Q. At the point Q, the productivity curve and indifference curve are tangent to each other on the 45-degree line, so that the actors cannot improve their intertemporal satisfaction (i.e. cannot get to a higher indifference curve), either through saving or through dissaving. The economic system has therefore reached a state of final equilibrium: marginal productivity and marginal time preference are equal, and their identical value is the equilibrium interest rate. In other words, the equilibrium interest rate is equal to the common slope of the productivity curve and the indifference curve on the 45-degree line.
Hayek first analyzes the case of a linear productivity curve (1941, 222), and then the more general case of a concave productivity curve (1941, 233). Only the latter, exhibiting the diminishing returns on capital accumulation, is represented here.At this point, we skip the quite important but a bit technical discussion by Hayek of the shape of this productivity curve. When the productivity curve is linear, the equilibrium interest rate is necessarily equal to the (constant) marginal productivity, and therefore does not depend on time preferences. Hayek argues that the productivity curve is linear or almost linear, and concludes that the level of the equilibrium interest rate is determined by productivity, not by time preferences. The bottom diagrams of Figure 2 display the typical changes. The bottom-left diagram illustrates both a technical progress and an increase in the supply of workers, through an upward shift and a rotation clockwise of the productivity curve. The bottom-right one illustrates a lowering of the preference for the present, through a rotation counter-clockwise of the pattern of indifference curves. The effects of these changes upon the distribution of the final output between capitalists and workers, depend on the hypothesis made about the pattern of intertemporal indifference curves. There are two main possibilities: as the economic system becomes more productive and wealthier (climbing the 45-degree line), people can become more present-oriented, or they can become less present-oriented. Correspondingly, the marginal rate of time preference can respectively increase or decrease as wealth grows. Graphically, these two cases are illustrated by the indifference curves becoming respectively steeper or flatter on the 45-degree line (see Figure 3). Under the assumption of a concave productivity curve, the two configurations are compatible with the existence of an equilibrium.In Hayek’s first model, i.e. with a linear productivity curve, then the existence of an equilibrium necessitates an increase of time preference with wealth (Molavi Vasséi 2015). However, the pattern with an increasing time preference is quite unlikely, since it implies that as people become wealthier, they are more and more eager to consume their marginal net income rather than saving and investing it. It is more plausible that, when people become wealthier, they also become more, not less, prone to save an extra unit of present good in order to get additional units in the future (see the discussion in Block, Barnett and Salerno 2006). This pattern—a decrease of time preference with wealth—is illustrated in the right diagram of Figure 3, and the consequences of the typical changes in the case when this pattern prevails are summarized in Table 2.
Figure 3. Two patterns of time preference in Hayek’s model
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Table 2. A summary of Hayek’s model (the effects of the typical changes are those that occur under the assumptions of a concave productivity curve and of a marginal time preference that decreases with wealth)
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1.3 Garrison’s Model
The models of Böhm-Bawerk and of Hayek rest upon an optimization process (graphically: a tangency between curves). Garrison’s model, on the other hand, rests upon the equalization between a supply and a demand (graphically: a point of intersection between two curves). Here, equilibrium is determined on a generalized loanable funds market.This market is generalized in the sense that it includes, not only business lending and borrowing in the strict sense, but also “retained earnings and saving in the form of the purchasing of equity shares” (Garrison 2001, 36). The intersection of the supply of and demand for loanable funds displays the equilibrium values of the interest rate and of the gross investment spending. These values are then used to determine the shape of a Hayekian structure of production, through the use of the production possibilities frontier (PPF) of the economic system (see Figure 4). This frontier indicates the “fundamental trade-off between consumer goods and capital goods” (Garrison 2001, 41): a greater investment during the current period requires a lower consumption, and a lower investment allows for a greater current consumption. For an equilibrium amount of investment Ie as determined on the loanable funds market (bottom-right quadrant), the PPF indicates the corresponding equilibrium amount of final consumption Ce, and from there on the Hayekian structure of production is itself determined (top-left quadrant).
Figure 4. Garrison’s model (adapted from Garrison 2001, 50)
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The typical changes analyzed by Garrison are (i) a technical progress and (ii) a lowering of time preference (there is no mention in his presentation of a change in the aggregate supply of labor). Let us begin with technical progress. If this progress “affects all stages of production directly and proportionally,” then “Investment, output, income, consumption, and saving would all rise together without putting pressure one way or the other on the rate of interest” (2001, 58). If, on the other hand, the technical improvement “is usable only in one or a few stages,” then the interest rate is impacted: first, the demand for loanable funds increases and the interest rate rises, as entrepreneurs “seek to take advantage of [the] new technology”; then, as incomes increase due to the enlarged investment, the supply of loanable funds also increases, and the interest rate falls; equilibrium aggregate investment Ie necessarily rises, but the resulting effect on the equilibrium interest rate ie is indeterminate since the effects of a higher demand for and a higher supply of loanable funds balance one another. Simultaneously, the PPF shifts outward since the economic system has become more productive, so that the amount of final consumption and the period of production also rise. In the case of a lowering of time preference: the supply of loanable funds shifts to the right, since people are willing to lend and invest more, but the demand does not move. As a consequence, the equilibrium interest rate diminishes, equilibrium investment increases, consumption falls, and the structure of production becomes more roundabout.The lengthening of the structure increases the productivity of labor and will eventually cause an outward movement of the PPF, but Garrison does not illustrate this effect. Garrison’s model is summarized in Table 3.
Table 3. A summary of Garrison’s model
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- VIENNA, WE HAVE A PROBLEM After this review of the Austrian models, the first and most obvious remark is that they are inconsistent with each other. In the case of the implementation of technical progress, for instance, Böhm-Bawerk’s model concludes that the interest rate will rise, while according to Hayek’s model it will rise first and then fall more than it has risen (under the assumption that time preference diminishes with wealth), and in Garrison’s model it can either rise or fall. In the case of a lowering of the preference for the present, all the models conclude that the interest rate falls and that investment necessarily increases. However, even when the conclusions converge they are deduced from incompatible premises, and this is the deeper problem that will be investigated hereafter. In order to carry out the comparison between these models, we are going to distinguish between the “productivity” models of Böhm-Bawerk and of Hayek on the one hand, and the “demand and supply” model of Garrison on the other. The comparative analysis will be carried out first between the “productivity” models, and then across the two kinds of models.
2.1 The “Productivity” Models
In both Böhm-Bawerk’s and Hayek’s models, productivity plays a key role and the convergence towards equilibrium takes place through a step-by-step optimization process, but there are significant differences between them. The first and main one pertains to intertemporal choice. In the two models, the economic agents make intertemporal decisions, but not at all of the same kind. In fact, while Hayek’s model is built upon a genuine intertemporal choice, Böhm-Bawerk’s rests upon what can be called a “pseudo” intertemporal choice. The actors in Hayek’s model face a trade-off between present and future consumption. If they want to consume more now, they must decumulate capital, and the less capitalistic structure will provide a smaller output and consumption in the future. Conversely, if they sacrifice a part of their present consumption and invest this net saving, then capital is accumulated, and the more capitalistic structure will provide a larger output and consumption in the future. There is of course nothing surprising or unusual in this kind of very basic intertemporal arbitrage. However, when we turn to what Böhm-Bawerk calls the “exchange” of present against future goods by capitalists, we realize that the phenomenon he is talking about is completely different.Böhm-Bawerk uses the word “exchange” many times in his chapter on “The Rate of Interest,” for instance in the very first sentence that reads: “The exchange of present goods for future goods, which constitutes the source of the phenomenon of interest, is merely one special case under the rubric of the exchange of goods in general” ([1889] 1959, 347). Here, the capitalists “exchange” present goods (present wages) against the goods that will be produced in the future with the help of the hired labor. In these exchanges, the capitalists invest the same amount at the beginning of a period (the wage), and they can get, over the period, different levels of interest rate according to the length T of the structure of production. It so happens, in the framework of the model, that there is a period of production that brings the highest interest rate (and also interest), and they choose this period. The crucial point is that the capitalists choose the highest interest that they can get at the end of each period, while their investment at the beginning of this period is fixed. This means that they do not choose between present and future goods, but rather between future goods available at the same moment (at the end of the period): at this moment, the capitalists can get more or can get less, and choose more over less. This choice cannot appropriately be considered as an intertemporal choice because it is made between options available at the same moment in time. Whether the period of production is longer or shorter does not require a greater or smaller sacrifice from the capitalist. There is no trade-off between present and future consumption. While the exchange in Hayek’s model is truly intertemporal, in Böhm-Bawerk’s it only appears, but is not, intertemporal.
The second significant difference between the two models has to do with the roundaboutness of the production process. The period of production is a pillar of the Austrian theory of capital, according to which capital accumulation takes place through a lengthening of the structure of production. Böhm-Bawerk’s model explicitly takes this length T into account as an endogenous variable. The period of production thus plays a key role in his formalization. Hayek (1941, 60) accepts the “roundaboutness” theory but maintains that it is not applicable in the framework of his model. The reason is that in his model “there is only one possible period of investment” (1941, 221), and as a consequence there cannot be any change in the duration of the period of production: capital accumulation takes place laterally, through the addition of similar processes of identical length, not longitudinally. His model indeed requires that, when an extra saving is invested, the increase in the production of consumption goods occurs in the very next period. Now, when the period of production lengthens, the reorganization of the structure extends over several periods, which means that a number of periods elapses before the eventual increase in the production of consumption goods. But such a waiting cannot happen in the framework of the model, which requires that the production of consumption goods increases in the period immediately following the period when the net saving is invested. Hayek’s model therefore does not integrate the phenomenon of roundaboutness that is the fundamental law of the Austrian theory of capital.This impossibility to integrate the phenomenon of roundaboutness is (in our opinion) the reason why Hayek did not try to combine his theory of the interest rate of The Pure Theory of Capital (1941) with his famous “triangle” of Prices and Production ([1931] 1935). When the economic system is depicted as a triangle, capital accumulation takes place through a lengthening of the overall period of production: the triangle becomes thinner and longer. This “longitudinal” or “vertical” accumulation of capital is incompatible with Hayek’s theory of the interest rate. To sum up, when compared to Böhm-Bawerk’s model, Hayek’s one offers a much more appropriate formalization of intertemporal choice, but uses a theory of capital accumulation that is not the core theory of the Austrian School.
2.2 Across “Productivity” and “Demand and Supply”
The “productivity” models are well suited for the study of changes that affect the real output, such as technical progress and an increase in the supply of labor: suffices to move the productivity curve and investigate the ensuing convergence process. The “supply and demand” model of Garrison, on the other hand, is especially appropriate for the study of lending and borrowing. Two questions now deserve to be answered. First, how does this “supply and demand” model address the issue of productivity? And second, are the “productivity” models able to integrate the phenomenon of lending and borrowing?
Can productivity be taken into account in the “demand and supply” model? Productivity has to do with quantities of goods, i.e. with real values. In Garrison’s model, there is an element that shows the real final output, namely the production possibilities frontier (PPF). Technical progress simultaneously affects the PPF and the loanable funds market. The PPF moves upwards, since for any level of investment I, the real final output Cr is now larger. In parallel, the supply and demand curves increase, simultaneously if technical progress is implemented all along the structure of production, and sequentially if it is implemented at one stage only (see Subsection 1.3 above). This “supply and demand” model can therefore analyze the productivity effects, even though its theory is in this case more convoluted than those offered by the “productivity” models.
This is the place to say a few words about the comparison between the Garrisonian PPF and the Hayekian productivity curve. These two curves bear a superficial resemblance, as they are both concave curves that relate consumption to investment. However, the two constructs are very different from each other. The Hayekian productivity curve is an intertemporal construct that shows how future consumption will change following a current net saving or dis-saving. This productivity curve therefore shows how a current net saving (for instance) turns into an increase in future consumption. Garrison’s PPF, on the other hand, is an instantaneous construct that shows how a current net saving implies a decrease in current consumption. Another difference is that the Hayekian productivity curve is a barrier that the economic system cannot cross, while the Garrisonian PPF is a boundary that can be crossed: the economic system can move beyond it. Garrison (2001, 70) defines the PPF as “sustainable combinations of consumption and investment,” so the economic system can indeed produce an amount that goes beyond the frontier if part of the capital is consumed.
The “supply and demand” model can take productivity into account, but can the “productivity” models integrate the phenomenon of lending and borrowing? The answer, in our opinion, is no. Hayek’s and Böhm-Bawerk’s models are exclusively based upon productivity. They have no place for a loanable funds market in which the economic agents supply or demand various amounts of present goods according to the level of the interest rate. Hayek (1941) never mentions loans in the two chapters of the book in which he develops his model. Böhm-Bawerk ([1889] 1959, 369) takes consumer loans into account, but not in his basic model, since the latter only features the wage and productivity of capital. He analyzes the demand for consumer loans separately, as an additional and specific force that impacts the interest rate and the structure of production: the economic agents who ask for consumer loans compete with workers to get a part of the subsistence fund; the more intense the demand for consumer credit, the higher the interest rate, and the shorter the structure.In the graphical representation of Böhm-Bawerk’s model (see Figure 1), the effects of the emergence of a demand for consumer loans can be visualized as a downward movement of the hyperbola wT = 2K/N, since this demand reduces the amount of capital K available for productive purposes.
Leaving aside consumer loans and focusing on the more relevant phenomenon of productive loans, a follow-up question arises: is it a serious defect for these “productivity” models that they do not integrate loans to producers? The answer depends in turn on the answer to another question: how significant is the role of loans to producers in a basic macroeconomic model? In the context of such a study, investors do not face any uncertainty, and have thus no reason to prefer less risky loans to more risky equity. Furthermore, there is no money creation by banks building additional credit (loanable funds) upon fractional reserves. It appears, therefore, that productive loans would play a secondary role in the study of the determination of investment and the interest rate. The fact that the “productivity” models cannot explicitly take these loans into account is therefore not at all a critical flaw. Furthermore, a developed economic system can be conceived without any loans, but not without any productivity of capital, so that the latter is more important from a theoretical viewpoint.In the context of his discussion of the tendency towards an equilibrium, Hayek (1941, 266) writes:We might conceive a society where the lending of money (at least at interest) was prohibited and where nevertheless, so long as the possibility of spreading investments by means of partnerships, joint-stock participation, etc., existed, the rate of return on investment would be uniform throughout the system. The rate of return on investment as determined by the price relationships between capital goods and consumers’ goods is thus prior to, and in principle independent of, the interest on money loans, although, of course, where money loans are possible, the rate of interest on these money loans will tend to correspond to the rate of return on other investments (our emphasis). Hayek does not clarify what he means by the rate of return on investment being “prior to” the interest on money loans, but he is likely talking of a historical and a theoretical priority. Decades before, Fetter ([1914] 1977, 234) argued that “capitalization” (interest on investment) is both historically and logically antecedent to “contract interest” (interest on loans).<
In conclusion, there are bridges between a “demand and supply” model such as Garrison’s and the phenomenon of productivity. The relationship between the “productivity” models and the phenomenon of productive lending and borrowing is more problematic, and has not been investigated either by Böhm-Bawerk or by Hayek in the framework of their “productivity” models.
- SOME COMMON FEATURES OF THE AUSTRIAN MODELS Even though the three models widely diverge in their specifics, at a more general level they share a number of significant characteristics.
First, they all implicitly or explicitly accept the validity and relevance of a “macro” approach in the realm of economic analysis. The idea of an “Austrian macroeconomics” may at first sight seem problematic and even paradoxical, on account of the importance that the economists of the Austrian School have attached to subjectivism and individual action since the seminal contribution by Menger ([1871] 1976). Now, as much as the proof of the pudding is in the eating, the proof of an Austrian macroeconomics is in the models presented above. Horwitz (2000, 1) writes that “In the eyes of many economists, Austrians are seen as rejecting the whole concept of macroeconomics in favor of a focus on microeconomic phenomena such as price coordination and entrepreneurship.” He adds that “there is an Austrian macroeconomics that is alive and well” (2000, 2), pointing to the study of topics such as money, banking, and the business cycle. This paper shows that Austrian macroeconomics is not limited to the theories of monetary disequilibrium and of cyclical fluctuations. It also covers much more elementary topics such as the determination of the static equilibrium interest rate and distribution between capitalists and workers. Like Horwitz, Hülsmann (2012) recognizes the existence of an Austrian macroeconomics. He notes that before Garrison’s first contribution (Garrison 1978), “the very expression Austrian macroeconomics was considered an oxymoron” (2012, 46) because the word macroeconomics was associated “with positivistic and mercantilist ideas,” ideas to which the Austrians were—and still are—strongly opposed. However, it can be argued that the Austrian tradition in macroeconomics was not born in the 1970s, but goes way back to the end of the nineteenth century.
The second common feature of these Austrian models is that they all have, in one way or another, a subjectivist foundation in human action. In Böhm-Bawerk’s model, the convergence process is driven by the capitalists aiming at maximizing the interest rate, and also competing with each other to invest their whole capital. Hayek’s model is formalized around the intertemporal choice of a Robinson Crusoe or a collectivist dictator. Garrison’s model is based upon a generalized loanable funds market in which the individual actors interact. Since the appearance in the 1930s of a macroeconomics severed from any micro-foundations (Frisch 1933), the Austrian scholars have ceaselessly criticized this kind of approach. Hayek was one of the earliest opponents of this search for relationships between aggregate statistical constructs,“In fact, neither aggregates nor averages do act upon another, and it will never be possible to establish necessary connections of cause and effect between them as we can between individual phenomena, individual prices, etc.” (Hayek [1931] 1935, 4–5). He expressed the very same thought in his last book, defining what he calls “macro-economics” as the search for “causal connections between hypothetically measurable entities or statistical aggregates,” and stating that it is a “delusion that macro-economics [in this sense] is both viable and useful” (Hayek 1988, 98). but his attack should not be understood as a criticism against any and all kind of macroeconomic investigation. The Austrian models do not suffer from the defects of the purely holistic macroeconomics that he strongly condemns. In the distinction elaborated by Lachmann (1973) between “formalism” and “subjectivism,” these models clearly belong to the latter category. Lachmann defines “formalism”—an approach with which he disagrees—as “a style of thought according to which abstract entities are treated as though they were real.” He then defines “subjectivism” as “the postulate that all economic and social phenomena have to be made intelligible by explaining them in terms of human choices and decisions” (1973, 9–10). The Austrian macroeconomic models indeed rest upon the subjectivist approach, in line with the Mengerian tradition of methodological individualism.
Third, all the models use very similar simplifications in order to make the analysis of the economic system manageable. These simplifications are too numerous to be listed exhaustively, but here are some of the most significant. The economic system produces a homogenous consumption good or basket. The capital goods, on the other hand, can be different from the consumption good, and to this extent these models are not as simple as the standard neoclassical model of Solow and Swan, in which there is only one good used both as a capital and as a consumption good. There are two kinds of factors of production, namely labor and capital goods (in the Böhm-Bawerkian sense of produced factors of production). In the more general case, there are three kinds of factors, labor, capital goods and land. If land is taken into account, then the corresponding (unproduced) natural resources are not exhaustible: if there were an exhaustible resource, then a static equilibrium could not occur because the quantity of one of the productive inputs would diminish over time. When the effect of technical progress is analyzed, the discovery of more efficient techniques of production is free, and these more advanced methods increase final production as soon as they are discovered and implemented.It would be more realistic to suppose that there is a delay between the implementation of new techniques and the eventual increase in the production of consumer goods. If the progress takes place at a stage far away from final consumption (for instance an improvement in the methods of extraction of deposits), then it could take several years before the increase in the final output occurs. The functioning of the price system that reallocates the factors of production where they are the most useful is taken for granted, and quickly adjusts the structure of production after an exogenous shock. Finally, these models eliminate uncertainty, and with it the entrepreneurial function. The absence of uncertainty gives them a “mechanistic” appearance that is discordant with the work in the Austrian paradigm that is more focused on the way the market process allows the agents to cope with radical ignorance.As Lachmann ([1991] 1994, 278) puts it, “In its essence Austrian economics may be said to provide a voluntaristic theory of action, not a mechanistic one. Austrians cannot but reject a conceptual scheme, such as the neoclassical, for which man is not a bearer of active thought but a mere bundle of ‘dispositions’ in the form of a ‘comprehensive preference field.’” This mechanistic aspect, however, seems to be the price to pay for the high degree of simplification required in order to cope with an economic system as a whole.
On the theoretical side also, these models bear an undeniable resemblance. As far as production is concerned, it can only grow if the quantities of factors increase or if better techniques are implemented. The increase in the quantities of factors can be either exogenous in the case of the original factors labor and land, or endogenous (through saving) in the case of capital goods. In all these models, the crucial theoretical problem that has to be solved is the problem of the determination of the interest rate. In fact, for two of the three models (Böhm-Bawerk’s and Hayek’s), the essential reason they were developed was to get a theory of the forces that lead to the determination of the level of the interest rate. In the case of Hayek, the problem was to weigh the relative influence of productivity and of time preference on the height of the interest rate. Another major theoretical similarity is the kind of shocks whose effects upon equilibrium and distribution can be analyzed, namely a change of time preference (capital accumulation or dissipation), technical progress, and a change in the supply of labor. A last theoretical common point between the models is the use of the Austrian structure of production and of the related Böhm-Bawerkian theory of roundaboutness. The only model that does not resort to either of these two elements is Hayek’s model, for reasons indicated above (see Subsection 2.1). It is surprising that Hayek’s model is the one that does not make use of the most famous construct in Austrian macroeconomics, namely the Hayekian triangle developed by Hayek himself ([1931] 1935).
Finally, from an epistemological viewpoint, the three Austrian models all exemplify the same kind of endeavor. They are not intended to be tested against empirical observations. They are not meant to be calibrated to match historical macroeconomic data in order to determine the value of their parameters.We are not claiming that it would be impossible to relate in one way or another these models to macroeconomic data, but it certainly has never been attempted and was not the reason why they were developed in the first place. Rather, they are conceived as intelligibility models that aim at clarifying some of the most basic economic questions in a very simplified setting. This clarification rests upon the logic of action, and has nothing to do with the empirical corroboration of hypothetical laws. These models therefore follow an epistemology that is not the one used in the experimental sciences.Hayek (1952) and Mises (1962) offer classic statements, from an Austrian perspective, of the epistemological specificity of the social sciences vis-à-vis the natural sciences.
For all these reasons, in spite of their divergences, the three Austrian models are part of the same family. They can be considered as declinations or exemplars of a common approach to basic macroeconomics, illustrating the search for simple frameworks that illuminate the determination of the interest rate and the distribution of the net output. All these attempts agree on the purpose of a straightforward and relevant macroeconomic model in terms of equilibrium analysis and response to typical shocks.
- WHY NO SINGLE MODEL DOMINATES Up to this point, it has been established that the Austrian macroeconomic models are contradictory in their premises and conclusions, but bear a family resemblance. The question remains as to why none of them has managed, at least until now, to dominate the scene within the Austrian School, and by “dominate” we mean: being generally accepted within the School as a sound theoretical foundation.
Böhm-Bawerk’s model was published in 1889, and was mathematically formalized a few years later by Wicksell ([1893] 1970). There is, however, no trace of this model in Wieser’s treatise ([1914] 1927), nor in Strigl’s main book on capital ([1934] 2000). The model was revived by Dorfman (1959), and the last specific reference to it by a major Austrian economist is found, to the best of our knowledge, in Kirzner (1966).Blaug ([1962] 1978) offers a detailed presentation of the model in the chapter devoted to the Austrian theory of capital and interest. In the meantime, the two main Austrian economists of the twentieth century, namely Mises and Hayek, had both aimed severe criticisms at Böhm-Bawerk’s approach of the theory of interest. Their criticisms are not consistent with each other, though, and furthermore do not rest upon a detailed examination of the model itself. Rather, they target some of the most general features of Böhm-Bawerk’s approach. Hayek (1941) criticizes the simplistic assumptions made by Böhm-Bawerk when he treats the quantity of capital and the period of production as purely technical data.“As will appear later in more detail, the quantity of capital as a value magnitude, no less than the different investment periods, are not data, but are among the unknowns which have to be determined.” (Hayek 1941, 192) Mises is extremely severe vis-à-vis the Böhm-Bawerkian concept of “average period of production,” which he labels an “empty concept.”“The length of time expended in the past for the production of capital goods available today does not count at all. These capital goods are valued only with regard to their usefulness for future want-satisfaction. The ‘average period of production’ is an empty concept.” (Mises [1949] 1998, 486) He also totally rejects the productivity theory of interest that forms the core of Böhm-Bawerk’s model. In this regard, the opinions of Mises and of Hayek diverge: Hayek considers Böhm-Bawerk’s criticism of earlier productivity theories as “mistaken,”“[Böhm-Bawerk’s] effective, although I think mistaken, critique of the earlier productivity theories of interest had the effect of causing later development to centre [sic] increasingly round the ‘psychological’ or ‘time-preference’ element in his theory rather than the productivity element.” (Hayek 1941, 42) while Mises lauds how “brilliantly” Böhm-Bawerk refuted these first productivity theories.“... Böhm-Bawerk in the elaboration of his theory did not entirely avoid the productivity approach which he himself had so brilliantly refuted in his critical history of the doctrines of capital and interest.” (Mises [1949] 1998, 486) So they both point out what they believe to be insurmountable flaws in Böhm-Bawerk’s theory. The latter’s model, therefore, could not be accepted by the followers either of Mises or of Hayek, which pretty much means that it could not be accepted by anyone in the Austrian School from the mid-twentieth century on.
In the 1970s, Faber (1979) developed a “neo-Austrian” approach to the theory of capital. After an in-depth analysis and criticism of Böhm-Bawerk’s model, Faber makes use of a mathematical model of the economic equilibrium elaborated by von Neumann (1945–46). This model rejects the concept of an average period of production, but it can be infused nonetheless with the Böhm-Bawerkian theory of roundaboutness. Faber is able, with his neo-Austrian version of von Neumann’s model, to investigate the cases of a two-period two-sector economy, and then of a multi-period (with a finite horizon) economy.The author wishes to thank an anonymous referee for the reference to and remarks about Faber’s work.
Hayek’s model has recently been brought to light by Molavi Vasséi (2015) and Fillieule (2017). White (2007) also devoted a few paragraphs to it in his “Introduction” to the new edition of Hayek (1941). There are a number of reasons why this model has not been used to build a cumulative tradition. The first one is that Hayek’s book failed to have a significant following in the Austrian School, in the sense that nobody tried to develop capital theory along the lines first set out in this book. Furthermore, the model does not deal with the core topic of the 1941 book, namely capital theory. An off-topic model in an idiosyncratic book had little chance to make an impression.In his recent presentation of The Pure Theory of Capital, Steele (2014) does not expound this model at all. A second reason is that the model was not conceived, and also not really recognized, as a macroeconomic model. In his ([1936] 2015) paper, Hayek insists upon the way his model formalizes time preference, and claims that the concept of “constant tastes” failed to be correctly understood by Böhm-Bawerk and by Schumpeter. Hayek ([1936] 2015, 36) then explains that “we... have to represent constant tastes by declaring the indifference map of the individual (or the indifference maps of all the individuals) to be the same at every moment.” His model indeed solves the problem of formalizing “constant tastes” as a pattern of intertemporal indifference curves that remains the same at the successive periods. But as a result of this presentation, the much wider range of the model may have been neglected. There were also probably more technical reasons, such as the hypothesis of a constant marginal productivity (which deprives the model of much of its appeal, since it restricts the acceptable kind of time preference pattern to the implausible case of a marginal time preference that increases with wealth), and such as the fact that Hayek did not systematically try to investigate the effects of changes in time preference, technology, and supply of labor. A major reason for the neglect of this model is that in the United States, where the Austrian School experienced a renaissance in the second half of the twentieth century, the scholars adopted the Fetter-Mises subjectivist theory of interest instead of a productivity theory. The time preference theory of interest was endorsed by Rothbard ([1962] 2009), Garrison (1979), Kirzner (1993), and other authors (see Pellengahr 1996). Hayek (1941), on the other hand, very explicitly chose the productivity explanation of interest, even though he thought that time preference could also play a (minor) role in the determination of interest.“Of the two branches of the Böhm-Bawerkian school, that which stressed the productivity element almost to the exclusion of time preference, the branch whose chief representative is K. Wicksell, was essentially right, as against the branch represented by Professors F. A. Fetter and I. Fisher, who stressed time preference as the exclusive factor and an at least equally important factor respectively.” (Hayek 1941, 420) As a result, his model—interpreted by Hayek as a validation of the productivity theory of interest—was largely overlooked.
Garrison’s model (2001) attracted a lot of attention within the Austrian School as soon as it was published. The reason is that this author had provided for more than two decades some of the most important macroeconomic work of the school (see for instance Garrison 1984). The book (not just the model) was received with great expectations by the Austrian scholars, but the reviews that were published in the two major Austrian journals were not entirely positive. In the Review of Austrian Economics, Oprea and Wagner (2003) criticized Garrison’s book for being dated, reviving discussions from the 1960s, and for not taking into account the more recent mainstream macroeconomic paradigms. The Quarterly Journal of Austrian Economics devoted a whole issue to the analysis and commentary of the book (Thornton 2001). While more positive in tone than Oprea and Wagner’s review, a number of criticisms were raised. The comments about the comparison drawn by Garrison between his “capital-based macroeconomics” and the macroeconomics of Keynes and Friedman do not concern us in this paper, and neither do the comments about the theory of the business cycle. The graphical construct is the focus here, and it was criticized by Hülsmann and by Salerno. Hülsmann (2001, 40) notes two inconsistencies in the diagrams displayed by Garrison (see Figure 4 above). First, there is a discrepancy between the nature of the variables in the top part of the diagram, namely between the real consumption on the vertical axis of the PPF and the nominal consumption on the vertical side of the Hayekian triangle. Second, there is a temporal discrepancy between the two horizontal axes, the bottom horizontal axis showing the current investment that will produce the future capital goods, and the top horizontal axis showing these future capital goods on the PPF. Salerno (2001) criticizes another aspect of the model, this time pertaining to the theory of growth. Garrison (2001, 54) claims that a “secular growth” can occur “without having been provoked by policy or by technological advance or by a change in intertemporal preferences.” This secular growth is simply the result of “the ongoing gross investment,” which “is sufficient for both capital maintenance and capital accumulation.” Salerno points out that the Austrian theory asserts, rather, that the growth brought by a net investment ends up in a stationary equilibrium and cannot lead to an indefinite growth.Writes Salerno (2001, 45): “However, in Austrian capital theory, each dose of net investment, ceteris paribus—and after a transition period during which the appropriate resource reallocations have been completed—brings about a stationary economy in which the new higher level of gross investment and the elongated structure of production is just sufficient to support a definite increase in the flow of consumer goods. As long as gross investment is maintained at its new higher level, the output of consumer goods per period will remain constant.” See also the recent qualified defense of Garrison’s theory of secular growth by Murphy (2017). So, even though Garrison’s diagrammatic exposition of Austrian macroeconomics was generally praised as a pedagogical tool (and still is“[P]erhaps the primary virtue of Time and Money is its exposition of capital-based macroeconomics in terminology and graphs that non-Austrian economists can understand.” (Murphy 2017, 353)), some of the reviewers were skeptical about parts of the theoretical underpinnings of the model.
CONCLUSION This paper has attempted to tell the little-known story of the basic Austrian macroeconomic models, models spanning from the end of the nineteenth century to the beginning of the twenty-first. After a presentation of each model, a detailed account of the differences between them has been provided. The main results of this investigation can be summarized as follows. (i) There exists an Austrian macroeconomics, even at a quite elementary level that does not take uncertainty and monetary disturbances into account. (ii) This macroeconomics is embodied in formal models that have been presented graphically as well as mathematically. (iii) These models are not consistent with each other. (iv) The inconsistencies between them are mainly due to disagreements on the theory of the interest rate. (v) Beyond these theoretical contradictions, these models all try to solve the same kind of problems by using of the same (actionist) methodology. (vi) The continuing search for a basic macroeconomic model, from the birth of the Austrian school until today, shows the importance and relevance of this topic from a theoretical viewpoint. (vii) Nevertheless, very few discussions, if any, have taken place in the history of this school on the relative merits of the different models. From a history of thought perspective, this study shows that in macroeconomics just as in other areas (banking, for instance), the Austrian School is not monolithic but has been traversed by deep tensions, some of them still unresolved.
We dive into Part Four of Human Action with Professor Jeffrey Herbener, Chair of the Economics Department at Grove City College.
This is a fantastic discussion of money and market exchange, with Mises proving timely as ever given the current financial meltdown and crazed response from Washington. Dr. Herbener and Jeff Deist cover catallactics and how imaginary constructs help us understand basic economics; markets as a system of social cooperation; how ordinal preferences find expression in money prices; the structure of production; consumer sovereignty; Mises's conception of monopoly; and the various media of exchange which complicate what ought to be the market's provision of commodity money.
Use the code HAPOD for a discount on Human Action from our bookstore: Mises.org/BuyHA.
Additional Resources Human Action: Mises.org/HumanAction
Bob Murphy's Study Guide to Human Action: Mises.org/Study
We continue our series on Human Action with Professor Per Bylund of Oklahoma State University.
Dr. Bylund and Jeff Deist consider Part Three of the book, "Economic Calculation," considering Mises's conception of value and the folly of attempting to define a "unit of value" in a highly subjective world. They discuss socialism and the elementary theory of value and prices; inputs and outputs in barter vs. under monetary exchange; prices as exchange ratios; why change is constant and price "stabilization" efforts fail; why mathematical calculation of money prices may rival the wheel as among the most important human inventions; and why Mises thought praxeology emerged when man started thinking about monetary calculation.
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Additional Resources Human Action: Mises.org/HumanAction
Bob Murphy's Study Guide to Human Action: Mises.org/Study
Our friend and economist Dr. Robert Murphy joins the show for a discussion of Part Two in Human Action, "Action Within the Framework of Society."
This is a great discussion of Mises's view of society and cooperation; Mises on Darwin; the Ricardian Law of Association; the case for treating ideological differences as purely ideological; Mises's utilitarianism as it relates to democracy and anarchism, and the critical importance of exchange and monetary calculation in developing society.
Use the code HAPOD for a discount on Human Action from our bookstore: Mises.org/BuyHA.
Additional Resources Human Action: Mises.org/HumanAction
Bob Murphy's Study Guide to Human Action: Mises.org/Study
On his podcast The Local Maximum, software engineer (and developer at Foursquare) Max Sklar has Bob Murphy explain Ludwig von Mises's distinction between class and case probability. They apply Mises's framework to other economic theory, and discuss Bayesian inference and machine learning.
For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
In the second installment of our series on Mises's Human Action, Dr. David Gordon joins the show to walk us through Part One. The beginning of the book is considered its most "philosophical" material, where Mises lays out the basics of praxeology and epistemology as fundamental to understanding economics.
Dr. Gordon and host Jeff Deist consider each of the book's first seven chapters, with topics including: Mises's categories of action and causality, a priori disciplines, polylogism, "felt uneasiness," value and preferences, praxeology as it relates to time and uncertainty, probability and its application to human action, and the nature of production.
If you've wanted to read Human Action, this is your opportunity to hear it explained by great economists and scholars!
Use the code HAPOD for a discount on the pocket edition of Human Action from our bookstore: Mises.org/BuyHA.
Additional Resources Human Action: Mises.org/HumanAction
Bob Murphy's Study Guide to Human Action: Mises.org/Study
Human Action is the book you want to read, you need to read, you've thought about reading. So make 2020 the year you do read it!
Over the next seven weeks the Human Action Podcast will guide you through this incredibly vital and intellectually transforming work, with a series of guest economists to explain and bring Mises's most important work to life.
Our opening show features Dr. Shawn Ritenour of Grove City College, who makes a compelling case for lay readers to engage with Human Action. Jeff Deist and Professor Ritenour share plenty of great background, insights, and anecdotes about Mises and the context surrounding the book, so this is an episode you don't want to miss.
Use the code HAPOD for a discount on the pocket edition of Human Action from our bookstore: Mises.org/BuyHA.
Additional Resources Human Action: Mises.org/HumanAction
Bob Murphy's Study Guide to Human Action: Mises.org/Study
The Mises Reader, edited by Shawn Ritenour: Mises.org/Reader
In Bob Murphy’s interview of Bryan Caplan, they briefly discussed Bryan’s essay criticizing Austrian economics. At listener request, in this episode, Bob presents a more comprehensive analysis of why he remains an Austrian economist, even after seeing top-notch neoclassicals in action during his own time in grad school.
For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
Reflections on Ethics, Freedom, Welfare Economics, Policy, and the Legacy of Austrian EconomicsIsrael M. Kirzner. Eds. Peter J. Boettke and Frédéric SautetCarmel, Ind.: Liberty Fund, 2018xiv + 782 pp.
Abstract: Everyone interested in Austrian economics owes a great debt to the editors of this vast collection of articles by Israel Kirzner. Two themes are commented on here: 1) the value-free nature of economics, and 2) the gap between the Kirznerian account of the entrepreneur and the causal realist view of Salerno and Klein. On the second theme, it appears that Kirzner may have come closer to Rothbard's view that capitalist entrepreneurs appraise profit-making opportunities in the face of an uncertain future.
uncertainty entrepreneurship kirzner Everyone interested in Austrian economics owes a great debt to the editors of the vast collection of articles by Israel Kirzner, one of the foremost students of Ludwig von Mises. Readers will find that Kirzner stresses certain themes repeatedly, and I should like to comment on two of these.
Enemies of the free market often claim that defenders of capitalism are ideologically motivated. Mises, for example, worked in Vienna as an official of the Chamber of Commerce, and he does not disguise his ardent support of the free market. Can those with other ideological commitments reasonably dismiss his views? Kirzner argues that they cannot. Economics is strictly value-free. Mises’s personal values and political allegiances make no more difference to the validity of his economic theory than Einstein’s political views do to the validity of the theory of relativity.
Kirzner puts the point in this way: “Mises, the passionate ideologue on behalf of classical liberalism insisted—in fact he passionately insisted—on the wertfreiheit of the economist. Precisely because he believed that economic science can offer powerful support for classical liberalism, he saw it is as crucially important that the reputability of that science be maintained beyond suspicion…. But the economist’s teachings can have the desired effect, Mises realized, only if the economist qua scientist maintains an austere detachment from the political ideological debates to which the science may be able to make crucial contributions.” (pp. 214–15, emphasis in original)
Even so strong a critic of the free market as Gunnar Myrdal recognized the commitment of the Austrian school to value freedom: “When Gunnar Myrdal wrote his The Political Element in the Development of Economic Theory... he gave the Austrian School high marks for refraining from permitting their political aims to shape their science.” (p. 213)
As an example, when Mises shows that economic calculation under socialism is impossible, this conclusion is in no way dependent on Mises’s own disdain for that system. It is a strictly scientific conclusion.
Important though this theme is, another theme surpasses it in interest to students of contemporary Austrian economics. Kirzner does a good deal to clear up the mystery surrounding his account of the entrepreneur, and in so doing narrows the gap between his position and the “causal realist” view that Joseph Salerno and Peter Klein have taken over and further developed from Mises and Rothbard. Some distance remains, but using material Kirzner himself provides, we can see why the causal realist account is better than its rival.
The key difficulty with Kirzner’s account concerns the opportunities for entrepreneurial discovery that he holds are “out there,” waiting to be found. Is this not bad metaphysics? Kirzner himself recognizes the difficulty:
My theory of entrepreneurship has sometimes been criticized as viewing the future as a kind of tapestry waiting to be unfolded: it is already there; it is simply behind the screen; it has only to be unrolled and then the future will come into the field of vision, whereas the truth surely is, the critics point out, that the future does not “exist” in any philosophically valid sense. It must be created so the notion of alertness in the sense of seeing what is out there in the future is a mistaken notion. (p. 696)
Kirzner accepts the criticism. He is not, he says, assuming that discoveries are “out there” but means only that entrepreneurs try to anticipate the future: “I recognize the philosophical validity of this kind of criticism.... I think the distinction surely is one between an ex ante and an ex post perspective…. From this perspective, the philosophical validity of the idea of future events is really not to the point. Ex post we look back and say: if only I had seen this coming. The opportunity was there. Does an opportunity exist? An opportunity is always something in the future: it does not exist. Yet we do talk about an opportunity existing, meaning that ex post we can say: well, the action I took was successful; or the action I took missed being a more proximate action that I might have taken.” (p. 695)
Has not Kirzner here come closer to Rothbard’s view that capitalist entrepreneurs appraise profit-making opportunities in the face of an uncertain future? Kirzner does not recognize this. He says, “Murray N. Rothbard... has argued that this recognition and emphasis by Mises on the role of uncertainty in the generation of pure profit is inconsistent with the interpretation which the present writer [Kirzner] has given Mises’s theory. For Rothbard, an ‘alertness’ theory of profit of profit must do away with uncertainty…. I have not been able to follow Rothbard’s reasoning on this matter….” (p. 349, note 33)
But exactly the target of Rothbard’s criticism was the view of profit-making opportunities as “out there” in the world, a view Kirzner has given up. In the article that Kirzner cites, Rothbard says:
Moreover, by stressing alertness, Kirzner is emphasizing a quality of perception, of perceiving an opportunity that virtually exists, as a real thing out there. In reality, however, any profit opportunity is uncertain, and rather than be a real existing entity, it must always be subject to uncertainty. It is never as simple as mere alertness. (Rothbard 1985, 281–82)
The difference that remains between Kirzner and the causal realists centers on profits and losses to the entrepreneur. The causal realists stress profits and losses to capitalist investors, but Kirzner is not satisfied: “It is true that the disembodied purely entrepreneurial function cannot be observed in the real world…. So that indeed entrepreneurial losses will, in the real world, be suffered by owners of assets. But this does not mean that the phenomenon of pure entrepreneurial loss is intrinsically associated with the purely capitalist function…. Entrepreneurial profit and loss is to be traced to the purely entrepreneurial function.” (p. 742)
We can use points Kirzner makes elsewhere to render his claim irrelevant. In his penetrating discussion of the Chicago School’s “economic imperialism” Kirzner very effectively notes that, absent the pursuit of monetary profit and loss in the capitalist market, no mechanism exists to enable good insights to drive out bad ones. “Within the setting of the market the entrepreneurial element in human action can be expected to set in motion a process of mutual discovery…. But outside the market setting…. there is nothing in the character of interpersonal interaction which suggests any systematic discovery process (analogous to the discovery process inspired in markets by the lure of pure entrepreneurial profit).” (p. 165)
In his skeptical remarks about non-market “spontaneous order,” Kirzner returns to this theme. “The emergence within society of a common language, a common set of standards for weight and measurement, and common codes of social behavior, differ sharply from the emergence of a market-clearing price for wheat or for unskilled labor in competitive markets…. The demonstration that widely accepted social conventions can emerge without central authoritarian imposition does not necessarily point to any optimality in the resulting conventions. What is demonstrated…. by short-run coordination theory (i.e., by the theory of the free-market economy) is that there does exist a spontaneous tendency toward social optimality under the relevant conditions.” (pp. 64–66)
Kirzner has thus given us sufficient grounds to render nugatory his insistence on “pure” returns to the entrepreneur outside the capitalist market. Nevertheless, readers will close the volume with admiration for Kirzner’s devotion to Austrian economics, immense learning, and dialectical skill.
Bob Murphy conducts a friendly but challenging interview of Bryan Caplan, focusing on his new book making the case for open borders. They also discuss Bryan’s essay, “Why I Am Not an Austrian Economist,” and close with some brief remarks on pacifism.
For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
Central bankers dismiss gold as a relic, even as they buy up more of it. Politicians dismiss gold as money they don't control and can't expand. Holders dismiss gold as outdated tech. And investors dismiss gold as a static metal paying no yields.
So why does gold still matter? Why does it hold value over millennia? Why does it threaten inflationist governments? Why does it seem to be flowing West to East? Why does an ounce of it still trade for more than $1,000, if the critics are right? This is the comprehensive show on gold and its enduring role in today's economy, with Keith Weiner of Monetary Metals.
Negative interest rates are now entrenched reality in Europe, and not just for buyers of sovereign or corporate debt – even retail savings accounts are affected. What does this mean for real people trying to save for retirement? And more broadly, what does it mean for Europe culturally? Not to mention America, since Alan Greenspan tells us negative rates are coming here soon?
Our guest Rahim Taghizadegan from the independent Viennese Scholarium joins the show to discuss the anti-economics of negative rates. He is co-author of a new book titled The Zero Interest Trap. He is also a co-author of Austrian School for Investors.
Professor Peter Klein teaches entrepreneurship based on fundamental Austrian principles from Carl Menger’s Principles Of Economics. His advice is unlike anything you’ll get from studying mainstream economics, or from business books and business school classes. In our podcast, Peter explains the fundamentals of economics under ten headings, below, and transforms that economic knowledge into entrepreneurial guidance.
Key Takeaways And Actionable Insights Humanism: Business is about serving others, making their lives better. You can engage customers by understanding their hopes and dreams and their highest aspirations. Make humanism the foundation of your business strategy.
Individualism: To understand customers, you must approach them as individuals, not as “targets” or “segments” or “demographics”. Individualism is a methodology: identify one perfect customer and then try to add more that are closely similar.
Means And Ends: Customers choose products and services that they believe will serve them as means to achieve their preferred ends or goals. Use means-ends analysis to identify the pathways customers will follow to embrace your offering. Think of it as the customer’s journey through a valued experience that you can make possible for them. (Our free e-book, Understanding The Mind Of The Customer can help.)
Subjective Value: Value is an experience felt by the customer. It’s subjective and idiosyncratic, and can change with time and context and mood. Entrepreneurs must be empathic in diagnosing how customers experience value or its opposite, dissatisfaction, and humble in following changes in value perception that can occur quickly and without warning.
Customer Sovereignty: The customer is your boss, and determines what is valuable, what they will buy and refrain from buying, and which products, services and businesses will be successful. Changes in customer preferences can sometimes seem arbitrary and hard to follow; nevertheless, the entrepreneur’s job is to follow, respond, and ideally, imagine where the customer will go next in their search for betterment.
Uncertainty: The future can not be predicted. Extrapolated trends and predictive models can not deal with the changing preferences of customers over time. Even the customer is not sure what value they will experience when they use your product or service — it emerges from the interaction. Entrepreneurs understand this uncertainty and deal with it, by imagining what the future could be, based on their customer understanding, and adjusting to new information as it becomes available.
Deductive Method: Uncertainty sounds so intimidating. Austrian entrepreneurs use the deductive method to help steer them. Find some principles you know to be true — we know for example, that customers are always seeking betterment — and use those principles to reason your way to understanding complex phenomena. Your specialized knowledge of your chosen business specialty will give you solid grounding. By all means add test data and evaluation data and marketplace results data to your reasoning. But try to find the bedrock principles you can reason from.
The logic of cause and effect: All things are subject to the law of cause and effect. If you can identify the causal linkages, you will be firmly in command of your business. Write the story of the future evolution of your growth path in cause-and-effect language and match it to actual events as they unfold.
The role of time in production: Austrian economics has a unique sensitivity to time in the production process. Entrepreneurs must commit capital now to start production that will be completed in the future, without knowing the future nature of the market — what prices will prevail, what competitive firms will do, how the customer will be feeling about future conditions. Time is a danger to entrepreneurial success — so be as quick as possible, make fast decisions, shorten production cycles, and use time as a scarce resource.
The division of the production chain into higher and lower orders: The value of every link in the production chain reflects the revenue flow from customers to which it contributes. If preferences change, the value of upstream production resources changes. Wherever you operate, B2B or B2C, always keep an eye on end-customer behaviors and preferences. As a B2B supplier, you can be very useful to your business customers by alerting them to end-consumer changes.
Additional Resources Download "Menger's Manifesto"—Professor Peter Klein’s list of 10 Austrian Principles from Principles Of Economics (PDF): Mises.org/E4E_40_PDF
Download our free e-book, Understanding The Mind Of The Customer (Mises.org/E4E_Understanding).
Download Menger’s Principles of Economics (Mises.org/E4E_Principles).
Marketing guru and fund investor Hunter Hastings joins the Human Action podcast for a look at Economics for Entrepreneurs, a new platform which uses Austrian theory to teach actionable entrepreneurship.
Can business acumen be taught, or is it innate? Hunter and Jeff examine consumer sovereignty, value creation, and the theory of the firm, all from a unique Austrian perspective. Austrians have a lot to say about how entrepreneurs ought to think, while business schools fail to adjust to the new decentralized, agile world. Austrian economics provides entrepreneurs with a different set of tools than any business book or MBA program, and our new podcast series will help anyone improve their business or career bottom line.
Additional Resources Mises for Business LinkedIn page
Economics for Entrepreneurs (E4E) podcast
The Marginal Revolutionaries: How Austrian Economics Fought the War of Ideasby Janek WassermanYale University Press, 2019xiii+ 354 pages
Janek Wasserman, who teaches history at the University of Alabama, has written a useful but deeply flawed book. Useful, because Wasserman has brought to light substantial archival material on the background of the Austrian school, but deeply flawed on two counts. First, Wasserman is beyond his depth when he writes about theoretical issues. In particular, he does not understand Mises, but his lack of knowledge is apparent elsewhere as well. Second, he obtrudes his political opinions on readers in a way that must generate skepticism about his presentation of his archival research.
Wasserman distinguishes a number of stages in the history of the Austrian school. I do not propose to discuss these in detail but will mention only a few highlights. In general, Wasserman stresses the networks among the leading Austrians. They all knew each other and, though often at odds, they tended to support one another in times of crisis. Further, the cultural ferment of Vienna affected them: “The exchange of ironical barbs and clever repartee reflected the mode of the Austrian School specifically and modernist Vienna in general. The famed literary critic and cultural icon Karl Kraus best embodied this spirit. … Good polemics demanded satire and unfairness. It also was not enough to win one’s dispute with intellectual foes: one had to best adversaries in style. Schumpeter and Bőhm[-Bawerk] excelled in these arts and used the tools of the Gymnasium and coffeehouse to great effect.”
Schumpeter and Mises are often, and correctly, viewed as rivals who had little use for each other, but one of Wasserman’s most valuable insights is that they sometimes worked together. “Schumpeter encouraged Mises to speak out on Austrian monetary problems in the Austrian Political Society, where the two made common cause against the wartime government.”
Wasserman rightly notes that, despite his deviations from classic Austrian theory, Schumpeter’s Capitalism, Socialism, and Democracy is best read as a defense of capitalism: “While capitalism in its current, desiccated form seemed destined for collapse, this need not transpire. Deploying a satirist’s wit and an ironist’s pen, Capitalism revealed that Schumpeter believed just the opposite. Capitalism may sow seeds of its own destruction, but it still constituted the surest guarantee of prosperity and democracy. … Schumpeter also leveled a hearty criticism against his economist colleagues, whose static models of perfect competition and complete information, of partial and general equilibria, possessed little explanatory power for a dynamic world. … Capitalism, Socialism, and Democracy is one of the greatest and subtlest apologia for capitalism and elitist liberalism ever written.”
If Wasserman deserves praise for his treatment of Schumpeter, unfortunately this same is not true for his account of Mises. He adopts uncritically the perspective of Hayek, who varied in his estimation of Mises, and Gottfried Haberler about Nationalőkonomie: “Hayek conceded that the book showed a glaring ignorance of recent developments. … Hayek’s critique followed the lead of Haberler, who had argued for years that Mises was no longer a significant economist and that his work offered no insights for anyone who had learned economics since the Great War: ‘If one had studied the classics and Marshall in 1912, then one would have learned nothing from Mises.’” Had Wasserman consulted the book itself, he would have found that it includes references to Haberler’s then contemporary work on international trade theory and Hayek’s work, also then recent, on the business cycle and the socialist calculation argument. Matters become even clearer if one examines Human Action, the English expansion and revision of the German treatise. In it, Mises responds to Haberler’s criticism of Austrian business cycle theory and dissents from Hayek on the Ricardo effect.
Even more important, though, are Wasserman’s mistakes about praxeology. He says, “Mises’s most controversial assertion was his insistence on the a priori quality of the praxeological axiom. … This unremitting stance, which denied explanatory power to inductive reasoning or empirical observations, left many scholars cold. … Moreover, it did not seem that praxeology was supple enough to address contemporary problems.” Incredibly, Wasserman appears to attribute to Mises the odd view that every statement about economics can be deduced from the action axiom. Instead, of course, Mises developed praxeology as a deductive science that economists could use to help explain particular events. Doing so does not preclude empirical investigation but rather requires it.
An even worse misunderstanding is this: “Mises’s elevation of economics to the status of logic had great seductive power. If all of Mises’s economic assertions could be deduced from his core tenet — ‘Human action is purposeful behavior’ — then decisions that impeded the smooth functioning of human action violated scientific law and human will.” This does not follow at all, and only someone bereft of ability to reason logically could think it did. If all actions are purposeful, then actions that impede other actions are also purposeful.
Wasserman’s incompetence in theoretical issues is not confined to mistakes about Mises. He rightly says that The Theory of Games and Economic Behavior is difficult, but at one point he quotes a long sentence, which I shall not reproduce here, and says of it: “As a further example take one of von Neumann’s more straightforward explanations from early in the book, the elements of a game. … [Then follows proposition 6.2.1] Virtually no economists at the time were familiar with set notation or group theory, rendering this passage incomprehensible to its intended audience.” In fact, the proposition is easy to understand and requires no knowledge of group theory or set notation. It says no more than that a game consists of a fixed number of moves, where a “move” is a choice among given alternatives, and provides symbols for these points.
Here is another example of Wasserman’s ignorance, though here I am captious. He says, “Rőpke attracted the support of Hayek and the Italian éminense grise social scientist Benedetto Croce…”. To call Croce a “social scientist” is jarring. Croce was a leading light of Italian Idealist philosophy, as well as a historian and man of letters, not a social scientist.
Wasserman has strong political opinions and, as I have said earlier, he obtrudes these on readers in a way that arouses mistrust about his presentation of archival material. He says, “In this spat, the Austrians of the LvMI [Mises Institute] renewed their ongoing feud with the Kochs, GMU [George Mason University, and Cato]. The Misesians rejected the separation of economics and politics: Austrian economics implied libertarianism — of a conservative stripe. The GMU Austrians were consistently anti-interventionist and pro-market not just in their scholarship but in their politics, and many of them identified ideologically with libertarianism. They nevertheless believed that one could keep one’s scholarship and politics separate. Rejecting the ‘value-free’ pretensions of the left-leaning libertarians — and the longer wertfrei tradition of the Austrian School — the LvMI bloc reached out to other marginal right-wing groups, such as states’ rights organizations, historical revisionists, and neo-Confederates.”
Murray Rothbard did not reject value-freedom in economics. To the contrary, he insisted on it, and a principal theme in his writings about policy is that economists should make clear their value-commitments. In this he has been followed by Joseph Salerno, whom Wasserman assails. A grosser misunderstanding on Rothbard could hardly be imagined.
As Dante long ago said, “non ragioniam di lor.” Let us look at this ill-thought out book and pass on.
Includes an introduction by Jeff Deist.
Ludwig von Mises and his work remain incredibly prescient and relevant today. The world needs his voice more than ever, and our speakers celebrate Mises as a supremely vital thinker well-suited for today's challenges. Recorded in Los Angeles, California, on October 26, 2019.
[All lectures from the Supporters Summit 2019 are available here.]
The late Murray Rothbard has passionate fans and critics alike—but was he really the intransigent person his detractors portray? Was he prickly and difficult, or actually generous and helpful to students and colleagues? Did his reputation as an economist suffer for venturing into philosophy, ethics, history, sociology, and anarchism—even though Hayek did the same? Was Man, Economy, and State really just a rehash of Human Action? Did he deviate from Mises on method? Were Power & Market and the Ethics of Liberty just too radical and off-putting?
Professor Patrick Newman considers critics like Arthur Burns, Kirzner, Leland Yeager, Nozick, Mario Rizzo, Selgin/White, Jason Brennan, Bryan Caplan, and of course Mises. If you like Rothbard you don't want to miss this show!
Additional Resources In Defense of "Extreme Apriorism" by Murray Rothbard
Conceived in Liberty, Volume V coming October 25
Join us for a celebration of Mises and his work in Los Angeles October 25–27. More info available here.
Professor Murray Sabrin, author of the new book Why the Federal Reserve Sucks, joins HAPod to explain why ordinary people should care about — and oppose — the Fed. This is a comprehensive look at central bank mythmaking: how money creation benefits wealthy elites at our expense; what Keynesians, monetarists, and supply-siders get wrong; and, why we should understand the sordid history of money manipulation and tyranny.
Subscribe and listen to the Human Action Podcast on iTunes, YouTube, Stitcher, Soundcloud, Google Play, Spotify, or via RSS.
Europe and Asia are awash with $13 trillion in negative yield sovereign and corporate bonds. Alan Greenspan says negative interest rates are coming to America. And the Fed just announced another rate cut, even while Chair Jay Powell and Mr. Trump assure us the economy is better than ever. Economist Bob Murphy joins Jeff Deist to make sense of the nonsensical world of negative interest rates.
Professor Walter Block joins the Human Action Podcast for a fantastic in-depth discussion of Henry Hazlitt and his work. Dr. Block has great insights into Hazlitt's work on inflation, economic fallacies, ethics and utilitarianism, and more, plus great anecdotes about Hazlitt, Mises, and Rand. Economics in One Lesson may be the most important economics book ever written for lay readers, and the Mises Institute will release a new edition of the book later this fall—available free to tens of thousands of students across the world. There is still time to be listed as a patron in the book by donating here!
Articles discussed: "The Task Confronting Libertarians"
"The Case for the Minimal State" (PDF), page 103
Download the slides from this lecture at Mises.org/MU20_PPT_08.
Recorded at the Mises Institute in Auburn, Alabama, on 14 July 2020.
JEFF DEIST: Does economics need philosophy? The idea of a school of economics having a philosophical underpinning might strike some people as odd. Why should economists care about philosophy at all?
DAVID GORDON: Well, that’s a very good question. You see, what Mises held was that economics has a distinct method or way of proceeding, and he felt that way of proceeding was under criticism by many philosophers and social scientists of his time. I think for Mises, what was always primary was to vindicate economic theory against its detractors. He wasn’t trying to construct a philosophical system. But if people criticized economics and said “well, there’s something wrong with Austrian economics because it doesn’t depend on verifying things empirically,” Mises wanted to come up with a reply to that, so that was what really got him into philosophy.
JD: For purposes of this conversation, logic is a critical branch of philosophy. What should we think about rhetoric?
DG: Well, clearly logic is a branch of philosophy. It brings in all the sciences which use logic. Rhetoric is the general study of techniques of persuasion. There are philosophers who have written about rhetoric, Aristotle and others, but that would be a somewhat broader category than they wrote about. To the extent you’re interested in persuading others of the truth, you could consider economics rhetorical, but one point that people miss is when you’re elaborating a structure of argument, it doesn’t involve necessarily arguing in the sense of trying to have an actual debate where you have an adversary you’re trying to win over.
JD: Let’s start with Aristotle then. Can we trace a line from him to Menger, Böhm-Bawerk, and Mises?
DG: I think this is one point Murray Rothbard stressed very much. In the pamphlet I wrote called Philosophical Origins of Austrian Economics, I tried to elaborate upon that. I’m not sure everything I said in that pamphlet was right. What Aristotle thought was that in science we’re really proceeding deductively from first principles. He says this in the Posterior Analytics. So, we start off with a fundamental principle. We’re starting from what Aristotle thought: that there are essences of things and substances which means that the essence is the property something has that makes it that thing. Like “what is a human being?” It’s a rational animal. Aristotle thought we could discern these essences and that’s a theme you get in both Mises and Rothbard who started with the action axiom that human beings act.
Mises didn’t really use an Aristotelian method, but Menger was very influenced by Aristotle. Menger studied philosophy with Franz Brentano, who was one of the great authorities on Aristotle of the nineteenth century. So Menger took a lot of his notion of method from Brentano who was this Aristotelian figure. And I think that Rothbard, in particular, argues that praxeology, the science of human action, could be understood in this Aristotelian way as knowledge of essences. It’s a bit different from Mises, but I think it’s a very valuable way to proceed.
JD: Modern economics, of course, doesn’t start for several hundred more years. Menger doesn’t publish his Principles of Economics until 1871. Talk about some of the interim thinkers of the 1600s and 1700s. What about Locke? What was his influence on the Austrian school?
DG: Locke had a very interesting theory of knowledge that was a bit different from Aristotle’s. Locke thought, like Aristotle, there were essences of things, but he thought we really can’t know what they are. We’re cut off from essences. So, we do have some knowledge. We can prove we exist. We know God exists. He thought we could derive ethics as some kind of deductive system and he also thought we know there is something behind our experience, but we can’t really know what it was. So it’s a much more skeptical view. But Locke certainly had influence on economics. Remember in Human Action, Mises talks about action as the relief of felt uneasiness. I think that comes from Locke. That’s his phrase, “felt uneasiness.” But Locke wasn’t especially influential in Austrian economics. He had the labor theory of value as well as the labor theory of original acquisition, and that wasn’t so influential with Austrians. I would say his influence on Austrians was much more in the area of political philosophy with his views on natural law and his particular defense of a somewhat libertarian view. In some respects, he was close to being an anarchist, with significant differences.
JD: So we fast-forward to the 1700s. Talk about the German Historical school, which in part the Viennese economists rebelled against.
DG: The Austrians thought there are economic laws that are true for everybody. We have the law of supply and demand, which applies regardless of where you are in time. We could apply the law in primitive societies, we can apply it in the Middle Ages. Everywhere. The German Historical school said no, there are different stages of history and each stage would have its own laws that when you’re investigating, economics, you’re interested in the particular. One should amass as many facts as one can and maybe be able to get some inductive generalization about what applies to particular periods. So, it isn’t that you can reason out things before, looking at the empirical facts. You could find, for example, that free trade benefits certain economies at certain periods, but not in others.
The theories of Gustav Schmoller, Adolph Wagner, and various others were important. Schmoller was very influential in scholarship about the history of Prussia. He wrote a great deal on the Prussian economy. Mises’s view of this was very interesting. He said, the real thrust of the Historical school’s views is that they didn’t like the idea that there were economic laws because this might limit what the state could do. Suppose, for example, we know by applying basic economic principles, that if you put into effect minimum wage laws, it’s going to cause unemployment. So then, if you don’t want unemployment, you can’t put in minimum wage laws. You shouldn’t do that, but the German Historical school didn’t like that and they said this is limiting the state. So, in Mises’s view, they were trying to undermine economic theory to promote their ends.
JD: They’re talking about economics as a historical discipline, with no universal laws or independent theory. It can’t be studied independently of history and other fields. Menger and Mises reject this.
DG: Yes, that’s right. Instead of thinking, as Mises did, there is a science that we can get just by thinking about our notion of action — trying to figure out what’s involved in that — they said we have to study the particular. Some of them did very important work on particular historical periods, but they didn’t believe in economic laws. So, they would say, we have to just study what’s going on at the time. We might eventually be able to come up with some kind of generalization that would apply to different periods, but not for now.
JD: And the German Historical school still held sway, in Germany and the Austro-Hungarian Empire, well into the 1800s and even 1900s.
DG: Yes. They lasted through the twentieth century. One of the great figures of the school was Werner Sombart, whom Mises knew. They were on fairly friendly terms. He was teaching until 1930, when they were really dominant. When the German historians named the Austrian school as opposed to the German Historical, the term “Austrian” was coined with the implication that Austria was stuck in the past, the future was really with Germany and Prussia. So, if you say “the Austrian school,” you’re saying “outdated reactionary group,” rather than progressive. They were certainly influential, not only in Germany, but they were very similar to a group in the US called the Institutionalists, who were very influential in the late nineteenth century and early twentieth century. There were even Austrians who were influenced by the Historical school. So, Mises had them very much in mind when he was writing Human Action, this was one of the main groups he wanted to oppose.
JD: Of course, there are two other Germans we need to consider, Hegel and Immanuel Kant. Both lived into the 1800s, but not by much. Talk about both these figures and their influence on Austrian thought.
DG: Kant said that in philosophy people hadn’t agreed on what the correct solution is to the various philosophical problems, like how can we prove that God exists or how we know if there is an external world. So, there are all sorts of disagreements on all of these various philosophical systems. He said the philosophers have so far made a basic mistake. Instead of asking, “what is the nature of the world,” what they should be studying is our knowledge. We should ask, “what are the categories that we use in trying to get knowledge?” And by thinking about that, then we would get some answers to the philosophical questions. For Kant, we can’t know the world as it is in itself. All we can know is the world as we construct it through using our concepts. There is a given element also, which is intuition. You get to space and time through intuition and we apply concepts to that, so that gives us the world that we know, which he called appearance. That’s the only world accessible to us.
JD: No wonder Ayn Rand called him evil. Constructing reality and using intuition certainly sounds very un-Randian.
DG: Oh yes, you know, she called him the machine gunner of the mind. There’s something to be said for that and it does introduce some kind of a skeptical way of looking at things, but Kant didn’t think he was a skeptic. He thought the world of appearances is the one we’re dealing with. So we do have knowledge of that.
But there are various views on what the relation is between the world that we know, which is called the phenomenal world, and then this other noumenal real world. So, he then thought that limits our knowledge. However, we could go beyond that in a certain way because we also know we’re ethical beings. We can recognize through reason that we have certain requirements, certain things we ought to do, just by thinking about them. He thought we could, from the concept of what we ought to do, get a notion of what was ethically required. This is his famous categorical imperative. When he applied this to his political views in practice to a large extent, it was reminiscent of classical liberalism. He believed in property rights and favored some sort of welfare state, but it would have to be very limited. He favored a peaceful foreign policy. He wanted some kind of federation of republics.
Now, Hegel reacted very much to this. He thought Kant was a great philosopher, but he said, “look, Kant is wrong in thinking that we’re limited to our own concepts. We really do know the world as it exists.” The mistake he thought Kant made was that Kant is assuming that there is some kind of separation between reason and the world. In fact, the world is rational, the world is reason developing itself, so there is no separation between the two and our minds are really just reason coming into consciousness. So, Hegel thought, that as the universe develops, rationality is increasingly coming to self-consciousness. And in ethics, in political philosophy, Hegel reacted somewhat against Kant. He said Kant is right that there is a sphere of freedom, but where he made the mistake is trying to come up with these abstract rules that were completely separate from the concrete lives of real people. In Hegel’s view, this concrete life is manifested in the state. A famous sentence from one of his writings is, “The State is the march of God on Earth.” That’s not a very classical liberal state, although if you look at his main work on political philosophy, which is called Philosophy of Right, Hegel says that people are free to make exchanges. But this isn’t freedom fully developed. It develops more when you have the state.
Hegel thought that up to this time, the Prussian state, as a limited monarchy, was the highest development of reason. He didn’t claim this would always be true, but at that time, the Prussian state was the most advanced. Hegel was quite aware of economics. He read Adam Smith and James Steuart, who was an early mercantilist writer. But he didn’t really develop an economic theory.
JD: Kant also discussed the importance of a priori knowledge, which is reflected in Misesian praxeology. How does Kant help us understand economics?
DG: In this way, suppose we get the law of supply and demand, thinking about who has a surplus or a shortage. But we know that minimum wage laws will result in unemployment. So then, if we can figure this out a priori, then we don’t have to say, “well, this is just a hypothesis, let me apply it to the real world and maybe it will turn out that minimum wages don’t cause unemployment.” We will be able to tell because we have this economic law that there will always be some effect from the minimum wage law. It may be that other things will override it, but we’ll know that the law has some effect in the world. It isn’t something that we have to investigate. So, the way it applies to economics is that it enables us to have a theoretical discipline that isn’t subject to further testing. We can be wrong and make mistakes in our deductions, but we can’t be wrong in the sense that it’s open to future investigation whether our reasoning, even if it is correct, arrives at truth or not. If we reason correctly from true premises, then what we come up with is true, then that’s it. That’s unpopular with many philosophers.
JD: Contrast this with the logical positivists of Mises’s time. His own brother, Richard, the mathematician, disagreed with him very strongly on method and logic for example. Give us the context of the time in which Mises developed his views, and the opposition he faced.
DG: There was a group of logical positivists, the Vienna Circle, originally headed by Moritz Schlick, who was a professor of philosophy at Vienna and a lot of the top philosophers of that time attended that group. They said there is a priori knowledge, but this is just really conventional, this is just definitions or parts of definitions. So, what they would say is, suppose I say something like this: “we choose our most highly valued preference.” We have a preference scale, this one is the one that ranks highest, so I’m going to choose that. They said, “that doesn’t tell you anything. That’s a tautology because it’s just saying you’re choosing whatever one you’re choosing. You’re just defining the highest value preference is the one you in fact, choose.”
For the Vienna Circle, if you want to know what’s true in the world, the only way we can find out is by investigating, by doing empirical work. One example they might use: suppose one says, “how many people are going to attend the Austrian Economics Research Conference next month?” The way you would find out is to see how many people show up. We couldn’t figure that out just by thinking about it. They have to find out by using their senses, their empirical senses, what actually is the case. But in the Austrian view — Mises’s view — that isn’t always true. Sometimes you can realize things have to be a certain way just by thinking about them. The positivists say no, if it isn’t empirical knowledge, then it’s a tautology. It doesn’t tell you anything. So, they said, “if you want to know what’s going on in the world, you just have to look at matters, investigate them.” What you would get would not be what has to be the case, but just what is the case. “Laws” developed this way would really not be statements of what’s necessary in this very strong sense that we have in other types of scientific laws like math.
JD: What would you say is Mises’s best rebuttal to this? Where in his writings, whether in Human Action or perhaps in The Ultimate Foundation of Economic Science, does he lay out his best philosophical case for the method of economics? Where do we find his most philosophical work?
DG: Well, I would say probably two. The first, say, 110 or 150 pages of Human Action. The second chapter of the book is titled “The Epistemological Problems of the Sciences of Human Action.”
JD: I noticed to my surprise that Kant is not specifically mentioned in Human Action. Mises mentions him very briefly in Liberalism, but as you point out even when Mises resorts to Kantian language nothing in his argument depends on Kant. Elaborate on this for us.
DG: Suppose you don’t know the game of chess, have never heard of it and then you see people moving these pieces on a board and just see them moving them in various ways. You wouldn’t understand what’s going on unless you had the concept of chess, you wouldn’t be able to figure out what they’re doing. Similarly, we can see people moving their bodies in various ways, but we wouldn’t know what they’re doing. But, once we have Mises’s concept of action we can understand things. So, in that respect, that’s a Kantian idea that you have to have certain concepts in order to understand what’s going on in various activities. But Mises doesn’t depend on particular controversial points in Kant’s theory of knowledge by any means. He’s not adopting a Kantian system at all, I don’t think, even though Mises is a very widely read scholar in philosophy and other disciplines.
Nevertheless, it’s sometimes surprising the range of Mises’s knowledge. For example, in Human Action, when he’s talking about quantum mechanics, he says quantum mechanics has some implications for free will. So, he quotes works on quantum mechanics. He’s up on all sorts of things, but he isn’t adopting a particular school.
I should say also: One thing I see when I talk of Human Action over a great many years at the Mises Institute is that a mistake a lot of people make is, they think well, because Mises discusses philosophical topics, they think he’s trying to solve some philosophical problems. One problem is: how do we know that there is a real world out there? Maybe we just have certain experiences and you could imagine, Descartes’s malicious demon that’s deceiving us, how do we know the world really exists? That isn’t a problem he is addressing, he’s not trying to solve problems of philosophical skepticism. It would be odd if we were saying how to explain the recession of 2008, it would be kind of strange to say, “well look, how can you talk about explaining the recession in 2008 when we haven’t even proved there’s an external world yet.” That wouldn’t make sense. So, we need to get he’s talking about the world we live in and he’s seeing economics as one of the sciences. It’s not part of philosophy. He’s just thinking that there’s a particular method in science, an a priori method that we can use. This is one of his objections to Karl Popper, who was a philosopher also from Vienna, and had some connection with the Vienna Circle but reacted very strongly against them. But Popper had a view that a statement is scientific if it can be falsified. So, they say, well, economics, as Mises conceded, it wouldn’t be falsifiable because if these laws of economics were a priori truths, then nothing can show they’re false. What Mises said is if you’re trying to come up with what is scientific, you should look at the actual sciences in question. You should do that and take that into account in trying to come up with your criteria of what’s a scientific statement.
JD: Let’s talk about the philosophy of Murray Rothbard.
DG: Rothbard was a very systematic thinker. He was interested in a great many things, but Rothbard in his philosophical views, he had been very much influenced by Aristotle and Thomas Aquinas and he made a study of scholastic philosophy. So he adhered to this view where he studied the essences of things in order to gain knowledge of them. He was able to absorb information very rapidly and had tremendous bibliographic knowledge and if you asked him something, he could just give you a bibliography immediately. He knew scholastic material very well and studied it a lot. For a while, his group, which was called The Circle Bastiat, attended sessions of Ayn Rand’s circle. Rand was a remarkable thinker in her own right. Although she hadn’t studied history of philosophy very systematically, she developed views that were in many respects similar to those of Aristotle. So, there was some convergence there. He didn’t really take it from her, but there was some convergence, because he was in his philosophical focus, very much an Aristotelian, like her. He didn’t really write on metaphysics, he wrote on epistemology insofar as it applies to economics, but he was very influenced by Aristotelian and Thomistic ethics and developed that further. He developed natural law thinking on that basis.
JD: We think of Aquinas as a philosopher, as a legal theorist, and of course as a religious thinker. Most people probably think of him more as a religious thinker than a philosopher per se.
DG: The relation between theology and philosophy is one of the most contested topics in the study of Aquinas. I would say he was a philosopher as well as a theologian in that a good many of his works are commentaries on Aristotle. He wrote books on how you could convert people who don’t accept Christianity, not presupposing that theology is true. For him, in fact, there was some knowledge that could be obtained just by reasoning, and there was certain knowledge that couldn’t be obtained by reasoning. This you could get only by faith, which is from revelation. But for him, even some of the knowledge obtained through reasoning could show why we should accept the Church’s teachings.
JD: When Rothbard makes the normative case for laissez-faire in The Ethics of Liberty, he makes that normative case without appeal to higher powers. He relies on a secular morality as the foundation for a free and just society. What’s his biggest influence there?
DG: Well, I think in this he talks about people as self-owners. You could say “why are we self-owners?” I think he would rely on an Aristotelian focus.
JD: Maybe this is my own Protestant upbringing, but when we talk about self-ownership it sounds inherently incompatible with Christianity. If you’re a Christian you believe you were made in the image of God, and thus you’re not some wholly independent being. You don’t “own” yourself as part of God’s creation.
DG: Yes. Well, that’s a very interesting objection. If you look at Locke, Locke did believe that God really owns everybody. He also defends the self-ownership principle.
JD: God owns everybody?
DG: The claim here is God created us so God really owns us. But under that, we’re in charge of our own lives, so it’s something like this: suppose for all practical purposes, unless God is directly trying to tell us something, we’re in charge of our own lives. The fact God owns everything doesn’t mean someone else can go around saying, “I’m God’s representative, so you have to do this, do that.” No one has direct access to God in that way that would justify that person imposing various limits on what a person can do. The notion of God owning us does have some bite to it in the real world. For example, many theologians have thought it’s wrong for you to commit suicide. Because God owns you, you don’t have the right to end your own life because that would be inconsistent with God’s ownership. You could say, you could acquire property in the world because subject to God’s ultimate ownership, you’re really free to homestead land at least under certain conditions.
Rothbard is probably best called agnostic. I think his atheism wasn’t as strong in his later years as earlier. His later position is something like, if there is a God, his actions and his knowledge would be so far different from normal, we wouldn’t really be able to grasp what he was doing. This is more in conformity with Aristotle because Aristotle did believe that God really takes no notice of what’s going on in the world and Aristotle says God is thinking about his own activities, his own being, and is not concerned with human beings.
JD: David, let’s talk about Ayn Rand. Both Mises and Rothbard knew her personally, and both socialized with her at one time. Many people think she was a highly derivative philosopher, that she didn’t exhibit much original thought. Many people disagree, and think she was a brilliant philosopher who developed a fully complete system of original ideas on her own. Tell us about her relationships with Mises and Rothbard, how they may have influenced her, and vice-versa.
DG: It is true that some of her thought certainly resembles Aristotle in many points, but she was able to get a lot of her views independently. I think in some respects, she deviated in an incorrect way from Aristotle. She was certainly a significant thinker in philosophy. I frequently disagree with her, but she’s certainly someone who’s worth reading.
We also know a bit about her thinking on Mises because she used to make notes on books she was reading. We have her notes on Human Action and one note on that always makes me laugh. She said that Mises usually talks about supply and demand, but one place he talks about demand and supply and she thought that there was something suspicious about that, but she didn’t say what it was. So, she thought Mises was extremely good with economic theory, but she thought he didn’t have the right theory of knowledge. She took him to be a Kantian and she didn’t like this. They met a few times in person and Mises liked her Atlas Shrugged. He thought she was portraying the businessman as a hero, she was really doing something very valuable, but apparently they didn’t get along. There’s this story Henry Hazlitt invited both for dinner and they had some big falling out. They both had very strong personalities.
Now, Murray Rothbard, when he first heard about her, he tended not to like her much because he thought she was a very dogmatic thinker and if you disagreed with her, she would exclude you and he thought the tendencies in her personal way of dealing with people, he didn’t like. So, he tended very much to stay away from her and was suspicious of her, but when Atlas Shrugged came out, he really liked it, admired her writing, so for a while, his group met with her group, but they didn’t get along. The thing she most opposed in Murray’s thinking was that Murray did not believe in the need for government, the state would be replaced by competing protection agencies. She was very much against that. She thought that would lead to having no law and order. There were also other issues as well.
JD: There’s a famous conversation, recounted in Nathaniel Branden’s biography of Rand, where she asked Rothbard how police and court services would be provided under anarchy. Rothbard responds with “private, competing defense agencies” and Rand expressed in horror: “You mean as in civil war?” Let’s just say their respective philosophies of governance diverged.
DG: There were other issues as well. One was that Murray’s wife, JoAnn Rothbard, also a great friend of mine, was a quite devout Protestant. So Rand wanted her to listen to some tapes by Nathaniel Branden on why God doesn’t exist and he felt that any rational person after listening to these tapes would be converted to atheism. So, if they listened to them and if she wasn’t converted to atheism, then Murray should divorce her. Of course, he wasn’t having any of that. of Barbara Branden’s master’s thesis where she said that, and used that argument. So then, when the volume came out, for some reason the citations to Branden were taken out, and Rand and Branden and the Rand group got very angry about it. They said, “oh, he’s plagiarized Barbara Branden.” In fact, the argument wasn’t original with her,it’s a very common argument. So, they were very angry and they protested, and they went to the publisher. And then Murray wrote to Mises, and Mises replied and said, “what’s going on here, everybody knows about this argument, what are they complaining about?” But the Randians never forgot it.
JD: David, one final question. Menger, Mises, Hayek, and the older Austrians all pre-dated the rise of postmodern philosophy in the late twentieth century. Did Rothbard address postmodernism, and what effects do you think it has on economics today?
DG: Rothbard did address postmodernism in his essay “The Hermeneutical Invasion.” There are many different varieties of postmodernism but in general, postmodernists attack the notion of truth as fixedand unalterable. Rothbard resisted this, relying on his Aristotelian realistic views. Fortunately, postmodernism hasn’t influenced economics as much as it has the humanities.
Bob continues his series on capital and interest theory. In this episode he explains Böhm-Bawerk's solution to the problem of interest, namely that present goods are more valuable than future goods. Bob also explains Böhm-Bawerk's three separate causes for the higher valuation of present over future goods, including the notorious third cause, which is the higher physical productivity of more roundabout processes. Finally, Bob addresses the criticism of Böhm-Bawerk's theory coming from Keynes, Fisher, Frank Fetter, and Mises.
For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
ABSTRACT: According to Austrian business cycle theory (ABCT), there is no macroeconomic market failure. Under laissez faire capitalism, with extremely limited or no government, there will be no credit-induced business cycles. However, suppose one part of the world engages in credit expansion, which, according to ABCT creates the business cycle, while another does not. Will the former infect the latter? Or will the latter be impervious to the governmental depredations of the former? We take the position that although the free market society will not remain impervious to the government failure of the interventionists, it will be sheltered from the full impact of the boom-bust cycle. Do the residual malinvestments constitute a market failure? After all, a free market, in this case, is indeed “failing” to bring about the greatest satisfaction of consumer preferences. We deny this claim.
KEYWORDS: business cycle, international relations, Austrian economics, market failure JEL CLASSIFICATION: B53, E32, E58, F33, F44 Walter Block (wblock@loyno.edu) is Harold E. Wirth Professor of Economics at Loyola University, New Orleans. Lucas Engelhardt (lengelha@kent.edu) is Associate Professor of Economics at Kent State University, Stark. Jeffrey Herbener (jmherbener@gcc.edu) is chair of the Department of Economics and Sociology at Grove City College. The authors would like to thank the other members of the faculty at the Mises University of 2015. The oral examination by the faculty of MU students was the catalyst for this paper, although our youngest co-author (Engelhardt, 2004) penned his thoughts much earlier on some of the issues we address in the paper. The authors also gratefully acknowledge the comments offered by participants of the Austrian Economic Research Conference and the International Conference of Prices and Markets on earlier drafts of the paper. Finally, we acknowledge several helpful comments by two anonymous referees. The usual caveats apply: we three authors are solely responsible for all remaining errors of omission and commission.
Quarterly Journal of Austrian Economics 21, no. 4 (Winter 2018) full issue, click here.
Even though various countries have “independent” monetary systems… inflation taking place in any one nation may have—and often does have—repercussions which go beyond that country’s confines…. Thus, even in the absence of an international monetary system, important economic units can transmit the “virus” of inflation to other countries (Heilperin, 1939, p. 164).
I. INTRODUCTION Austrian economists often advocate a free market monetary system—one that operates without credit expansion or monetary inflation. Such a system is advocated because it would provide greater economic stability, as it would eliminate the Mises-Hayek-style credit-induced business cycle. At the same time, it is admittedly unlikely that one could expect the entire world to immediately change from the current fiat, expansionary monetary system to free market money. So, given that most of the world operates on a fiat basis, could a single country protect itself from credit-induced business cycles by adopting a free market money and banking system? Or, would the existence of credit-induced business cycles in the rest of the world continue to have an impact on a country that adopted a free market regime? This paper suggests that credit-induced business cycles would indeed transmit to a country with a free market monetary system, but that the misallocative effects of these business cycles from abroad would be significantly dampened. In short: the adoption of a free market money in a fiat money world is beneficial, even if it does not completely insulate the country that adopts this system from credit-induced business cycles originating elsewhere.
This paper draws from two existing literatures. First, from the literature on international business cycle transmission. Second, we base our analysis on Austrian business cycle theory, which place a strong emphasis on credit-driven distortions in the capital structure and economic calculation.
An extensive literature exists on how business cycles transmit across political boundaries—going at least as far back as the specie-flow mechanism described by David Hume in the 18th century. In examining the transmission of monetary disturbances, neoclassical literature has adopted an expenditure-flow approach in which real production is asserted to move in lockstep with movements in aggregate demand. Within this framework, Frederic Mishkin (1995) summarizes four so-called channels of transmission from monetary disturbances to real production: via interest rates, foreign exchange, asset prices, and credit.
We combine these four channels with Austrian business cycle theory, with its emphases on the capital structure and economic calculation. Following the work pioneered by Carl Menger and Eugen von Böhm-Bawerk, we depict production as a capital structure and changes in production as driven by the profit and loss calculations of entrepreneurs.Capital structure analysis appears in Carl Menger (1976), Eugen von Böhm-Bawerk (1959), Richard Strigl (2000), F. A. Hayek (2008), Ludwig von Mises (1998), Murray Rothbard (2004), Ludwig Lachmann (1978), Roger Garrison (2001), and Jesús Huerta de Soto (2006). Specifically, we postulate a conjectural case of a worldwide division of labor and capital structure constructed, maintained, and improved by entrepreneurs operating private enterprises within an international market economy. This construction permits us to explore the particular manner in which resources will be reallocated and the capital structure altered across the world economy by monetary disturbances arising in one geographical area and transmitted to another.
Neoclassical attempts to overcome the confining character of the basic Keynesian model have been limited to modifications of minor assumptions of the framework, instead of augmenting the expenditure-flow model with the microeconomics of production and investment in the market. By introducing elements of complexity in the basic model, neoclassical economists have sought to generate more robust explanations and predictions. The neoclassical synthesis of the 1950s developed the IS-LM model which grafted onto the basic Keynesian framework limited behavioral assumptions. Within the context of the neoclassical synthesis, Robert Mundell developed his work on the international economy. Mundell (1963) and Marcus Fleming (1962) launched open economy macroeconomics by extending a basic Keynesian macroeconomic model to include international trade. In keeping with its Keynesian framework, the dynamics of the system operate through expenditure flows, which now include net exports along with consumption, investment, and government spending. While such models incorporate the exchange rate along with the interest rate as explanatory factors affecting real production, they still exclude the array of prices of consumer and producer goods and the structure of production. As neoclassical macroeconomics worked toward the new neoclassical synthesis, the extended behavioral assumptions generated more complex macroeconomic models.On the new neoclassical synthesis, see Goodfriend and King (1997). The New Open Economy Macroeconomics (NOEM) began with the work of Obstfeld and Rogoff (1995) who modified the more complex, closed-economy Keynesian models of that period. More recently, the dynamic stochastic general equilibrium models widely used in macroeconomics have become the basis for NOEM. Despite their greater sophistication, NOEM models incorporate neither the interrelated array of prices throughout the economy nor its integrated structure of production. Mainstream economists tend to continue to use their models to analyze the same problems of system dynamics and the consequences of policy variations among countries. We find this approach inadequate for the discovery of the cause-and-effect structure of a changing international economy.
Meanwhile, Austrian macro-theorists have generally considered business cycles within a domestic context. In recent years, several economists working in the Austrian tradition have sought to move the Austrian business cycle into an international context. As a few recent examples: Hoffman and Schnabl (2011) consider the impacts of credit expansion in large “center” economies on smaller “periphery” economies. Cachanosky (2014) extends the Mises-Hayek theory from the original context of the classical gold standard to a world of open economies and fiat currencies, considering both fixed and floating exchange rates in that context. Bilo (2018) places credit-driven business cycles in an international framework, focusing on the coordinating roles of interest rates and exchange rates.
These analyses provide important insights into how Austrian business cycles transmit in the current monetary regime, and, in that way, provide an update to, and expansion of, the work of Mises and Hayek. Our paper builds on the recent literature in three ways: first, drawing from Mishkin (1995), we introduce additional potential channels of transmission to the Austrian analysis. Hoffman and Schnabl (2011) focus primarily on the interest rate channel. Cachanosky (2014) adds exchange rates to the analysis, and Bilo (2018) also focuses on these two channels. We add the asset price channel and credit channel as well. Second, we are explicitly considering a case where one country is operating on a fiat basis while the other is operating on a market-chosen monetary system. Hoffman and Schnabl (2011) and Bilo (2018) do not take a stand on the monetary systems in the countries not currently engaging in credit expansion. In contrast, Hayek (1989) analyzed international aspects of three possible monetary regimes, but assumed that each country adopted a similar policy (commodity, national reserve, or fiat). Similarly, Cachanosky (2014) is quite explicit that the analysis in that paper applies to fiat currencies. Third, we introduce the role of economic calculation, which receives no explicit attention in any of the recent work (though economic calculation certainly underlies the coordination failures described by Bilo (2018)).
In the present paper, we explore a conjectural case not found in the literature, which we call a dichotomous monetary regime. The extant literature postulates a homogeneous monetary regime across the international economy, e.g., fiat money produced by the state in each country. We postulate an international economy consisting of a laissez-faire monetary regime in one area and fiat money in the other. This arrangement permits us to develop a complementary conclusion to the one reached by Hayek. He (1989, p. 4ff) began his analysis, conceptually, with an international commodity money and showed that moving toward a monetary nationalism of fiat currencies generated more monetary volatility, a result counter to the claims of proponents of monetary nationalism. Our analysis, in contrast, demonstrates that the process of beginning with an international system of fiat currencies moving toward monetary decentralization based on a commodity standard leads to superior results for the countries adopting the latter. In the period of transition, a dichotomous monetary regime exists, one sector with market money and the other with a state monetary system. Nor is this case interesting only theoretically; it also has relevance for international monetary reform movements toward a pure market economy. It demonstrates that even unilateral adoption of a commodity money standard in a world economy with fiat currencies will, at least partially, insulate a commodity money country from the effects of monetary inflation and credit expansion arising in the rest of the world.
In section II, we describe the channels of transmission. In section III, we report on the two dimensions of the international structure of capital. In section IV, we review F. A. Hayek’s work on the transmission of monetary disturbances in uniform, international monetary regimes. Section V stipulates the conditions for our analysis and draws the implications from these stipulated conditions. In section VI, we assess the claim of market failure in the laissez-faire sector of the orthogonal monetary regime international economy. We state our conclusions in section VII, along with suggestions for further research.
II. CHANNELS OF TRANSMISSION Mishkin (1995) provides a summary of four channels through which business cycles can transmit internationally from one country to another as a result of expansionary monetary policy, within an expenditure flow framework.
First, the interest rate channel transmits the effects of monetary inflation by lowering interest rates, which increases investment spending, resulting in a stimulus to production. The interest rate channel can operate internationally through capital-funding arbitrage. If monetary inflation in country B pushes down interest rates in B, then some of the additional credit will be arbitraged via international financial markets into country A, reducing interest rates and increasing investment spending there also. Hoffman and Schnabl (2011), Cachanosky (2014), and Bilo (2018) provide similar arguments, and apply this channel to Austrian business cycle theory.
Second, the exchange rate channel operates as monetary inflation in country B devalues B’s currency relative to that of country A. Ceteris paribus, net exports in B rise, stimulating production in B, and in country A net exports decline, suppressing production in A. Cachanosky (2014), and Bilo (2018) apply this argument to the heterogeneous view of capital present in Austrian capital theory.
Third, the asset price channel works via a wealth effect. Monetary inflation in country B increases asset prices in B as interest rates are lowered. Investment and consumption expenditures in country B increase in response and production is stimulated. With world-wide asset markets and international financial markets, the same sequence of effects will occur in country A from monetary inflation in country B. In country A, we can explain the asset price effect on two bases: first, the interest rate effect described above leads country A’s interest rates to fall as country B’s do, which raises the present discounted value of assets paying future cash flows. In addition to this, the wealth effect in B leads some market participants in B to purchase consumer goods, capital goods, and financial assets in A. So, this international arbitrage simultaneously affects interest rates and asset prices. Thanks to the increased value of domestic assets, people in country B will also increase their investment and consumption expenditures.
Fourth, the credit channel transmits the effects of monetary inflation in country B through a rise in bank reserves and consequently bank lending in B. The additional credit finances more investment and consumption which, in turn, stimulates production in country B. With an international system of banking, the central bank purchase of securities in B can expand bank reserves not only in B but also in A, leading to more investment and consumption in A with the concomitant increase in production in country A. This channel works in concert with the interest rate channel, amplifying the effects. The interest rate channel focuses on the direct impacts of the interest rate on investment decisions, while the credit channel focuses on the impacts of the availability of credit. When monetary policy is expanding credit, both effects typically happen hand-in-hand.
III. INTERNATIONAL CAPITAL STRUCTURE In contrast to other business cycle theories, Austrian business cycle theory placed the capital structure (as described by Menger [1976] and Böhm-Bawerk [1959]) at the very center of the analysis. Böhm-Bawerk’s framework has been further expanded by later Austrians, especially Hayek (1966), Rothbard (2004), and Garrison (2001). Garrison (2001) suggests that Austrian business cycle theory can be thought of as the “capital-based” explanation for the business cycle.
In the Austrian view, capital is best thought of as concrete capital goods that are somewhat specific in their use in the structure of production. Unlike most other theories, which either omit capital almost entirely or which simplify capital to a single homogeneous variable,All too often perfunctorily depicted as “k” and then almost ignored. in the Austrian tradition, capital is thought of as being arranged based on its relationship to its ultimate purpose: transforming the original factors of labor and land into specific, final consumer goods.
The international capital structure brings together two different dimensions in terms of which entrepreneurs must economize: time and space. Each is open to mal-investments, and may potentially be affected by monetary policy.
First, capital has a time dimension. All action is geared toward the future fulfillment of some want—or “consumption.” However, immediate want-fulfillment is typically not possible using only the original factors of production, or is less productive of satisfaction than somewhat delayed round-about methods of want-fulfillment. We can arrange capital based on how far removed from consumption it is. Consumption goods (or goods of the “first order”) are directly useful in satisfying human wants. Capital goods require some period of time—typically because of the need for some physical transformation—before they will be capable of satisfying a direct want. (As an example of the simplest case: wine must have time to age for it to attain the greatest value for consumers.) Capital goods then can be divided between lower order capital goods—which are closer to consumption and higher order capital goods—which are further removed from consumption. For example: finished products in transit to retail outlets are very low order capital goods. Raw, unprocessed iron still in the ground is a higher order capital good.Garrison, 2001 speaks of earlier (higher) and later (lower) capital goods; Barnett and Block, 2006, in terms of interest elasticities.
Second, capital is arranged in space. Resources and consumers are not evenly distributed across the terrain, and so capital tends to be geographically concentrated based on ensuring access to resources by consumers. While we are not particularly interested in the spatial allocation of capital in and of itself, we are concerned with the fact that spatial allocation leads capital to be placed in different currency areas. Because of the spatial distance that often separates resources and consumers (as well as complementary capital goods!), interregional trade is quite common—and, at times, the regions involved are located in countries that use different currencies. The spatial dimension can also carry with it a financial component. Investors are generally not constrained to only invest in local capital. Rather, through the use of financial assets like stocks, investors can invest in physical capital in a country that uses a different currency than their own. So, while physical capital is more location-bound, the ownership of that physical capital is typically not.
When making investments, entrepreneurs consider these two dimensions of time and space. As in all profit-oriented decision-making, businessmen engage in economic calculation to determine the best temporal and spatial location of capital investments. In their calculations, entrepreneurs will consider the interest rate—which impacts their decisions regarding the time axis, and will also consider currency exchange rates (and especially expected changes in those rates)—which will impact their decisions regarding in which country to locate physical capital or in which nation to invest in financial assets. Since monetary policy can affect both interest and exchange rates, it has the potential to alter entrepreneurs’ economic calculations—and therefore decisions—along both the time and space dimensions.The Austrian business cycle literature—from Mises (1953) through de Soto (2006)—has emphasized the role of interest rates on the time dimension. The new international Austrian business cycle literature has added a consideration of exchange rates, as seen in Cachanosky (2014) and Bilo (2018).
IV. UNIFORM INTERNATIONAL MONETARY REGIMES In his book, Monetary Nationalism and International Stability, Hayek (1989) compared and contrasted the inter-connectedness of the economies in various countries under three different monetary regimes: a homogeneous commodity standard; a national reserve system (e.g., the classical gold standard); and independent national currencies (e.g., fiat monies during the decade before the Bretton Woods system).Milton Friedman (1953) also examines three international monetary regimes: fixed, flexible, and pegged exchange rates. The first corresponds to Hayek’s National Reserve System and the second to his National Fiat Monies (with Independent National Currencies). Hayek does not consider Friedman’s third case of pegged exchange rates, the prominent example of which, Bretton Woods, occurred after Hayek’s book was published. The case Hayek favored, a Homogenous Commodity Standard, is conspicuously absent from Friedman’s analysis.
In a Homogeneous Commodity Standard, there are no monetary disturbances. Neither monetary inflation (deflation) nor credit expansion (contraction) is possible. Instead, the production of money is regulated by profit and loss in the same manner as that of any other good. If demand for money increased (decreased) relative to other goods, then the revenue of money production would rise (fall) relative to its costs of production. In response, entrepreneurs would expand (contract) production of money which would lower (raise) the price of their output and raise (lower) the price of their inputs eventually making even further expansion (contraction) of output unprofitable. Increased (decreased) production of money would be balanced by diminished (augmented) production of other goods. Moreover, the calculation of profit and loss for every item in every location would be in the same monetary unit, allowing entrepreneurs to make direct, worldwide comparisons to determine the most economizing use of resources. Likewise, entrepreneurs would be able to directly compare their appraisements of assets in different lines of investment across the entire worldwide capital structure. All production and investment decisions would survive only by passing the market tests of economic calculation. The result of free enterprise and free trade within such a monetary regime would be the greatest degree of satisfaction of consumer preferences via the most extensive development of the division of labor and of capital accumulation. Goods, including money, would move across borders from territories in which they had lower value into those in which they had higher value.
In a Homogeneous Commodity Standard, Hayek (1989, pp. 17–25) showed that the movement of money from one country to another would occur in response to differences in money demand. As would be the case for any good, entrepreneurs earn profit by moving money from the hands of those who value it less and into the hands of those who value it more. Far from disruptive of production processes, such movements of money, as with any other good, adjust the supply that has been produced to accommodate people’s preferences. Trade, then, augments the division of labor, increasing the efficiency with which resources satisfy people’s preferences. In this system, international trade is similar to domestic trade. In the latter, a change in demand leads to an alteration in the distribution of goods according to the consumers’ new preferences. The same occurs with international trade under this system, with the monetary system causing no specifically monetary disruption to the adjustment process.
While there is a common commodity money used in every country in a National Reserve System, it serves as a reserve for each country’s currency which consists of fiduciary media issued by each government or its privileged banks or both. Production of money itself, in such a system, can still be regulated by profit and loss since it entails production costs rendered by the market. Moreover, by defining its currency in terms of commodity money, each country fixes the ratio between its own currency and that of every other nation. Without the issue of fiduciary media in each country, this arrangement would not differ in operation from the Homogeneous Commodity Standard.
The issue of fiduciary media, however, is not regulated by profit and loss, but rather always generates seigniorage for every amount issued up to the point at which the currency is destroyed in hyperinflation.The term seigniorage has been used to describe several distinct phenomena. For examples, see Neuman (1992) and Rolnick (1997). We will use the term seigniorage to refer to the net income generated by exercising a legal privilege in the production of money and money substitutes. Because it is not regulated by profit and loss, generating seigniorage introduces inefficiency into the operation of the market economy. And when privileged banks issue fiduciary media via credit expansion, it not only is indefinitely profitable to the point of hyperinflation, but sets in motion the boom-bust cycle with its attendant malinvestments of capital investment and misallocations of resources.On Austrian business cycle theory (ABCT), see Mises (1953, 1998), Hayek (2008), and de Soto (2006). Because its issue is not constrained by demand for money relative to demand for other goods, any issue of fiduciary media introduces an alien element into the market economy. We can call this alien element monetary inflation (deflation) when fiduciary media increases (decreases). In addition to the disturbances to the economy in each country from monetary inflation and deflation, the disparate issue of fiduciary media in each nation can cause monetary disturbances in one country to be transmitted to another. Monetary inflation and credit expansion in one jurisdiction sets in motion a domestic boom. As prices rise domestically and the exchange rate stays anchored to the underlying commodity price ratio, the purchasing power of the currency becomes higher elsewhere. Imports increase relative to exports. When foreigners obtain the currency of the inflationary country, they redeem it for the commodity reserve and it moves from the inflationary country to others. The outflow of commodity reserve, then, collapses the boom in the inflationary country and the inflow of commodity reserve abroad stimulates a boom there.
As Hayek (1989, pp. 25–34) argued, these twin effects in the supply of money are not, however, identical to those brought about by changes in the demand for money in the two countries. The collapse in one area does not translate into expansion in the other area because the movement of money does not occur to satisfy differences in money demand through voluntary exchange. Instead, the adjustment falls upon a different set of people apart from those with differing money demands. Money moves into the hands of investors in the boom area, not those who desire to hold more money. If the exchange rate does not adjust downward to restore purchasing power parity of the inflationary country’s currency across other countries, then profit can be earned by moving the commodity reserve in the inflationary country to other countries, even though this does not satisfy a greater demand for money in the latter relative to the former.
The system of National Fiat Monies consists of government-directed production of currency which serves both as money and as reserve for fiduciary media issued by commercial banks. The government directs monetary inflation by printing additional currency and thereby, increasing bank reserves upon which these firms issue more fiduciary media. In such a system, neither money production nor the movement of money is brought forth exclusively by differing extents of money demand relative to other goods among people in different places. Without any change in people’s demand for money schedules (and hence, no demand-induced increase in money’s purchasing power to justify more production of money), the government and commercial banks can generate monetary inflation by expanding bank reserves and thus the accompanying credit expansion. Even though this activity is not regulated by profit and loss, it does generate seigniorage for the government and commercial banks. As the purchasing power of money is driven downward by its increased supply and interest rates are suppressed by the expansion of credit, people respond by increasing the quantity they demand of both money and credit. The process over time of the lowering of money’s purchasing power will be uneven across persons, places, and times because the new money produced will come into the hands of particular people in particular places sooner and other people in other places later. During this process, money will tend to be moving out of the hands of people in places for which its purchasing power has already been lowered and into the hands of people in places for which its purchasing power has not yet been lowered. Because the production of money is not economizing and therefore, leads to artificial volatility in real production processes, the movement of money from the earlier recipients in some places to the later recipients in other places is not economizing overall either. Instead it transmits artificial volatility, bringing more people and places under its effects.
With National Fiat Monies there are two variations. The first, which is the case Hayek examined, may be called Independent National Currencies. In this system, none of the currencies of the various countries serves as a reserve for any other currency. There is no integration of currencies themselves across the various national borders. Changing conditions of demand for and supply of each currency adapt to demand and supply changes of every other currency through movement in exchange rates. Monetary inflation and credit expansion in one country that lowers the purchasing power of its currency domestically will not result in the movement of its currency to less-inflationary countries. Instead, the exchange rate of its currency will devalue relative to the currency of less-inflationary regions. If the exchange rate devalues before the purchasing power of money declines (rises) domestically, the monetary inflation and credit expansion will increase net exports (net imports) in the more-inflationary (less-inflationary) country and thereby, impose changes in real production processes in less-inflationary countries.
As Hayek (1989, pp. 35–53) pointed out, then, in a regime of Independent National Currencies, the movement of money cannot perform its economizing function at all. He argued that in such a system, actual imbalances between money demands among countries will be dealt with politically. Monetary policy in each country will result in fiduciary expansion and contraction, which brings with it cyclical volatility. This is the very consequence that monetary nationalists claimed to avoid with their program of monetary nationalism. In light of these consequences, Hayek rejected the regime of National Fiat Monies in favor of a worldwide Homogeneous Commodity Standard.
The second variant of a system of National Fiat Monies might be called an International Reserve System. Bretton Woods after the Second World War serves as an example. The currency of one country serves as reserve for those of other countries. Each government pegs its exchange rate with each of the currencies of every other government and buys and sells currencies in foreign exchange markets when necessary to maintain the pegged exchange rates. Monetary inflation and credit expansion of the reserve currency will put pressure on it to devalue against other currencies. Other governments respond with monetary inflation and credit expansion of their currencies in an effort to maintain the pegged exchange rates. As Hayek said about the case of Independent National Currencies, in this case as well neither money production nor its movement can perform the economizing function that entrepreneurs attain in the production and movement of commodity money and other goods. Unlike the case of Independent National Currencies, however, devaluation that would have occurred as a consequence of sufficient monetary inflation of one currency relative to another will be preempted by monetary inflation of the other currency. Instead of real production processes in the second country being affected solely by the rise in its net imports, it will suffer its own domestic boom from its domestic monetary inflation and credit expansion.
In summary, applying Hayek’s analysis demonstrates: (1) both the production and movement of commodity money in a Homogenous Commodity Standard is economizing; (2) the production of commodity money can be economizing under the National Reserve System, but the movement of commodity money set in motion by fiduciary issue in one country generates a boom in foreign lands; (3) the production of fiat money cannot be economizing in a regime of National Fiat Monies; instead there will be monetary inflation and either (3a) the movement of the reserve currency from its country of origin into other countries as a result of monetary inflation will generate booms across them (the sub-case of an International Reserve System) or (3b) the impact of monetary inflation in one country on the money stock of other countries will be determined by politics since the movement of money cannot perform its economizing function (the sub-case of Independent Fiat Currencies).
V. THE DICHOTOMOUS MONETARY REGIME All the cases that Hayek considered involved a “uniform” international monetary system. That is, he considered examples in which all countries adopted the same type of system. In contrast, we examine a dichotomous international monetary system, in which two countries have adopted different monetary systems. Country A has a market-based commodity money, where the production of money is decided by entrepreneurs engaged in economic calculation of profit and loss, and banks do not issue fiduciary media.With this structure, credit-induced business cycles would not occur. See Rothbard, 1962a, 1962b, 1963a, 1963b, 1969, 1983, 1988. Country B has a fiat money and regulates the issue of fiduciary media by commercial banks, but is, otherwise, a free market economy.Austrian business cycle theory describes how this structure leads to business cycles. Keynesianism in its various forms drives this process onward. For critics of Keynesianism, see North, 2013; Block, 1999; Rothbard, 2002; Wapshott, 2012; Cochran and Glahe, 1999; Dempster, 1999; Garrison, 1985, 1992, 2010; Hoppe, 1992; Hutt, 1979; Rostan, 2010; Rothbard, 1992; Skousen, 1992; Hammond, 2012; Ritenour, 2000, Murphy, 2008; Anderson, 2009. Our goal is to analyze the precise manner in which monetary disturbances are transmitted from a fiat money country like Country B into a commodity money country such as Country A, a case Hayek did not study. Given the precise manner of transmission in such an example, we consider a system of “private-enterprise protection” to limit the malinvestments of capital and misallocations of resources in A in response to monetary inflation and credit expansion in B.Our literature search included the following, none of whom addressed this possibility, even though all of them write widely and deeply about international economics and macroeconomics: Haberler (1936), Heilperin (1939), Machlup (1943), Roepke (1959), Viner (1937).
Because of international trade linkages, people in Country A would have a limited demand to hold the money of Country B, while those in Country B money would have a limited demand to hold Country A’s money. So, international transactions could occur in either currency, allowing for an exchange rate to be established between these currencies (Mises, 1953).
Unlike either the National Reserve System or the National Fiat Currency system with International Reserve Currency, monetary inflation in B does not directly affect the supply of money in A. The money of B cannot become a part of A’s money stock. Instead, monetary inflation in B would lead to an appreciation of A’s money against that of B as traders in B increase their demand to hold A’s money. Even if this appreciation of A’s money against B’s leads to an expansion of money production in A, the additional production would itself be regulated by profit and loss. With economizing production of money reserve and no issue of fiduciary media, there can be no domestic credit expansion in A. The credit channel’s impact is minimal.
Shielded from the possibility of generating its own domestic monetary inflation and credit expansion in concert with the rest of the world, business cycles emanating from B can be transmitted to A by one or more of the other three channels: exchange rates, interest rates, and asset prices. Within the framework of the international division of labor and worldwide capital structure, however, these channels operate, not through expenditure flows themselves but, via the patterns of trade of particular goods and services. As well, resource and capital capacity used in their production according to the economizing position of production and investment that A occupies in the international economy play a role.The effects on the prices and production of particular goods during monetary inflation are attributed to Richard Cantillon (1931). On his contribution to ABCT, see Hülsmann (2001), Rothbard (1995), and Thornton (2006).
Consider first the exchange rate channel. Monetary inflation and credit expansion in B distorts economic calculation, generating a boom in B. The money relation in A, however, is only minimally affected since B’s currency is held only to a very limited extent in A’s economy. Instead, the pending imbalance in the purchasing power of B’s currency in B compared to A will lead to a devaluation of B’s currency relative to A’s. Entrepreneurs in A, therefore, are in a better position than their counterparts in B to limit the misallocation of resources and malinvestment of capital. Why? This is because the supply of A’s commodity money would only increase in response to the increased demand for that money, leaving the purchasing power of A’s money relatively stable. Traditional profit and loss accounting is backward-looking. And, generally speaking, there is a temporal gap between when costs are incurred in the purchase of resources and when the revenues from selling the resulting product are earned. If there is a significant change in the money relation—specifically, if the purchasing power of money falls significantly over time, then accounting profit will be overstated. Economic calculation, though forward-looking, is informed by past experience, and when that experience is misrepresented, economic calculation becomes less reliable. Because of the relative stability of the money relation in A, economic calculation in A is more reliable as a guide to production and investment decisions than it is in B. Unless devaluation of country B’s currency against that of country A occurs synchronously with the decline in the purchasing power of B’s currency domestically, however, the balance of trade will be distorted between the two countries. In the typical case, the devaluation of B’s currency occurs sooner than domestic reduction in the purchasing power of B’s currency causing net exports (imports) in B (A) to rise. This effect is then reversed as the domestic purchasing power of B’s currency falls to parity with its purchasing power in A, given the already devalued exchange rate. The particular goods affected will be those in line with the latent comparative advantages of the two countries.
One would expect B’s exports to increase in two ways: first, some goods that B would otherwise consume domestically may now be sent abroad, as the alteration in exchange rates makes exporting look relatively more attractive. Assuming that nominal prices remain nearly the same at first, then the depreciation in B’s currency will raise the B-currency price that businesses can receive from exporting simply because a single unit of A’s currency has a higher B currency value than previously. Second, non-specific resources initially placed in less export-oriented industries may move into those that are more export-oriented, for similar reasons. This point is emphasized in Cachanosky (2014). Changes in production and investment in the two countries will move along the lines of the worldwide capital structure. Because the exchange rate channel sets in motion a self-reversing effect on profit in particular lines, the effect on production in A depends on the anticipations of entrepreneurs in those lines of production. Just as entrepreneurs in particular lines of production can anticipateWagner (1999) argues that businessmen will tend to anticipate the machinations of the Fed which would otherwise create the Austrian Business Cycle, and thus the ABCT is incorrect. For an alternative view, see Block (2001). other types of cyclical variations in demand for their products, they may be able to keep malinvestments of capital and misallocations of resources within manageable limits. Although the exchange rate channel is not entirely closed, its flow can be mitigated by entrepreneurship exercised in a free market economy.
Consider next the effect of movements of interest rates. As described by Hoffman and Schnabl (2011), credit expansion in B will suppress interest rates in credit markets in that nation. Arbitrage opportunities would arise for financiers who shift investment away from credit markets in B into those in A. As with the exchange rate channel, however, interest rates will operate through investment in particular lines of production across the capital structure according to latent comparative advantage in A. These investments will increase the prices of assets along particular lines of the capital structure in country A. Unlike the asset channel that operates from monetary inflation and credit expansion within B, however, in A the increased prices of assets will be countered by the decreased prices of other goods. Because any rise in demand for A’s commodity money in B will be met by money producers increasing the supply of that money, and there is no other reason for either the demand for A’s money relative to other goods or the supply of A’s money to alter, the overall purchasing power will change little. Only minimal overall wealth effects will occur. The asset price channel’s impact is minimal.As income is reallocated from asset price inflation, distributional effects on wealth may occur. On wealth effects during the business cycle, see Salerno (2012).
Even though the asset price channel is weak, prices of particular assets in country A will rise along the lines of the boom generated in country B. The extent and timing of asset price inflation will depend upon the anticipations of entrepreneurs who are appraising the realized market price of assets in the future. Alongside these entrepreneurs are investors in financial markets, including foreign exchange, who are, likewise, forming anticipations of the realized market price of future financial assets and currencies. Given an economizing distribution of entrepreneurial acumen across the different lines of entrepreneurial activity in production and investment, the asset price inflation in country B and the devaluation of its currency against that of country A should reflect a similar accuracy relative to the relevant realized market prices. Currency devaluation and asset price inflation set in motion by a given episode of monetary inflation and credit expansion should be roughly synchronous or, at least, more synchronous than currency devaluation and the reduction in its domestic purchasing power. The rise in asset prices in region B, however, will still generate some profit for investors who shift their purchases to A. The extent of the resulting arbitrage, however, will be blunted by devaluation of country B’s currency. The more synchronous the devaluation is with the rise in asset prices, the less monetary incentive there will be for such arbitrage. To some degree, then, the interest rate channel and exchange rate channel generate offsetting effects on A.
Dornbusch (1976) speaks to the question of timing and how effects on interest rates and exchange rates interrelate. Assuming uncovered interest parity (that is to say: assuming international financial arbitrage), if the interest rates in country A do not immediately and fully adjust when interest rates in country B do, then the exchange rate will “overshoot.” Since interest rates are lower in B than in A, the only way for this to be consistent with arbitrage is if B’s currency depreciates immediately and severely—so much so that the currency is expected to appreciate over time, to make up for the difference in interest rates. If this is not the case, then investors will continue shifting investments from B to A, which increases the interest rate in B, decreases it in A, and leads to further depreciation of B’s currency. This implies that the strength of the interest rate effect and the power of the exchange rate effect are inversely related. If interest rate effects are large, then little overshooting will happen—so the exchange rate effect will be somewhat smaller. If interest rate effects are small, then significant overshooting will occur, resulting in exchange rate effects greater than otherwise would have occurred.
Whatever the residual extent of asset price inflation remains in A, its effect on the broader array of economic activity will depend upon the response of entrepreneurs in the lines of production experiencing asset price inflation. If they resist expanding production, then other lines of production will likewise experience neither significant misallocation of resources nor malinvestment of capital. Whether or not entrepreneurs can provide “private protection” against infection from business cycles generated externally, and if so, in what way they can do this, will be taken up in the next section.
In preparation to addressing this issue, let us summarize the manner in which the virus attempts to spread from B to A. Monetary inflation and credit expansion in country B will generate a boom in B. The money of country A, however, cannot be inflated. Neither can credit in A be expanded. The virus cannot spread significantly through the credit channel. The malinvestment of capital and misallocation of resources in B will be driven by suppressed interest rates and asset price inflation in B and devaluation of its currency against that of A. Investors in B, who wish to earn the now higher interest rates in A, may do so by purchasing assets and claims to assets in A, which further suppresses the value of B’s currency in comparison to A’s. Although the asset price inflation in B can have a wealth effect, resulting in further malinvestment and misallocation in B, since the purchasing power of money changes very little in A, only a minimal wealth effect occurs there from the asset price inflation in A. The virus cannot spread significantly through the asset price channel. To the extent that devaluation occurs synchronously with the lowering of the domestic purchasing power of B’s currency, the balance of trade between A and B will not change and the asset price inflation infecting A will be limited to the difference between the asset price inflation in B and the decline in purchasing power of B’s currency. In the typical case, in which devaluation occurs prior to the lowering of the domestic purchasing power of B’s currency and synchronously with asset price inflation in B, net exports (imports) in region B (A) will rise along with the increased demand for assets in area A by investors in B. These effects would then be reversed as the purchasing power of B’s currency domestically fell into line with its devalued purchasing power internationally. On net, then, the exchange rate and interest rate channels have offsetting effects on A. In short, the virus of monetary inflation and credit expansion in B does indeed infect country A through changes in the prices of particular goods produced in A along the lines of its comparative advantage. Contrary to the cases of uniform international monetary regimes, in which a boom in one country can lead to a general boom in the other, the transmission of monetary disturbances from fiat money countries into a commodity money country are strictly limited and readily identifiable.
VI. DOES LAISSEZ FAIRE FAIL? Although a commodity money economy would be largely insulated from monetary disturbances generated in fiat money economies, Cantillon effects would occur from the residual asset price inflation in the commodity money country. The consequences for real production processes, however, depend on entrepreneurial anticipations. Entrepreneurs with superior foresight in the lines of production experiencing Cantillon effects will be less prone to malinvest capital and misallocate resources.On the spectrum of entrepreneurial foresight, see Engelhardt (2012). They will assess more accurately the extent of asset price inflation and exhibit proper restraint in expanding capital capacity and resource use in production during the boom so as to avoid the losses during the bust. By cutting off the spread of rising entrepreneurial demand for resources and capital capacity at the source, the malinvestment and misallocations associated with the boom-bust cycle can be contained within a narrow scope in country A. Moreover, during the course of the boom-bust cycle, resources and capital capacity tend to move out of the hands of the less insightful and into the hands of those more able to anticipate the future course of events. The less insightful entrepreneurs malinvest capital capacity during the boom and liquidate during the bust. The more insightful ones, by restraining from malinvestment during the boom, put themselves in a position to acquire capital capacity cheaply as the less insightful entrepreneurs liquidate their assets during the bust.John D. Rockefeller’s acquisition of oil-refining capacity during the volatility of the 1870s provides an example of the process. See DiLorenzo (2005, pp. 121–130).
This market process of transferring command over resources and capital capacity away from less insightful and toward more insightful entrepreneurs could be institutionalized into a system of “private enterprise protection.”On Rockefeller’s use of the institution of the trust, see Folsom (2004, pp. 88-89). But, here, “protectionism” would take on a very different meaning than that usually accorded to this policy. Entrepreneurs in A would be the agents offering protection to others from the losses of the boom started by B. In contrast with bureaucrats who rely on the ability of the state to punish those who do not comply with regulations, entrepreneurs persuade others to join them in their ventures by finding and offering them mutually advantageous terms for their cooperation. In this case, they would offer protection by persuading others to join them in sustainable lines of production and to avoid the harm to those who might otherwise succumb to the temptation to participate in the boom. Entrepreneurs could form voluntary trade associations to increase the incentives to refrain from short-term gains so as to avoid malinvestments. Voluntary unions among workers could reinforce the entrepreneurs’ decisions to avoid participation in B’s boom.Voluntary associations have a long and fruitful role in American life, see Bradley (1965), Dekker and Broek (1998), Gamm and Putnam (1999), Merton (1957), Olasky (1992), de Tocqueville (2003 [1835]) During the boom, entrepreneurs who refrain from increasing production and expanding capital capacity, can still earn profit from higher output prices and equity from the asset price inflation. By forestalling misallocation of resources and malinvestment of capital investment, they can also largely avoid the losses and consequent liquidations of the bust. And although economic calculation is made more difficult by credit expansion elsewhere, movements in foreign exchange rates between the inflated monies and the commodity money provide information that entrepreneurs can use to aid economic calculation which would not be available in absence of at least one country using commodity money. Entrepreneurs have a firmer basis on which to form anticipations of the lines of the boom that might tempt residents of country A into making malinvestments of their capital and misallocations of their resources. Adherence to a free market regime of commodity money would be critical for entrepreneurs to sharpen their anticipations to judge between the lines of production and investment that will prove to be sustainable and those that will not.
Even accounting for “private protection” from the ill effects of monetary inflation and credit expansion generated externally, some residual effects of the boom-bust will remain in the laissez faire territory. The final issue, then, is whether or not the residual misallocation of resources and malinvestment of capital investment occurring in A constitutes a market failure.
The main “players” in the market failure literature are monopoly, externalities, public goods, and informational asymmetries.There are literally dozens, scores, maybe even hundreds of others. Here are some of the critiques of this material: Anderson, 1998; Barnett, et. al, 2005; Block, 2002; Callahan, 2000; Cowen, 1988; DiLorenzo, 2011; Guillory, 2005; Higgs, 1995; Hoppe, 2003; MacKenzie, 2002; Rothbard, 1985; Simpson, 2005; Tucker, 1989; Westley, 2002; Woods, 2009a, 2009b. The question now arises: does the fact that economic “infection” can indeed infect economy A constitute a market failure? We deny that this is the case. Why? It is simple. It is not market failure that undermines the economy of A. Rather, it is the government failure of B that leads to this result.Contrary to the tendency among neoclassical economists to see market failures everywhere, however, we maintain the Austrian view on this matter that there is no such thing as market failure.
Even with the success of voluntary associations to moderate the malinvestments and misallocations arising from Cantillon effects, entrepreneurial errors will occur in A. Some residual malinvestments and misallocations will remain. We agree with Hayek that a country whose economy is an integral part of the world’s cannot be entirely isolated from inefficiencies emanating outside its borders. However, what impairs efficient production in country A is not a market phenomenon but rather one of government intervention in the economy in B, in this case. It is a general conclusion of economic theory that entrepreneurs economize on the use of resources for consumers as best they can in the face of barriers established by government intervention. The reaction by entrepreneurs to government obstacles result in the secondary effects that Mises (1998) demonstrated lead to the tendency for government interventions to accumulate. If the overall result of government intervention and the ensuing entrepreneurial reaction is sub-par compared to the laissez faire starting point, the fault lies with the government in B, not the market, in A.For example, the unemployment of the least productive workers under an effective minimum wage is not caused by the inability or unwillingness of free enterprise to employ such workers absent the legally imposed wage. Instead, the blame rests with the state.
A similar claim can be made about monetary inflation and credit expansion within a given country. It is not a market failure that entrepreneurs in A, striving to economize anew in the face of a B central bank driven credit expansion malinvest capital and misallocate resources. The former are, to the contrary, economizing as best they can, given the barriers to doing so instituted by B’s central bank policy. Because having a money independent of the inflationary and expansionary process of the central bank would allow them to economize even more fully, entrepreneurs, if given the freedom to chooseMilton Friedman (1990) argues in favor of being “free to choose.” Yet, he was a bitter opponent of the gold standard, something “chosen” by the marketplace, whenever economic actors were, you guessed it, free to choose. See on this Rothbard (2002); Block (1999). would establish their own sound money system to insulate their operations somewhat from the ill-effects of expansionary monetary policy. One of the key insights of this paper is that, at times, the blame does not rest on the government of the country that feels the ill effects, A in this case. In some circumstances, one must be willing to look abroad to find the original government failure.The South Park Movie featured a song called “Blame Canada.” We adopt this as our own, only we substitute “Blame B.” See on this: https://www.youtube.com/watch?v=bOR38552MJA
Assume that areas C and D both have a policy of total free trade on a unilateral basis. Whereupon D suddenly imposes protectionist measures on imports from C. Will the economy of C be negatively impacted by this unwise measure? Of course it will be. Specialization and the division of labor will no longer be as thorough and all-encompassing as they once were, before protectionism was introduced by D. Would we then acknowledge that “market failure” had overcome C? Of course not. Matters would be clear. We would maintain, instead, that the reason for C’s economic plight had nothing to do with free markets. Rather, we would lay the blame at the door of D, the originator of tariffs and other interferences with full free trade. In like manner, we arrive at the same conclusion for A and B, and the monetary inflation and credit expansion of the latter. Both of these were examples of government failure, not market failure.
Just as unilateral free trade results in the most economizing use of resources for a country adopting it within an international economy of protectionism in other countries, unilateral movement to commodity money will insulate a country as much as possible within an international economy of fiat money inflation and credit expansion. Such monetary reform improves the economizing operation of the market economy within the country that adopts it.
VII. CONCLUSIONS AND SUGGESTIONS FOR FURTHER RESEARCH Stated very briefly, we conclude that economic “infection” is indeed possible. A, despite its market-based commodity money, can still “catch” the disease of the Austrian business cycle from B. However, A will be less susceptible to the spread of this sickness than would otherwise be the case. And, this does not constitute any “market failure.” Rather, this is yet another example of government failure.
Before we move to consider directions for future research, we should consider one question that our analysis has assumed away: why don’t the two countries in question use the same money? We have built an argument—centered on the reliability of economic calculation—for why entrepreneurs would prefer a commodity money without credit expansion. So, it is no mystery why Country A limits its use of Country B’s money. But, why wouldn’t the entrepreneurs in B simply begin using A’s money? There are two answers. First, we note that, in the short run, a particular money experiences significant network effects. If most of my trade relations are with those who use B’s fiat money, then a market actor would likely hold B’s money in his portfolio and would probably keep financial records in B’s currency. In our analysis we consider a time frame in which Country B simply has not yet adopted Country A’s money. Another possibility is that Country B’s fiat money may be supported by interventions such as legal tender laws, which provide a domestic advantage to using B’s currency which would not apply to A.
What are our suggestions for further research?Unhappily, the answers to these research proposals are beyond the scope of the present paper. One possibility is that we pursue evidence of the insulating effect of sounder money. We recommend for all those interested in pursuing it, an analysis of the severity of the boom-bust across different countries with varying degrees of expansionary monetary policy during the recent boom-bust cycle. For example, Zimbabwe, Argentina and Venezuela would be at one end of this spectrum, the U.S. would occupy a position somewhere in the middle of it, and Switzerland would be located at the other end of the spectrum.
Another possibility would be to consider just one country, say Switzerland, which had a floating currency against the Euro before 2011 and a pegged currency from 2011 to early 2015. Under which system did Swiss entrepreneurs do better, ceteris paribus? E.g., under which regime was the ABC more powerful? Cachanosky (2014) provides a good resource for those considering empirical work in relating Austrian business cycles to exchange rate policy regimes.Other empirical studies of ABCT include the following: Bisman and Mougeot, 2009; Butos, 1993; Carilli and Dempster, 2008; Cochran, Yetter and Glahe, 2004; Cochran, 2011; Gallaway and Vedder, 1992; Hughes, 1997; Keeler, 2001; Montgomery, 2006; Mulligan, 2002, 2005, 2006; Murphy, 2009; Murphy, Barnett and Block, 2010, 2012; Powell, 2002; Wainhouse, 1984; Young, 2005.
A third suggestion is to reconsider the experience of those countries that maintained the gold standard during the Great Depression relative to those that abandoned it. The counterclaim that countries that left the gold standard earlier recovered faster than those that left later, may be, in turn, offset by the fact that nations less integrated into the U.S. economy, like Sweden, suffered less during the depression than those more integrated, for example Canada.On France during the Great Depression, see Irwin (2012). In short: the present paper suggests that assuming a strong connection between the domestic monetary system and business cycles, without consideration for international impacts, can lead to misleading conclusions.
Our hope is that this paper provides a theoretical grounding for those looking to do this historical work, and an encouragement to those who do it to look at the impacts of the international monetary system on national economies, since, in some cases, solving the mystery of poor economic performance in a generally free market economy requires looking over the border.
Bob begins his three-part series devoted to Capital and Interest Theory in the tradition of the Austrian School. This is his area of expertise, and the focus of his doctoral dissertation. In this episode, Part 1, Bob explains Böhm-Bawerk's critique of the "naive productivity theory" of interest, and also reconciles it with the standard approach in modern economics models of equating the real rate of interest to the "marginal product of capital."
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The Theory of Money and Credit—Mises's first major work—revolutionized economics by introducing a new theory of how and why money has value.
It deserves serious attention, and Dr. Jeffrey Herbener joins The Human Action Podcast for an extended discussion of this seminal work and the achievement it represented.
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Compiled by Edward W. FullerEdited with an Introduction by David Gordon
Are you a Murray Rothbard fan? Do you love his writing? His clarity and style? His razor-sharp economic analysis? His penchant for slaying sacred cows?
One of the most remarkable aspects of Murray Rothbard's career wasn't simply the power of his ideas, or his razor-sharp wit, but the sheer breadth of his knowledge.
A brilliant economist, revolutionary political philosopher, bold revisionist historian, and even joyful cultural commentator, Rothbard was one of the most prolific scholars — perhaps one of the most quotable.
This is the ultimate Rothbard reference book, and your single source for his best excerpts and quotes on all the core subjects: economics, philosophy, epistemology, ethics, history, law, and libertarianism.
Considering Rothbard's 62-page bibliography — consisting of 30 full-length books, 100 full chapters for edited works, and more than 1,000 scholarly and popular articles — consuming all of his work is almost impossible. Now, thanks to Rothbard A to Z, the ability to search for Rothbard's unique views on hundreds of topics is now at your fingertips.
Compiled by Edward W. Fuller and edited by David Gordon, this massive book is a must-have for any true Rothbard aficionado.
Prolific and radical hardly begin to describe him — but his important work has never been brought together like this, a reference guide and a fun book you can open at random for the best “Murrayisms” on any topic!
Here are just a few teasers:
Deflation, far from being a catastrophe, is the hallmark of sound and dynamic economic growth. Deflation — Making Economic Sense, p. 16 ...throughout history, despots and ruling elites of States have had far more need of the services of intellectuals than have peaceful citizens in a free society. For States have always needed opinion-moulding intellectuals to con the public into believing that its rule is wise, good, and inevitable; into believing that the “emperor has clothes.” Intellectuals — For a New Liberty, p. 14 Integration cannot be achieved by law and coercion; it must first come willingly into the hearts of men. Racism — Left and Right, p. 491 Professor Mises has keenly pointed out the paradox of interventionists who insist that consumers are too ignorant or incompetent to buy products intelligently, while at the same time proclaiming the virtues of democracy, where the same people vote for or against politicians whom they do not know and on policies which they scarcely understand. To put it another way, the partisans of intervention assume that individuals are not competent to run their own affairs or to hire experts to advise them, but also assume that these same individuals are competent to vote for these experts at the ballot box. Democracy — Man, Economy, and State, p. 886 Secession is a crucial part of the libertarian philosophy: that every state be allowed to secede from the nation, every sub-state from the state, every neighborhood from the city, and logically, every individual or group from the neighborhood. Secession — Libertarian Forum v. 1, p. 17
You probably haven't read Carl Menger's Principles of Economics, but you should: it's a groundbreaking work that created a new theory of value and built a foundation for praxeology. Dr. Joe Salerno joins us for the definitive podcast on the founder of the Austrian school.
Dr. Joe Salerno's brief biography of Menger
Dr. Peter Klein's foreword to Principles of Economics
Carl Menger's Principles of Economics online in PDF and ePub formats
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ABSTRACT:
Hoffmann (2018) attempts to reconstruct a typology of risks deemed more accurate and useful to both economists and risk managers than currently received views on the subject within mainstream economics/finance and Austrian economics. This comment argues that his criticisms of the Misesian approach and his case for an alternative are unconvincing. We explain weaknesses in his criticisms of the Misesian approach and outline some problems with his constructive task of building up the alternative.
KEYWORDS: Austrian economics, risk, uncertainty, complexity, probability JEL CLASSIFICATION: B4, C1 Dr. Xavier Méra (xmera@uco.fr) is Assistant Professor of Economics at Université Catholique de l’Ouest in Angers, France.
Quarterly Journal of Austrian Economics 21, no. 3 (Fall 2018) full issue, click here.
I. INTRODUCTION Drawing on the general literature on risk and uncertainty, as well as Mises, Knight and Weaver, Hoffmann (2018) attempts to reconstruct a typology of risks deemed more accurate and useful to both economists and risk managers than currently received views on the subject within mainstream economics/finance and Austrian economics. In particular, the author emphasizes what his approach and the Knightian/Misesian one have in common and where they differ. Formally, this is done by identifying two “research gaps” in the Misesian literature—a lack of conceptual clarity in dealing with risk and uncertainty (1) and a lack of justification for the view that classical probability theory is irrelevant when dealing with human action (2)—and trying to close them.
In what follows, we focus on some reasons why both his criticisms of the Misesian approach and his case for an alternative strike us as unconvincing, although this is not to deny that the paper is thought provoking and displays valuable information. First, we explain why his criticisms of the Misesian approach appear to us as weak, and second, we outline some issues with his constructive task of building up the alternative.
II. WEAKNESSES IN THE CRITICISMS OF KNIGHT/MISES While Hoffmann (pp. 2–3) delves into some epistemological considerations, in order to make some proposals regarding the requirements of a proper definition of risk, he nevertheless neglects to identify what could be the epistemological grounding for the Misesian position, as if it did not have any, before telling us about the two research gaps that allegedly characterize it. It is true, as the author suggests, that Mises is less than perfectly explicit regarding the proper scope of application of classical probability theory. However, the impression left that the traditional dichotomy of risk and uncertainty could be considered as an ad hoc piece of theorizing, somehow independent of the praxeological edifice and its justifications, is unwarranted. On the contrary, as can be inferred from Mises’s discussions, as well as Hoppe’s (2007) defense and elaboration of it that the author refers to without ever mentioning why Hoppe thinks Mises is right, Mises’s views on this particular topic are arguably grounded in his general epistemology. If they are flawed, ultimately it must then be either that Mises’s epistemological views are wrong, or that he inconsistently applies them to the particular questions under consideration (or a combination of both). But the author provides no assessment of the sort. It seems obvious to this commentator, in any case, that the author is on shaky grounds when identifying some research gaps in Mises’s approach without first paying some attention to those considerations.
At the risk of oversimplifying, the Misesian approach on probability, risk and uncertainty that the author describes, can be defended along the following lines:
The distinction between risk and uncertainty and their fields of application mirrors the methodological dualism Mises advocated between the natural sciences on the one hand and economics on the other and derives from it.This, incidentally, helps explain why Knight’s views came to be typically associated with the Austrian school after Mises systematized and refined the theory of knowledge and the corresponding method used by the Austrian economists, and as the Chicago school became unambiguously positivist. According to Mises and his followers, sound economics has to be structured as statements logically derived from and implied in the so-called axiom of action (the “logic of action” or “praxeology”). Action has to be understood as purposeful behavior. It implies the necessity of choice regarding the use of some scarce means to arrive at some ends. All the categories of goods, value, cost, profit and loss, etc. are implied in this insight which is considered by Mises as valid knowledge derived a priori of experience, via discursive reasoning. The axiom is self-evident in the sense that one cannot deny it without performative contradiction since any attempt would have to be an action itself, using some means to arrive at some end, etc.
One implication of the axiom is that action in general and therefore any production process takes time and that the future must be uncertain to the actor. For there would be no choice to make if future courses of events were known in advance in a world of complete certainty (Mises, 1949, p. 105). Actors must lack perfect foresight then. When acting, they must rely on their more or less probable knowledge about the world.
Now, for our purpose here, a relevant implication is, as Hoppe (1995, p. 78) puts it, that “action presupposes a causally structured observational reality but the reality of action which we can understand as requiring such structure, is not itself causally structured.” Action itself is not causally structured since it is purpose-directed. The actor chooses to use scarce means in some ways instead of some other ways to arrive at some ends and by necessity, chooses to abandon or postpone the fulfillment of other ends. On the other hand, action presupposes the “constancy principle,” “time invariant operating causes” in the actor’s environment, or a “causally structured” physical reality in which action takes place. In Mises’s words, “causality is a category of action.” The reason is that the very idea of action implies interference in the actor’s environment in order to produce a preferred state of affairs compared to the course of events without such an action. Success and errors must be ever present possibilities as long as there is action, and being able to conceive of a course of events and its successful deviation initiated by an actor means he can grasp some relationships between things which stay constant over time. There cannot be any meaningful concept of success and error, planning and therefore action under complete randomness or indeterminacy in the actor’s environment. The range of applicability of teleology and causality must therefore be clear and are determined a priori. Action has to be categorized teleologically, as purpose-directed, and the non-acting entities in the actor’s environment must be categorized causally (Mises, 1949, p. 107; Hoppe, 1995, pp. 77–81).
Now the insight here is that there are two categorically different realms of phenomena and that different methods are required to learn about them accordingly. On the one hand, the actor will have a less than complete knowledge of causally structured natural phenomena. On the other hand, he will lack knowledge of his own and other people future actions. As for the methods, there is no way one could identify fundamental laws of action by treating it as some causally structured movements of bodies that one has to experiment with to find the cause and effect relationships a posteriori, and there cannot be a priori knowledge of specific causal relations apart from the fact that they are causally structured.
In the realm of natural phenomena, the constancy principle allows us to project past observations regarding peculiar cause and effect relationships into the future. In other words, actors can hypothesize some specific time invariant causes at work and test their views thanks to experiments. The more tests are made, the more the relationships can be confirmed or discarded. That is how natural sciences proceed, of course. At some point, it becomes known with practical if not absolute certainty that combining two atoms of hydrogen and one atom of oxygen produces a molecule of water. Or, some engineers are able to build and operate high speed rail networks which work most of the time without significant technical failure. Now, sometimes observations of natural phenomena do not shed light on all the relevant cause and effect relations, but still allow actors to discover some regularity that can be expressed in terms of a numerical probability distribution. That is what Mises (1949, p. 107) refers to when discussing “frequency” or “class probability.”
The important consideration here is that the very possibility of being able to identify a class and the related probability distribution of some event presupposes that it is ruled by causality. No quantitative constant can be expected as a rule from an acting entity. That is why frequency or class probability can strictly be applied only in the field of natural sciences and that is why Knight’s concept of risk should apply to this realm only.
Now, not every event can fit the “ruled by causality” category. People act—people choose, that is—and choices cannot be predicted on the basis of time-invariant causal laws. A particular action is not the automatic answer to an external stimulus but the deliberate employment of chosen means to reach chosen ends. Different actors or even the same actors facing the same situation at different times can make different choices. Therefore, there can be no question of grouping some acts in a class of supposedly homogeneous events (Mises, 1949, pp. 110–113). This is the realm of “case probability.” This is why Knight’s concept of uncertainty should apply to actions only.
One may also refer to Hoppe’s (2007) elaboration of why action is intractable by frequency theory. In a nutshell, we may typically “know of no rule how to distinguish one bottle from another as far as breakage is concerned,” (Hoppe [2007, p. 14], referring to the manufacturing of beers in a factory for instance) so that a class may meaningfully be identified and probability calculus applied. However, understanding (verstehen) via verbal communication with other actors puts us “in a position to precisely distinguish one actor from any other actor and one action of a given actor from any other” (Hoppe, 2007, p. 17). Hence, as Knight puts it, in most cases in daily life, “there is no valid basis of any kind for classifying instances.” That is, “the essential and outstanding fact is that the ‘instance’ in question is so entirely unique that there are no others or not a sufficient number to make it possible to tabulate enough like it to form a basis for any inference of value about any real probability in the case we are interested in” (Knight, 1921, p. 226). Should a particular manufacturer expand production? With no valid basis for classification, limited knowledge of the possible outcomes and no calculation of the sort insurance deals with being possible, actors must then resort to “intuitive judgment” and “estimates” in “any typical business decision.” Being irreducible to fixed costs, they permanently leave room for errors in judgment, hence the existence of profits and losses.These errors should not be confused with technical failures, when one’s technological recipes do not work, which essentially have to do with our grasp of the laws of nature. Typical business decisions being based on such estimates, failure to forecast future prices and quantities is perfectly normal and results in bidding up factors of production “too much” or “not enough” in relation to their marginal productivity.
Now perhaps that approach is flawed, but where is it exactly? Why is the identification of risk with the frequency interpretation of probability naïve, in light of Mises’s whole system? Is it, for instance, that his methodological dualism is wrong? Shall we get rid of the whole edifice? If not, why not? What shall we keep, why, and how does that affect our treatment of risk or uncertainty? Unfortunately, the author does not give us a clue, since he does not treat Mises’s take on risk and uncertainty as a part of a larger system. Instead, the author takes another route. He occasionally alludes to other paradigms or builds his case for another framework and in light of it, incorporates elements of Misesian thought which fit and rejects those who supposedly do not. This is not necessarily problematic, although a possibly enlightening discussion of the above considerations is lost in the shortcut. If one refers to or builds an alternative paradigm, demonstrates it to be the truth on the matter, one may spare oneself a thorough analysis of the Misesian—or any other—view on uncertainty and risk and its relationship to Mises’s epistemology and simply point out that this view must be wrong to the extent that it deviates from the said truth.
An example of such an “external” critique of the Misesian approach is when Hoffmann (2018, p. 21) claims he is justified in asserting that, “we can reason about human action and choices probabilistically” as Luce and Raiffa (1957, pp. 19–23) show or, referring approvingly to Hájek (2011), that the frequency interpretation of probability is flawed anyway, so that the Misesian identification of risk with the frequency interpretation of probability is naïve. Apart from the fact that it is hardly obvious how both claims could be held at the same time, the problem is that the author does not tell us what are the objections exactly, and why we should consider them as valid.As a matter of fact, a cursory look at the relevant section in Luce and Raiffa’s book, called “Individual decision making under risk,” reveals that its authors do not assign numerical probabilities to human acts at all. The probabilities discussed there are those of the outcomes of a gambling game such as a lottery!,Yes, one can point toward objections in the literature to virtually any view under the sun, but if merely pointing out that stance A runs counter to stance B was deemed decisive to make a case for stance A, one could have as well demonstrated that stance A is wrong by pointing out that stance B exists. And if one can “prove” one thing and its opposite by the very same procedure, this should say something about the procedure.
III. WEAKNESSES OF THE ALTERNATIVE PARADIGM More constructively, Hoffmann (2018, pp. 11–14) lays down the foundations of an alternative paradigm, by providing the reader with four requirements that a sound definition of “risk” should meet, and tries to sort out what is right and wrong in the Misesian approach, in light of that new framework. The requirements are (1) that “risk should be defined in such a way that it can be distinguished between risk per se (what risk is) and how risk is measured, described or managed”; (2) “risk should be defined in such a way that it can be distinguished between what risk is and how risk is perceived as well as that the definition does not presuppose an interpretation of either objective or subjective risk”; (3) “risk should be defined in such a way that it is helpful to the decision-maker in lieu of misguiding her in many cases, and, thereby, the risk definition should capture the main pre-theoretic intuitions about risk”; and as a weaker requirement (4) “Risk should be defined in such a way that it does not divert attention away from systemic effects that have an impact on not only the actor, but also on other actors.” While these requirements sound by and large reasonable, the main issue is the following: the author tells us that their notion of risk (in a broad sense, or “risk I”) is introduced “in a deductive manner by postulating four requirements that a risk notion should meet.” Yet what is the epistemological status of those postulates? As far as the present writer can see and for our purposes here, it is clear that, at least, the Misesian treatment of probability, risk and uncertainty, can be thought of as grounded in an identifiable epistemology. It is far less clear that the alternative proposed by the author has such firm grounding.
In addition, why does the risk definition provided actually suit those requirements? It is hardly obvious that it does and that it fills research gap I, as intended, for it is quite close to Mises’s notion of probability (except for the uncommon inclusion of desirable outcomes) which allegedly does not: risk is “the real or realistic possibility of a positive or negative event the occurrence of which is not certain, or expectable but only more or less likely. However, the probability that the positive or negative event will occur does not have to be known or be subject to exact numerical specification.” (Hoffmann, 2018, p. 16). In fact, it turns out that the concept includes as subcategories the familiar Knightian concepts of risk in the narrow sense (later called Risk II) that the author finds problematic in other sections of the paper, and uncertainty: “Thus, the term ‘risk’ is not used as an antonym to ‘uncertainty,’ as is customary in decision theory, but rather as a generic concept that covers both ‘risk in a narrower sense’ (what Knight calls measurable uncertainty) and ‘uncertainty.’” (Hoffmann, 2018, pp. 16–17) What is the improvement then?
Now it is true that further elaborations of the author reveal that he deals with additional distinctions, Knightian risk and uncertainty being one among others. This is another consideration that leads him to disagree with Mises on the scope of classical probability theory. For not only human action could sometimes be made tractable by it. When it is not, when we deal with (deep) uncertainty instead of risk narrowly understood, this would not so much be because of some feature inherent to human action but because we are in the presence of what Weaver (1948) calls “organized complexity.” In other words, we are “dealing simultaneously with a sizable number of factors which are interrelated to form an organic whole. Interactions and the resulting interdependence lead to emergence, i.e., to the spontaneous appearance of features that cannot be traced to the character of the individual system parts and, therefore, cannot be fully captured in probability statistics nor sufficiently reduced to a simple formula.” (Hoffmann, 2018, p. 22) Again here, it is unclear what is the epistemological status of the proposal, it is unclear why we are supposed to adopt Weaver’s view. But even if we do not dive into the deep waters of epistemology, it should be clear that the proposal is not as plausible as the author wishes it to be. For we can conceive of situations in which we deal with human choices without organized complexity. For instance, the range of possible choices of a shipwreck survivor alone on a desert island or in a lifeboat would be very limited and there would be no interaction to speak of (at least no interactions between human actors). Yet, if what makes some choices intractable by probability theory is organized complexity, would that not mean that we can predict the choices of this person, using classical probability theory? Now the author would have to tell us how we could do so.
IV. CONCLUSION Aside from some apparent internal inconsistencies, the main problem with the author’s thesis is the lack of a systematic analysis of how both the praxeological treatment of risk and uncertainty on the one hand and his own on the other are or can come to be known and validated. His apparent eclecticism leaves his approach with shaky foundations.
ABSTRACT: Whenever risk managers are confronted with deep uncertainty and organized complexity, probabilistic inference methods which claim crisp inputs and precise results cannot be used effectively. This is a thesis of this paper which we derive from a systemic viewpoint and discuss in the context of praxeology. More specifically, our contribution to the literature of Austrian Economics is twofold. First, after revisiting the Knightian nomenclature of risk vs. uncertainty, which according to Hoppe (2007) is similar to Ludwig von Mises’s work on the subject matter, we present our own conception of risk which differs from their notion. Second, we follow Hoppe (2007) in assessing the arguments provided by Knight and Mises against the possibility of applying probability theory in the area of human action, but reach a different, more nuanced conclusion. In particular, we outline a case which parts ways with the praxeological approach.
KEYWORDS: Austrian economics, risk, uncertainty, complexity, probability JEL CLASSIFICATION: B4, C1 Dr. Christian Hugo Hoffmann (choffmann@ethz.ch) is a postdoc at the Chair of Entrepreneurial Risks at the Swiss Federal Institute of Technology in Zurich (ETH), Switzerland.
Quarterly Journal of Austrian Economics 21, no. 3 (Fall 2018) full issue, click here.
It is high time, however, that we take our ignorance more seriously. – (Friedrich A. Hayek, 1967)
- INTRODUCTION This paper characterizes and discusses different concepts of risk and seeks to define a proper meaning of the term in the realm of economics and finance. The purpose is not only to simply deepen our conceptual knowledge, but to, and this is particularly relevant to Austrianism, identify and examine the potential of going beyond the mere and rigid dichotomy of risk vs. uncertainty which Knight and Ludwig von Mises rely on. This is achieved by exploring if and how far systematization can be deemed possible in the non-probabilistic realm of uncertainty. Even though at the end we will also differentiate between Knightian risk and uncertainty (so to speak), it is important to note that we only endorse a single concept of risk which is different from Knightian risk and which will be baptized Risk I (section 5). We introduce Risk I in a deductive manner by postulating four requirements that a risk notion should meet (section 4). Prior to that, we review the literature (section 2) and turn the spotlight to Knight’s and Mises’ angle on risk (section 3). We close this paper in section 6 and 7 where we detail lessons from the taxonomy of risk we are proposing for Austrianism.
The absence of an accepted and appropriate definition of risk in the literature is not simply an abstract academic ivory tower issue. For example, risks in and to economic and financial systems are regarded as triggers of global financial crises (Schwarcz, 2008, pp. 193–249; Kelly, 1995, pp. 221ff.). Having lucid definitions is a fundamental requirement for management and modeling (Fouque and Langsam, 2013, p. xxviii). Without a well-thought notion of (financial) risk and approaches for measuring and managing the amount and nature of the risks, it would be difficult to effectively target indispensable (e.g., mitigating) action without running the real risk of doing more harm than good.
- THE NOTION OF RISK IN THE LITERATURE In non-technical contexts and contexts of common parlance, the word “risk” refers, often rather vaguely, to situations in which it is possible but not certain that some undesirable event will occur (Hansson, 2011; Heinemann, 2014).The origin of the concept of risk is not clear. Etymologically, the term is, among other things, derived from the Greek word “rhiza” which can be translated with “cliff”, supporting the above negative mode of explanation, and from the Latin vulgar expression “risicare” / “resecare”, meaning “to run into danger” or “to wage / to hazard”. Cf. Heinemann, 2014, p. 59.a More precisely, the philosopher Sven O. Hansson distinguishes five particularly important and more specialized uses and meanings of the term, which are widely used across academic disciplines and/or in everyday language (Hansson, 2011).
(1) risk = an unwanted event which may or may not occur.
An example of this usage is: “The risk of a financial collapse is vast.”
(2) risk = the cause of an unwanted event which may or may not occur.
An example of this usage is: “Subprime lending is a major risk for the emergence of a housing bubble.” Both (1) and (2) are qualitative senses of risk. The word also has quantitative meanings, of which the following is the oldest one:
(3) risk = the probability of an unwanted event which may or may not occur.
This usage is exemplified by the following statement: “The risk that a financial collapse will occur within the next five years is about 70%.”
(4) risk = the statistical expectation value of an unwanted event which may or may not occur.
The expectation value of a possible negative event is the product of its probability and some measure of its severity. It is common to use the total amount of monetary costs as a measure of the severity of a financial crash. With this measure of severity, the “risk” (in sense 4) laden with a potential financial collapse is equal to the statistically expected number of monetary costs; i.e., for example, 70% (building on the example from (3)) times USD 10T results in USD 7T of expected overall costs of a global financial crisis. Other measures of severity give rise to other measures of risk.“Although expectation values have been calculated since the 17th century, the use of the term ‘risk’ in this sense is relatively new. It was introduced into risk analysis in the influential Reactor Safety Study, WASH-1400, (Rasmussen, 1975).” (Hansson, 2011). Today, Hansson (2011) regards it as the standard technical meaning of the term “risk” in many disciplines. Some risk analysts even think that it is the only correct usage of the term (ibid.).
(5) risk = the fact that a decision is made under conditions of known probabilities (“decision under risk” as opposed to “decision under uncertainty”).“Most presentations of decision theory work from Luce and Raiffa’s (1957) [building on Knight, 1921; C.H.] classic distinction between situations of certainty (when the consequences of actions are known), risk (when the probability of each possible consequence of an action is known, but not which will be the actual one) and uncertainty (when these probabilities are unknown)” (Bradley and Drechsler, 2014, p. 1229). See footnote 28 for an example.
All concepts of risk have in common what philosophers call contingency, the distinction between possible and actual events or possible and chosen action (Renn, 2008, p. 1). In addition to these five common meanings of “risk”, according to Hansson (2011), there are several other more technical meanings, which are well-established in specialized fields of inquiry. With regard to economic and particularly relevant analyses for the purposes of this study, nota bene that the current debate on risk resembles a Babylonian confusion of tongues. The present situation is characterized by many weakly justified and inconsistent concepts about risk (Aven, 2012, p. 33). Some of the many different definitions that are circulating are triaged and a subsumption system for them is given in Table 1. The purpose of this overview is to lay out the variety of material risk notions, rather than to claim that the categories proposed are exhaustive or mutually exclusive.
Table 1: Classification system for risk definitions and characterization of different risk definition categories.x: yes, o: no, x?: answer depending on the meaning of the terms or it is not specified. A similar, but not fully satisfactory summary is found in Aven (2012, p. 37).
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In light of this ambiguity, the next section pays special attention to how the term “risk” has been coined by the Austrian school of economics, by Ludwig von Mises and Frank Knight in particular.
- THE NOTION OF RISK IN AUSTRIANISM Hoppe (2007) deserves credit for investigating a systematic, yet rarely noted similarity in the works of Knight (1921) and Mises (1949), namely in terms of their stance on risk, uncertainty and (the scope of) probability (theory).However, cf. also Rothbard (1962, pp. 498–501). However, the similarity concerns more than he spells out. Hoppe’s conclusion is not sufficiently satisfying because it remains incomplete when he simply notes that both Knight and Mises share a similar critical view on the limitations of mathematical probability theory, which would not prove to be useful in our daily endeavors of predicting human action (Hoppe, 2007, p. 19). Leaving that for the moment, Hoppe fails to discuss an intriguing shortcoming from which both oeuvres suffer. Knight (1921, ch. 7 and 8) and Mises (1949, ch. 6) treat the notions of uncertainty and probability, which are a primary concern of praxeology, but both treatments lack some conceptual clarity. To be precise, we do not disagree with Hoppe’s or Knight’s / Mises’s critical attitude towards the applicability of numerical or Kolmogorovian probability theory. Rather, the aforementioned lack of conceptual clarity on risk notions refers to a naïve identification of risk with (a frequency interpretation of) probability both Knight and Mises succumb to and which is not critically appraised by Hoppe.
Knight (1921, pp. 223f.) spots empirical-statistical probabilities and defines them as “insurable” contingencies or “risk.” Mises concurs with him (Hoppe, 2007, p. 11). Yet, why is this approach naïve? In section 4, we will call it problematic because it does not meet the first, second and third of four requirements which we will establish regarding an appropriate concept of risk. On top of that, the frequency interpretation of probability itself is laden with inconsistencies (cf. Hájek, 2011 for a synopsis). Therefore, by anticipating the reasoning underlying criteria 1 to 3 in section 4 and by pointing to the objections to frequentism in the literature, we are justified in stating the first of two research gaps.
Research Gap I: Poor conceptualization of the term “risk” as well as knowledge deficits concerning the conceptual relationships between “risk,” “uncertainty,” and “probability” in a finance and economics context.
Mises (1949, pp. 107ff.) actually does not even single out “risk” as a terminus technicus in this connection of elaborating on the interpretations of probability. Instead, he first comments rather vaguely:A precise definition includes the logical operator “if, and only if”, which is missing in how Mises introduces “probability.”
A statement is probable if our knowledge concerning its content is deficient. We do not know everything which would be required for a definite decision between true and not true. But, on the other hand, we do know something about it; we are in a position to say more than simply non liquet or ignoramus. (Mises, 1949, p. 207).
Within this wide, general, and under-determined class of probabilistic statements, Mises then distinguishes two categorically distinct subclasses. The first one—probability narrowly understood and permitting the application of the probability calculus—bears the signature of his brother Richard, who first and foremost coined the objective concept of probability (Mises, 1939), and is called “class probability”:Moreover, that Mises (1949) shows himself in complete agreement with his brother (Mises, 1939) in this regard, entails that he deliberately uses “random” to mean “chancy,” which is problematic (cf. Eagle, 2012).
Class probability means: 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, 1949, p. 207).
On the other hand, Knight (1921, pp. 223f., 226, 231f.) calls the other sort of contingency (i.e., probabilities which are not a priori or empirical-statistical) “true uncertainty” and describes it as an estimate or intuitive judgment. For example, business decisions “deal with situations which are far too unique, generally speaking, for any sort of statistical tabulation to have any value for guidance. The conception of an objectively measurable probability or chance is simply inapplicable.” (Knight, 1921, p. 231). Almost three decades later, Mises (1949, p. 110) adds that true uncertainty or case probability, which is how he refers to it, means:
We know, with regard to a particular event, some of the factors which determine its outcome; but there are other determining factors about which we know nothing. Case probability has nothing in common with class probability but the incompleteness of our knowledge. In every other regard the two are entirely different. (Mises, 1949, p. 110).
In particular, while the probability calculus is only applicable to ‘genuine’ classes or collectives (hence the name class probability), case probability is about individual, unique, and non-repeatable cases/events “which as such—i.e., with regard to the problem in question—are not members of any class” (Mises, 1949, p. 111). Thus, they lie outside the scope of classical probability theory. Yet, what kinds of events must be considered as instances of case probability according to Mises? He provides the reader with the following initial answer:
The field for the application of the former [class or frequency probability] is the field of the natural sciences, entirely ruled by causality; the field for the application of the latter [case probability] is the field of the sciences of human action, entirely ruled by teleology. (Mises, 1949, p. 107).
It follows that “human action is the source of ‘true,’ nonquantifiable (Knightian) uncertainty” (Hoppe, 2007, p. 11). We share Hoppe’s observation that, unfortunately, Mises (1949) is less than outspoken in elucidating why human actions (choices) are intractable by probability theory (in the frequency interpretation) (ibid.). Moreover, we claim however that Hoppe’s intended main contribution in his paper, namely to render the reason why choices are intractable by the frequency interpretation of probability explicit based on the Misesian framework, is insufficient and provide evidence in section 6. To put it in a nutshell already, we will not accept Hoppe’s rationale because we reject the Misesian framework for this particular purpose. Instead, we will bring forward Proposition II and, thereby, ground the matter of the scope and limitations of probability theory on questions on complexity in lieu of human action. For now, we acknowledge
Research Gap II: Lack of understanding of whyhuman action and choices lie outside the scope of classical (Kolmogorovian) probability theory.
We address those two research gaps in the following. Section 6 seeks to close research gap II although the proposition that human action per se cannot be captured by probability statistics turns out to be untenable. Section 5 targets research gap I and the very next chapter constitutes a necessary stepping stone in this direction. Put differently, some notes on the epistemology of risk are in order first to escape possible snares before we deduce our own definition of risk.
- THE EPISTEMOLOGY OF RISK When there is a risk, there must be something that is unknown or has an unknown outcome. Therefore, knowledge about risk is knowledge about lack of knowledge (Hansson, 2011). This combination of knowledge and lack thereof contributes to making issues of risk difficult to grasp from an epistemological point of view.
Second, it is sensible to acknowledge that risk not simply refers to something unknown, but to draw a conceptual framework distinguishing between the known, the unknown, and the unknowable (“KuU” as it is labeled by Diebold et al., 2010). Accordingly, Kuritzkes and Schürmann (2010, p. 104) call a risk known (K) if it can be identified and quantified ex ante; unknown (u) if it belongs to a collective of risks that can be identified but not meaningfully quantified at present;The unknown might, therefore, also be knowable insofar as there (will) exist mechanisms that allow transforming the unknown into the known. These mechanisms can be either known or unknown. It is often unknown whether a risk or circumstance is a “knowable unknown” or an “unknowable unknown”, which might remind the reader of Donald Rumsfeld’s dictum of known and unknown unknowns—another demarcation line. and unknowable (U) if the existence of the risk or set of risks is not anticipatable, let alone quantifiable, ex ante. Nota bene: there is no sharp definitional line to be drawn between these classes, maybe leaving the KuU classes lying along a continuum of knowledge.
Third, things are even more confusing because even “known” risks (in the sense of Kuritzkes and Schürmann, 2010) contain uncertainty: “[…] as recent evidence coming from the financial markets painfully shows, the view according to which a ‘known probability distribution’ contains no uncertainty is not quite right” (Fedel et al., 2011, p. 1147).Ellsberg (1961) speaks of the ambiguity of a piece of information. The authors strengthen their assertion as follows (Fedel et al., 2011, p. 1147): Suppose a die is being rolled. One thing is to be uncertain about the face that will eventually show up (a “known” risk). One quite different thing is to be uncertain about whether the die is fair or unbiased (is the ostensibly known risk really known?) (Fedel et al., 2011, p. 1147). In other words, we can rather naturally differentiate between first order and second order uncertainty, respectively. In the former case, we are uncertain about some (presently unknown) state of affairs. In the latter, we are uncertain about our uncertainty, i.e., second order uncertainty refers to the assessment that an agent makes about her own uncertainty (Fedel et al., 2011, pp. 1147f.).In principle, even higher orders of uncertainty are conceivable.
Finally, fourth, Hansson (2011) observes that a major problem in the epistemology of risk, a problem which is paid special attention to in this study, is how to deal with the severe limitations that characterize our knowledge of the behavior of unique complex systems that are essential for estimates of risk (e.g., modern financial systems). Such systems contain components and so many, potentially shifting, interactions between them that it is in practice unpredictable (Hansson, 2011).
These four points already presage that the relationship between the concepts “risk,” “knowledge,” and “uncertainty” seems to be wide-ranging, multi-layered and elusive. Hereafter, we try to cope with these issues and, further, to establish four explicit conditions for defining a proper, i.e., a more useful and a consistent,Following Rothschild and Stiglitz (1970, pp. 226f.), it is, of course, impossible to prove that one definition is better than another. Instead, they point out that definitions are chosen for their usefulness as well as their consistency. notion of risk.
Condition 1: Risk should be defined in such a way that it can be distinguished between risk per se (what risk is) and how risk is measured, described or managed (Aven, 2012, p. 33; Bradley and Drechsler, 2014, p. 1226).
Rationale: This condition is important because there exist perspectives on risk in which this distinction is not made (see Table 1 and cf., e.g., Beck, 1992, p. 21; Hansson, 2007, p. 27). Like MacKenzie (2006, pp. 143–179), George Soros (2008, p. 3) notes how “our understanding of the world in which we live is inherently imperfect because we are part of the world we seek to understand” and he focuses on “how our knowledge of the world is interdependent with our measurements of it” (Blyth, 2010, p. 460).An impressive example of how knowledge is interwoven with our measurement tools can be taken from fractal geometry: Intuitively, we would assume that a question like “How long is the coast of Britain?” is well-defined and can be answered clearly and precisely by pointing to a certain fact. However, by adding to the observations by Lewis Richardson (1881–1953), Mandelbrot (1967) shows that the length of a coastline, a self-similar curve or fractal object, depends on the scale at which it is measured (which has become known as the ‘coastline paradox’). In principle, every (measurement or description or management) tool in use (which could be based on stochastic models) should be treated as such. Every such tool has its limitations and these must be given due attention. By a distinction between risk as a concept, and its descriptions or assessments “we will more easily look for what is missing between the overall concept and the tool” (Aven, 2012, p. 42). By the same token, if a proper framework clarifying the disparity between the overall risk concept, and how it is being measured or operationalized etc. is not established, it is difficult to know what to look for and how to make improvements in these tools (Aven, 2012, p. 42). In addition to that, it is a central principle of systems science, which in turn is in consonance with the Austrian line of thought,For example, Mises (1949, p. 874) places the learning of economics within the context of systems thinking and the “interconnectedness of all phenomena of action” at the core of systems thinking. to examine issues from multiple perspectives—“to expand the boundaries of our mental models” (Sterman, 2000, p. 32)—and, as a consequence, the risk concept should not be illuminated by one theoretical perspective only (e.g., mere probabilistic underpinnings); it should not be founded on one single measurement tool. Because in the various scientific environments, application areas or specific contexts, there might not be one best way to measure/describe risk. This appears to be, therefore, a reasonable and uncontroversial premise which can be further strengthened by an analogy to the Austrian debate on the single concept “utility” that has been operationalized in different ways. One camp around Böhm-Bawerk would maintain a cardinal understanding of utility, namely that the utility of goods can be measured and expressed as a multiple of a unit. By contrast, Čuhel, Mises, and many more would defend an ordinal understanding of utility (Moscati, 2015). Thus, once we allow for the distinction between utility and its measurement, we enable both and potentially other parties to talk sense about utility from different angles, to elaborate on different facets of the broad notion, and so forth (be it a cardinal utility function or an ordinal understanding).
Application to Knightian/Misesian framework: When Knight (or Mises, for that matter) identifies risk with (a frequency interpretation of) probability, he does not pass this test because then it is not differentiated between the notion (i.e., risk and hence probability) and its operationalization (i.e., the probability measure).
The second condition purports the following:
Condition 2: Risk should be defined in such a way that it can be distinguished between what risk is and how risk is perceived (Aven, 2012, p. 34)According to Aven (2012), this premise is not in line with cultural theory and constructivism (cf. also Jasanoff, 1999; Wynne, 1992; and critical comments in Rosa, 1998). Beck (1992, p. 55), for example, writes that “because risks are risks in knowledge, perceptions of risks and risk are not different things, but one and the same.” as well as that the definition does not presuppose an interpretation of either objective or subjective risk (Hansson, 2011).
Rationale: There is a major debate among risk professionals about the nature of risks: are risks social or subjective constructions (human ideas about reality, a feature of the agent’s informational state) or real-world, objective phenomena (representations of reality, a feature of the world itself;). Willett (1901) and Hansson (2011), for example, speak up for a strong objective component of risk: “If a person does not know whether or not the grass snake is poisonous, then she is in a state of uncertainty with respect to its ability to poison her. However, since this species has no poison there is no risk to be poisoned by it” (Hansson, 2011). On the other hand, it is obvious to others that risks constitute mental models (Renn, 2008, p. 2). They are not veritable phenomena, but originate in the human mind (Renn, 2008, p. 2). As Ewald (1991, p. 199) notes: “Nothing is a risk in itself; there is no risk in reality. […] [A]nything can be a risk; it all depends on how one analyses the danger, considers the event.” The definitional framework should, hence, try to “avoid the naïve realism of risk as a purely objective category, as well as the relativistic perspective of making all risk judgments subjective reflections of powerPower, for example, to the extent that what counts as a risk to someone may be an act of God to someone else, resigned to his fate (Bernstein, 1996b). and interests” (Renn, 2008, p. 3).
Application to Knightian/Misesian framework: Needless to restate the well-known objections to objective probabilities (e.g., cf. Hájek, 2011 for an overview), but interestingly, since Knight and Mises embrace a frequentism-based notion of probability, they also seem to endorse a purely objective interpretation of “risk.” Thus, their framework does not pass this second test either. At least, some more clarification would be required because, on the other hand, subjectivism is considered a central pillar for economists of the Austrian School (e.g., Spitznagel, 2013, pp. 21, 76). Or maybe it simply follows then that an agnostic position should be taken as Condition 2 suggests it.
There are at least two more requirements for a good risk definition.
Condition 3: Risk should be defined in such a way that it is helpful to the decision-maker in lieu of misguiding her in many cases (Aven, 2012, p. 42), and, thereby, the risk definition should capture the main pre-theoretic intuitions about risk (Rothschild and Stiglitz, 1970, p. 227).
Rationale: At first glance, this condition might sound trivial, but it must not be forgotten that risk cannot be confined to the ivory tower of scholarly deliberations. Even though it might be a theoretical and abstract concept, risk has forged a direct link with real-life management of challenges and actual decision-making. It has a direct impact upon our life and the orientation along decision-making and human action is key for Austrianism (Mises, 1949) as well. Speaking for the banking context, banks, taxpayers, governments lost a lot of money (and much more; e.g., credibility) because risk managers (in a broad sense) ignored or misjudged risks, miscalculated the uncertainties or had too much confidence in their ability to master dangerous situations (FCIC, 2011). Ultimately, only time and feedback from the economic practice can tell whether or not this premise is fulfilled.
Application to Knightian/Misesian framework: Some proposals such as R = P V OU, i.e., the framework of Mises, 1949 and Knight, 1921 (see Table 1), do not fulfill this criterion because, to put it in the words of Aven (2012, p. 41), “referring to risk only when we have objective distributions would mean we exclude the risk concept from most situations of interest.” Thus, this risk concept would not prove helpful in many or most cases of decision-making.
In conjunction to this third premise, opening the debate to a wider (namely, to a non-academic) audience, one can also see the following ethical demand.
Condition 4: Risk should be defined in such a way that it does not divert attention away from systemic effects that have an impact on not only the actor, but also on other actors (Rehmann-Sutter, 1998, p. 120).
Rationale: The school of Austrian economics also emphasizes the importance of systemic effects that are usually associated with (very) low-frequency events in a high-dimensional space—cf. for example, Spitznagel, 2012: “The Austrians and the Swan: Birds of a Different Feather.” Yet, Rehmann-Sutter (1998, p. 122) goes one step further and bemoans the fact that in some economic concepts of risk, “there is only one personal position: the decision-maker,” whereas most risks are not individual but rather social (Sen, 1986, pp. 158f.), i.e., there might be negative consequences for others from “taking risks.” He adds, however, that we have difficulty in adequately including those other persons (e.g., taxpayers in our context) affected by the consequences of the (risk management) decision (of a bank) in the decision-making process, where the concept of risk is worked out in reality (Rehmann-Sutter, 1998, p. 122). “These other participants are abstract; attention is diverted away from them. These participants are conceptually hidden” (Rehmann-Sutter, 1998, p. 122).
Application: We cannot regard this critique as fundamental in terms of the economic risk concepts taken into consideration in Table 1—e.g., the definition R = EV does not entail a narrow reading of the consequences. Therefore, we consider 4 as a weak condition which can in principle be met by every risk definition. In other words, condition 4 is more about the interpretation of the definition than about the risk definition itself. Nevertheless, an important lesson can be learned from that admonition, among the most prominent of which was drawn by Kristin Shrader-Frechette.
Shrader-Frechette (1991) points to the unease we feel when we are using a concept which was elaborated for optimization of entrepreneurial behavior in an unpredictable market to describe interventions into the (financial) system with potential or actual adverse effects to other persons and institutions. What is prima facie rational might secunda facie not be rational if a feedback view of the world is adopted (Sterman, 2000). Since only those risks enter standard probabilistic risk measurement procedures that (directly!) affect the respective organizations, risk managers or traders etc. often do not see a direct connection between their actions and other actors (Garsten and Hasselström, 2003, p. 259) or with significant changes in the financial system or even the global economy, which, in the end, bounce back on the individual institutions themselves.
For now, a first bottom line is that, unfortunately, many extant definitions of risk do not even meet the first two basic requirements (see Table 1, rows 3 and 7). In terms of Table 1, only risk in the sense of uncertainty (R = U) and risk as the real or realistic possibility of a negative, (very) rare and uncertain event with serious or even extreme consequences (R = U&C) remain in the game. Since seeing risk as uncertainty can be considered a special case of U&C, the latter seems to be the most promising candidate whereas the other risk concepts presented do not only turn out to not have some desirable properties, but also suffer from other shortcomings. For example, the especially in a banking context relevant identification of risk with volatility or the variance of returns (R = V) is clearly unsatisfactory: “We can construct distributions that have identical variance but with which we would associate very different degrees of ‘riskiness’ – and risk, as the saying goes, is one word but is not one number” (Rebonato, 2007, p. 237; cf. also Rootzén and Klüppelberg, 1999); “[i]n any case, anyone looking for a single number to represent risk is inviting disaster” (Taleb et al., 2009, p. 80; cf. also Power, 2007, p. 121).
Before we shed some more light on U&C, it makes sense to first look closer at another example, namely the field of the risk definition R = P V OU where Mises (1949) and Knight (1921) made one of the first large-scale distinctions between risk and uncertainty, for what became known as ‘Knightian risk’ (= measurable uncertainty) and ‘Knightian uncertainty.’ Albeit there might be good reasons for regarding Knight’s original argument for distinguishing between risk and uncertainty as going astray (see condition 3),Taleb and Pilpel (2004) and Aven (2012), for example, argue that we should leave the Knightian nomenclature once and for all: “[…] the distinction is irrelevant, actually misleading, since, outside of laboratory experiments, the operator does not know beforehand if he is in a situation of ‘Knightian risk’” (Taleb and Pilpel, 2004, p. 4). it is nevertheless important to bear it in mind due to several reasons.
First, it is very puzzling to see how different economists, risk experts and others have reacted to Knight’s oeuvre, how they interpreted it and what conclusions have been drawn. A good example is that while both the critical finance community (e.g., Stout, 2012; Bhidé, 2010; Aven and Renn, 2009; Power, 2007; or Taleb and Pilpel, 2004), on the one hand, and the economic (imperialistic) mainstream (Friedman, 1976; Ellsberg, 1961; Savage, 1954) on the other, consider Knight’s distinction between risk and uncertainty as invalid because his risk perspective is too narrow, the interests of these two groups are diametrically opposed to each other: Whereas the former repels probability based definitions of risk (“risk as a concept should not be founded on one specific measurement tool [such as probability—C.H.],” Aven, 2012, p. 42) in favor of uncertainty, the latter maintains that Knightian risk, i.e. risk measured by probability, would prevail instead of “uncertainty” (“for a ‘rational’ man all uncertainties can be reduced to risks [because it is believed that we may treat people as if they assigned numerical probabilities to every conceivable event—C.H.],” Ellsberg, 1961, p. 645).However, the agent’s acting as if the representation is true of her does not make it true of her. Cf. Hájek, 2009, p. 238.
Second, Knight’s seminal work might, therefore, be seen as very influential or even path-breaking for the more recent history of economic thought (Heinemann, 2014, pp. 61f.; Aven, 2012, p. 41; Esposito, 2011, p. 32) and as laying the grounds for a common meaning of “risk” (Hansson, 2011), especially relevant in economics and decision theory (Luce and Raiffa, 1957). Indeed, the tie between risk and probability is seen as so strong that only few seem to question it: “Risk can only be found in situations that have to be described by probabilities” (Granger, 2010, p. 32). Moreover, Knight (1921) introduced a simple but fundamental classification of the information challenges faced in banks’ risk management, between Knightian risks which can be successfully addressed with statistical tools (Value at Risk, Expected Shortfall, etc.), and Knightian uncertainties which cannot (Brose et al., 2014, p. 369). Good risk management, thus, calls for toolkits that handle both Knightian risk and uncertainty (Brose et al., 2014, p. 369).
Hence, third, it is important to have a risk concept based on probability models to be able to participate in, and contribute to, the discourse of risk if a great number of participants and economists or people interested in risk management in banking, in particular, should be reached. Since such a definition of risk (which will be baptized Risk II) would not do justice to the requirements set above (e.g., the first condition), however, it will not be the one which is pursued and embraced in this study after all.
Hence, it would be premature to simply and uncritically take on Taleb and Pilpel’s (2004) or Aven’s (2012) position of pleading in favor of leaving the Knightian nomenclature once and for all. Instead, our strategy is twofold. We first conclude that the kind of definitions by Heinemann (2014), Steigleder (2012), Aven and Renn (2009), etc. are the most appropriate before we approve a narrow notion of risk that is compatible with how risk discussions are commonly held.
- UNDERSTANDING RISK As an answer to research gap I, risk, in this paper, is paraphrased broadly asThese first two passages are taken from Steigleder (2012, p. 4).
… the real or realistic possibility of a positive or negative event the occurrence of which is not certain, or expectableWe follow Steigleder (2012, p. 4) in calling an event expectable here “if it is known to be a normal and common consequence of certain circumstances or actions. Whenever an event that is expectable in this sense does not occur, that is something abnormal and needs explanation.” but only more or less likely. However, the probability that the positive or negative event will occur does not have to be known or be subject to exact numerical specification.
Thus, the term “risk” is not used as an antonym to “uncertainty”, as is customary in decision theory, but rather as a generic concept that covers both “risk in a narrower sense” (what Knight, 1921, calls measurable uncertainty) and “uncertainty”. This is because we frequently lack a sufficient basis to determine the probabilities with any precision (Greenbaum, 2015, p. 165) as it will be clarified below.
This broad notion of risk is designated by Risk I. Structurally, risk in this sense captures:
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What can happen?
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Answering this question requires the identification or description of consequences or outcomes of an activity.
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Is it more or less likely to happen (in contrast to how likely is that to happen)?
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Attention is directed to rather rare or systemic events in this piece for reasons that become transparent below.
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If it does happen, what is the impact?
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Answering this question requires the evaluation of consequences which are rather serious or even extreme. Otherwise, risks would turn out to be immaterial.
We thereby follow the call of Das et al. (2013, p. 715) that risk management research will have to dig deeper “in going from more frequency oriented ‘if’ questions to a more severity oriented ‘what if’ approach, and this at several levels”. In this particular treatise, the focus lies on (very) low-frequency events in a high-dimensional space or, in particular, on low-frequency, high-severity (monetary) losses for several reasons. For example, pushing natural phenomena to an extreme unveils truths that are ensconced under normal circumstances. As stressed in Johansen and Sornette (2001) and following the 16th century philosopher Francis Bacon, the scientific appeal of extreme and systemic events is that it is in such moments that a complex system offers glimpses into the true nature of the underlying fundamental forces that drive it (Johnson et al., 2012, p. 3).
Accordingly, the need to address unexpected, abnormal or extreme outcomes, rather than the expected, normal or average outcomes is a very important challenge in risk management (McNeil et al., 2005, p. 20; Malevergne and Sornette, 2006, p. 79; Greenbaum, 2015, p. 164); because improving the comprehension (of the distribution) of extreme values, which cannot be dismissed as outliers because, cumulatively, their impact in the long term is dramatic, is of paramount importance (Mandelbrot and Taleb, 2010).The need for a response to this challenge also became very clear in the wake of the LTCM case in 1998 (McNeil et al., 2005, p. 20). John Meriwether, the founder of the hedge fund, clearly learned from this experience of extreme financial turbulence; he is quoted as saying: “With globalization increasing, you’ll see more crises. Our whole focus is on extremes now—what’s the worst that can happen to you in any situation—because we never want to go through that again.” (Wall Street Journal, 2000).
Benoît Mandelbrot uses a nice metaphor for illustration’s sake (cf. also Churchman, 1968, p. 17): “For centuries, shipbuilders have put care into the design of their hulls and sails. They know that, in most cases, the sea is moderate. But they also know that typhoons arise and hurricanes happen. They design not just for the 95 percent of sailing days when the weather is clement, but also for the other 5 percent, when storms blow and their skill is tested.” (Mandelbrot and Hudson, 2008, p. 24). And he adds: The risk managers and investors of the world are, at the moment, like a mariner who “builds his vessel for speed, capacity, and comfort—giving little thought to stability and strength. To launch such a ship across the ocean in typhoon season is to do serious harm.” (Mandelbrot and Hudson, 2008, p. 276).
Clearly, this does not mean that (very) low-probability risk events matter simply because they have a very low probability. For example, there is some probability that a pink elephant will fall from the sky. But such a risk does not affect managerial decisions in economic and financial systems (such as banks). The known or unknown risks that matter for our purposes are, of course, those that, had senior or top management been aware of them, would have resulted in different actions (Stulz, 2008, p. 64)—e.g., the bursting of a pricing bubble or an escalating political conflict etc.
Second, a narrow concept of risk is invoked (Risk II); it is basically circumscribed by two key variables, the severity of the consequence and its probability of occurrence,The probability of occurrence or at least the subjective probability must be less than 1 and more than 0, otherwise there would be certainty about the event or the possible outcomes of an action. (Going back to Lewis [1980], the principle that, roughly, one’s prior subjective probabilities conditional on the objective chances should equal the objective chances is called the principal principle.) Moreover, the probability should be seen in relation to a fixed and well-defined period of time. For the concept of probability including objective and subjective probabilities, in general, cf. Hájek (2011). and it presupposes that possible/significant consequences and the corresponding values of severity and probabilities are known.For readers well versed in economic theories of decision sciences, it should be added that, depending on the particular theory, probabilities are not always assigned to the consequences of action alternatives (e.g., Jeffrey, 1983), but also, for example and actually more often, to so-called states of the world (e.g., Savage, 1954).2 Risk II encompasses Hansson’s (2011) risk definitions 3 to 5The risk formula “Risk = probability * measure of severity (e.g., utility, monetary unit, etc.)” directly follows from the Risk II concept (Hansson’s fourth definition). Since Risk II presupposes known probabilities (with 0 < p < 1), decisions under “risk” are made, and not decisions under conditions of “uncertainty” (Hansson’s fifth definition). And, finally, seeing risk as probability (third definition) can be considered a special case of Risk II and it can be regarded as a special and rare case of the broad risk definition (Risk I). Figure 1 depicts the conceptual relationships between Risk I, Risk II, and uncertainty, and can be viewed as our proposal to close research gap I.
Figure 1: Two relevant risk concepts: Risk I encompasses Risk II and uncertainty.A similar illustration (but insufficient explanation of the concepts) is found in Heinemann (2014, p. 61).
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Risk II is rather hypothetical or an exception and this case is basically constructed only to participate in regular risk discussions (see above, p. 15).See above: “Hence, it is third in turn important to have a risk concept based on probability models to be able to participate in, and contribute to, the discourse of risk if a great number of participants and economists or people interested in risk management in banking, in particular, should be reached. Since such a definition of risk (which will be baptized Risk II) would not do justice to the requirements set above (e.g., the first condition), however, it will not be the one which is pursued and embraced in this study after all.” Apart from the different orders of uncertainty (Fedel et al., 2011, p. 1147; Ellsberg, 1961), different types of uncertainty need to be taken into account. In Figure 1, we distinguish three qualitatively different types of uncertainty: (a) what decision theorists or philosophers might call state uncertainty, (b) what they might call option uncertainty and/or state space uncertainty, and (c) what corresponds to ethical uncertainty, a form of normative uncertainty (cf. Bradley and Drechsler, 2014). On top of that, many different kinds of risk (business risk, social risk, economic risk, etc., Kaplan and Garrick, 1981, p. 11) or categories of risk (market, credit, operational risk, etc.) are discussed in the literature and many more classification systems are introduced. We argue, however, that, even though some of the taxonomies offered for bank risks or for knowledge (or the lack thereof) are persuasive, e.g., the conceptual framework “KuU” by Diebold et al. (2010), at least the silo-treatment of risks should be overcome. Instead of devoting much attention to different forms of risk, the focus lies here on R = U&C in general. The broad concept of risk is chosen as a form of description since it is not a priori clear for concrete risks at issue whether or not the probabilities and potential consequences as well as their severity are known. Knight’s (Mises’s) important distinction between risk and uncertainty is esteemed by separating Risk II from uncertainty. This differentiation is, in some cases, indispensable for the discourse of risk (management) in banking because different implications arise: The risk perspective chosen strongly influences the way risk is analyzed and, hence, it may have serious effects on risk management and decision-making (Aven, 2012, p. 42). However, much of what we today call risk management is “uncertainty management” in Knightian terms, i.e., courageous efforts to manage ‘risk objects’ for which probability and outcome data are, at a point in time, unavailable or defective (Power, 2007, p. 26; Willke et al., 2013, p. 9).
- A TAXONOMY OF UNCERTAINTY: SCALES OF MEASUREMENT AND QUANTITATIVE VS. QUALITATIVE PROBABILITIES It is a commonplace that we must not undertake impermissible transformations on the data we wish to analyze, nor must we make interval statements on ordinal data, in particular (Flood and Carson, 1993, pp. 41f.).We differentiate among four types of scales: nominal, ordinal, interval and ratio. According to Tal (2015, 3.2), “[n]ominal scales represent objects as belonging to classes that have no particular order, e.g., male and female. Ordinal scales represent order but no further algebraic structure” and admit of any transformation function as long as it is monotonic and increasing. Celsius is an example of interval scales: “they represent equality or inequality among intervals of temperature, but not ratios of temperature, because their zero points are arbitrary. The Kelvin scale, by contrast, is a ratio scale, as are the familiar scales representing mass in kilograms, length in meters and duration in seconds.” This classification was further refined to distinguish between linear and logarithmic interval scales and between ratio scales with and without a natural unit (Tal, 2015, 3.2.). “Ratio scales with a natural unit, such as those used for counting discrete objects and for representing probabilities, were named ‘absolute’ scales” (Tal, 2015, 3.2.). We agree with Mises (1949, p. 113) that there is a form of uncertainty, which he calls case probability and we will call deep uncertainty, and which does not lend itself to classical probability-based methods: “Case probability is not open to any kind of numerical evaluation” (Mises, 1949, p. 113). On this basis, we hypothesize that when we as risk modelers are in a state of deep uncertainty about some future data or events, then we can perform, not a cardinal, but an ordinal ‘measurement’ of that risks only.It is an open issue whether the representation of magnitudes on ordinal scales should count as measurement at all (Tal, 2015). In other words freely adapted from the logician and philosopher W.V.O. Quine, cardinalists’ overpopulated universe offends the aesthetic sense of us who have a taste for desert landscapes. Their aspiration after pedantic preciseness abets a breeding ground for disorderly mathematical operations on data and risks that necessitate modesty.
Proposition 1: Deep uncertainty or case probability does not admit of degrees, but is a merely comparative notion.
However, we do not agree with Mises (1949) about the scope of case probability vs. deep uncertainty. While he claims that “[c]ase probability is a particular feature of our dealing with problems of human action” (Mises, 1949, p. 111) and, thus, that human action and choices lie outside the scope of classical (Kolmogorovian) probability theory, Mises remains short on providing us with a sufficient reason for this assertion (see research gap II).
Our strategy by contrast is twofold: We suggest that the class of human choices and actions is both too broad and too narrow for capturing uncertainty statements that cannot be expressed in probabilistic terms. It is too broad because we can reason about human action and choices probabilistically (see “decision-making under risk,” Luce and Raiffa, 1957, or Table 1 [the column in the middle] below). Admittedly, it can be argued that all decisions are made “under uncertainty” if one abstracts from clear-cut and idealized textbook cases, but if a decision problem is treated as a decision “under risk” (e.g., the probability of rain is 70 percent [according to the weather forecast]; shall I take an umbrella to work?), this does not mean, as Hansson (2011) clarifies, that “the decision in question is made under conditions of completely known probabilities. Rather, it means that a choice has been made to simplify the description of this decision problem by treating it as a case of known probabilities. This is often a highly useful idealization in decision theory” yet it is, at the same time, important to distinguish between those probabilities that can be treated as known and those that are genuinely uncertain.
The class of human choices and actions is also too narrow because what some (not all) human actions and choices intractable by probability theory is organized complexity (Weaver, 1948), as we argue below, and organized complexity characterizes many different systems, not only human action.
Proposition 2: Deep uncertainty emerges from highly organized and dynamic complexity.
In a classic and massively referenced article, Weaver (1948) distinguishes three significant ranges of complexity, which considerably differ from each other in the mathematical treatment they require. He offers a classification that separates simple, few-variable problems (or a small number of significant factors) of ‘organized simplicity’ at the one end from the ‘disorganized complexity’ of numerous-variable problems at the other, where the variables exhibit a high level of random behavior. This leaves ‘organized complexity’ sitting between the two extremes. The importance of this middle region does, however, not depend primarily on the fact that the number of variables involved is moderate—large compared to two, but small compared to the number of atoms in a pinch of salt. The hallmark of problems of organized and dynamic complexity lies in the fact that these problems, as contrasted with the disorganized situations where statistical or probabilistic methods hold the key, show the essential feature of organization (Weaver, 1948, p. 539). This in turn involves dealing simultaneously with a sizable number of factors which are interrelated to form an organic whole. Interactions and the resulting interdependence lead to emergence, i.e., to the spontaneous appearance of features that cannot be traced to the character of the individual system parts (Anderson, 1972), and, therefore, cannot be fully captured in probability statistics nor sufficiently reduced to a simple formula. Something more is needed than mathematical analysis or the mathematics of averages (Weaver, 1948, p. 540; Huberman and Hogg, 1986, p. 376).
Weaver (1948, p. 539) lists examples of problems of organized complexity where in each case a substantial number of relevant variables is involved that are varying simultaneously, and in subtly interconnected ways. In particular, the economic, but not only the realm of human action, is viewed as being within the realm of organized complexity (Klir, 1991, p. 119). Table 1 resumes the relationship between Weaver’s notions of complexity and the suitability of stochastic methods in terms of the respective status of probabilistic statements. It paves the way for bringing risk and its non-probabilistic form (deep uncertainty) as well as complexity, the latter as an answer to research gap II, together in one single scheme.
Table 2: A suggested taxonomy of uncertainties and complexities based on Weaver (1948).
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Figure 2: The disassembly of complexity: The unifying framework.
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We share the same ground with Mises (1949) and Knight (1921) when we are very wary about the predominance of probability statistics in the realm of economics and finance which is more characterized by case probability, that we presented as a merely comparative notion (Proposition 1), than by class probability. However, many outcomes of this study are not in accordance with the praxeological approach. In light of the two research gaps we singled out, we would like to highlight two instances:
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“Risk” should be grasped as Risk I, not Risk II.
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Not human vs. non-human action (or, phrased positively, human action vs. natural sciences, cf. Mises 1949: 107) decides on the applicability of probability theory, but a system’s degree of organized complexity where deep uncertainty arises from (Proposition 2).
If this study stimulates further controversy of how to conceive risk and identify the limitations of probability theory, as such debate is considered very important for the development of the risk fields (Aven, 2012, p. 34), it will already have served a useful purpose.
JEFF DEIST: You were born in Romania. Were you born in the countryside or in Bucharest?
CARMEN ELENA DOROBĂŢ: I was born in a very small town in the eastern part of Romania close to the Republic of Moldova, Ukraine, and Russia. That part of Romania, it’s pretty small, I think about 50,000 people. It is just your regular small town. Growing up, everyone knew my family, we knew everyone. I moved to Bucharest when I went to college, when I was 18.
JD: You’re too young to remember much of the Soviet era in Romania or the Ceaușescu regime, but tell us what you do remember.
CD: I was only a year-and-a-half old when the end of communism came. Personally, I don’t remember much, but my dad has talked to me a lot about this because he did grow up in the communist period. He was born in 1955 so he was 33 or 34 when the regime collapsed in December of 1989.
He remembers staring at the TV and having this feeling of disbelief as to whether it was actually happening or not. He’s tried to explain to me why he couldn’t believe it. He used to tell me, “I thought I would be happy and I should’ve been happy, but I was so scared that I just couldn’t allow myself to be happy.” For him, it felt like something was going to go really wrong and this dream of being able to get rid of communism was going be taken away from them. So, he didn’t allow himself to really think things had ended until a few weeks later when Ceaușescu was executed. So, as far as how it was before, he used to tell me about the poverty that was so widespread. It was two hours of electricity every day in the 80s, and a maximum two hours of hot water.
Everything was rationed: bread, oil, meat, eggs. If you wanted to get gas you needed to go at specific times. If you couldn’t because of your work, your neighbor would take the car. You would drive the car and put it in the queue and then you’d leave a neighbor with his car and your car and he kept moving both of them up the line. I heard all sorts of stories like that growing up and it has definitely made an impact.
My dad was so strict about that sort of thing that he didn’t even allow me to learn Russian at some point when I wanted to. For no other than purely aesthetic reasons. I thought Russian was really nice and I liked Dostoyevsky, but my dad was completely against anything that had to do with the East. So yes, a big part of my childhood was influenced by stories from him.
JD: Would you say your father was strongly anti-communist or was he anti-Russian?
CD: No, no, he was strongly anti-communist. He had a problem with the regime. The Russia connection was just because that’s how communism came, more or less, to Romania. He was forced to learn Russian as a pupil, so that was an issue, but, no, he was strongly anti-communist.He had wanted to study philosophy but then discovered that he would only be allowed to study a particular type of philosophy, which was just Lenin at that time.
He wanted to flee the country when he was 19, thinking he could go abroad and study there.But then a friend of his did that, and his parents ended up in serious trouble with the security services, and almost went to jail because the state considered them as accomplices with their son having fled. So my dad abandoned the plan and remained quietly anti-regime for the rest of the time until ’89.
JD: Studying Lenin’s philosophy sounds pretty bleak to me ... can you imagine?
CD: Yes, that was the case for my father, as he had other plans in mind. He would have been very happy to study literature as well but that was significantly curated as to what you were allowed to read and what you were allowed to study, as well. Again, it was a lot of Russian authors, specifically regime-approved Russian authors, and so on. He eventually went into civil engineering so did something non-ideological in the world.
JD: Americans and a lot of westerners don’t realize there were severe hardships and rationing in Romania during the 1980s.
CD: No — and this is quite interesting — the 60s and 70s weren’t as bad as the 80s, because of problems of capital consumption. In the interwar period Bucharest used to be known as ‘little Paris’. We had the monarchy during that time. We never had anything you could compare to a free market, but the market could breathe a little in those days, and the economy really developed until the war. Then, when the communists came after the Second World War they consumed that accumulated capital for 15 to 20 years until the 80s when the effects of the era of central planning became visible. And by then you had no more capital to consume. You’ve burned all your house’s furniture by the 1980s, and it became even worse than it had been before.
JD: Growing up, what was your perception of other places in the old Eastern Bloc?
CD: I remember thinking of Poland as a much different place from Romania in that period. Poland went through the same process as Romania at about the same time. I remember — it’s just bits and pieces that I’ve basically put together after growing up — at the time even my dad was thinking that Poland was too radical in the way the Poles were privatizing pretty much everything. In Romania there were all these slogans in the early 90s about not ‘selling your country’ and not allowing the foreign companies to come in. That feeling stayed, and it was Poland that seemed to be an extremely radical place that was talked about a lot in the early 90s.
JD: Tell us about your mother.
CD: My mom was not overtly political in how she expressed her opinions. She just kept to herself on these sorts of issues. She’s an engineer as well and she did fashion design as a passion afterward, she combined the two.
JD: But you mentioned earlier how much your dad’s experiences affected you. You grew up in a household that had been under the thumb of Ceaușescu, even as a girl you developed a sense of the political situation in Romania.
CD: When I was five or six, I discovered in a drawer a stash of dollars or some other foreign currency, and asked my dad what it was. I remember him telling me that we shouldn’t tell people that we had it because you were not allowed to hold foreign currency before 1989. There are all sorts of these odd things that didn’t fit with the time that I was growing up in.
For example, there was this idea that you don’t talk to your neighbors or don’t share with your neighbors. Romanians really suffered from this point of view. In the communist period, you never knew who was going to go and tattletale at the security services. A lot of times it used to be the neighbors or the people you would take into your confidence, so generally people were very reluctant to do that unless they knew someone for a very long time.
And then there was the way people behaved around buying consumer goods or spending on things. Among many Romanians, there’s a certain thriftiness, the idea that you don’t throw anything away, and it was all because of the hardships they had gone through when they couldn’t find anything on the shelves. I remember my grandmother couldn’t understand that you would just throw away a shirt that’s been torn, that you wouldn’t bother repairing it. I kept saying “well, it’s actually cheaper to go and buy a new one,” and she wasn’t able to understand how that was possible. Those kind of things stay with you and you develop in that way.
JD: So how did you find your way from a small town in the eastern part of Romania to university in Bucharest?
CD: Well, my mom wanted me to study economics. She thought it was a very lucrative thing and she wanted me to work in a bank!
JD: Lucrative?
CD: Yes, she said go be an economist, so you can work in a bank. That was her impression,and my mom is not the kind of person you say “no” to. So, my only condition was that I would go far, far away to study so I picked Bucharest. I got into the Bucharest Academy of Economic Studies. It’s a free-standing university, focusing on economics, business administration, and management. I started in 2007 and after two years I really regretted I had taken my mom’s suggestion, because I didn’t enjoy the material. I was always more inclined toward literature and foreign languages, reading and writing. I would get the mechanics of economics, I just never got any passion for it or any desire to learn more. And it’s worth mentioning that I think for the first two years I didn’t read anything other than textbooks and pages and pages of textbook exercises. I think it was my second year when I started gaining a little bit of independence and I thought, “I’m just going to finish this year, I’m going to put it on hold and just go do something that I want at least for one year. And then if it turns out this is how university is and I don’t like college in general, then I’ll go back and finish this and keep mom happy. Or maybe I find my vocation.” In doing that, I randomly signed up for an optional course in my second year, which sounded interesting. It was on comparative economic policies: capitalism, socialism, interventionism.Now in hindsight that should’ve been a dead giveaway, but you have to remember I had not heard much about these things at all up to that point. The class, it turned out, was given by Vladimir Topan, who’s now the president of the Ludwig von Mises Institute — Romania. I remember him walking into class, introducing himself, and the very next question was, “Have you ever heard of Ludwig von Mises?” and him writing Mises’s birth and death dates “1881–1973” on the blackboard. And then he started giving us things to read. The first was Mises’s lectures from Argentina. There are a couple of chapters there on inflation and interventionism. And then he assigned Murray Rothbard’s What Has Government Done to Our Money? It was the first time reading Mises’s lecture on inflation, after two years of economics that I actually understood what inflation was. It just made sense, and Vlad is an excellent teacher. He was willing to spend the extra half an hour chatting with me after class, because I started having questions and it just became so interesting. Then I thought, well, I’m going to finish the third year. At that point Vlad supervised my bachelor’s thesis, which was on international trade and it snowballed from there.
JD: Amazing — there you were in a former Eastern bloc country learning about Mises from your professor, when so many western students never hear his name.
CD: Vlad had a pretty similar experience himself with one of his professors, Dan Cristian Comănescu. Comănescu started the Ludwig von Mises Institute in Romania, and he translated Mises’s Human Action into Romanian. He traveled to the US and met Bettina Bien Greaves, Mises’s longtime assistant and bibliographer, and it was Comănescu who started it all. As far as I remember from his stories, he accidentally came across a copy of Rothbard’s Ethics of Liberty in French. It was a string of happy coincidences that ended up with me taking Vlad’s class.
It was a very small group of libertarians. It’s been growing tremendously in the past few years, but back when Vlad was a student, I think it was maybe a handful of them and then back when I was a student maybe we were 20, 30 people. Now it’s become a lot more popular.
JD: Isn’t that funny — we like to think of ourselves as captains of our lives, yet so often luck or coincidence leads us to discover something important.
CD: Yes, it was a complete accident. In fact, the first department at the university that I applied for had something to do with business administration, or something like that, and I didn’t get in. I got into this one where Vlad was teaching. So, it was all completely coincidental, but, in a way, it was meant to be.
JD: And this sparked enough of an interest you decided to get a doctorate?
CD: I remember Vlad seeing the first few drafts of my bachelor’s thesis, and saying “well there’s potential here. You can develop this further,” and I felt very happy and very proud. So it stuck with me. We together picked a very good topic — international trade — and it was something that I really liked and it was something that I could carry through. I did the same thing during my master’s program. And then I met Guido Hülsmann when I was a Research Fellow at the Mises Institute in 2011 and I thought it was just too good an opportunity to miss. I wanted to do a PhD anyway but then there was a glimmer of hope that I could do the PhD with Guido, so I thought “okay I’m going to do this for sure.”
JD: This is also when you met your husband Matthew McCaffrey?
CD: Matt was the first person I talked to when I got to the US. He just happened to drive into the Institute as the shuttle from Atlanta dropped me off and I was so lost, and he helped me get the key to the apartment and so on.
JD: Yes, very serendipitous.
CD: I know, I know he was apparently very helpful. He’s like “oh very nice to meet you.” Later on I found out his ulterior motive.
JD: So, you met Dr. Hülsmann during that same summer and ultimately decided to get a PhD from the University of Angers in France?
CD: Yes. I approached Guido with a paper I was writing that summer and he read it and he said, “It’s terrible, you need to start over!” and I thought, “This is gonna be a really good experience!” You know, he was still happy to help me apply and he said, “I mean it’s terrible but there’s potential, so we can work together.” He was extremely helpful, and I started my PhD in 2012.
JD: And ultimately your PhD thesis was about trade and the Cantillon effect.
CD: Yes, it was on Cantillon effects in international trade. This came primarily from Dr. Hülsmann because he’s an extremely good PhD advisor. He’s good at figuring out where your research should go, both from the point of view of what you can do, and what it’s interesting to actually study, where there are gaps in the literature. He is also aware of what makes sense from the point of view of a career. He very quickly dissuaded me from going into pure international trade theory, the barter-like models. I was interested in studying those because those were the ones that I was familiar with. But he said I needed to focus on monetary theory because there was the biggest gap. So then we looked at the effects of monetary policy, and expansion of money supply on international trade.
JD: You researched and wrote your dissertation squarely in the aftermath of the financial crash of 2008.
CD: Yes, the ’08, ’09 crash happened when I was in my second undergraduate year. It happened when I met Vlad, and it was all that we talked about through our masters program. Sometimes I still refer to it as the “recent financial crisis,” to my students and then I realize that they were eight when it happened!
JD: Given now almost a decade of hindsight, do you think the Cantillon effect explains why so much of the newly created central bank money flowed unevenly into equities and certain housing markets instead of CPI?
CD: Yes, exactly. That’s the whole point. We talk about it as the Cantillon effects and so on because that’s how they were later coined, but Mises actually never referred to it as the Cantillon effect. He, whenever he talks about these aspects, just says this is the way money behaves. Mises’s explanation is that the money supply doesn’t exist outside of people’s cash balances, so when you increase the money supply the only way you can do it is by increasing people’s cash balances. And you cannot increase all cash balances at the same time and to the same extent.
JD: Mises argued money can never be neutral.
CD: Yes, exactly. Whenever the central bank increases the money supply through whatever complicated operations it uses, the money will go into some balances and then it will trickle down. And, by the time it’s seen in the CPI it’s already displaced wealth from the last receivers toward the first receivers. It’s already completed some of the effects in that sense. And, evidently this doesn’t happen only within national borders because we have very connected capital markets and financial markets and now it crosses national borders as well.
JD: Before we wrap up discussing your PhD at Angers, there’s a debate among Austrian academics. Some say PhD students should attend the highest rated program that accepts them, and some say it’s better to study under an Austrian or free-market mentor like Hülsmann.
CD: Well for me, to put it simply, the University of Angers was the best university that at the time I could get into, so I wasn’t really faced with that dilemma in a sense. I do understand that sometimes people may think it’s a lot more difficult to cut it in the mainstream if you don’t go to a top mainstream university. If you can do a PhD program in a mainstream university and do have a fairly supportive committee — that won’t block your thesis simply because they maybe disagree with you on some issues — then there’s no point in not doing it. It will definitely make it far easier for you to teach at a good place where you may find students that you can influence. So there’s nothing wrong with doing that.
At the same time, if your passion lies more toward developing something in detail within Austrian economics, it may be better to work with someone like Dr. Hülsmann. But be aware that Dr. Hülsmann’s program is still an old-style PhD program in which you write hundreds of pages — basically a book. In the US, on the other hand, it’ll be only three papers that need to be published. So it depends where you want to invest your effort. I guess it just depends on the person. There is nothing wrong with getting a PhD at an extremely highly ranked program. I think that’s usually what the debate is about. Mises got a perfectly mainstream PhD, so if you can do it why not?
JD: Do you think we ought to encourage young PhDs to care more about about teaching and mentoring? There’s too much emphasis on publishing. Let’s win over some young minds in the classroom.
CD: From what I know from the US, and from the experiences of people that I know who teach in the US, there is indeed a really big push on publishing and it’s happening in Europe for sure as well. In Europe it’s a little bit counter-balanced by the push from the administrative side. There’s so much bureaucracy here in higher education that you basically need to carve out time for research out of all the administrative duties that you have. But in both cases teaching is definitely at the bottom of the scale in terms of a lecturer’s or an assistant professor’s priorities and it’s really disheartening because it’s a very selfish way of doing things. It’s all about your career and publishing, but then you know you never get to influence anyone else. I do worry, as does Matt sometimes, that he and I will never get to do for someone else what Vlad did for me, for instance. Or what Mises did for Rothbard and so on. I think teaching should come first and I think research supports good teaching. That’s how we should go about it. You do research so you can be a better teacher, so you’re at the top of your game, and you constantly teach your students from what you know.
JD: Would you say the relentless focus on publishing academic papers is less intense in Europe? Because in the US publishing is the key to one’s academic career, not teaching.
CD: Well, it always depends. It depends on the university here evidently. If it’s a highly ranked university with a rich research culture, there will definitely be that push. Smaller universities are trying to gain a little bit of a competitive advantage by having excellence in teaching. There’s the research-excellence framework that universities compete to be extremely well ranked within, but there’s also the teaching-excellence framework that they’re trying to compete in.
But on the other hand there is no actual tenure here. After a while, of course, if you become associate professor or professor, it’s sort of implied. Your contract is designed so the likelihood of getting fired is a lot lower than before. However, it’s more for promotion than creating a situation in which you have a safe job for the rest of your life. I personally don’t feel the pressure as much as I think colleagues of mine of my age at universities in the US feel.
JD: Tell us about your students in the UK, give us a sense of their mindset.
CD: Well this is a small Catholic university so the students that come here are fairly local. They’re very interested, especially since this is a business school, in getting skills that they can use in employment. A lot of them are not interested in pursuing a master’s program or any-thing of the sort. They just want to get a degree because they heard that they can get a better job at the end. So in a way it’s very good for teaching because the students put a lot of emphasis on their need for the program to be extremely relevant to what they want to do. They want it to be oriented toward making students employable.
JD: Does that mean they’re serious and not spoiled?
CD: Yes, in a sense. Sometimes it’s not about being spoiled, though. I think they’re unprepared. The faults in primary, secondary, and high-school education are evident, you know, and when they come and don’t have the practice of reading or writing effectively, they don’t know how to reference things they’ve read. But the ones that are motivated, they are motivated from some very good reasons that feeds back well into what we do. For instance, they will not be interested in high-level research, especially not at this university. I could go in front of my students and tell them how well published I am, and they wouldn’t care about it. My colleagues who have worked for Pepsi or Proctor & Gamble — they’re much more successful than I am in the students’ eyes, because those professors are practitioners. They’re former practitioners who moved into higher education, who can actually deliver something really practical for them. That’s what they like. In a way it’s healthier, I think the connection is a little bit healthier, the feedback is, you know, more important for the students and it keeps our teaching on a better line than otherwise.
JD: Do they seem susceptible to socialist nonsense?
CD: I think they come ingrained with it. In principles of micro and macro classes, you can ask, “Are balance-of-payments deficits good or bad?” The students say they’re bad. You know they heard that somewhere. This is the first time they have ever come to class and they already think they know that these deficits are bad. What about minimum wage? They say automatically, “That’s good, minimum wages are good.” You know that’s the kind of thing that they come into class with, but I think that’s the same everywhere.
I remember talking to Vlad and he was saying that sometimes students can go through your whole class — and they’re good students and they understand what you tell them and you explain why a balance of payments deficit is not a bad thing and so on — they’re able to repeat that back to you. But if you ask the question in a different way, they’ll still give you the same answer they gave you at the beginning of the semester. They’ll say, “Well, actually maybe we should still encourage exports rather than imports.” Although the deficit is not a problem they still think exports must be better than imports. They’ve heard that one thing so many times it just becomes a form of common sense to them.
JD: Do you think you’re making progress with these young people?
CD: It depends on the day when you ask me. It can depend on the size of the class too. I do have some classes, some small seminars or some MBA classes with eight, ten, or fourteen in class. With them I can go into a lot more depth and we do have a little bit more time to talk. Then I do feel like sometimes I’ll get the oohs and ahhs and students saying, “Oh, I never thought about it that way.” So then I feel happy. The bigger the class, the harder it is sometimes to get through to them and even though you tell them those same things they can just block you very easily. In an ideal world, you would be only teaching Oxford-style tutorials. It would be you and four students — the way I used to learn from Vlad pretty much, in seminars at the Mises Institute Romania. It was six or seven of us around a table just dissecting Mises’s Theory of Money and Credit. I can’t really do that with 100 students in a room.
JD: But don’t we have an obligation to meet these kids where they are and do what we can — even if that means reaching the best and brightest and encouraging them?
CD: Sure, that’s why we go back to work every day and not give up. I’m not toning down anything that I say, and I keep putting all the resources out there even though I know that 99% of them won’t read them. But maybe every once in a while a student will engage with the material and appreciate it. But a lot of what you say will fall on deaf ears and, well, at least you’ve done your job. Sometimes it’s how you present it too — sometimes I do try to meet them halfway and maybe I won’t get them fully convinced. Maybe they’ll still say minimum wage laws should be pursued, but at least they understand that they create unemployment among the young. They’ll say, “It does create unemployment, however, we should still implement it for some other reasons.” That’s okay, as long as I got through the first part to them. At least they’re aware of it.
JD: Let’s talk more about Mises, whom you’ve studied quite seriously. You wrote an introduction to a series of nine lectures Mises delivered in 1951, and as you point out he was already nearly 70 yet still producing amazing work. In that introduction you distill those lectures into three big buckets, namely method, calculation, and money. Elaborate for us.
CD: Mises’s career started by working on monetary theory. But very soon you start to see that he realized of what central importance money is in general. It’s not just a separate issue in economics. It’s at the heart of all economic analysis, and he realized that by looking at the importance of the calculation debate that there is no such thing as a barter economy lying underneath monetary values.
You need money to calculate profit and loss in an economy that goes beyond that of a small household, so you need money prices in order to have a fully developed economy. Once money surfaces as a general medium of exchange, those barter exchange ratios disappear. Prices do not exist without exchange. If we don’t use barter anymore, there aren’t any more barter prices to analyze or contemplate. Similarly, money prices cannot exist in the absence of free voluntary monetary exchanges in the market. And if you need money prices then automatically you know central planning is impossible.
Mises started on a very practical line in this sense. He used monetary theory, figuring out some issues, criticizing some older theories, disagreeing with classical economists, filling in small gaps. I think as his career progressed, after he moved to the US, after Human Action, he starts to publish a lot more on epistemology and praxeology and so on because he started to ask: why are people not talking about money the way Austrian economists are talking about money? Why is money put in a separate box in the rest of economic science, especially in mainstream economics? He realized it’s a problem of method.
It’s the way we conceptualize economics, the way we make abstractions, the way we think about human beings as homo economicus, or rather from a praxeological point of view.
So, it’s not three separate things he focused on, it’s just three lines of inquiry that he went through in turn in his scholarly research. Monetary theory on one hand, calculation — applying all the insights for monetary theory and explaining how markets work — and then this meta-level analysis of the epistemological problems of economics.
JD: Guido Hülsmann thinks The Theory of Money and Credit is in some sense a bigger achievement than Human Action, given Mises’s relative youth when it was published.
CD: Yes. I’ve heard Guido express that view. I think it’s worth asking him again because I didn’t get a chance to ask him exactly what he means. In a sense The Theory of Money and Credit is a lot more focused. I can see where Guido’s coming from, if I remember other similar discussions I’ve had with him. The theory of money is at the heart of economic theory in a sense, so perhaps — not to put words in his mouth — Guido’s trying to hint at the fact that focusing on monetary theory just automatically illuminates other discussions. Mises didn’t necessarily have to do those discussions in Human Action, where he basically takes these insights and develops them further into other areas. So maybe Mises spreads himself a little thinly by tackling so many issues in Human Action. Maybe that’s what Guido’s trying to say? But I do disagree. Human Action is a tremendous piece of work because it stretches across such a vast area. It’s the entire theory of economic science, and while The Theory of Money and Credit is really great, I do think that the older Mises is actually better.
JD: And as you point out he’s so comfortable writing across disciplines like philosophy and history, so comfortable discussing a wide range of scholars. Nobody writes overarching treatises today. Academics have become hyperspecialized.
CD: Yes, it comes back to what we were saying about the PhDs. In the West, they push you for hyperspecialized areas of expertise before you’ve even gotten your PhD.
That’s certainly not what Mises did. Mises studied Latin and rhetoric and ancient Greek when he was in secondary school. Then his PhD thesis and his habilitation thesis were real proper books, proper research projects. The reason Guido wants you to write 200 to 300 pages for your dissertation — and not just three papers, “on so and so” — is because with a true book-length project, one can go beyond just a single narrow topic.
Mises does this in Human Action too and what’s even more striking is he assumes readers can follow him, so he won’t put footnotes or explanatory notes or anything of the sort. He’ll leave quotes in Latin untranslated, assuming everyone knows Latin. Or he’ll use a phrase saying “it is very well known that Fisher’s quantity theory of money is wrong.” In today’s world you would expect a list of five citations following that kind of statement. But Mises just says it’s well known and assumes he won’t be challenged on it. Everyone knows!
JD: Imagine a brilliant 28 year-old PhD working at the Fed today, with an Ivy League pedigree but knowing nothing about classical languages or world history or philosophy. They’re not an educated person in the Misesian sense.
CD: No, and I think it goes further beyond that. I remember back when I was a Mises Research Fellow, some students who were doing a PhD or a masters at the time were telling me that they had colleagues in their class who were extremely good at mathematics used in economics. But at the same time, those students didn’t really know who Adam Smith or David Ricardo or David Hume were. And there are plenty of economics graduate students today who barely know who Irving Fisher was.
And this is a very common thing, which is why when I was trying to put together a program in economics here I had to fight to put in a couple of classes on the history of economic thought. The administration told me it’s not a priority because it’s not important according to the new academic standards. It’s not included here in the standards, and it was implied that what we really need is more basic math because that’s in the standards. It’s very sad.
JD: It’s just not taught anymore.
CD: No, it’s considered old, just history, and in economics what’s newer is better, allegedly. Why do we need to know that old stuff?
JD: In your intro to Mises’s nine lectures you had a sentence which really sums up Mises on money:
The determination of the purchasing power of money is accomplished as part of the same market process that creates the structure of money prices and brings about the division of labor, thus making clear that monetary analysis must be an integral element of economic analysis.
CD: Mises explicitly denies that there’s a significant distinction between the short run and long run. The long run is just a composite of short runs. There’s no such thing as the economy in the short run and the economy in the long run. There’s no such thing as the economy in the micro elements and the economy in the macro elements as two separate things. That’s what Rothbard remembers primarily learning from Mises — that the economy is a coherent whole, it’s one big structure. You can’t study a part of it without other parts and you can’t talk about prices unless you talk about money prices. This was Mises’s whole point. Once you have, from direct exchange, a commonly accepted medium of exchange such as money, the barter prices that economists talk about don’t exist anymore. They’re just gone. They’re not hidden somewhere. They’re gone because in order for a price to exist, a transaction needs to happen and there are no barter transactions anymore. There are just monetary transactions. So the only thing that actually exists are money prices and it’s fascinating that economists will talk about the economy, still pretending there’s such a thing as a barter economy with relative barter ratios. It’s easier and a lot more mathematically elegant to do it with barter. That’s why they do it. It’s a lot messier if you try to put money in.
JD: A closing question about the term “Austrian economics,” the same question we asked of Joe Salerno. Is it a loose term of convenience to describe a body of thought with roots in Vienna, or is it a well-defined school based on praxeology and drawing inferences from premises? Is method what really distinguishes an Austrian from a general free-market economist? Is it useful or cumbersome to label yourself an Austrian economist?
CD: It hasn’t really bothered me at all and I am aware of the debate. I do find it funny sometimes that people like to make sure that whatever they’re calling themselves or whatever label they put on themselves is a quite accurate label. Mises never referred to it necessarily as Austrian economics other than in the historical sense. But in general every time Mises writes, he just says “economics” or “economist” and that’s pretty much how I’ve always referred to myself. I don’t think I’ve ever used for myself the term Austrian economist. I’ve just called myself an economist because if you do accept that whatever Mises or the Austrian economists or the Austrian school teaches you is actual truth, then it’s just economics.
If what Mises writes in Human Action on the praxeological approach is the true approach, is the right approach, then there’s no point in calling yourself something other than an economist. Maybe the mainstream economists should call themselves something different! I never felt the need to distinguish myself in that way, because I’ve always thought the whole point is to reveal the truth of economic science, the way Dr. Salerno talks about economics as a vocation or as a profession. If you understand it as a vocation, it’s all about figuring out the truth in the science of economics and then you’re an economist and that’s it. That’s what Mises was and that’s what Rothbard was.
Research Handbook on Austrian Law and EconomicsTodd J. Zywicki and Peter J. Boettke, eds.Northampton, Mass.: Edward Elgar, 2017, 440 pp.
Alexandre Padilla (padilale@msudenver.edu) is an Associate Professor of Economics at Metropolitan State University of Denver. Quarterly Journal of Austrian Economics 21, no. 2 (Summer 2018) full issue, click here. Few scholars disagree that Austrian economists and their fellow travelers have made significant contributions to law and economics. Anyone familiar with the works of Carl Menger, Friedrich Hayek, Ludwig von Mises, Murray Rothbard, and Israel Kirzner recognizes their undeniable additions to law and economics, particularly in analyzing institutions, monopoly and antitrust laws, and regulations and their (unintended) consequences. The contributions in the Research Handbook on Austrian Law and Economics build on and expand the work of these great Austrian economists by applying what editors Todd Zywicki and Peter Boettke (2017, p. 21) call the “propositions that are the defining substantive position of the contemporary Austrian school of economics” to a large variety of areas in law and economics. Such areas include property rights and conflict resolution in the absence of formal rules (Krause), criminal constitutions (Skarbek), the efficiency of the common law (Zywicki and Stringham), family law (Horwitz), and rule reform (Coyne).
Because many of these contributions build on the work of the great Austrian economists, they share common themes that are not necessarily emphasized in mainstream law and economics:
1) The institutions that define the rules of the game, particularly property rights, matter. They “have been devised by human beings to create order and reduce uncertainty in exchange” (North 1991, p. 97).
2) Competition is not a state of affairs but a market “process of entrepreneurial discovery” (Zywicki and Boettke, 2017, p. 21).
3) Utility and costs are subjective.
4) Individuals, including those working in government and the courts, face a knowledge problem and operate under uncertainty.
5) Formal institutions are not necessarily superior or better-performing than informal institutions if those formal institutions are not being recognized as beneficial by the members of the group or society operating under those (competing) institutions.
The third and fourth themes are important because they lead Austrian economists to conclude that government usually cannot do a better job than markets. The fifth theme lies at the core of chapter 2, “Property Rights, the Coase Theorem and Informality” (Krause, 2017), and chapter 8, “Self-Governance, Property Rights, and Illicit Commerce” (Skarbek, 2017). Krause (2017, p. 31) shows that people living in slums in poor and developing countries, despite lacking a formal definition of private property rights or a formal justice system, have recourse to voluntary solutions as well as informal mediation services to resolve disputes between neighbors. He provides several examples showing that people have incentives to negotiate an outcome that benefits both parties, as predicted by Coase (1960), even when property rights are not formally defined. Even when there is a formal justice system, Krause (2017, p. 35) shows that, in the case of Peru, the overburdened administrative authorities eventually accepted the decisions of the informal organizations in the slums.
Krause (2017, p. 31) also draws another lesson from these natural experiments: “informal solutions of disputes among neighbours follow a ‘rights’ approach and do not intentionally look for efficiency, although this may be an unintended or secondary result of allocating rights.” According to Krause (2017, p. 39), “this speaks against a cost/benefit analysis on such decisions since making the allocation of property rights dependent on a judge’s evaluation of a net result would bring instability back.”1 Krause’s discussion of dispute resolutions in slums represents another piece of empirical evidence supporting the idea that people have incentives to voluntarily resolve their disputes outside the government authority. His work also complements Williamson and Kerekes (2011), who, among others, show that formal institutions are not necessarily superior to informal institutions when it comes to securing property.
Skarbek (2017, p. 178) “challenges the legal centrism hypothesis by examining the internal governance institutions of prison gangs, arguing that order and property rights can emerge without the state” or, more accurately, despite the state. His chapter discusses how one of the largest prison gangs in Northern California, Nuestra Familia (NF), which operates outside the law both in and out of prison, has developed “effective self-enforcement internal governance mechanisms to limit opportunistic and shirking behavior” (Skarbek, 2017, p. 178). As Skarbek discusses (2017, p. 181), NF recruits members primarily in prison, and one of its main revenue sources is drug trafficking behind bars. Skarbek’s analysis of the internal organization of NF is consistent with the idea that prison gangs operate like a profit-maximizing enterprise that seeks to reduce shirking, opportunism, and turnover when it comes to retaining its best employees.
NF recruits its members and associates by offering them protection against predatory inmates and rival gang members. In exchange, recruits swear lifetime allegiance to the Familia and work for the Familia while in prison and after release (Skarbek, 2017, p. 183). In addition, NF has rules that its members and associates must follow and punishments for breaking those rules. NF has also established rules that govern interactions outside the gang. Those rules are just as important as the rules governing interactions within the gang, because intergang violence diverts resources away from NF’s main source of profit: drug trafficking. All these rules have been codified in a written constitution that, similarly to what corporate culture does, sets workable principles and routines that create shared expectations for group members (Kreps, 1996).
Much of Skarbek’s work on the prison gangs’ internal organization echoes Peter Leeson’s work on the internal governance institutions of pirate ships (Leeson, 2009). Whether pirate ships or prison gangs, it is in the interest of these criminal organizations to develop self-governance mechanisms to mitigate moral hazard and adverse selection so as to maximize their profits. They cannot use the government to enforce contracts or to arbitrate conflicts.
These two chapters by Martin Krause and David Skarbek undoubtedly represent important contributions to the law and economics literature, particularly as it relates to the development of self-governance institutions to coordinate human interactions in the absence of government or, in the case of criminal organizations, in spite of government. However, it is unclear what makes these two contributions uniquely Austrian. Challenging the legal centrist assumption that without government, there are no property rights, does not make one’s contribution uniquely Austrian.
When it comes to the economic analysis of the law and particularly property rights, Austrian economists have long disagreed with mainstream scholars on efficiency. Building on the Austrian literature, Zywicki and Stringham (2017, p. 193), in their chapter “Austrian Law and Economics and Efficiency in the Common Law,” are highly critical of Posner and his followers who argue that “the common law is efficient (Kaldor-Hicks efficient) because judges view wealth maximization as a normative ideal.” Zywicki and Stringham (2017, p. 195) acknowledge not all mainstream economists agree that the common law maximizes wealth. The problem is these economists who argue in favor of changes to make the common law more efficient ignore that judges suffer from the same problems that public choice scholars identify with legislatures: interest-group pressures, rent-seeking, and rent-dissipating (Zywicki and Stringham, 2017, p. 196).
Since costs and benefits are subjective, judges cannot predict how specific decisions will affect litigants’ willingness to pay. Willingness to pay might make sense in markets where willingness to pay changes as market conditions change, but within the context of the courtroom, judges face the same challenge as those “of a Soviet-style economic central planner” (Zywicki and Stringham, 2017, p. 197). In light of this conclusion, Zywicki and Stringham (2017, p. 198) argue that “the primary purpose of the law is not to try to impose rules that bring about the wealth maximizing ‘outcome,’ but instead to provide a stable institutional framework that will enable individuals to plan and coordinate their affairs in a world of constant dynamism.” If the rules that individuals operate within are constantly changing, it will indeed be much more difficult for individuals to coordinate their plans, and we should expect much more judicial intervention. Higgs’s (1997, 2012) concept of “regime uncertainty” defined as “a pervasive lack of confidence among investors in their ability to foresee the extent to which future government actions will alter their private-property rights” illustrates the point made by Zywicki and Stringham when applied to explain why the Great Depression lasted so long.2
Zywicki and Stringham (2017, p. 198) also believe, like other Austrians such as Block, Kirzner, and Rothbard, that the law should be evaluated “using extra-economic means,” that is, “society-wide shared ethical perspectives” (Kirzner, 2000, p. 85). They argue that “Austrian economics is a positive discipline that does not say what any given policy or any given law should or should not be” (Zywicki and Stringham, 2017, p. 198). This argument echoes Mises, Kirzner, and Rothbard’s position about economics being “a value-free science” that cannot tell us anything about whether a policy or a law should be passed or repealed. At best, economics might be able to tell us whether some goals are incoherent (Rothbard, 2006, p. 251).
Zywicki and Stringham (2017, p. 202) take their argument further and argue that Hayek ought to be praised for his analysis of the common law. However, his belief that “ultimately judges must be subservient to the legislature which can step in to alter the law when common law reaches a ‘dead end’ through adherence to precedent or when the law develops in ways that are inconsistent with the market economy” runs into the same problems that judges would face if they were to maximize Kaldor-Hicks efficiency when deciding cases (Zywicki and Stringham, 2017, p. 202). Instead of relying on the government to “improve the law,” Zywicki and Stringham (2017, pp. 203–204) argue that we should allow for competition in law in the same way that we allow for competition in the market process, which enables entrepreneurs to discover unexploited profit opportunities to better satisfy consumers.
We can find precedent in the Middles Ages, when litigants sought out private judges for their expertise, judges who competed de facto with each other since part of their pay came from litigants’ filing fees. Competition made judges more efficient in adjucating cases and also resulted in better laws and procedures to meet parties’ needs (Zywicki and Stringham, 2017, p. 204). As the authors remind us, to some extent today, “competition takes place alongside government law, as with modern arbitration, mediation, and other forms of alternative dispute resolution,” which suggests that “consumers” do not necessarily value government law since they use those alternative mechanisms of dispute resolution (Zywicki and Stringham, 2017, p. 205).
There is little doubt that competition as a discovery procedure is a better mechanism than government to sort out the rules and enforcement procedures that people actually value. But before reaching that conclusion, the authors spend two-thirds of the chapter arguing against Kaldor-Hicks efficiency—which no law and economics scholars claim is the panacea—without providing an alternative way to evaluate the law. More importantly, when Zywicki and Stringham (2017, p. 202) say that “the real test of the usefulness of a legal rule is found in the unseen effects of the rule in terms of the number accidents avoided or conflicts averted, not the seen effects of the cases that come before the judge,” they seem unaware that by writing this, they are saying that the law’s role is to minimize the costs associated with accidents or conflicts—which is another way of saying that the law’s role is to maximize wealth.
Similarly, as discussed previously, Zywicki and Stringham’s argument that the law’s role is “to provide a stable institutional framework that will enable individuals to plan and coordinate their affairs in a world of constant dynamism” (2017, p. 198) sounds a lot like the argument that the law’s role is to ensure that people can pursue their activities in an environment that fosters peaceful cooperation as opposed to plundering or, to be more accurate, to foster an environment where people are discouraged from engaging in violent wealth-extraction-type behaviors—and it is the law’s role to do this because it allows people to maximize wealth. This is why theft is illegal: if stealing were allowed, people would spend resources trying to perfect their craft in stealing other people’s property while others would spend resources attempting to protect their property. Tremendous resources would be wasted on activities that do not create wealth.
Nobody denies that we can rely on noneconomic means such as ethical principles to explain why theft should be and is illegal, but certainly efficiency and wealth maximization seem to be useful tools to explain why theft should be and is illegal. It is curious that Austrian scholars who have written on the tragic consequences of alcohol and drug prohibitions would argue that we should either rely on society-wide ethical principles or, better yet, abstain from evaluating any law or policy. It is partly because of those society-wide ethical principles that most drugs remain illegal in the United States despite the obvious inefficiency of the war on drugs and its tragic consequences, intended and unintended. If Austrian scholars want mainstream economists to pay attention to their work, we should avoid telling them that economists should rely on noneconomic means to evaluate a law or a policy, and we definitely should avoid telling them that economists should abstain from evaluating a given law or policy because economics is a positive science.
Steven Horwitz’s (2017) chapter, “Family Law, Uncertainty, and the Coordination of Human Capital,” shows how Austrian economics can contribute to both the economic analysis of the law and to the economic theory of the family. His chapter updates Gary Becker’s model of the family in several ways. First, Horwitz integrates the Austrian theory of capital into his analysis to help explain how “marriage and the family can be understood as structures of human capital formed in the face of uncertainty and intended to create an ongoing enterprise of cooperation to achieve a set of goals at lower costs than feasible alternatives” (Horwitz, 2017, p. 398). To complicate matters, members of the family produce not only for the market to earn income but also for the household when engaging in childcare and other household activities. Therefore, family members have to decide how much “market human capital” and “household human capital” they will respectively invest to make the whole venture successful (Horwitz, 2017, p. 398).
With an Austrian theory of marriage and the family, a law and economics analysis of family law will then investigate to what extent “the law facilitates or complicates the coordination process by which couples form marriages and decide on questions of market and household production” (Horwitz, 2017, p. 399). Horwitz (2017, pp. 407–408), for example, shows how laws that favor granting custody to the mother can alter significantly both parties’ decisions regarding how much to invest in market human capital versus household human capital. This phenomenon also can help us understand part of the gender pay gap, since the mother will be less likely to invest in market human capital and more likely to invest in household human capital if she is more likely to end up with custody of the children.
When it comes to no-fault divorce law, its effects are more ambiguous. On the one hand, no-fault divorce law somewhat increases the uncertainty about how long the marriage will last compared with fault divorce law, thus decreasing incentives for both parties “to invest in the sorts of relationship-specific forms of human capital that are necessary to sustain the marriage and the large family that might result” (Horwitz, 2017, p. 411). On the other hand, “no-fault divorce can be seen as an effective institutional adaptation” to reduce the costs of exiting a bad marriage when one or both parties realize that they are not a good match and the probability of having a successful marriage and family is low (Horwitz, 2017, p. 413). Horwitz’s analysis of family law as it applies to custody and no-fault divorce is further evidence that rules matter when it comes to coordinating human action, whether in a market or a nonmarket environment.
One thing Horwitz does not address (maybe because it is beyond the chapter’s scope) is the impact of low-skilled immigration on women’s incentives to invest in market human capital while still attempting to have a family. There is evidence not only that increased low-skilled immigration allows women to increase their labor supply, but also that increased low-skilled immigration that provides affordable household services leads to increased fertility among college-educated women (Furtado and Hock, 2010; Cortés and Tessada, 2011). Therefore, when it comes to analyzing marriage and the family, such empirical evidence shows that other laws, such as immigration law, can indirectly impact women’s human capital investment decisions.
Christopher Coyne’s (2017) “The Law and Economics of Rule Reform” represents the best chapter in this volume and should be recognized as an important Austrian contribution to which mainstream law and economics scholars should pay attention. In this chapter, Coyne (2017, p. 92) combines the tools of mainstream law and economics with those of Austrian economics to explain why some rule reforms succeed and others fail. His work builds on North’s work on institutions as well as the works of Mises and Hayek and their intellectual heirs analyzing why central planning is bound to fail. As Coyne (2017, p. 92) explains, the goal of rule reform is to make “changes to existing rules in order to achieve a preferable state of affairs from the standpoint of the reformer.” When analyzing rule reform, mainstream law and economics scholars tend to focus on how to generate the proper incentives such that the “relevant players” prefer those new rules to the old ones.
Certainly, incentives are a necessary but not sufficient condition for success in rule reforms. As Coyne (2017, p. 93) points out, a vast empirical literature shows that failures in economic, political, or social rule reforms attempting “to improve the human condition” abound. The major reason for these failures is what Austrian economists call the “knowledge problem,” which “emphasizes that planners lack the context-specific knowledge to effectively achieve their ends through rational planning” (Coyne, 2017, p. 93). As Coyne (2017, p. 93) tells us, “determining the appropriate incentives is a difficult task given that the perceptions of citizens in other societies are grounded in a cultural context that often cannot be understood by outsiders in a manner that can be effectively incorporated into policies.” For Coyne (2017, p. 93), the core of the problem with determining the appropriate incentives so that rule reform will succeed resides in “the distance between the local knowledge and the knowledge possessed by those designing the rules.” The greater the “knowledge distance” between the rule reformers and “the locus of knowledge associated with the problem they seek to address,” the more likely the rule reform is to fail (Coyne, 2017, p. 93).
Similar to how Buchanan argues that Hayek was warning us not only against “rational constructivism” but also against “‘romantic constructivism’ which attempts to design rules while ignoring ‘culturally evolved rules for human behavior that constrain the set of institutional alternatives,’” Coyne warns us against “romantic rule reform” (Coyne, 2017, pp. 103–104). The more disconnected reforms are from “the underlying realities of the society in which they are imposed”—the less rule reform appreciates people’s underlying beliefs and attitudes and the informal rules they operate under—the more likely such intervention will fail, regardless of how well intended the reformers are (Coyne, 2017, pp. 103–104). The overarching implication of Coyne’s work is that rule reformers are significantly constrained in what they can do and, therefore, sometimes the status quo is the least bad option.
Other chapters in the Handbook deserve attention, also. But—though this is not necessarily a bad thing—too many of those chapters read like a literature review of what Austrians have said on a particular law and economics topic rather than novel contributions. As mentioned at the beginning of this review, there is little doubt that Austrian economists have made significant contributions to law and economics, and the Research Handbook on Austrian Law and Economics is additional evidence of that.
When it comes to catching the attention of mainstream scholars, a problem Austrians face is that mainstream law and economics journals, with a few exceptions, tend to publish papers on narrow topics relying on advanced statistical analysis. One problem for mainstream law and economics is that the research question has become subservient to the methodology. Austrians, by contrast, agree that the research question should dictate the methodology used to answer that question; therefore, they are more able to tackle a larger variety of questions using whatever methodology is necessary. Some of the chapters reviewed, particularly Krause, Skarbek, Horwitz, and Coyne, are evidence of how much more versatile Austrians are when it comes to tackling some interesting law and economics questions. Those chapters also answer partially some of the three questions Zywicki and Boettke (2017, p. 426) think “demand our attention in the field of law and economics,” questions about the emergence and evolution of norms and the dichotomy between market and government in creating law.
Finally, it is also this reviewer’s viewpoint that Austrian scholars should not shy away from engaging mainstream law and economics scholars, even using their preferred methodology when appropriate, but also scholars in other fields. Many topics covered in this volume certainly are of interest not only to law and economics scholars, but also to scholars in political science, criminal justice, management, finance, sociology, and other subjects. Austrian economics can shed new light on questions that scholars in those other fields are interested in answering, questions that mainstream law and economics scholars might sometimes refrain from tackling because they cannot be addressed using their preferred methodology.
ABSTRACT: In his recent book, Money, Interest and the Structure of Production (Machaj, 2017), Mateusz Machaj advances two significant criticisms of Mises’s theory of time preference and his pure time preference theory of interest (PTPT). First, he claims that time preference only exists under certain unrealistic conditions, and second, that the PTPT, as presented by Mises, is unable to provide a coherent explanation for the spread between the prices of inputs and output that characterizes production processes in a monetary economy. In this paper I present a brief defense of Mises’s conception of time preference and of his PTPT from both of these criticisms. I argue that, contrary to Machaj’s claims, the existence of time preference does not require any unrealistic assumptions and also provide an analysis of how the PTPT can provide a satisfactory explanation of the monetary surplus that permeates the production structure.
KEYWORDS: time preference, interest, production, Austrian economics JEL CLASSIFICATION: B53, E14, E23, E43 G.P. Manish (gmanish@troy.edu) is associate professor of economics at Troy University. Quarterly Journal of Austrian Economics 21, no. 2 (Summer 2018) full issue, click here. I. INTRODUCTION Mateusz Machaj’s Money, Interest and the Structure of Production (Machaj, 2017) is a welcome addition to the recent groundswell of works on Austrian macroeconomics. In this book Machaj covers a broad range of topics, some of them theoretical, such as the theory of interest, the inter-temporal structure of production, and the relationship between the rate of interest and the length of the production structure, along with others that are more policy-oriented, including an analysis of the cogency and practical relevance of popular macroeconomic concepts such as potential output and full employment, and the implications of the non-neutrality of money for monetary policy. The entire range of topics is covered in a manner that is intellectually courageous, provocative and thought provoking.
In part I of the book, which comprises two chapters on the theory of interest (Machaj, 2017, pp. 3–36) and on the inter-temporal structure of production (Machaj, 2017, pp. 37–86), Machaj advances a number of criticisms of traditional Austrian macroeconomics. In the first chapter, in addition to presenting an original theory of interest, Machaj focuses his critical ire on the theory of time preference as presented by Böhm-Bawerk (Böhm-Bawerk, 1930, pp. 237–281) and Mises (1998 [1949], pp. 476–487), and on the pure time preference theory of interest (PTPT) as advanced by the latter (Mises, 1998 [1949], pp. 521–534).It should be noted that Machaj is not alone in doing so. Prominent recent critics of the theory of time preference and of the PTPT also include Lewin (1997), Hülsmann (2002) and Gunning (2005). And in the second chapter, he presents a detailed and highly critical analysis of a proposition that has long been of great importance to the Austrian of economic growth and business cycles: the inverse relationship between the rate of interest and the length of the structure of production.In doing so Machaj builds on the critical analysis of this proposition advanced by Fillieule (2007) and Hülsmann (2008; 2010).
In this paper I present a brief defense of Mises’s theory of time preference and the PTPT from the criticisms advanced by Machaj. In doing so, I do not explicitly address his criticisms of the relationship between the rate of interest and the length of the structure of production.See Newman (2014) for a recent defense of the traditional Austrian position of this subject. Nevertheless, I do so implicitly, since the PTPT, especially as advanced in its most refined form by Mises, is critical to understanding the nature of this relationship. In fact, it is the PTPT that provides the microeconomic, price theoretic foundation to the traditional Austrian position that these two variables share a negative relationship.This, for example, is the position advanced by Hayek (2008 [1931]), Mises (1998), Rothbard (2009) and Garrison (2001). Thus, it is no surprise that Machaj, having rejected the PTPT, is also highly critical of the traditional Austrian position on the relationship between the rate of interest and the length of the structure of production.
II. MISES AND THE PURE TIME PREFERENCE THEORY OF INTEREST: THE TWO IMPORTANT CRITICISMS OF MACHAJ There are two main charges that Machaj levels against Mises’s pure time preference theory of interest (PTPT). First, he claims that the theory of time preference, including the one advanced by Mises, can only be worked out under certain unrealistic and unrealizable conditions. “With typical time preference theory,” Machaj notes, “one has to assume very sophisticated and quite unrealistic clauses about the other things being held equal […]” (Machaj, 2017, p. 27). Along with the assumption that “people compare two identical goods that are non-perishable and do not change,” he argues that the theory also makes two patently unrealistic assumptions: first, that “the circumstances surrounding them [the people: GPM] also stay the same, except for the passage of time,” and second, that there is “full certainty and predictability of future states of affairs” (Machaj, 2017, p. 27).To support these claims, Machaj, immediately after the passage cited here, provides a reference to a paper by Peter Lewin (Lewin, 1997). In order to avoid any potential misunderstandings, I would like to clarify that the criticisms offered in this paper only address the claims made by Machaj and not those made by Lewin in the paper that is referenced.
Two important implications follow from the unrealistic assumption of perfect certainty. First, time preference can only explain the rate of originary interest, or the rate of interest as it appears within the confines of the evenly rotating economy (ERE), where there is a uniform rate of return in every production process. And since the imaginary construct of the ERE is built on the assumption of perfect certainty and predictability of the future,For a detailed explanation of the assumptions underlying this imaginary construct see Mises (1998 [1949], pp. 247–251) and Rothbard (2009, pp. 320–329). it follows that the theory of time preference can only explain the rate of return that appears within the production structure under these artificial conditions, and is unable to explain the price spread between input and output that permeates the production structure in the real world characterized by uncertainty.
Second, adherents of the PTPT cannot explain how the rate of originary interest comes to be what it is. As Machaj notes, if the theorist is confined to explaining interest only in the ERE and has no explanation of the interest rate that appears within the production structure in the dynamic and uncertain world of reality, there is no way for him (or her) to provide any coherent and meaningful explanation of why the rate of originary interest is what it is. In such a scenario, the theorist is forced to acknowledge that the rate of interest within the ERE “is equalized not by the mechanisms of the model but merely by the assumptions of the model: everything is the same because everything is the same” (Machaj, 2017, p. 25).Mises advances a similar criticism of economists who focus purely on an analysis of the ERE, thereby assuming uncertainty away from their analysis. See Mises (1998 [1949], pp. 352–354).
Now, this first charge that Machaj levels against the PTPT, while restricting its scope to the imaginary world of the ERE, at least assumes, albeit implicitly, that the theory can actually explain the rate of originary interest that characterizes such an economy. The second and stronger charge that Machaj levels against the PTPT, however, denies even this possibility. The PTPT, he claims, cannot even explain the rate of originary interest. And why is it unable to do this? Because the concept of time preference simply cannot explain why there should be a monetary surplus that characterizes any production process, even in the ERE.
While Machaj accepts that time preference is indeed “an element of a pure theory of action,” he argues that there is “a gap” between accepting this proposition and “making it a prerequisite for physical monetary surplus” (Machaj, 2017, p. 25). In fact, as he goes on to note, “there is no clear bridge between a preference for sooner rather than later and a physical surplus of money in interest payments” (Machaj, 2017, p. 26). Thus, consider a production process where a capitalist-entrepreneur pays out 100 units of money today to hire various factors of production. An acceptance that his actions are guided by the concept of time preference does not in any way imply that he will sell his output tomorrow for a sum that is greater than 100 units, thereby earning some positive rate of return. Instead, “the transaction could well be 100 units of money today in exchange for 100 units tomorrow, such that monetary interest is zero.” Or, in fact, “interest could even be negative: 100 units today for 95 units tomorrow” (Machaj, 2017, p. 26).
Thus, Machaj throws a one-two punch at Mises’s PTPT. The first attacks the conditions under which the concept of time preference holds true, and the second focuses on the implications that can be derived from the concept itself. In the following two sections I will try to defend Mises’s exposition of time preference and the PTPT from both of Machaj’s criticisms. In doing so, I will begin with a defense against the initial blow, regarding the realism or lack thereof of the conditions under which the concept of time preference itself holds true, and will then deal with the second criticism, which focuses on whether the existence of time preference can explain a monetary surplus within a process of production.
III. HUMAN ACTION, VALUE JUDGMENTS AND VALUE IMPUTATION Before dealing with the specific criticisms that Machaj advances against the Misesian PTPT, I think it is important to mention and explain some important implications that follow from the existence of human action. These propositions, although they belong, first and foremost, to the realm of praxeology, and thus take us beyond the realm of catallactics, are still worth laying down in some detail since they are essential to my defense of Mises’s exposition of the theory of time preference and the PTPT.
Human action, as Mises defines it (Mises, 1998 [1949], p. 10), is purposeful behavior. It is the purposeful reaction of an individual to his (or her) environment and involves an attempt, on the part of this individual, to alter this given environment and to replace it with a different state or situation.
Such purposeful behavior, as Mises goes on to note (Mises, 1998 [1949], pp. 13–14), implies the existence of certain conditions. Action, to begin with, requires an individual to be less than fully satisfied. He must, in a given situation, be aware of certain unfulfilled wants, and must experience “some uneasiness” (Mises, 1998 [1949], p. 13). Given this lack or insufficiency in the conditions that define his existence, the individual must be aware of alternate states of the world that will enable him to satisfy one or more of these unfulfilled wants. Moreover, these alternate states must, in his eyes, be realizable and worth striving towards.
The ultimate goal or the ultimate purpose of all action, it follows, is the satisfaction of some unfulfilled wants, or the removal of the uneasiness that the actor experiences. Action, however, also requires the actor to choose between alternate states of satisfaction. It forces him to prefer and strive after one possible state of the world and the satisfaction that it opens up, and to renounce another realizable state of the world and the satisfactions that it has to offer.
These preferences, first and foremost, rank the ultimate goals of action: the alternate states of satisfaction that the actor has to choose between in any given situation. One or more unfulfilled wants that offer greater satisfaction are deemed to be of more importance to the actor’s well-being, and of greater value to him, and are ranked above other unfulfilled wants that offer less satisfaction and are valued less. These valuations then guide the conduct of the actor. Of two possible paths of conduct open to him at any given moment, he chooses the one that allows him to satisfy the wants that he values more, while renouncing the path that promises less value.
Now, although the actor attributes value to the possible states of satisfaction that he can bring about, he also necessarily imputes and attributes this value to the means that he uses to attain these states of the world. For, although the attainment of a state of satisfaction is the ultimate goal for an actor, he finds himself in a situation where these states of satisfaction are unattained or unfulfilled. And, it is in this current, given scenario that he plans to employ certain scarce elements in his environment, or means, to try and attain these ultimate ends. As a result, the value that he attributes to these states of satisfaction is also imputed to the means that enter into his action.
This holds true both for actions involving consumer goods, or first order goods, and for actions that involve producer goods, or higher order goods.For a detailed analysis of the valuation of first and higher order goods in a scenario of economic self-sufficiency, see especially Menger (2007 [1871], pp. 114–174), Böhm-Bawerk (1930, Bk. III) and Rothbard (2009, pp. 17–46). Thus, consider the case of Crusoe, all alone on his island, using a fish in his possession to satisfy a want. Since the fish, by assumption, is a first order good, the value that Crusoe attributes to it will be a reflection of the value that he attributes to the marginal utility that he expects to attain with it. The want that he will use it to satisfy has some importance to his well-being, and this importance is directly imputed to the fish at hand.
Now, consider a situation where Crusoe employs an hour of his labor-time to start producing a raft. When completed, he will use this raft to catch some fish. On what will the value of this first hour of labor devoted to raft production depend? The value of the services of the raft that it helps produce will be imputed to it. Thus, the value of the third order good, the hour of labor-time, reflects the importance that the second order good, the services of the raft, has for Crusoe’s well-being. And on what does the value of this second order good depend? It, in turn, reflects the value of the fish, or the first order good that can be produced with it, and therefore the value of the states of satisfaction that the fish will help Crusoe attain.
IV. CHANGE, UNCERTAINTY AND TIME PREFERENCE Just as action requires the actor to make value judgments, it also implies the existence of time preference. Since the actor strives towards the gratification of an unfulfilled want, it follows that he prefers to satisfy this want in the nearer as compared to the more distant future. And since the attempt to gratify an unfulfilled want is essentially an attempt to attain a state of satisfaction, it follows that, in the eyes of the actor, “other things being equal, satisfaction in a nearer period of the future is preferred to satisfaction in a more distant period” (Mises, 1998 [1949], p. 480). An individual’s actions necessarily reflect time preference: at any given moment, he attributes greater importance and more value to satisfaction that lies relatively close at hand, and less value to satisfaction that lies further away in time.As Mises argues, individuals “value fractions of time of the same length in a different way according as they are nearer or remoter from the instant of the actor’s decision…. If any role at all is played by the time element in human life, there cannot be any question of equal valuation of nearer and remoter periods of the same length” (Mises, 1998 [1949], p. 480).
Given that time preference is implied in every act, the conditions under which it exists or manifests itself will necessarily be identical to the conditions that necessitate action. Keeping this firmly in mind, let us now analyze Machaj’s first criticism of Mises’s PTPT, i.e., that time preference only exists under the unrealistic conditions that “circumstances…stay the same except for the passage of time” and that there is “full certainty and predictability of future states of affairs” (Machaj, 2017, p. 27).
Let us begin by clarifying the meaning of the first assumption. When Machaj states that “the circumstances surrounding them [the people: GPM] stay the same except for the passage of time” (Machaj, 2017, p. 27), I am going to assume that he means the following: the theory of time preference assumes that, when an individual acts, no changes in circumstances or conditions that are exogenous to the action itself can take place. To be sure, every action itself is an agent of change and implies an alteration in the conditions surrounding the actor. In fact, to effect such changes is the overarching goal of action. But no changes in an actor’s environment that are unrelated to the specific act that he undertakes are allowed.
Now, given that time preference is implied in human action, the veracity of Machaj’s claim can be assessed by answering the following question: does action require such an assumption? Does the existence of action require one to assume that only changes endogenous to action can take place and no changes that are exogenous to it can impact the environment of the actor? For, if this condition is not necessary for the existence of action, it is also not implied in Mises’s theory of time preference.
Turning now to the conditions necessary for the existence of action that I have mentioned earlier (Section III), one finds that action only assumes that there are unfulfilled wants. It does not, however, require any assumption regarding the lack of changes exogenous to action. Indeed, such changes can and indeed necessarily do buffet the world of the actor. But all that action assumes is that, despite such changes, the actor perceives and believes that there will still be certain unfulfilled wants. And it is only the existence of these ungratified wants that are necessary for him to act.
Now, what about the second unrealistic assumption? Does the theory of time preference assume away the endemic uncertainty that characterizes the real world? Once again, given that time preference is implied in the fact that human beings act, we can determine the validity of Machaj’s claim by answering the following question: does action imply perfect certainty? For, if this is not a necessary assumption for the existence of action, then it is also not a necessary assumption for the existence of time preference.
The answer to this question has been given, and given quite emphatically, by Mises in Human Action (Mises, 1998 [1949], pp. 105–106). Far from action requiring full certainty and predictability of the future, it is, in fact, impossible for any action to take place in a world characterized by perfect certainty and predictability of the future. Indeed, as Mises notes, “if man knew the future, he would not have to choose and would not act” (Mises, 1998 [1949], p. 105). Far from being a striving, purposeful creature, man, under these conditions, “would be like an automaton, reacting to stimuli without any will of his own” (Mises, 1998 [1949], p. 105).
Thus, far from perfect certainty being a necessary condition for action, it is the uncertainty of the future that is “implied in the very notion of action” (Mises, 1998 [1949], p. 105). And since the conditions necessary for the existence of action are also those that are necessary for the existence of time preference, it follows that Machaj’s claim that the latter exists only under the unrealistic conditions of “full certainty and predictability of the future state of affairs” is not true. Time preference exists and influences the actions and choices of individuals in the dynamic, real world of change and uncertainty.
Two important implications follow from this. First, since time preference does not appear only in the artificial and unrealistic thought construct of the ERE and does manifest itself in the real world that confronts acting man, it does, assuming that it can explain the price spreads that permeate the production structure, help explain the phenomenon of interest as it appears in the real world. And second, since it does influence the actions undertaken in the real world, and thus does influence the allocation of resources within the production structure, it does play a role in analyzing the step-by-step process by which the ERE would emerge and interest rates in the various processes of production would be equalized, if tastes, techniques and the stock of the original factors of production (land and labor) were assumed to be given.
Thus, the theorist who espouses the Misesian version of the PTPT does not, contrary to what Machaj claims, conclude that price spreads within the production structure are equalized in the ERE “merely by the assumptions of the model,” and “not by the mechanisms of the model.” And he is certainly not forced to conclude “that everything is the same because everything is the same” (Machaj, 2017, p. 25).
V. TIME PREFERENCE AND MONETARY SURPLUS WITHIN THE PRODUCTION STRUCTURE 1. Time Preference and the Value Spread Between Input and Output: The Case of a Crusoe Economy
The existence of time preference has important implications for the process of value imputation. Let us reconsider the case of Crusoe devoting an hour of labor to the production of a raft. As discussed above, both the value of the labor-time as well as the value of the services of the raft produced with it depend, proximately, on the value of the fish, and ultimately, on the value of the unfulfilled wants that these fish will help satisfy.
Nevertheless, although the services of the raft and the hour of labor-time both ultimately derive their value from the same states of satisfaction, their values will not be equal. The hour of labor that Crusoe plans to devote, right now, to the production of the raft is of less importance to his well-being, and therefore of less value to him, than the services of the raft that it helps produce. The cause of this spread or difference between the value of the input, the hour of labor, and the value of the output, the services of the raft, lies in how far away each of them is, in time, to the ultimate goal of Crusoe’s action: the attainment of satisfaction.For a more detailed discussion of this point see Böhm-Bawerk (1930, pp. 179–185).
Assume that it takes two days of labor-time for Crusoe to produce the raft. It follows, therefore, that when he is about to devote an hour to start its production his ultimate goal lies more than two days away. But when he has finished producing the raft, the services of it that this first hour helped produce are a few hours, or maybe just a few minutes away from the attainment of some satisfaction.
Now, as mentioned above, time preference implies that Crusoe, when embarking on a course of action, attributes greater importance and value to states of satisfaction that lie in the nearer future and less importance to those that lie further away in time. In this instance, the hour of labor-time contributes, ultimately, to the gratification of some unfulfilled wants that lie in the more distant future, whereas, the services of the raft, once it has been completed, help him to attain satisfaction in the nearer future. It follows, therefore, that at the moment when he is about to start producing the raft, he values the services of the raft more than the services of the hour of labor-time that help produce them; to the former he attributes the greater value of satisfaction that lies in the nearer future, and to the latter he imputes the lower value of satisfaction that lies in the more distant future.
- Time Preference and the Price Spread between Input and Output: The Case of a Monetary Economy
Turning our attention now to a monetary economy, consider the case of a capitalist-entrepreneur and his actions in the market for a producer good. Just as in the case of Crusoe, the value that the capitalist attributes to a unit of the good in question is ultimately determined by the contribution that it can make to the ultimate goal of his (or her) actions: the gratification of unfulfilled wants and the attainment of states of satisfaction. However, given the existence of the division of labor and specialization, the path that the capitalist takes to achieve this ultimate goal is very different from the one taken by Crusoe.
In Crusoe’s self-sufficient world, a unit of a producer good is utilized by him to produce a first order good either directly or indirectly, and then attain some satisfaction. As a result, the value of the producer good depends, proximately, on the consumer good that he produces with it, and ultimately, on the satisfaction that he can attain with the latter. The capitalist, acting in a different institutional scenario, uses a unit of the producer good to produce a product that he sells for a sum of money. He then proceeds to use this money to purchase consumer goods produced by other capitalists. These consumer goods, in turn, are used by him to gratify unfulfilled wants and to attain states of satisfaction.
The value of a unit of the producer good to the capitalist, it follows, depends proximately on the value of the sum of money that it helps him attain, and ultimately on the value of the states of satisfaction that it enables him to bring about. The value of the satisfaction that he can ultimately attain is imputed, via the consumer goods, to the sum of money, and finally to the unit of the producer good in question.
Now, the existence of time preference has significant implications for this process of value imputation. Assume that the capitalist, in his estimation, can earn 100 units of money by hiring and employing a unit of the producer good in a process of production. Thus, both the unit of the producer good and the 100 units of money derive their value from the satisfaction that they enable the capitalist to ultimately attain. Nevertheless, due to the existence of time preference, there is a difference in the value that he attributes to these two things. The 100 units of money that he expects to earn at the end of the production process, which is the marginal value product that he expects the unit of the producer good to contribute to his possessions, is of greater importance to his well-being than the unit of the producer good that helps him acquire this sum of money.
As in the case of the labor-time and the services of the raft considered above, there is a difference in how far away in time the 100 units of money and the unit of the producer good is to the capitalist’s ultimate goal of attaining satisfaction. Thus, assume that the production process takes a year to complete. The unit of the producer good, it follows, will take a year to yield the expected marginal value product of 100 units of money. At the moment when the capitalist hires this unit, the attainment of satisfaction lies more than a year away. However, once the product has been produced and the 100 units of money is in the hands of the capitalist, satisfaction lies merely a few days, or only a few hours away.
Thus, at the moment when the unit of the producer good is hired by the capitalist, it contributes to satisfaction in the more distant future, whereas the sum of money that it is expected to yield, once it is in hand, helps the capitalist attain satisfaction in the relatively near future. Given that he attributes greater importance and value to satisfaction that lies in the near future and less value to satisfaction that lies in the more distant future, it follows that he values its services less than he values the 100 units of money that he expects it to yield: at the moment when he hires the unit of the producer good, he attributes to the former the lower value of satisfaction that lies in the more distant future, whereas he imputes to the latter the greater value of satisfaction that lies closer at hand. As a result, the capitalist would only be willing to part with less than 100 units of money to hire the unit of the producer good.
Other capitalists competing to hire the unit of the producer good will be in a similar position. Due to the existence of time preference, they too would only be willing to offer the discounted marginal value product of the unit in question. Each of them would only be prepared to offer a sum that is less than the revenue that the unit of the producer good is expected to yield in the various production processes that they wish to embark upon.
Thus, contrary to the claim made by Machaj, time preference does provide an explanation for the existence for the spread between revenues and costs, or for a monetary surplus, within a production process. Specifically, it explains the ex ante existence of such a surplus or spread when the capitalist-entrepreneurs enter the markets for producer goods and bid for their services. Ex post, or after the product has been produced and sold, however, such a surplus may or may not characterize a production process due to the uncertainty that characterizes the real world. The actual, ex post rate of return consists of a mix of the rate of interest, owing to the influence of time preference, and profit (or loss), owing to the influence of the uncertainty that plagues the estimates of the marginal value products of the various producer goods.See Rothbard (2009, pp. 509–516) for an insightful discussion of this point.
It is only in the imaginary world of the ERE, where there is no uncertainty, that the ex ante and the ex post align, and where the surplus due to time preference appears in its pure form, distinct from profit and loss.See Rothbard (2009, pp. 367–410) for a detailed analysis of how the interaction of the valuations of the various participants in the time market that permeates the production structure gives rise to the rate of originary interest within each production process in the ERE. Nevertheless, time preference does influence the actions of the capitalists in the markets for producer goods even in the real world and does influence the bids that they are willing to make for their services, even in the presence of uncertainty regarding their estimations of the marginal value products involved.
VI. CONCLUSION In his recent book, Money, Interest and the Structure of Production (Machaj, 2017), Mateusz Machaj advances two significant criticisms of Mises’s theory of time preference and his pure time preference theory of interest (PTPT). First, he claims that time preference only exists under certain unrealistic conditions, and second, that the PTPT, as presented by Mises, is unable to provide a coherent explanation for the spread between the prices of inputs and output that characterizes production processes in a monetary economy.
In this paper I present a brief defense of Mises’s conception of time preference and of his PTPT from both of these criticisms. I argue that, contrary to Machaj’s claims, the existence of time preference does not require any unrealistic assumptions and also provide an analysis of how the PTPT can provide a satisfactory explanation of the monetary surplus that permeates the production structure.
[Originally printed in the journal Procesos de Mercado: Revista Europea de Economía Política 14, no. 2 (Autumn 2017).] 1. Personal Life and Career 1.1 Early Life
Prof. Jesús Huerta de Soto Ballester is one of the leading Austrian School economists in the contemporary era. On December 23, 1956, Huerta de Soto was born in a devout Catholic and business family in Madrid, Spain. As early as 1928, his grandfather Jesús Huerta Peña started running an insurance company called “ESPAÑA S.A”. In 1954, Jesús Huerta Ballester, father of Huerta de Soto, began running this enterprise with Huerta Peña. After two generations of painstaking efforts, the business reached a considerable size and strength and grew into one of the most important companies in the insurance industry in Spain. The growing business environment and classical liberalism played a significant role in shaping Huerta de Soto, and led him to become an insightful Austrian School economist. In 1972, 15-year-old Huerta de Soto read Milton Friedman’s Capitalism and Freedom from the book collection of the library of his libertarian father's library.Huerta de Soto (2016). This is the first libertarian book that Huerta de Soto read. Some time later, by chance, Huerta de Soto also read Ludwig von Mises’ Human Action at the age of 16.Huerta de Soto (2010a). After that, he became a convinced libertarian. In the autumn of 1973, with the help of his father Huerta Ballester and other passionate scholars, Huerta de Soto started to participate in the seminars of Austrian Economics that took place every Thursday in Madrid. The participation in these seminars provided Huerta de Soto a unique and excellent opportunity to explore the thoughts of the Austrian School and the errors of Keynesian Economics and the Chicago School.Huerta de Soto (2015), pp. 11
Huerta de Soto soon showed his interest and talent in law and economics, and the relatively well-off family made the young Huerta de Soto fully devoted to his academic research. He obtained his bachelor degrees in both law and economics from Complutense University of Madrid (UCM) in 1978, and one year later he began working as an assistant professor of Political Economy at the Faculty of Law of the UCM. With a recommendation letter from Prof. F. A. HayekIbid, pp. 11. and the support of his family, Huerta de Soto went to study at Stanford University from which he obtained his MBA in 1983. During this period he deepened his knowledge on Austrian Economics, especially on the capital theory and on the theory of the market process. During his studies in the USA, with the help of his friends from the Institute of Humane Studies, Huerta de Soto met Murray Rothbard, one of the best students of Ludwig von Mises. Together they discussed the most controversial and exciting topics in economics.Ibid, pp. 11. When remembering this story, Huerta de Soto said that knowing Rothbard was “possibly the greatest intellectual experience.”Translated from Ibid, pp. 11. The original text in Spanish is “posible la gran experiencia intelectual”.
1.2. Academic Career and Contributions to Liberty
When Huerta de Soto finished his studies at Stanford, he went back to Spain. Once back in Spain his thesis Private Pension Planning;Ibid, pp. 12. The original title of the thesis in Spanish is Planes de pensiones privados. was awarded King Juan Carlos International Prize of Economy. His thesis discussed how to articulate a private pension system and its relative advantage compared to that of the government. One year later, based on his thesis,Huerta de Soto (2017). he obtained his Ph.D. degree in law from the Complutense University, and his doctoral thesis Private Pension Planning was published. During his tenure in the law faculty of Complutense University, Huerta de Soto continued studying economics and shorty after was awarded his Ph.D. degree in economics. In 1992, based on his economics thesis, The Controversy over Socialist Economic Calculation,Ibid. The original title of the thesis in Spanish is La polémica sobre el cálculo económico socialista. and other academic works, the 36-year-old Huerta de Soto published his famous book Socialism, Economic Calculation and Entrepreneurship,The title of the book in Spanish is Socialismo, cálculo económico y función empresarial. See Huerta de Soto (1992). which demonstrates the impossibility of socialism. The historical and academic background of the debate on the economic calculation problem of socialism of the 1920’s between the Austrian School and the Neoclassical School, served as a starting point. Huerta de Soto’s bookHuerta de Soto (2010b). soon became the Austrian School reference book for the study of the socialist economic calculation problem. In his book he systematically and comprehensively discusses the impossibility of socialism from the perspective of entrepreneurship and the nature of socialism.
The 1990s was one of the peaks of Huerta de Soto’s academic career. In 1998, his other great book, Money, Bank Credit, and Economic CyclesHuerta de Soto (2006). (a systematic analysis of business cycles and free banking theory) was published. Dr. Jörg Hülsmann believes that this book was “the first Misesian treatise on money and banking to appear since [the] publication”Hülsmann (2000), pp. 86. of Mises’s original work Theory of Money and Bank CreditMises (2013). in 1912, and is “the most comprehensive analysis of fractional-reserve banking and of business cycles in print,”Hülsmann (2000), pp. 88. and considers that “[a]ll serious students of these subject matters will have to become acquainted with it.”Ibid.
Professor Huerta de Soto makes every effort to cultivate younger generations of Austrian School scholars. In 2000, he became a full-time professor of Political Economy at Rey Juan Carlos University in Madrid (URJC),Huerta de Soto (2017). See http://www.jesushuertadesoto.com/curriculum-vitae-en/teaching-activities. continuing his systematic teaching of Austrian School Economics which he began in the 1980s at Complutense University. Prof. Huerta de Soto currently also serves as a doctoral director. In 2004, Huerta de Soto founded the journal Procesos de Mercado,Ibid. See http://www.jesushuertadesoto.com/curriculum-vitae-en/other-achievements. which is the first contemporary Austrian Economics’ academic journal in Spain. Austrian economists all around the world, especially the Spanish speaking young scholars, enthusiastically submit their articles to this journal, regarding it as a good place to improve their academic research and to communicate with other researchers.
During Huerta de Soto’s academic and teaching career, he inherited the life insurance company that his grandfather and father had operated for many years, and gradually he has become a fruitful and steady entrepreneur. In 2005, after 51-years working for the company, Huerta de Soto’s father Jesús Huerta Ballester retired and became the Honorary President of the Company.España, S.A. (2012). The management of the company was then transferred to Huerta de Soto.
That same year, with the assistance of Huerta de Soto, Spain established its first libertarian-economic institute, Instituto Juan de Mariana, building a bridge between the Spanish speaking countries and libertarians all around the world. The Instituto Juan de Mariana has been heavily influencing on the Spanish speaking libertarians.
In pro of the new generations of Austrian School economists, in September 2007 Huerta de Soto founded the Official Master in Economics of the Austrian SchoolThe title of the master’s program in Spanish is: Master Oficial en Economía de la Escuela Austríaca. See its official web page: https://www.urjc.es/universidad/facultades/facultad-de-ciencias-de-la-comuni-cacion/909-economia-de-la-escuela-austriaca. at the Rey Juan Carlos University in Madrid, and started working as its director and coordinator. This program is the world’s first master program on the Austrian School of Economics. Since then, Huerta de Soto has been cultivating young Austrian scholars and students from undergraduate to doctoral students all-around the world at Rey Juan Carlos University. Every Thursday night Professor Huerta de Soto’s economics seminar takes place. Libertarians and Austrian scholars from all around the world, as well as influential people in the areas of politics and business, from both Spain and Europe, attend his seminars and courses. The participants enjoy his passionate and unique style when giving his lectures. He has inspired some of his students at URJC to become Austrian scholars, including the professors of the Master in Economics of the Austrian School, such as Miguel Ángel Alonso Neira, Philipp Bagus, Juan Ramón Rallo, and others. Young students can also choose these professors as directors of their master and Ph.D. theses. Other students have become entrepreneurs, and others are contributing in many ways to the libertarian movement.One example of Huerta de Soto’s outstanding students in the libertarianism movement is Dr. Wolf von Laer, who is the current CEO of Students for Liberty, and received his master degree in Economics from the Austrian School at Rey Juan Carlos University.
Professor Huerta de Soto has also contributed to the global libertarianism movement by donating his publications and his collections of Austrian School works. In Spain, he has given thousands of books to the Instituto Juan de Mariana, Students for Liberty (SFL) and other research institutions and movements related to the Austrian School and libertarianism. Many young Spanish people, who have become libertarians and followers of the Austrian School by reading Huerta de Soto and by listening to his speeches, are devoting themselves to the libertarian movement as Austrian scholars, journalists, editors, and entrepreneurs. Now, every year, thousands of young Spanish people participate in SFL activities through conferences, meetings, and dinners. The books of the Austrian School of Economics have also appeared in leading libraries and bookstores in Spain because of the effort of Professor Huerta de Soto and his disciples. His followers continue to express their views through media and academic journals, extending the influence of the Austrian School and libertarianism to the public and to academia. The idea of libertarianism and market economy is becoming more and more of a concern within the Spanish people, especially the younger elite.
As Spanish is also one of the main languages in Latin America, these libertarian activities supported by Professor Huerta de Soto have also been introduced into that region through donations of books, correspondences, online courses and other means. A variety of research institutions, student movements, conferences and other activities on the Austrian School and libertarianism continue to flourish in Latin America. In Guatemala, the great disciples of Huerta de Soto, represented by Gabriel Calzada, are teaching Austrian School Economics at the libertarian university, Francisco Marroquín University (UFM).The name of the university in Spanish is Universidad Francisco Marroquín. The UFM has become one of the roots of the Austrian tradition in Latin America, and has started researching with George Mason University, the Mises Institute, the Cato Institute, the Foundation of Economic Education (FEE) and other prestigious libertarian educational institutions and think tanks. Even in the dictatorship of the Communist Cuba, by the efforts of Professor Huerta de Soto and other liberty fighters, the real economic knowledge and classical liberal ideas have gradually broken through the ideological fence.Constanza Huerta de Soto, personal communication in Students for Liberty Madrid’s activities, October 8, 2016. Some Cubans expressed their desire to know more about the essence of communism, capitalism and the Austrian School Economics, and Huerta de Soto generously sent the related books as gifts.Ibid. After reading the books, these Cubans were enlightened by the impossibility of the socialist economic calculation and the need of building a true free society in Cuba.Ibid.
Professor Huerta de Soto’s enthusiasm in academia and libertarianism has changed the fate of countless people, especially many young students. Both the perseverance of Huerta de Soto and his disciples’ academic research are particularly noteworthy in the expansion of libertarianism in Spain and Latin America. Huerta de Soto not only pursues his personal success in business and the development of his own academic knowledge, but also the benefit of all people around the world, especially the young generations, who seek to understand and construct a free society through their creativity and entrepreneurship.
In 2009, Huerta de Soto’s third scholarly work The Theory of Dynamic EfficiencyHuerta de Soto (2009). was published, which developed the definition of dynamic efficiency in economic science. His books and papers have been translated into at least 21 languages and have been published all around the world. In the next section, Huerta de Soto’s academic contributions will be reviewed.
We consider that Huerta de Soto has made three great theoretical contributions: the systemic understanding of the theory of the impossibility of socialism, the theory of bank credit and economic cycles, and the theory of dynamic efficiency. Based on MisesMises (1998). (the thoughts of entrepreneurship, the critics of socialism and the understandings of the methodological and theoretical problems of Neoclassical Economics), RothbardRothbard (1998), pp. 3-26. (the theories of natural law in banking issues), and HayekHayek (1988). (the theory of the social evolutionary process and spontaneous order), he has become a worldwide reference on the Austrian School of Economics. With his deep understanding of both Austrian Economics and Neoclassical Economics, Huerta de Soto has innovatively outlined the systematic and comprehensive theories of the Austrian School. His greatest academic challenge has been inheriting the Austrian traditions and at the same time breaking new academic ground for the future; which are vital for the development of the Austrian School and are particularly important for young scholars to have a comprehensive understanding of the economic science.
Huerta de Soto is also significantly contributing to the development of the Austrian School in China, by helping young Chinese scholars to study Austrian Economics. Because of his support and invitations, at least six young Chinese libertariansThe young Chinese libertarians who have come to Madrid to study with Professor Huerta de Soto, since 2012, are the following (in order of the time they arrived in Spain): William Wang, Yang Zhou, Jason Li, Tyler Xiong, Chao Pan and Isla He. After reading and watching the materials of Austrian Economics online, a young gentleman, Alan Bi, who had just graduated with a bachelor’s degree of trade at the Complutense University, joined the Chinese libertarian group in 2015, and is now organizing the weekly seminars of Austrian Economics for Chinese students in Madrid inspired by what Huerta de Soto and other Austrian scholars have done. have come to study under his direction in the Master in Economics of the Austrian School since 2012. Three of them continued their Ph.D. research in economics deepening their knowledge on the Austrian School. Additionally, with the help of Professor Huerta de Soto, a series of works on the Austrian School have been published in China, including his book The Austrian SchoolHuerta de Soto (2010c). and his three-other major academic books: Socialism, Economic Calculation and Entrepreneurship; Money, Bank Credit, and Economic Cycles; and The Theory of Dynamic Efficiency. He also maintains regular communication with the Chinese Austrian scholars, following the development of the Austrian School in China, and providing help and guidance to the Chinese scholars. Huerta de Soto’s theories on socialism, free-banking, and dynamic efficiency are being widely disseminated among Chinese libertarians, and are becoming the focus of study, analysis and discussion of the Austrian School in China. With the guidance and help of Professor Huerta de Soto, more and more articles from the Chinese scholars on the application and extension of his theories have been published in China and abroad. On behalf of the Chinese scholars studying Huerta de Soto’s academic works, we are very grateful for his selflessness and generosity. In this way, Professor Huerta de Soto’s ten recommendations for young students are spurring us forward:
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Be enthusiastic. Enthusiasm is the inner psychic energy that moves us to act to achieve our goals. What do we do when we don’t feel enthusiasm? Act as if we are enthusiasts, and we will be enthusiastic.
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To persevere.
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Always act the best you can. Put the principles before the seemingly useful or practical.
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Never worry about anything. Worrying means you are wasting time.
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Learning languages (English). Learning English is as important as academic study.
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Being aware of what is happening in the world.
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Properly balance professional, family and cultural goals. The family side includes family and friends and the cultural side includes physical and spiritual culture (art, travel, history, etc.).
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Be a good entrepreneur.
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Have a critical spirit. Ludwig von Mises said, “Tu ne cede malis sed contra audentior ito.” (Do not give in to evil, but proceed ever more boldly against it).
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Having an excellent, serious and ethical behavior in all areas in our lives. If we ever act badly we must recognize the error, try to solve the damage caused by it and go ahead with all the advice we have learned.González (2011).
For decades, Huerta de Soto has devoted significant effort to academia, business, and the libertarian movement in Spain and in the international society. His modest, professional and serious attitudes towards the thoughts of economic schools, his hard work in the insurance industry, his care and guidance to students, his deep love of freedom, and his selfless, sincere and enthusiastic contribution to liberty has already become a milestone in the history of the Austrian School and libertarian movement, inspiring the revival of the Austrian school and classical-liberalism. In the next section, we will focus on the main academic achievements of Professor Huerta de Soto.
- Theoretical Contributions of Huerta de Soto 2.1. Theory of the Impossibility of Socialism
One of Huerta de Soto’s greatest academic contributions is his theory on socialism. He redefines socialism by introducing the concept of entrepreneurship, and makes a synthesis of the economic calculation problem of socialism based on the previous Austrian scholars. He also contributes to the theory of different types of socialism and the theory of impossibility of computerized central planning.
2.1.1. Entrepreneurship and Why Socialism is Impossible
In Human Action, Mises defined entrepreneurship in a broader sense as “acting man exclusively seen from the aspect of the uncertainty inherent in every action,”Mises (1998), pp. 254. which means that the entrepreneur has to take the risk of uncertainty in the future as a result of his entrepreneurial decision. Mises also believed that entrepreneurship is the driving force of the whole market system. He said,
"[I]t is impossible to eliminate the entrepreneur from the picture of a market economy. … In eliminating the entrepreneur one eliminates the driving force of the whole market system."Mises (1998), pp. 248.
Inheriting Mises’ definition of entrepreneur, Huerta de Soto creates two related definitions on entrepreneurship, in the broad and the strict sense. The broad sense is equal to human action. He argues that by bearing uncertainty, “[E]ntrepreneurship actually coincides with human action. In this respect, it could be said that any person who acts to modify the present and achieve his objectives in the future exercises entrepreneurship.”Huerta de Soto (2010b), pp. 15. And human action is “any deliberate behavior or conduct”; “In acting, all men seek to accomplish certain ends which they have discovered are important to them.”Ibid, pp. 16. Based on Israel Kirzner’s strict definition of entrepreneurship as the function of alertness,Huerta de Soto comments on what Kirzner has contributed to the concept of entrepreneurship. He says, “Kirzner holds that the exercise of entrepreneurship entails a special alertness; that is, a constant vigilance, which permits a person to discover and grasp what goes on around him”. See Ibid, pp. 16. For more about Kirzner’s theories of entrepreneurship, see Kirzner (1973, 1979, 1985). Huerta de Soto defines that being an entrepreneur means trying to find a profitable market opportunity and the information for this end through a dynamic market process; thus entrepreneurship “consists basically of discovering and perceiving (prehendo) opportunities to achieve an end, or to gain a profit, and acting accordingly to take advantage of these opportunities which arise in the environment.”Ibid, pp. 19.
As Huerta de Soto points out, “[i]t is impossible to grasp the concept of socialism without a prior understanding of the essence of entrepreneurship.”Huerta de Soto (2010b), pp. 15. Based on the analysis of entrepreneurship, Huerta de Soto defines the characteristics of information as subjective, creative, tacit, practical, and dispersed.Ibid, pp. 10. He further defines socialism as “any system of institutional aggression on the free exercise of entrepreneurship,”Ibid, pp. 49. and aggression or coercion by means of “all physical violence or threats of physical violence which another person or group of people initiates and employs against the actor.”Ibid, pp. 49.
Huerta de Soto also systematically reviews the historic debate between the Austrian School, represented by Ludwig von Mises, and the Neoclassical Economics represented by Oskar Lange.For more details about the background and arguments on the economic calculation debate between Austrian School and Neoclassical Economics, see Ibid, pp. 99-172 (Chapter 4 to Chapter 6). In the great debate on the economic calculation problem, Mises and other Austrian School Economists demonstrated that it is impossible for any coercive social institution to make economic calculation. Huerta de Soto concludes why socialism is impossible, as an intellectual error, it is impossible to coordinate “social behaviors via a system of institutional coercion against free human interaction.”Ibid, pp. 254. He argues that if there is no freedom to practice entrepreneurship, and if the decision is made arbitrarily and coercively, the subjective information necessary for rational economic calculation cannot be created, nor “is it possible for economic agents to learn to discipline their behavior in terms of the needs and circumstances of [other social coordination].”Ibid, pp. 254.
2.1.2 Different Types of Socialism
Huerta de Soto also connects the theoretical definition of socialism with its various types in real world.Prof. Huerta de Soto’s accurate illustrations of different types of socialism in the real world provide our Chinese scholars with a good tip to expound upon another two typical types of socialism: authoritarian socialism (威權社會主義) and Chi-nese socialism (中國特色社會主義). Both types of the socialism believe that a political dictatorship, irrespective of whether it is a political party or a personal dictatorship, would be good for the civilization that it rules. Chinese Socialism, which is mainly applied in the ruling communist countries like Mainland China or Vietnam, is more aimed to maintaining the dictators’ coercive power and benefit through dis-inter-vened entrepreneurial activities. However, Chinese socialism does not dynamically see the market process as the best way to coordinate the needs of different individ-uals, but rather, statically sees it as a stratagem to maintain the political power and economic benefit of the crony elites. Under Chinese socialism, the entrepreneurship of individuals is limited to commercial activities. One could think that with regard to the conditions for exchange, individuals can’t blame political coercion. The truth is that the political coercion of Chinese socialism also extends to commercial activi-ties, by violating property rights and creating discoordination and distortion for individuals in the exercise of their entrepreneurship. Not only does he mention the typical and well-known Soviet-type socialism (“real socialism”Ibid, pp. 77-78.), democratic socialism,Ibid, pp. 78-79. social engineering,Ibid, pp. 80-82. and syndicalist socialism,Ibid, pp. 83. but also the conservative or “right-wing” socialismIbid, pp. 79-80. and Christian or solidarity-based socialism,Ibid, pp. 82-83. which are usually ignored by the conservatives in western countries. He argues that conservative or “right-wing” socialism is “institutional aggression … employed to maintain the social status quo and the privileges certain people or groups of people enjoy”;Ibid, pp. 79. thus, he sharply criticizes that “conservatism is an obscurantist doctrine which completely overlooks the manner in which social processes driven by entrepreneurship function, and specifically, the problem of the ineradicable ignorance which envelops all leaders.”Ibid, pp. 80. Further, Huerta de Soto also points out that some spiritual socialists, like Christian socialists, are in favor of “systematic, institutional use of coercion to modify” Ibid, pp. 82. the “immoral” or “unjust” results of human action. He argues that the development of our civilization relies on the social process of human interaction in which many people are far away from knowing each other, and thus pursuing morally superior goals per se is immoral.Ibid, pp. 82-83.
2.1.3. Computer and Central Planning
Another contribution of Prof. Huerta de Soto’s theory of socialism is the theory of the impossibility of computerized central planning. One common fallacy related to computer science is that many people believe that as the technology of computers develops so fast, one day computers can completely receive, create and transmit all the information, making it possible for central planners to deal with the information problem. On the contrary, Huerta de Soto clearly illustrates that though computers can help people manage information better, as information is “practical, dispersed, and tacit,”Ibid, pp. 59. individuals would entrepreneurially generate “progressively deeper and more detailed”Ibid, pp. 59. information by their entrepreneurship, making it harder for central planners to handle more informatio. Ibid, pp. 59. Huerta de Soto illustrates that it is not only the development of computer science that makes it more difficult for central planners to deal with information, but the nature of computers, as manmade machines, “will never be capable of acting or exercising entrepreneurship,”Ibid, pp. 59. and “will never be able to create new practical information from nothing, to discover and seize new profit opportunities unnoticed up to that point.”Ibid, pp. 59. The reason why computers cannot act as a human being to deal with information is that the information itself is “entrepreneurially discovered or created” by acting men;Ibid, pp. 60. thus computers can “only be used to manage articulated, formalized, and objective information.”Ibid, pp. 60. Huerta de Soto, therefore, distinguishes two related but different concepts, knowledge (subjectively created by human being) and data (objectively stored by computers), successfully refuting the fallacy that computer science can make socialist calculation possible.
2.2. Theory of Bank Credit and Economic Cycles
The second great and original theoretical contribution of Huerta de Soto is his theory on bank credit and economic cycles, especially the theory of free-banking laws, the clear demonstration of the business cycle, the theory of distortion on entrepreneurs created by fractional-reserve banking, the application of the theory of the impossibility of socialism in the banking system, the critiques on fractional-reserve free-banking, and his policy suggestions on banking reform.
The study of monetary theory not only involves the content of political economics but also various other subjects such as law, ethics, and mathematical statistics. Huerta de Soto has a thorough grasp of the above subjects, achieving mastery through a comprehensive study of monetary issues.
2.2.1. The Distinction between Loan Contracts and Deposit Contracts in both Economics and Law
Huerta de Soto starts by reviewing how Roman law defined banking credit,Huerta de Soto (2006), pp. 1-36. and points out that it is necessary to clarify two different types of financial contracts, loan contracts and deposit contracts, which are often confused by the modern banking system. For the loan contracts, Huerta de Soto defines two sub-classifications. The first is the loan of use, “in which case only the use of the lent item is transferred and the borrower is obliged to return it once it has been used,”Ibid, pp. 1. and the second is the loan for consumption, “where the property of the lent item is transferred.”Ibid, pp. 1. No matter what the specific classifications of loan contracts are, both “entail the transfer of the availability of the good, which shifts from the lender to the borrower for the duration of the term.”Ibid, pp. 4. In the perspective of economics in deposit contracts,For more cases of 100 percent gold dollars, see Rothbard (2001). Though we do not agree with Rozeff’s view on being against 100 percent reserve, his argument of whether if it is proper to call an institution that cannot issue loans but only keeps deposits a bank, should also be discussed. He said, “[a] proper bank would … hold all deposits intact and become a 100 percent reserve-storage or safety-deposit bank, although to call such a business a bank under these conditions is something of a misnomer because such a so-called bank makes no loans.” See Rozeff (2010), pp. 497. exchanging present goods for future goods is not allowed, as goods should always be available for the depositor. However, in the loan contracts, the situation is the contrary — there is always a transfer of availability from the lender to the borrower.Ibid, pp. 15. After the above theoretical demonstrations, Huerta de Soto provides an amazing historical review of how bankers and politicians violated the legal principles of both loan contracts and deposit contracts from ancient Greece and Rome through the 20th century, especially how the violations happened in Europe.Ibid, pp. 37 to 114. Thus, we can conclude that, “throughout history central banks have emerged not as a result of the spontaneous, evolutionary free-market process, but as a consequence of deliberate government intervention in the banking sector.”Ibid, pp. 647.
2.2.2. The Demonstration of Business Cycles
Huerta de Soto demonstrates two types of economic cycles, the cycles in voluntary saving or in the free banking system,Ibid, pp. 313-346. and the cycles triggered correspond to credit expansion of the central banking system.Ibid, pp. 347-384. The latter, which the current government central-banking system, can cause more severe and systematic problems than the cycles in voluntary saving and the free-banking system. Based on Austrian Capital Theory,For more information about Austrian Capital Theory, see Böhm-Bawerk (1890), Garrison (1990) and Kirzner (1996). Huerta de Soto demonstrates the stages of the business cycle which are created by central banking. In the first place, though entrepreneurs have made incorrect market decisions, the central bank still creates more credit and grants it to entrepreneurs, causing a decrease in the interest rate. As more credit has been invested in the market, the prices of capital goods and the prices in the stock market will rise, and productive structures will also be lengthened artificially. This leads to more workers being hired in capital-good fields because of the artificial growth in productive structures. As the money in the market and the production of capital goods seems to be promising, the wages of workers will also rise; the “[m]onetary demand for consumer goods begins to grow.”Huerta de Soto (2006), pp. 506. Then the Ricardo Effect occurs and “capital equipment is replaced by workers.”Ibid, pp. 506. The collapse of the boom emerges: the demand decreases, while costs, interest rate and prices all rise, marking the start of the depression. Capital-good sectors suffer heavily from accounting losses, and more workers will be fired in capital-goods industries. At this stage, entrepreneurs find that they have made many poor investments, and liquidate the erroneous investment projects. Some enterprises will go bankrupt and suspend their payments due to the malinvestment plans. As entrepreneurs are not able to repay their credits, banks will also face bankruptcy, thereby squeezing their credit to avoid more mistakes. The crisis makes the productive structures shorter and the economy gradually enters recovery, and the increase in voluntary saving can recover.
2.2.3. The Theory of Distortion on Entrepreneurs caused by Fractional-reserve
Huerta de Soto points out how artificial credit expansion distorts entrepreneurship in a fractional-reserve banking system. He states, “While the expansion lasts, people’s capacity for work is pushed to the limit and their entrepreneurial spirit becomes corrupted,”Ibid, pp. 457. and they focus on short-term goals based on the credit expansion instead of long-term goals and frugality. This also discourages entrepreneurship of the “society’s youngest, most innovative and dynamic generations.”Ibid, pp. 458. And as businessmen, intellectuals and other economic agents and social elites take it for granted that the artificial credit expansion and the boom and recession are natural economic phenomena, government will support more pro-credit-expansion policy to meet the satisfaction of the above popular opinions. Thus, credit expansion has become an “old story [that] repeats itself.”Mises (1998), pp. 578.
2.2.4. The Application of the Theory of the Impossibility of Socialism to the Banking System
Huerta de Soto also applies his theory of the impossibility of socialism to the Austrian Business Cycle Theory. First, he demonstrates that the central banking system is against traditional monetary legal principles, causing social discoordination. Through central banking, entrepreneurs will be misled by inaccurate information and by the privileges authorized by the state. Some entrepreneurs would even irresponsibly make their decision of investment due to the cheap artificial credit.Huerta de Soto (2006), pp. 651. As Huerta de Soto points out, even if we suppose that the decision makers of central banks are not corrupted to give privileges to some bankers (we have to admit that it rarely happens as the decision making of the central banking system is based on coercion of political power), central banking still faces the problem of not being able to create and carry out sufficient information for serving the financial system.Ibid, pp. 656 to 657. Huerta de Soto says,
"[T]he central bank is obliged to make an unceasing effort to collect an extremely vast quantity of statistical information on the banking business. … For such information is not only extraordinarily profuse; but what is more important, it is also subjective, dynamic, constantly changing, and particularly difficult to obtain in the financial sector. Hence it is painfully obvious that the central bank cannot possibly acquire all the information it would need to act in a coordinated manner, and its inability to do so is one more illustration of the theorem of the impossibility of socialism, in this case applied to the financial realm."Ibid, pp. 656 to 657.
2.2.5. The Critiques on the Fractional-reserve Free-banking Theory
According to Huerta de Soto, the fractional-reserve free-banking theory (FFT) has six fallacies. The first fallacy is that it assumes that the demand for money in fiduciary media is exogenous to the fractional-reserve free-banking system (FFS).Ibid, pp. 679. In fact, it is the credit expansion per se in FFS that causes the demand of fiduciary media, distorting the productive structure and causing the economic boom and the recession.Ibid, pp. 681. Thus, the demand for money in fiduciary media is an endogenous variable in FFS. The fundamental error, which FFT makes, “lies in a failure to reflect that public demand for credit depends precisely on banks’ inclination to lend.”Ibid, pp. 683. The second fallacy of FFT is the monetary equilibrium formula of the FFT’s equilibrium theory. Like Neoclassical monetary theory, the FFT also uses equilibrium formula; however, the monetary equilibrium formula can only deal with the last stage of the social and production process. On the contrary, the Austrian methodology says that there is always a dynamic entrepreneurial process and tendencyIbid, pp. 685. to reach equilibrium in monetary issues, but that the equilibrium is never actually reached.Ibid, pp. 685. New credit issuers will make errors as they have to face the uncertainty of the new demand for credit; thus, the equilibrium theory and formula of FFT are false.Ibid, pp. 685 to 686. The third fallacy of FFT is that it ignores the microeconomic effects but over analyzes the macroeconomic effects triggered by FFS. Ibid, pp. 688. Huerta de Soto points out that FFT focuses on analyzing the equation of exchange of the general price level, as monetarists or Keynesians do.Ibid, pp. 689. But as price and production structures have been distorted, the newly issued credit will never be immediately and directly sent to the people who value and prefer them more in a fractional-reserve system, making the equation of exchange impossible.Ibid, pp. 689. The fourth fallacy of FFT is the confusion between the concept of saving and the demand for money. FFT claims that money balance is equal to “savings”. However, Huerta de Soto illustrates that there are only three ways in which economic agents can employ their money: spending on consumer goods and services, spending on investments, and holding them (hoarding)Murray Rothbard also gives a specific explanation on hoarding. For more information about hoarding see Rothbard (2016). as cash balances or fiduciary media.Huerta de Soto (2006), pp. 695. Thus, savings (investment) and money balance are two different concepts and “a rise in the balance of fiduciary media may very well depend on a drop in investment spending, … which makes it possible to increase final monetary expenditure on consumer goods and services.”Ibid, pp. 695. “Under these circumstances an individual’s savings would drop, while his balance of fiduciary media would rise.”Ibid, pp. 695. Additionally, FFT confuses note or depositing bank issues with financial assets. Financial assets can be issued as loans for consumption and investment, but a bank note or money is a present good different from financial assets.Ibid, pp. 696. Having a cash balance “says nothing about the proportions in which the economic agent wishes to consume and invest”. The fifth fallacy of FFT is that it per se doesn’t match empirical evidence. Huerta de Soto points out how FFS has caused economic booms and busts in at least two countries; in Scotland from the 18th to the 19th century and in Chile after the middle 19th century.Huerta de Soto points out that, before the establishment of the fractional-reserve free-banking system in 1853, the financial sectors were stable in Chile, and there was no systematic economic recession, see Ibid, pp. 704. The sixth fallacy of FFT is that it excludes legal considerations. In fact, the legal considerations are as important as economics to understand the banking system.Ibid, pp. 706. Furthermore, FFT even confuses the difference between the two different contracts in the traditional legal principles. Huerta de Soto also points out that FFS can not only cause economic recessions, but also result in externality problems,Huerta de Soto (2006) does not use the word externality in his demonstration of the harm of fractional-reserve free-banking system to the third party and to public order, but we think that using the word externality would make his claim stronger and more clearly demonstrate that the issuance of credit through a fractional reserve system (even a free-banking one) also invades the monetary property rights of the third party. According to Huerta de Soto’s theory of the harm of a fractional-reserve free-bank-ing system on the third party, Rozeff’s argument for supporting a fractional-reserve free-banking system is false. Rozeff claimes that “[p]eople themselves [have the rights to] decide what kinds of property rights they want and find acceptable in bank accounts”. According to the legal principles in monetary contracts presented by Huerta de Soto, one does not have the right to decide anything that is a violation of another individual’s property (i.e., the value of the third party’s currency). For more about Rozeff’s false arguments, see Rozeff (2010), pp. 498. as FFS disrupts the public order and harms third parties’ property rights. Ibid, pp. 707-708.
2.2.6. Policy Suggestions on the Reform of the Banking System
Three policy suggestions on the banking system are made by Huerta de Soto. The first proposal is “complete freedom of choice in currency.”Ibid, pp. 736. He argues that currency choice is also an evolutionary process according to the monetary regression theorem.Huerta de Soto says “[w]e should also remember Mises’ monetary regression theorem, according to which the price or purchasing power of money is determined by its supply and demand, which is in turn determined not by its purchasing power today, but by the knowledge the actor formed on its purchasing power yesterday. At the same time, the purchasing power of money yesterday was determined by the demand for money which developed based on the knowledge of its purchasing power the day before yesterday. We could trace this pattern back to the moment when, for the first time in history, people began to demand a certain good as a medium of exchange.” See footnote 35 on Ibid, pp. 737-738. Mises also explained the regression theorem, stating, “[t]he theory of the value of money as such can trace back the objective exchange value of money only to that point where it ceases to be the value of money and becomes merely the value of a commodity. … If in this way we continually go farther and farther back we must eventually arrive at a point where we no longer find any component in the objective exchange value of money that arises from valuations based on the function of money as a common medium of exchange; where the value of money is nothing other than the value of an object that is useful in some other way than as money… Before it was usual to acquire goods in the market, not for personal consumption, but simply in order to exchange them again for the goods that were really wanted, each individual commodity was only accredited with that value given by the subjective valuations based on its direct utility.” See Mises (2013), pp. 120. In applying Mises’ regression theorem to digital coins, Tucker (2014) believes that Bitcoin matches the regression theorem, as its original value of use is based on the payment network. More about monetary regression theorem, see Mises Wiki (2016). The free-banking currency reform can be practiced more easilyIbid, pp. 739. if people themselves, who have specific and first-hand information, decide which kind of currency units they prefer and want to adopt.Ibid, pp. 737. With currencies having been chosen spontaneously by people in a long human history as gold, silver, etc.,Ibid, pp. 739. Here we must emphasize, that many people who declare that Huerta de Soto only prefers gold as monetary unit, misunderstand and have perhaps not read his claim seriously. Huerta de Soto has never stated that gold is the only monetary unit which we should accept, on the contrary, his point is that any monetary unit which has been spontaneously accepted throughout history, like gold or silver, can be used as a valid substitute for current monetary currencies. In footnote 37 on Ibid, pp. 739-74, Huerta de Soto expresses his understanding of the function of silver as a unit of currency in human history. He says, “[s]ilver could also be considered a secondary, parallel metallic standard which, if economic agents should wish, could coexist with gold at the fluctuating exchange rate determined by the market. Furthermore we must recognize that the decline in the use of silver as money was accelerated when nineteenth-century governments established fixed exchange rates between gold and silver which artificially undervalued the latter.” it is not reasonable to artificially and constructivelySee footnote 36 of Ibid, pp. 738. adopt a new monetary unit.Ibid, pp. 739. Besides, Huerta de Soto also argues that any new currency, like electronic currency, should match the traditional legal principles, that do not allow the systematic economic cycle and recession. Under legal principles, the current currency could be retroacted to the early money accepted spontaneously and evolutionarily, like gold and silver.See footnote 35 of Ibid, pp 738. His second proposal is to establish a free-banking system with 100% deposit, which can avoid economic discoordination caused by the fractional-reserve system.Ibid, pp. 740. According to subjective value theory, individuals know their best monetary preference; thus, in the free-banking reform, people can make better choices between different types of banks than the state.Ibid, pp. 740. In addition, private banks should be reformed completely into free institutions without any state intervention.Ibid, pp. 740. His third proposal is “the obligation of all agents in a free-banking system to observe traditional legal rules and principles, particularly a 100-percent reserve requirement on demand deposits.”Ibid, pp. 742. He argues that only following the traditional legal principles of deposit contracts can we avoid economic discoordination caused by FFS.
2.3. Theory of Dynamic Efficiency
The third great theoretical contribution of Huerta de Soto is his theory of dynamic efficiency. Not only does he review the initial definition of efficiency in history, pointing out the wrong and static definition made by Neoclassical Economics (influenced by mechanical physics), but he also provides the dynamic definition of efficiency from an economic science perspective. Additionally, Huerta de Soto originally contributes to the theory with the relationship between dynamic efficiency and ethics, and he also calls for more academic studies in the approach of dynamic efficiency.
2.3.1. The Review of the Original Definition of Efficiency in History
Huerta de Soto reviews the original definition of efficiency in history, covering both the static and dynamic parts. In ancient Greece, Xenophon defined static efficiency as “the sound management of the available (or ‘given’) resources, to prevent them from being wasted.”Huerta de Soto (2009), pp. 2 Xenophon also defined dynamic efficiency as “the effort to increase one’s goods by way of entrepreneurial creativity; that is, by trade and speculation, more than the effort to avoid wasting the resources already in one’s power.”Ibid, pp. 3.
2.3.2. The Wrong and Static Definition of Efficiency by Neoclassical Economists Influenced by Mechanical Physics
As Huerta de Soto points out, Neoclassical Economics has only developed the definition of efficiency in the static part, but not in the dynamic part. He illustrates that Neoclassical Economists use the same methodology as mechanical physics, replacing “the concept of energy with that of utility”Ibid, pp. 4. and applying “the same principles of conservation, maximization of the result and minimization of waste” to economics.Ibid, pp. 4. Thus, this static definition of efficiency of Neoclassical Economics excludes the real and creative part in human action through which human beings are pursuing efficiency. Huerta de Soto criticizes that “the influence of mechanical physics eradicated the creative, speculative dimension which belonged to the idea of economic efficiency from its very origins, and all that remained was the reductionist, static aspect, which focuses exclusively on minimizing the waste of (known or given) economic resources.”Ibid, pp. 4. Huerta de Soto also criticizes that instead of accepting the dynamic aspect of efficiency present in the human action, welfare economics only understands efficiencyFor more information about welfare economics, see Feldman (1991) and Rothbard (1977). in a static sense influenced by mechanical physics. He says,
“[T]hese standards focus solely on one of the two aspects of economic efficiency, namely the static aspect, which entails the presumption both that resources are given and constant, and that the fundamental economic challenge is to avoid wasting them. Furthermore, when, for example, a company, social institution or entire economic system is to be judged, such criteria completely ignore its Dynamic Efficiency, understood as its capacity to foster entrepreneurial creativity as well as coordination; in other words, the entrepreneurial capacity to seek, discover, and overcome different social maladjustments.”Huerta de Soto (2009), Ibid, pp. 8.
2.3.3. The Dynamic Definition of Efficiency in Economics
After the profound rediscovery of the original definition of dynamic efficiency in history and after analyzing the fallacies of the static definition of efficiency in Neoclassical Economics, Huerta de Soto goes on to define what is the correct definition of dynamic efficiency as an economic concept: creativity and coordination driven by human beings’ entrepreneurship.See part 2, Theory of Impossibility of Socialism in this thesis. From this dynamic perspective of efficiency, we can understand more deeply and clearly how human beings work efficiently: not only preventing the waste of the ‘given’ sources but using entrepreneurship to create and coordinate means to realize their goals. Huerta de Soto points out that “the truly important goal is not so much to prevent the waste of certain means considered known and ‘given’ (the prime objective from the viewpoint of static efficiency) as to continually discover and create new ends and means, and thus to foster coordination while accepting that in any entrepreneurial process new maladjustments will always appear and hence a certain amount of waste is inevitable and inherent in any market economy.”Ibid, pp. 10-11. He also points out that as the ways to prevent waste can be discovered by entrepreneurial creation and discovery, the dynamic perspective of economic efficiency also incorporates the static concept of efficiency in economics. He says,
“[F]or the same entrepreneurial force which propels dynamic efficiency through the creation and discovery of new profit opportunities is precisely the one which achieves the highest degree of static efficiency humanly possible at each moment by coordinating pre-existing maladjustments.”Ibid, pp 11.
2.3.4. Dynamic Efficiency and Ethics
Huerta de Soto’s other great and original contribution is the connection made between the ethics of property rights and dynamic efficiency. The ethics of property rights and dynamic efficiency have not been put in connection by many economists, or others simply believe that the connection between ethics and economics has been already stated in welfare economics: productions can be transferred into social welfare if we find out the “optimum optimorum”Ibid, pp 10. in the condition of given and static sources. Huerta de Soto points out that the ethics of property rights is both the necessary and sufficient condition for dynamic efficiency. This is the necessary condition because obviously if people cannot own the products that they have created for themselves, they no longer have the incentive to seek for profitable opportunities. He states,
“[B]ecause to impede the private ownership of the fruits of each human action is to remove the most powerful incentive to create and discover profit opportunities as well as the fundamental source of creativity and coordination that propels the system’s dynamic efficiency.”Ibid, pp 21.
The reason why the ethics of property rights is also the sufficient condition of dynamic efficiency is that, if property rights can be respected or protected, entrepreneurs can continually create and coordinate resources that are needed in production. Huerta de Soto further argues, “[g]iven the vital drive which characterizes all human beings, an environment of freedom in which they are not coerced and in which their private property is respected constitutes a sufficient condition for the development of the entrepreneurial process of creativity and coordination which marks dynamic efficiency.”Ibid, pp. 21.
Based on Hayek’s theory of spontaneous order,For Hayek’s theories of the relationship between spontaneous order and tradition, see Hayek (1988), pp. 66-88. Huerta de Soto also points out that some existing institutions have already been maintaining and enhancing the entrepreneurial creativity and coordination throughout history, arguing that “certain social institutions carry major significance in transmitting and encouraging the observance of these personal moral principles which, by their very nature, cannot be imposed by force but are nevertheless of vital importance to the dynamic efficiency of society.”Ibid, pp. 22. As a devout Catholic, he also emphasizes the function of religion in the promotion of dynamic efficiency. He argues that by practicing sexual morality through religion or some traditions, people would have a better self-discipline, which is “of crucial importance to the successful working of the social process of creativity and coordination, and to its fostering dynamic efficiency in society as well as possible.”Ibid, pp. 22-23. He says,
“Religion plays an important role in the life of an economy. It transmits from generation to generation certain patterns of behavior and moral traditions that are essential for the rule of law, which makes economic exchange possible. For example, if contracts are not kept, society can fall apart. Religion, not the state, is the primary means for imparting to us a sense of our obligations to keep our promises and to respect the property of others.”Ibid, pp. 274-75.
2.3.5. Call for More Studies on Dynamic Efficiency
As Huerta de Soto points out, there are many fields that could be enriched by the dynamic-efficiency approach: taxation theory; the theory of regulation, interventionism and antitrust legislation; the economic theory of development; macroeconomics and monetary theory; the economic analysis of law, legal regulations and social institutions,Ibid, pp. 28 to 29. etc. In The Theory of Dynamic Efficiency, Huerta de Soto has used the theory of dynamic efficiency to analyze socialism, to develop the theory of free market environmentalism, the theory of liberal nationalism, the libertarian theory of free immigration, the theory of crisis and reform of social security, the critical note on fractional-reserve free-banking, the ethics of capitalism, and the strategy to implement free market reforms. These profound, abundant and original theoretical contributions provide us with an excellent foundation and clues for further studies both in theoretical and applied parts of economics. Especially for the younger generation of economists, who should continue investigating on the concept of dynamic efficiency.
- Conclusion We have reviewed the biography of Prof. Jesús Huerta de Soto, a successful entrepreneur, a profound Austrian School economist, and a tireless fighter for liberty. We also reviewed his original and significant academic contributions to the theory of socialism and entrepreneurship, the theory of bank credit and economic cycles, and the theory of dynamic efficiency. What we as young scholars should learn from Prof. Huerta de Soto, is how to be as entrepreneurial as we can in our research and to be as passionate as possible in our engagement with the ideas of liberty, helping us contribute to the scientific research and attracting more and more people to the philosophy of libertarianism.Tyler Xiong provided thoughtful suggestions on the structures of this article and his help is greatly appreciated.
The works Dr. Gordon mentions are available on Mises.org:
Frédéric Bastiat - The LawMurray N. Rothbard - What Has Government Done to Our Money?Henry Hazlitt - Economics in One LessonLudwig von Mises - Socialism: An Economic and Sociological AnalysisMurray N. Rothbard - Man, Economy, and State, with Power and MarketLudwig von Mises - Human ActionMurray N. Rothbard - An Austrian Perspective on the History of Economic Thought
Presented at the Mises Institute's 2018 Supporters Summit in Auburn, Alabama. Recorded on September 29, 2018.
Private Graduate Seminar. Recorded at the Mises Institute in Auburn, Alabama, on July 20, 2018.
Recorded at the Mises Institute in Auburn, Alabama, on 16 July 2018. Includes an introduction by Jeff Deist.
People generally believe that economics is of interest only to businessmen, bankers, and the like and that there is a separate economics for every group, segment of society, or country. As economics is the latest science to have been developed, it is no wonder that there are many erroneous ideas about the meaning and content of this branch of knowledge.
It would take hours to point out how common misunderstandings developed, which writers were responsible, and how political conditions contributed. it is more important to enumerate the misunderstandings and discuss the consequences of their acceptance by the public.
This first misunderstanding is the belief that economics does not deal with the way men really live and act, but with a specter created by economics, a phantom that has no counterpart in real life. The criticism is made that real man is different from the specter of the “economic man.” once this first misunderstanding is removed, a second misunderstanding arises—the belief that economics supposes that people are driven by one ambition and intention only—to improve their material conditions and their own well-being. Critics of this belief say that not all men are egoistic.
A third misunderstanding is that economics assumes all men to be reasonable, rational, and guided by reason only, while in fact, the critics maintain, people may be guided by “irrational” forces.
These three misunderstandings are based on entirely false assumptions. Economics does not suppose that economic man is different from what man is in everyday life. The only supposition of economics is that there are conditions in the world with regard to which man is not neutral, and that he wants to change the situation by purposeful action. So far as man is neutral, indifferent, content, he takes no action, he does not act. But when a man distinguishes between states of various affairs and sees an opportunity to improve conditions from his point of view, he acts.
Action is the search for improvement of conditions from the point of view of the personal value judgments of the individual concerned. This does not mean improvement from a metaphysical view, nor from God’s point of view. Man’s aim is to substitute what he considers a better state of affairs for a less satisfactory one. He strives for the substitution of a more satisfactory state of affairs in place of a less satisfactory state of affairs. And in the satisfaction of this desire, he becomes happier than he was before. This implies nothing with reference to the content of the action, nor whether he acts for egoistic or altruistic reasons.
To eliminate the misunderstanding that arises when a distinction is attempted between “rationalism” and “irrationalism,” it must be realized that what man does consciously is done under the influence of some force or power which we call reason. Any action aimed at a definite goal is in this sense “rational.” The popular distinction between “rational” and “irrational” is entirely without meaning. Examples of “irrationalism” cited are patriotism or the purchase of a new coat or a symphony ticket when something else might have appeared a more sensible action. The theoretical science of human action presupposes only one thing—that there is action, i.e., the conscious striving of individuals to remove uneasiness and to substitute a more satisfactory state of affairs for one that is less satisfactory. No judgment of value is made as to the reason or content of the action. Economics is neutral. Economics deals with the results of value judgments, but economics itself is neutral.
Nor is there any sense in trying to distinguish between “economic” and “non-economic” actions. Some actions deal with the preservation of man’s own vital senses and necessities—food, shelter, and so on. Others are considered to be driven by “higher” motivations. But the value placed on these various goals vary from man to man, and differ for the same man from time to time. Economics deals merely with the action; it is the task of history to describe the differences in goals.
Our knowledge of economic laws is derived from reason and cannot be learned from historical experience because historical experience is always complex and cannot be studied as in a laboratory experiment. The source of economic facts is man’s own reason, i.e., which we call in epistemology a priori knowledge, what one knows already; a priori knowledge is distinguished from a posteriori knowledge, knowledge which is derived from experience.
Regarding a priori knowledge, the English philosopher John Locke [1632–1704] developed the theory that the human mind is born a blank slate on which experience writes. He said there was no such thing as inherent knowledge. Gottfried Wilhelm von Leibniz [1646–1716], a German philosopher and mathematician, made an exception in the case of the intellect itself. According to Leibniz, experience does not write on empty white pages in the human mind; there is a mental apparatus present in the human mind, a mental apparatus that does not exist in the minds of animals, which makes it possible for men to convert experience into human knowledge.
I am not going to enter into the argument between “rationalism” and “empiricism,” the distinction between experience and knowledge, which the British philosopher and economist John Stuart Mill [1806–1873] called a prioristic knowledge. However, even Mill and the American pragmatists believed that a prioristic knowledge comes in some way from experience.
The way in which economic knowledge, economic theory, and so on relate to economic history and everyday life is the same as the relation of logic and mathematics to our grasp of the natural sciences. Therefore, we can eliminate this anti-egoism and accept the fact that the teachings of economic theory are derived from reason. Logic and mathematics are derived in a similar way from reason; there is no such thing as experiment and laboratory research in the field of mathematics. According to one mathematician, the only equipment a mathematician needs is a pencil, a piece of paper, and a wastebasket—his tools are mental.
But, we may ask, how is it possible for mathematics, which is something developed purely from the human mind without reference to the external world and reality, to be used for a grasp of the physical universe that exists and operates outside of our mind? Answers to this question have been offered by the French mathematician Henri Poincaré [1854–1912] and physicist Albert Einstein [1879–1955]. Economists can ask the same question about economics. How is it possible that something developed exclusively from our own reason, from our own mind, while sitting in an armchair, can be used for a grasp of what is taking place on the market and in the world?
The activities of every individual—all actions—stem from reason, the same source from which come our theories. Man’s actions on the market, in the government, at work, at leisure, in buying and selling, are all guided by reason, guided by choice between what a person prefers as against what he does not prefer. Reason is the method by which a solution (whether good or bad) is reached. Every action can be called an exchange insofar as it means substituting one state of affairs for another. Hopefully the actor is substituting a situation he prefers for one which he likes less.
The starting points for the natural sciences are the various facts established by experiment. From these facts, theories are built to more and more abstractions, to more and more generalities. Final theories are so abstract that they are practically inaccessible to the general multitude. That doesn’t make them less valuable; it is enough that they are accessible to the few scientists.
In an a prioristic science, we start with a general supposition—action is taken to substitute one state of affairs for another. This theory—meaningless to many—leads to other ideas that become more and more understandable and less abstract.
Natural sciences progress from the less general to the more general; economics proceeds in the opposite direction. Natural sciences are in a position to establish constant relations of magnitude. In the field of human action, no such constant relations prevail, so there is no opportunity for measurement. The value judgments which spur men to act, which lead to prices and market activity, do not measure; they establish distinctions of degree; they grade. They do not say “A” is equal to, or is more or less than “B.” They say, “I prefer A to B.” They don’t establish judgments. This has been misunderstood for 2000 years. Even today there are many persons, even eminent philosophers, who misunderstand this completely. It is from the system of values and preferences that the price system of the market arises.
Aristotle wrote, among other things, about the various attributes of men and women. He was often mistaken. Had he asked Mrs. Aristotle about women, he would have found he was mistaken in some respects; he would have learned differently. He was also mistaken in stating that if two things were to be exchanged on the market, they must have something in common, that they were being exchanged because they were equal. Now if they were equal, why was it necessary to exchange them? If you have a dime and I have a dime, we don’t exchange them because they are the same. It follows, therefore, that if there is an exchange, there must be some inequality in the items being traded, not equality.
Karl Marx [1818–1883] based his theory of value on this fallacy. In Capital and Interest, by Eugen von Böhm-Bawerk [1851–1914], see Chapter XII dealing with Marx (“The Exploitation Theory” in Volume I, History and Critique of Interest Theories). Long after Marx, Henri Bergson, in a much-admired book about the two sources of morals in religion, accepted the same fallacy—if two things are exchanged on the market they must be equal in some way. But things that are “equal” are not exchanged; exchanges take place only because things are unequal. You take the trouble of going to the market because you value the loaf of bread more highly than the money you give for it. People exchange things because at that time they prefer other things to money. An exchange never occurs with the intention of a loss. The acting man is never pessimistic because his action is inspired by the idea that conditions can be improved.
The aim of action is to substitute a state of affairs better suiting the men taking the action than the previous situation. The value of any change in their situation is called a “gain” if it is positive, a “loss” if it is negative. This value is purely psychic, it cannot be measured. You can say only that it is greater or less. It becomes measurable only insofar as things are exchanged on the market against money. As far as the action itself is concerned, it has no mathematical value.
But, you say, this contradicts our daily experience. Yes, because our social environment makes calculations possible insofar as things are exchanged for a common medium of exchange, money. When things are exchanged against money, it is possible to use monetary terms for economic calculations, but only when three conditions are filled:
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There must be private ownership, not only of the products, but also of the means of production;
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There must be division of labor and, therefore, production for the needs of others;
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There must be indirect exchange in the terms of a common denominator.
By and large, given these three conditions some mathematical values may be established, although not precisely. These measurements are not exact because they deal with what took place yesterday, historically. Business financial statements may look precise, but even the money value of an inventory entered at “so many dollars” is a speculative value of future anticipations; the value credited to equipment and other assets also is speculative. The real problem of inflation is that it falsifies these calculations and brings about tragic problems.
Monetary calculations do not necessarily exist in all kinds of organizations or societies. They did not exist when economics began. The earliest humans acted; humans have always acted; but it was thousands of years before the evolution of the division of labor and of a financial apparatus made monetary calculations possible. Monetary calculations developed step by step during the Middle Ages. In their early development they lacked many features we think of today as necessary. (In a socialist system, these conditions would again disappear and make such calculations and measurements impossible.)
The quantitative nature of the natural sciences enables mechanics to make plans and build bridges. If you know what must be built, technology based on the knowledge of the natural sciences is sufficient. The questions are, however: What should be constructed? What should be done? Technologists cannot answer these questions.
In life the materials of production are scarce. No matter what we do there will always be other projects for which the necessary factors of production cannot be spared. There will always be other urgent demands. This is the factor that businessmen take into account in calculating loss and success. When a businessman decides against a certain project because the cost is too high, it means the public is not prepared to pay the price to use raw materials in that manner. Use is made of the available factors of production for the realization of the greatest number of those projects that satisfy the most urgent needs without wasting factors of production by withdrawing them from more urgent to less urgent employment.
To establish this it is necessary to be in a position to compare the outlays of various factors of production. For example, let it be assumed that it is necessary to build a railroad between two towns—A and B. Let us assume that there is a mountain between A and B. There are three possibilities—to go over, through, or around the mountain. A common denominator is necessary to calculate the comparative value. But this can give only a picture of the monetary situation; it is not a measurement. It is an evaluation in the light of present-day needs and situations. Tomorrow conditions will be different. The success or failure of every business project depends upon its success in anticipating future possibilities.
The problem with trying to develop a quantitative science of economics is that many persons imagine that theoretical economics must follow the evolution of other branches of science. The natural sciences developed from being qualitative to being quantitative in nature and many people are inclined to believe that the same trend must take place in economics also. However, there are no constant relationships in economics, so no measurement is possible. And without measurement, the quantitative development of economics cannot take place. Quantitative facts in economics belong to economic history—not to economic theory.
A book titled Measurement of the Elasticity of Demand was reviewed recently by a man now in the U.S. Senate, Paul Douglas [1892–1976], who may even be hoping for higher political office sometime. Douglas said economics should become an exact science with fixed values like atomic weights in chemistry. But this book itself does not refer to fixed values; it refers to the economic history of one definite period of time in one particular country, the United States. The results would have been different if another period of time or if another country had been considered. Within the framework of the universe in which we operate, atomic weights do not change from one period of time or from one country to another. On the other hand, economic values and economic quantities do change from time to time and from place to place.
Economics is the theory of human action. It is a historical fact of great importance, for example, that the usefulness of the potato was discovered by the natives of Mexico, brought to Europe by a British gentleman, and that its use spread all over the world. This historical fact has had important effects on Ireland, for instance, but from the point of view of economic theory it was just an accident.
When you introduce figures into economics you are no longer in the field of economic theory, but in the field of economic history. Economic history is also, of course, a very important field. Statistics in the field of human action is a method of historical study. Statistics give a description of a fact, but they cannot prove any more than that fact. (It is true that some statisticians are “swindlers” and, as a matter of fact, some statisticians in the government were probably appointed merely for that purpose.)
Some people may misinterpret these statements and conclude that the purpose of economics, being a purely a prioristic science, is to develop a program for a future science, and that economics is a theory practiced only by “armchair gentlemen.” Both these statements are wrong. Economics is not a program for a science that doesn’t yet exist. And it is not a science merely for purists. Therefore, we must reject the ideas of some people that one must learn history to study human action. History is important. But you cannot deal with present-day conditions by studying the past. Conditions change.
As an example of what I mean. The National Bureau of Economic Research published a report on the subject of installment selling which appeared on the eve of World War II, on the eve of inflation, and on the eve of government credit restrictions. At the moment when the study was made, it was already “dead”; it dealt with matters that were already past. I don’t mean to say that it was useless. With good brains one can learn a lot from it. But don’t forget it is not economics—it is economic history. What they were really studying was the economic history of the most recent past.
Darwin realized this too. He saw that in studying animals, the animal was killed at the moment when it was dissected for study, so that one could never actually study the animal—one can never study life itself.
The same is true of economics. One cannot describe the present economic system—one can only describe the past. One cannot predict about the future as a result of studying the past. Very often economic historians teach history under the label of “economics.” Even though you know everything about the past, you know nothing about the future.
This week, Mises Weekends features a 1988 lecture from Dr. Hans-Hermann Hoppe on Marxist and Austrian class analysis.
It might surprise some that Dr. Hoppe sees some "intellectual affinities" between Austrianism and Marxism, in the way that each identifies exploitation among a ruling class. Of course, for Austrians, we identify that it is the state — not the bourgeois — that is the threat to the masses. Tune in for a fascinating talk.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audiobook is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
The Mises Reader is intended to give a taste of the many facets of Mises’s thought in a way that accessibly communicates most of his key contributions to the social sciences. It therefore includes excerpts from his larger and more technically demanding works side-by-side with shorter, more introductory articles and lectures. The finished product is sort of an intelligent person’s guide to the work of Ludwig von Mises. It is especially suitable for those with an interest in Mises, but find jumping right into Human Action, Socialism, or The Theory of Money and Credit rather daunting. The hope is to give the reader a survey of Mises’s insights in a format that nourishes his intellectual soul, while also whetting the appetite for his larger corpus of work.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Download the complete audio book (22 MP3 files) here. This audiobook is also available on Soundcloud, Apple Podcasts, Google Podcasts, and via RSS.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Narrated by Millian Quinteros. This audio book is made available through the generosity of Mr. Tyler Folger.
Many critics of Mises are attacking a caricature of what Mises called praxeology — which is simply logic applied to human choice, or action. Text version: "3 Ways the Critics Get Praxeology Wrong". Narrated by Chris Calton.
Quarterly Journal of Austrian Economics 20, no. 3 (Fall 2017)Abstract: Shawn Ritenour provides a review of my two-volume book Money, Banking, and the Business Cycle in the Winter 2016 issue of this journal. In his review, he provides a number of criticisms of the book and offers some compliments of the book as well. While I appreciate the compliments, most of the criticisms are not valid. In this response, I explain why it is that more money in the economy leads to more profits. I also show the difference between making a distinction between the rate of profit and the interest rate and saying they are independent of each other. Furthermore, I discuss the effect of changes in interest rates versus changes in the rate of profits. I discuss criticisms of Objectivist philosophy as well.
KEYWORDS: Austrian school, business cycle, net consumption-net investment theory of profits, profit, interest, ObjectivismJEL CLASSIFICATION: E14, E32
DEIST: Let’s begin with your assessment of the state of Austrian economics today.
MURPHY: Well, the first thing is that it’s so much bigger than it was. I’m relatively young, but even when I was going through grad school in the early 2000s, there was still a question we asked ourselves, “If you’re a grad student in Austrian economics, do you advertise that fact or do you engage in what they were calling the stealth strategy?” With the stealth strategy, you just keep your perspective to yourself, get published, and do your dissertation on a mainstream topic. You get yourself into a school, get tenure and only then do you say “surprise, I’m an Austrian.”
Now, though, the advice that people are giving is “you want to, by all means advertise that fact because we have enough of a foothold in various places that you’ve got to let them know that you’re an Austrian because if they’re looking to hire somebody who thinks like that, you’ve got to stand out from the crowd.
And so, that’s just the most immediate thing that comes to my mind. So yes, we do have — and unfortunately it took the financial crisis to make this happen — a certain amount of recognition now. We’re definitely getting out there more.
One last thing I’ll mention: when I’m talking to a crowd of financial professionals and I show them what I think happened with the housing boom and bust, I’m using Austrian business cycle theory, but I’m not using that term necessarily. I’m just explaining how the Fed blew up a bubble, and so on. And they all soak that right up. They don’t bat an eye. That sounds perfectly plausible to them.
DEIST: Austrian economics is also becoming increasingly integrated into the larger profession. Do you think the term itself still has value, as a loose term of convenience? Or do you think we should jettison it and focus on individual Austrians and their impact?
MURPHY: It’s a tricky question. I think it was Milton Friedman who kind of flippantly said there’s just good economics or bad economics and I get that, but on the other hand, there really are schools of thought, and that’s a separate discussion as to why that is the case in economics. In physics, you don’t necessarily have it, but I think that’s partly because the social sciences are different from the natural sciences and it really does matter, and there are reasons that things that make sense in physics don’t necessarily translate over to economics.
I do think there are schools of thought and so I don’t think it’s helpful to get rid of the term. I’ll put it to you this way. The kind of people who aren’t going to like it because of the label, I don’t think you’re going to convince them by switching the label to something else like coordination economics or whatever some of the other phrases are that have been offered. I’m being a bit of a hypocrite because I just mentioned that when I speak to a crowd of financial professionals, I don’t necessarily volunteer right off the bat, “Hey everyone, this is the Austrian theory of the business cycle.” Depending on how much time I have, I might get back with them and say hey, if you want to learn more, this is coming from Ludwig von Mises and F.A. Hayek, you may have heard of them. I’ll do that because with some crowds, if you say this is the Austrian explanation, you’re kind of telling them, this is something that is an obscure theory and so they might somewhat shut down. They think that you’re lecturing them and just giving them some irrelevant hobby horse. It depends on the crowd, but in terms of being a professional academic economist and publishing, I certainly think we need journals dedicated to Austrian economics.
DEIST: What about economics as a profession. Is economics doing any good? Does it benefit society? Its models certainly seem useless at predicting or explaining anything.
MURPHY: That’s a good question. I’m thinking, if everybody just took a standard principles class on microeconomics, even on net, that makes the world a better place. I don’t necessarily mean a microeconomics class taught by one of my buddies, either.
Just seeing the arguments about rent control, just to know what tradeoffs are, to realize that there’s scarcity, that kind of stuff, I think that helps people. In general, the kind of information that would be covered, even if they used a standard textbook.
It gives them enough of a foothold, a grounding to think critically and better understand the purpose of high prices when there’s a natural disaster, and the politicians start talking about “price gouging.” It is easier to get that message across to somebody who has literally at least taken one economics class in his or her life.
But, beyond that, economics is not necessarily helpful to people. The way that macroeconomics is taught in standard courses, I think that’s actively harmful. They begin to think, “Spending’s what drives the economy.”
So, yes, I think you don’t really need that many economists walking around. There are way too many people going into the field of economics in terms of what I think is actually useful socially.
The stuff you would learn in a basic principles micro class, that’s pretty helpful because that’s what Austrians would think of as normal price theory, and it helps people to think like an economist. I guess that’s the way I’ll say it. People should know how to think like an economist. Students should know what it means to think like an economist just like a well-rounded student should know what’s utilitarianism is, what did this philosopher think, what happened to ancient Rome, and so on. These are basic things one should know to be an informed citizen, and some of them are learned in economics classes.
DEIST: What is the state of economics in terms of its place in academia? We judge professors by their ability to publish in relatively obscure journals, journals that few people read, rather than judging them by their teaching ability.
MURPHY: Yes, it’s a good question and I’m a little bit cynical on this, so take it with a grain of salt. But something’s screwed up with the system.
An example of this can be found in the so-called “replication crisis” in other areas of the social sciences where new results have been published in areas that people thought were rock solid. Now, researchers are going back and trying to replicate those results and are not able to do it in a shocking number of cases. And so, there is this growing realization in the social sciences generally — not just economics — that maybe we don’t have things figured out as much as we thought we did.
And with economics in particular, it really was an eye opening experience for the profession. It has been a crisis for the profession in the sense that there have been guys like Robert Lucas, and other heavyweights in the 2000s who had said things along the lines of “We basically solved the business cycle, we can move on now to something else.” Well, that clearly wasn’t the case, but the hubris and overconfidence is pretty shocking.
Just to go back to the distinction between the natural sciences and the social sciences, people a lot of times pooh-pooh Mises on this and state, he was an obscure person making these medieval distinctions. But it really is true that it’s important to realize that the techniques are different and that’s why it can still be the case that Keynesians and Austrians — and Chicago school, for that matter — argue about what happened in the 1930s, and why we still argue about was the Obama stimulus good or bad.
As a result, the state of the literature in economics, it’s not good. I think people would be shocked to learn the details of the economics models we were using when I was in graduate school 15 years ago.
The standard workhorse models you would learn there, they would have one consumer or one household who lived forever and they would have one representative firm. It was a very simplistic model. The profession doesn’t use these models because the scholars are lazy. It was just because the full mathematical model gets really complicated and so to be able to “solve a model,” by which they meant lay out what the equilibrium states were, it couldn’t get too complicated. Otherwise, you wouldn’t be able to solve it.
And so, you have people informing monetary policy and writing academic papers telling the Federal Reserve what it should do in certain circumstances. But the underlying model was incredibly crude.
Just think, if NASA said they were going to send a manned mission to Mars, but their model didn’t include moons because they didn’t have enough computing power. That would make you think, “I don’t want to get on that spaceship.” But, that’s the kind of reasoning that’s going into what’s guiding the Federal Reserve. So, to answer your question, I understand why, if you thought economics was a science like physics, it would make sense that you wouldn’t want Einstein and Niels Bohr and such heavyweights to be bogged down by teaching undergrads basic principles about Newton’s Laws, that would be crazy. You’d want them sitting in the lab or writing the latest cutting-edge research.
But with economics, I think the latest cutting-edge research is very flawed and so that sort of analogy breaks down. The good that economists do is in teaching basic principles like scarcity and opportunity cost to the general public so they can at least evaluate political claims, even if they’re not reading the latest thing in the American Economic Review.
DEIST: As a student and a scholar you’ve spent time at Hillsdale, at NYU, and now at Texas Tech. Do you think the undergraduate and graduate education model in general — which is very costly in terms of time, debt, and money — is broken, or do you think it’s salvageable?
MURPHY: I think it’s unsustainable at the current scale and I was saying this even when I was a professor at Hillsdale. That was back from 2003 to 2006, and at that point, I felt like half of the students that were going to college shouldn’t have been there.
This isn’t a knock against those students. I’m not saying they weren’t smart enough. That’s not even the issue. You could clearly tell, there were plenty of students that were there to get a business degree or something similar and they were only taking my class because they had to check a box to get a degree. They weren’t interested in economics, and their real goal was to run the family business and get an MBA. There’s nothing wrong with that, but it just meant that half the people in class had that attitude, and that affected the way you could teach. The result was that everybody was kind of miserable. Many of the people who were there didn’t really need to be in college. They should have gone right into the workforce after high school or gone to a trade school. They were miserable. But then there were other students that were there because they loved learning for its own sake — they were also miserable because you couldn’t teach just to them because that would leave everybody else behind.
How this system is funded makes a big difference and if genuine market forces were allowed to work that could be a big part of how the problem could eventually fix itself.
The effects of the current subsidized system can be seen this way: I say to people, do you think everyone in the United States should get a PhD before they get a job? And of course that would be crazy. It would be very expensive, most people would be miserable, and it would lower the quality of what does a PhD mean if everybody as a matter of course gets one. Having a PhD would then be no big deal. By the same token, why do we just assume, “Oh, you’ve got to go to college or else you won’t get a good job.” That’s kind of crazy when you see what it means in practice. The stereotypes about students partying all the time are true. I’m not just talking about big huge state schools, but I’m including many schools I’ve visited and seen — which are somewhat elite private liberal arts schools. So the stereotype of what many students really spend their time doing is not completely made up out of whole cloth. And nowadays they’re coming out of school with tens of thousands of dollars of debt and they can’t even get a job. So, clearly that system can’t last.
DEIST: Turning back to the profession itself, what do you see as the dominant thought in economics today? Has Keynesianism led to “neo-liberalism,” whatever that is?
MURPHY: Even though we might like to make jokes about it, it is true that the average economist is generally a fan of markets. They’re not rabid laissez-faire, obviously. With most economists, though, they know socialism doesn’t work and they understand that yes, the way to bring prosperity to the third world is not just a matter of sending them aid. There’s a growing realization that yes, they need to have private property rights and solid social institutions, and that it’s not just a mere matter of technology.
So, there is a growing acknowledgement of the importance of those social institutions and that’s a good thing. But on the other hand, there is hostility toward the term neo-liberal — the critique is a little bit off with the people who rail against neo-liberalism and they complain about the World Bank and the IMF foisting free trade policies.
That’s all misguided, but the people who criticize neoliberalism are not just making all the negative aspects of it up. It is true that in many cases, this is what happens: In the stereotypical, paradigmatic case, there’s a country that maybe the military takes over. They’re in a shambles. They need foreign currency because they’ve been running their own printing press and so yeah, the World Bank or the IMF might come in and impose an “austerity” program on them. The World Bank and IMF say “yes, you have to liberalize, get rid of your state run enterprises. You need to tie your currency to gold or do these other things tied to the dollar. Open up your markets to imports.”
And some of that is coming out of a textbook for economic policies moving toward markets. But a lot of it is causing the citizens in that country to eat the losses that were imposed on them by their corrupt ruling regime as opposed to just letting the government suffer the consequences of years of mismanagement. The people again, they smell a rat and I think they’re largely correct.
They know that these outsiders are coming in and they don’t have their people’s interests at heart and they’re in bed with these big corporations and other huge nongovernmental organizations. So, I think they’re right to be suspicious. It’s just that their conclusion is “something’s wrong with capitalism per se.” Then, obviously, they come to the wrong conclusions.
DEIST: Last year, the economist Richard Thaler won the Nobel Prize in Economics for his work in behavioral economics and he’s being lauded as someone who has integrated economics with psychology. Of course, 70–80 years ago, Mises and the Austrians were talking about what humans actually do. Has behavioral economics borrowed from Austrianism?
MURPHY: It’s a difficult question to answer and I don’t know that I have enough interaction with certain regular mainstream economists who are not familiar with the Austrian tradition to be able to give a confident answer. There are two ways of looking at it and I’ve seen this reaction among my colleagues, either pessimism or optimism in reaction to the announcement that Thaler won. So, the good way to look at it is to say, “Oh, this is great, at long last the mainstream profession is admitting problems with the standard neoclassical textbook models of how rational economic man operates. That’s not how real people behave and so thank goodness, the mainstream finally kicking and screaming has been dragged to the point where they’re willing to admit it.”
So, there’s that element, but on the other hand — and here’s where the pessimist’s take comes in — it’s sort of like this: yes, the mainstream’s finally realizing what thinkers like Mises were saying long ago, that the way to model human behavior, if you will, is not to try to come up with a precise mathematical description that makes quantitative predictions.
But that’s not what the people who are embracing Thaler are saying. What they’re saying is “okay, so now we’re going to refrain from this hubris in trying to predict behavior and treat people like automatons.” But, for them, that just means updating the model. It’s not that they’re trying to get rid of mathematical modeling of people, they’re just trying to make the math model more accurate.
And so, if what you think is no, they’re fundamentally going down the wrong path here and that’s not the way to approach economic science, it’s a bit disheartening. Also, it’s unavoidable to bring up the fact that Thaler is involved with the whole “nudge” literature and using this knowledge of how people respond to incentives to say, “this is the way we can influence people, this is the way we can modify their behavior in ways that we economists desire.” In some settings, that’s pretty creepy.
DEIST: When Thaler claims that humans don’t always act rationally, he’s not refuting Mises — he’s simply not distinguishing between action and motivation.
MURPHY: Oh, absolutely, right. And this is again sort of the frustration one might have with Thaler. So, the neoclassical mainstream, when they say, as a working assumption, “we assume people are rational, that means people solve their economic optimization problems the way a mainstream economist would.” And so, number one, it means that people are experts at using calculus and solving difficult mathematical problems. Here’s your budget constraint and what’s your consumption path over time? This is stuff that grad students initially don’t even know how to solve because it’s too hard mathematically. And yet, economists routinely assume that consumers, when they go to the store, are able to unconsciously do the same problem.
Beyond that, there’s the way economists talk about what rational behavior is looking at in a strategic setting. One example of this is the so-called Prisoner’s Dilemma. Even if people play a situation like that a thousand times in a row, mainstream economists will say the “rational thing” to do is to keep screwing the other guy a thousand times in a row, even if they could be better off by cooperating.
But no, cooperating's not the way you solve the model, so it’s therefore “not rational.” There’s that element. So yes, when Thaler says “hey, people aren’t rational,” what he means is they behave in ways that this narrow economistic model would not have predicted. In contrast, when Mises says people are rational, all that means is “they’re engaging in human action to try to achieve some goal that they value.”
Assigning motives is not the approach you take when someone throws a rock up in the air and then it comes back down, we don’t say, “ah, the rock desired to be closer to the earth and that’s why it chose to do so.” No, we use a completely neutral, objective measure without any motivation or preferences involved because that’s the way that science has gone. In our minds, that’s the correct way you deal with predicting the motion of matter.
But when it comes to the social sciences, we do attribute motives to people, so that’s what Mises means by rational, there’s a reason, so that’s where reasoning comes in, not that the people are superhuman calculators, just that yes, they’re a being with an ego and they have preferences. But those preferences could be anything. It could be, you want to go get cocaine or heroin, or it could be you want to go help set up a homeless shelter. From that level of analysis, it doesn’t matter what the content of your preferences are, it’s just that you have them and then you use your reason to try to achieve it. So, the classic example that Mises offers is, you’re looking at some primitive tribe — primitive by your standards — and they’re dancing around and their crops need rain. A rain dance is perfectly rational in the Misesian framework. Because again, it doesn’t mean that “from our scientific viewpoint, we think that’s the right means to an end.” We just mean, “ah, I’m going to interpret what I’m observing by saying these beings have subjective preferences and they have this cause and effect relationship in their minds that they’re trying to invoke to change the future.”
DEIST: There are endless debates within Austrian circles about how best to advance our ideas. The two broad ideas have been what we might call a Hayekian top-down model, where we win over academics and their ideas trickle down to other intellectuals. The other we might call a bottom-up Rothbardian populist strategy.
MURPHY: It’s going to sound like I’m trying to be wishy-washy and not take a firm stand, but I really do think both are important and I mean it in the following way.
Part of why Mises, Hayek, and Rothbard were so able to influence the masses, is that they had academic posts. If Murray Rothbard had written word for word Man, Economy, and State and you found out that he was a chiropractor and he just in his spare time was this genius who had absorbed Human Action, it wouldn’t have carried the same weight. And in a sense, that’s a shame, that shouldn’t matter. Credentials shouldn’t matter, but yet they certainly do, if only just to guide people. You might just say, “this huge thick book that a chiropractor wrote on economics, what are the chances that this guy knows what he’s talking about?” So, I think it is important that Austrians, to get their message out — to change the world to use a bold goal — they can’t abandon academia.
Appealing right to the public is also a good thing, as opposed to just spending one’s whole life trying to convince academic colleagues and trying to convince the Dean of Harvard to take your business cycle seriously. I think that’s a waste of time when you’re setting yourself up for heartache and frustration. The idea of just teaching students and publishing peer reviewed papers for the rest of your life and going to conferences and talking with other economists — to some people, that sounds like the most horrible hell ever, and to some people, that sounds great. So, if you’re in the latter group then by all means do that, but again, it’s because that will give you a platform so that the public is more likely to listen to you. Also, if you get something like an op-ed published in a newspaper, you’re more likely to be able to do that if the byline says that you’re an Economics Professor at such and such university. I definitely do agree that going to the masses is the important thing to do right now, as opposed to tweaking the latest mathematical economics model. But again, that doesn’t mean you should ignore academia because I think there’s an interplay there.
DEIST: As a strategic matter, are some of the debates within Austrian economics harmful or helpful in your view? For example, there are debates about Mises versus Kirzner on entrepreneurship or Rothbard and Hoppe versus Selgin and White on free banking. Do you think we ought to spend time on these internal debates?
MURPHY: Well, I’m going to be debating Selgin on fractional reserve banking in New York at some point in the spring of 2018, so I hope that’s not a waste of time, I hope it’s useful.
I definitely understand the people who say, come on, guys, these internal battles, they’re not productive and they just make us look like a weird cult. I understand where those people are coming from and I used to be somewhat sympathetic when I was younger. But on the other hand, you could just as well flip it and say, well wait a minute, if we’re supposed to be a science, then of course we’re going to debate with each other and disagree. If we all just uniformly had the same answer on everything to put on our show for outsiders to where we’re trying to attract followers, that would be creepy too. That reallywould be a cult.
And so, I don’t think that to gain popularity, we ought to restrict our arguments — even if that strategy actually worked. I reject that in part because it means we’re sort of being dishonest to the public and I don’t want to do that. I’m not personally going down that road if that’s what we’ve got to do to gain popularity. But having said all that, I actually don’t think that that’s really the trade-off.
I think what is true, and it is true for anything in life, is you don’t need to be a jerk about it. I get the sense that sometimes there are people within the Austrian camp who genuinely just dislike some of the other people and they want to have a fight and they use these particular doctrinal differences as the pretext to have a fight with someone they don’t like. And yes, that’s probably not productive — just because in general, going around having a grudge against somebody is not helpful. I think that these debates are important and because that’s how it’s going to progress, that actually the critics are wrong. This isn’t a cult, it’s not that we look at Mises and Hayek and Rothbard as our prophets and we’re not allowed to disagree with them. No, that’s not true at all and so there is a vigorous disagreement and that’s how this thing progresses. Yes, be civil about it, but if there’s somebody you think is wrong, then it’s your job as a scholar to try to correct it.
DEIST: A few years ago, you had some run-ins with the aforementioned Paul Krugman, also Brad DeLong on issues like quantitative easing and inflation and Austrian business cycle theory. How do you assess those run-ins today?
MURPHY: For people who don’t know the backstory: After the financial crisis, a woman emailed me and she said, “I just saw Paul Krugman in a Barnes and Noble and he was on a book tour. In the Q&A period, I asked him ‘why don’t you debate Austrians on business cycle theory?’ His answer was, ‘this is going to sound elitist, but mainstream economists, the profession doesn’t listen to those guys anymore. They were big like in the 20s, but they’ve been eclipsed since then, so I wouldn’t give them a platform.’”
And so then I thought, “okay, well he’s going to ignore us that way, so I have to somehow provoke him.” I set up this goofy effort to challenge him to a debate, and then we were going to raise money to go to a New York City food kitchen, if he debated me. And so, that was kind of a publicity stunt. It was kind of funny, but I think that’s why he knew who I was and why he specifically attacked me later. Obviously, he was not happy with my shenanigans.
The official CPI did not jump as much in response to the Fed’s quantitative easing as I predicted in those years right after the Crash of ’08. Then Brad DeLong and Paul Krugman noticed people arguing on my blog and responded, “Aha, these Austrians, what a bunch of religious people here in the sense that they don’t respond to objective evidence. This guy Murphy made a prediction, he was wrong and yet he’s not updating his model.”
This shows how slippery these guys were because the economists I was busy debating about QE were not exactly in agreement with DeLong and Krugman. Bryan Caplan at George Mason is an anarcho-capitalist, for example, and Krugman and DeLong obviously weren’t about to declare Caplan right. Obviously, they didn’t say “anarcho-capitalism is vindicated because that anarcho-capitalist Bryan Caplan was right and Murphy was wrong.”
In their minds Keynesianism was right, even though there was nothing expressly Keynesian about QE. And the jury is still very much out concerning what the ultimate effects of monetary expansion willbe now that the Fed says it will reduce its balance sheet over the next few years. Admittedly, though, I should have been more careful with predictions that reflected my personal view. I mean, Austrian economists, number one, don’t make quantitative forecasts based on Austrian theory, per se. That’s one of the hallmarks of Mises’s view, if you think you’re going to predict the stock market just by using praxeology, then you’ve misunderstood what praxeology does for you.
So, there’s that element. But also, the Austrians themselves make important distinctions when it comes to price inflation. In the 1920s, the Austrians were saying just because there’s not rampant price inflation, doesn’t mean things are good. But since I had been poking Krugman and some people were learning their Austrian economics through my writings, I should have been more careful. And this is what I say to this day at Mises U and at other events with students: whether it’s fair or not, we’re in the minority, the mainstream is going to use any excuse to discredit us. And so, it’s sort of like you’re representing Austrian economics and watch yourself and don’t commit unforced errors.
That’s sort of my takeaway. Ben Bernanke, for instance, made a string of mistaken predictions, and you can go watch them on YouTube. You can see just how wrong he was time and time again going up to the crisis, and of course, Krugman, once Bernanke got reappointed was lauding him on his blog and saying, there’s nobody he would rather have at the helm of the Fed than Ben Bernanke. So, obviously Krugman doesn’t think a bad prediction disproves a theory. But when an Austrian gets caught losing one particular bet to other free-market guys, that’s somehow supposed to discredit an entire theory.
DEIST: What do you say to young people who ask you whether they ought to pursue a PhD, in economics or otherwise?
MURPHY: One thing I’ll do right away is just say, do you want to teach or at least is that acceptable to you? Could you imagine that is your day job for the rest of your life, that you’re at a college teaching the students and writing peer reviewed papers and if the answer is yes, then I say yeah, by all means, go ahead and go into it.
But if the motivation is “I really love Austrian economics or libertarianism and the free market and I guess, gee, the next logical step is to go get a PhD,” then I would say be careful and caution them that they could be wasting some valuable years of their lives.
Fortunately, a PhD in economics is more marketable beyond just academia — compared to, say, a PhD in philosophy. So, there is that element that you’re not as constrained if you get a PhD in economics as you would be in some other fields.
But, I do caution them that if you’re not sure if you want to go into academia, a PhD might be not worth the cost, all things considered. And I don’t mean money. I mean the time, the available years that you’re losing time you could have been out earning experience in industry or whatever you’re going to do with your life.
If you are going to go into it, though, be sure to work on research that you’re passionate about because that’s going to be the thing you’re known for. You’re going to be a world expert in this little thing that your dissertation’s on. You’d better be interested in it.
Another upside to the degree is there’s a huge area of overlap between financial economics and Austrian economics. A lot of the conflict between Austrians and other schools isn’t there when it comes to talking to people in the financial sector. I think there are a lot of applications that young Austrian economists in academia could do by publishing articles relevant to a financial crowd as opposed to the more official economics journals.
DEIST: Finally, you have been outspoken on your personal blog and otherwise about your own Christian beliefs. Why have you chosen to be outspoken about this and do you think that this has in any way helped or hindered you career wise?
MURPHY: It’s a great question. I’m outspoken on it just for the obvious reason that if you’re a Christian, that’s the most important thing, period. And so, why you would be focusing on other things and not talking about that is problematic if you really are a Christian. If you believe that the state of people’s souls are resting on an issue, that’s far more important than the heterogeneity of the capitalist structure. But, as far as whether it is helping or hurting, I really can’t say. My guess is that there are plenty of my colleagues who are agnostic or outright atheists who might see the things that I post on Sundays on my blog and think, “Bob’s very rational, but I’m glad he can compartmentalize because when he talks about economics, he’s real smart and rational and gee, when he starts talking about the Bible I just don’t get it.”
I’m sure there’s plenty of people who think like that, but I think probably they just say well, there’s a lot of religious people and that’s just how they were raised and they move on and they kind of give us a pass, if you will. So, to be honest, I don’t think it’s really hurt me. I do consulting work in the insurance sector, and not that anything in terms of professional relationship has anything to do with a religious litmus test, but I have noticed just as I reflect, that a lot of the people that I work the most closely with in that realm are also Christian.
I think it’s more of a worldview thing, that the kind of people who believe in the Bible, they see the world a certain way and so, if they hear me talking about the Federal Reserve, that’s going to resonate with them even if we’re not literally talking about scripture. I do think this sort of goes back to what we were saying about the state of Austrian economics. Some people might say, “You want to keep that to yourself so people don’t blackball you.” But on the other hand, if there is the remnant out there, the minority who thinks like you, they need to know who you are, so they can find you and work with you. I think there’s something like that too with my spiritual beliefs, that hiding it, that’s going to make me feel bad and I’m going to feel miserable, afraid to share my beliefs. But also, you should be a beacon of light to the other people who think like you.
The last thing I’ll say is, it wasn’t that I was worried about professional blowback. In the beginning I was worried about some pretty militant atheists in the free-marketsort-of-libertarian community, and they did hammer me in the beginning but I think they just got bored of it. Things like, “Can’t you see that the state and the church are identical?” They both tell you, you need us, give us your money or you’re going to suffer. I certainly get those superficial similarities, but like I said, it kind of went away and what really encouraged me though, was I got a lot of emails over the years from people saying, “hey, I keep my head down because I don’t feel like fighting with people online, but I’m glad you’re out there doing that.” I used to think I was one of the few Christian libertarians. Now I realize that’s not the case.
Listed and linked below are the readings that all students must complete before attending RGS.
All materials are available on Mises.org free of charge, and most readings are available in multiple formats (e.g., PDF, ePub, HTML, audio). Complimentary physical copies of the readings will be available to attendees upon arrival at RGS. Physical copies can be mailed in advance to U.S. addresses upon request by emailing felicia@mises.org.Required ReadingsHuman Action: Scholar's Edition
Recommended Resources
Human Action Study Guide
Audio: Mises Weekend: Yes, You Should Read Human Action (Jeff Deist, Joseph Salerno, and Karl-Friedrich Israel)
Schedule The conference begins with dinner and opening remarks, Sunday, June 6, at 6:00 p.m. Central Daylight Time, and ends with dinner Friday, June 11. A final schedule will be posted here before the event, as well as emailed to each attendee.
Accommodations will be provided with arrival Sunday, June 6, and departure Saturday, June 12. Details forthcoming.
Travel Information Tiger Taxi provides transportation to Auburn from airports in Atlanta, Birmingham, Montgomery AL, and Columbus GA. Reservations and payment can be made on this page. Atlanta and Birmingham are about an hour and 45 minutes from Auburn. Montgomery and Columbus are about an hour from Auburn. Groome Transportation provides transportation to Auburn from Atlanta airport. Reservations and payment can be made on this page. Driving directions are here. Parking is free at the Institute.
Attire Casual, but appropriate for an office environment. Nice jeans or khakis, collared or polo shirts.
Mises's Socialism is one of the great classics of 20th-century social science. It contains the famous calculation argument, refuting the possibility of socialism; but it also covers much more.
In our new online course, "Themes from Ludwig von Mises’s Socialism," Dr. David Gordon walks through the major themes of Mises's treatise. Students who complete the course will gain a good working knowledge of an essential work of the Austrian school.
As an enrolled student, you can watch lecture videos, review and download lecture materials, take quizzes, and utilize a full list of all readings.
This course is provided free to access by the Mises Institute. Please consider a donation to support more courses!
David Gordon joins Jeff Deist to consider the important philosophy—and philosophers—libertarians need to know. Starting with Mises's influences in Human Action, Dr. Gordon moves through the 20th century with a great discussion of John Rawls and Robert Nozick. He also suggests the books that Austro-libertarians need to read, even if they're primarily interested in politics or economics.
Dr. Joe Salerno and Karl-Friedrich Israel join Jeff Deist to discuss Mises's Human Action, perhaps the greatest treatise on economics ever written. But the book can be daunting for many, given its length and the sheer enormity of the systematic thought it presents.
Our guests break down how and why everyone should read it, echoing Mises's belief that economics was the proper area of study for every thinking person. This is a great discussion of the history and behind a masterpiece of economics, epistemology, and philosophy. Read it free here!
Enroll in 2017's Virtual Mises U for only $20 (free for Mises Institute members thanks to the Richard E. Fox Foundation)
For almost thirty years, Mises Institute scholars have presented Mises University, a world-class, week-long, intensive mini-university in Austrian economics. Virtual Mises University is the online component of this seminar for students, professionals, business people, absolutely anyone, anywhere who is interested in the pursuit of economic truth. For Virtual Mises University, there is no time limit, and students can log-on for independent study.
Anyone who desires this in-depth experience online, can enroll in Virtual Mises U for $20. As an enrolled student, you can watch live and archived lectures, review and download lecture slides, utilize a full list of all required readings (just like the on-site attendees), and earn a certificate of completion.
[This series of four articles is a condensation of chapters in Human Action, by Ludwig von Mises, which deal with various forms of government interference with the free market. They were published in the Wall Street Journal, December 12, 13, 14, 15, 1949, and were recently found in a folder of newspaper clippings collected by Murray Rothbard. There is no byline or author name connected to the series.]
The Socialist SocietyIts Crucial Question: Can It Operate As a Workable System?"Economics is a theoretical science and as such abstains from any judgment of value. It is not its task to tell people what ends they should aim at. It is a science of the means to be applied for the attainment of the ends chosen, not, to be sure, a science of the choosing of ends.
"Ultimate decisions, the valuation and the choosing of ends, are beyond the scope of any science. Science never tells a man how he should act; it merely shows how a man must act if he wants to attain definite ends."
This is Ludwig von Mises' approach to economics. For instance, it is not the duty of economics, he thinks, to tell people whether they ought to choose or reject socialism as a way of organizing their economic life. The economist's duty is to determine first whether socialism is a workable system, and if so, what it will do. Arguments about the effect of socialism on men's personal lives, their liberties and happiness, are important — but they are for philosophers, not economists.
Socialism is not a workable economic system. It not only fails to deliver what it promises; it can deliver nothing but chaos.
This is one of the major conclusions in von Mises' comprehensive study of economics and civilization, Human Action, published this fall by the Yale University Press. The Wall Street Journal begins this morning a condensation of the chapters dealing with the economic problems of all the various forms of government interference with the free market. These forms of interference go under many names — communism, the managed economy, the welfare state — but they are all varieties of socialism. And all have one fatal economic flaw.
Only the main conclusions will be presented here. For the reasoning and the elaborate data supporting these conclusions, the reader is referred to the full work, possibly the most important economic treatise of our time.
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The socialist creed rests upon three dogmas:
First: Society is an omnipotent and omniscient being, free from human frailty and weakness.
Second: The coming of socialism is inevitable.
Third: As history is a continuous progress from less perfect conditions to more perfect conditions, the coming of socialism is desirable.
For the study of human action and economics, the only problem to be discussed in regard to socialism is this: Can a socialist system operate as a system of the division of labor?
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- *All older social reformers wanted to realize the good society be a confiscation of all private property and its subsequent redistribution; each man's share should be equal to that of every other.
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These plans became unrealizable when the large-scale enterprises in manufacturing, mining, and transportation appeared. The age-old program of redistribution was superseded by the idea of socialization. The means of production were to be expropriated, but no redistribution was to be resorted to. The state itself was to run all the plants and farms.
This inference became logically inescapable as soon as people began to ascribe to the state not only moral but also intellectual perfection. Then one could not help concluding that the infallible state was in a position to succeed in the conduct of production activities better than erring individuals. It would avoid all those errors that often frustrate the actions of entrepreneurs and capitalists. There would no longer be malinvestment or squandering of scarce factors of production; wealth would multiply. The "anarchy" of production appears wasteful when contrasted with the planning of the omniscient state.
The socialist mode of production then appears to be the only reasonable system, and the market economy seems the incarnation of unreason. In the eyes of the rationalist advocates of socialism, the market economy is simply an incomprehensible aberration of mankind. In the eyes of those influenced by historicism, the market economy is the social order of an inferior stage of human evolution which the inescapable process of progressive perfection will eliminate in order to establish the more adequate system of socialism. Both lines of thought agree that reason itself postulates the transition to socialism.
Karl Marx was not the originator of socialism. Nothing could be added to the description of the socialist system as developed by his predecessors, and Marx did not add anything. What he did was to integrate the socialist creed into this meliorist doctrine. The coming of socialism is inevitable, and this by itself proves that socialism is a higher and more perfect state of human affairs than the preceding state of capitalism. It is vain to discuss the pros and cons; socialism is bound to come "with the inexorability of a law of nature."
The Marxian taboo branded all attempts to examine the economic problems of a socialist commonwealth as "unscientific." Nobody was bold enough to defy this ban. It was tacitly assumed by both the friends and the foes of socialism that socialism is a realizable system of mankind's economic organization. The vast literature concerning socialism dealt with alleged shortcomings of capitalism and with the general cultural implications of socialism. It never dealt with the economics of socialism as such.
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- *The essential mark of socialism is that one will alone acts.
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It is immaterial whose will it is. The director may be an anointed king or a dictator, ruling by virtue of his charisma, he may be a Fuehrer or a board of Fuehrers appointed by the vote of the people. The main thing is that the employment of all factors of production is directed by one agency only. One will alone chooses, decides, directs, acts, gives orders. All the rest simply obey orders and instructions. Organization and a planned order are substituted for the "anarchy" of production and for various people's initiative.
In terming the director society (as the Marxians do), state (with a capital S), government, or authority, people tend to forget that the director is always a human being, not an abstract notion or a mythical collective entity. We may admit that the director or the board of directors are people of superior ability, wise and full of good intentions. But it would be nothing short of idiocy to assume that they are omniscient and infallible.
In an analysis of the problems of socialism, we are not concerned with the moral and ethical character of the director. Neither do we discuss his value judgments. What we are dealing with is merely the question of whether any mortal man, equipped with the logical structure of the human mind, can be equal to the tasks incumbent upon a director of a socialist society.
We assume that the director has at his disposal all the technological knowledge of his age. Moreover, he has a complete inventory of all the material factors of production available and a roster enumerating all manpower employable. The crowd of experts and specialists which he assembles provides him with perfect information and answer correctly all questions he may ask them.
But now he must act. He must choose among an infinite variety of projects in such a way that no want which he himself considers more urgent remains unsatisfied because the factors of production required for its satisfaction are employed for the satisfaction of wants which he considers less urgent.
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- *It is important to realize that this problem has nothing at all to do with the valuation of the ultimate ends. It refers only to the means by the employment of which the ultimate ends chosen are to be attained.
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We assume that the director has made up his mind with regard to the valuation of ultimate ends. We do not question his decision. Neither do we raise the question of whether the people — the wards — approve or disapprove of their director's decisions. We may assume, for the sake of argument, that a mysterious power makes everyone agree with one another and with the director in the valuation of ultimate ends.
Our problem — the crucial and only problem of socialism — is a purely economic problem, and as such refers merely to means and not to ultimate ends.
[The second article will deal with the specific problems of the social planner.]
The Socialist PlannerHis Plight Is That He Can't Plan At All[The private planner in the capitalist society measures his costs and returns — and chooses between alternatives — on the basis of prices set by the free market. Socialist economies substitute government action for the free market; the things called "prices" are controlled by the government, move up or down according to the desire of the moment.
How does the socialist planner plan? Can he do so on the basis of these government-controlled prices? If not, is there some other workable method of making judgments other than dependence on prices? Or need the government planner make economic calculations at all? May he not just plan to do what "ought" to be done and disregard the cost?
Let us say the socialist director has decided what he wants to do. He begins to plan how to do it. ...]
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- *The director wants to build a house.
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Now there are many methods that can be resorted to. Each of them offers, from the point of view of the director advantages and disadvantages with regard to the utilization of the future building, and results in a building's serviceableness. Each of them requires other expenditures of building materials and labor and absorbs other periods of production. Which method should the director choose?
Without meaningful prices, he cannot reduce to a common denominator the items of various materials and various kinds of labor to be expended. Therefore he cannot compare them. The plans of his architects enumerate a vast multiplicity of various material items in kind; they refer to the physical and chemical qualities of various materials and the physical productivity of various machines, tools, and procedures. But all their statements remain unrelated to each other. There is no means of establishing any connection between them.
Imagine the plight of the director when faced with a project. What he needs to know is whether or not the execution of the project will increase well-being, that is, add something to wealth available without impairing the satisfaction of wants which he considers more urgent. But none of the reports he receives gives him any clue to the solution of this problem.
We may for the sake of argument disregard the dilemmas involved in the choice of goods to be produced. We may assume [in the socialist economy] this problem is settled. But there is the embarrassing multitude of producers' goods and the infinite variety of procedures that can be resorted to for manufacturing define consumer goods.
The most advantageous location of each industry and the optimum size of each plant and of each piece of equipment must be determined. One must determine what kind of mechanical power should be employed in each of them, and which of the various formulas for the production of this energy should be applied. Each case offers special conditions and requires an individual solution. The director does not deal with coal as such, but with thousands of pits already in operation and with the possibility for digging new pits, with various methods of mining in each of them, with the different qualities of the coal in various deposits, and with the various methods of utilizing the coat for production of heat, power, and a great-number of derivatives.
Eliminate economic calculation and you have no means of making a rational choice between the various alternatives.
We have assumed that the director has already made up his mind with regard to the construction of a definite plant or building. However, in order to make such a decision he already needs economic calculation. If a hydroelectric power station is to be built, one must know whether or not this is the most economical way to produce the energy needed. How can he know if he cannot calculate costs and output?
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- *For more than a hundred years the substitution of socialist planning for private enterprise has been the main political issue. Thousands and thousands of books have been published for and against the plans. Wars have been fought and rivers of blood have been shed for the cause of socialism. Yet, in all these years the essential question has not been the raised.
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From the writings of the mathematical economists the imaginary construction of a socialist commonwealth emerges as realizable system of cooperation under the division of labor, as a full-fledged alternative to the economic system based on private control of the means of production.
The director of the socialist community [it is alleged] will be in a position to allocate the various factors of production in a rational way, i.e., on the ground of calculation. Men can have both socialist cooperation under the division of labor and rational employment of the factors of production. They are free to adopt socialism without abandoning economy in the choice of means. Socialism does not enjoin the renunciation of rationality in the employment of the factors of production. It is a variety of rational social action.
An apparent verification of these errors was seen in the experience of the socialist governments of Soviet Russia and Nazi Germany. People did not realize that these were not isolated socialist systems. They were operating in an environment in which the price system still worked. They could resort to economic calculation on the ground of prices established abroad. Without the aid of these prices their actions would have been aimless and planless.
Only because they were able to refer to these foreign prices were they able to calculate to keep books, and to prepare their much talked about plans.
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- *We may admit that in its initial period a socialist regime could to some extent rely upon the experience of the preceding age of capitalism. But what is to be done later, as conditions change more and more? Of what use could the prices of 1900 be for the director of 1949? And what use can the director in 1980 derive from the knowledge of the prices of 1949?
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The paradox of "planning" is that it cannot plan because of the absence of economic calculation. What is called a planned economy is no economy at all. It is just a system of groping in the dark. There is no question of a rational choice of means for the best possible attainment of the ultimate ends sought. What is called conscious planning is precisely the elimination of conscious purposive action.
[The third article will discuss attempted methods of making calculations other than by the price mechanism.]
Socialism's Unique ProblemIt Can Find No Way to Make Its Economic CalculationsThe socialist tracts deal with everything except the essential and unique problem of socialism — viz., economic calculation.
It is only in the last years that socialist writers have no longer been able to avoid paying attention to this primordial matter. They have begun to suspect that the Marxian technique of smearing "bourgeois" economics is not an entirely sufficient method for the realization of the socialist utopia. They have embarked upon schemes for socialist economic calculation.
It would hardly be necessary to deal with these schemes were it not for the fact that such examination offers a good opportunity to bring into relief fundamental features of both the market society and of the imaginary construction of a [socialist] non-market society.
The various schemes proposed can be classified:
Calculation in kind is to be substituted for calculation in terms of money. This method is worthless. One cannot add or subtract numbers of different kinds (heterogeneous quantities).
The "labor-hour" is recommended as the unit of calculation. This suggestion does not take into account the original material factors of production and it ignores - the different qualities of work accomplished in the various labor-hours worked by the same and by different people.
The unit is to be a "quantity" of utility. However, acting man does not measure utility. He arranges in scales of gradation. Market prices in the free economy are not expressive of equivalence but of a divergence in the valuation of the two exchanging parties.
Or:
Calculation is to be made possible by the establishment of an artificial quasi-market.
Calculation is to be made with the aid of the differential equations of mathematics.
Calculation is to be made superfluous by resorting to the method of trial and error.
Trial and Error. The entrepreneurs do not have advance assurance about whether their plans are the most appropriate solution for the allocation of factors of production, to the various branches of industry. It is only later experience that shows them whether they are right or wrong; they apply trial and error. Why, say some socialists, should not the socialist director resort to the same method?
The method of trial and error is applicable in all cases in which the correct solution is recognizable as such by unmistakable marks not dependent on the method of trial and error itself. If a man mislays his wallet, he may hunt it in various places. If he finds it, he recognizes it as his property. There is no doubt about the success of trial and error.
Things are quite different if the only mark of the correct solution is that is has been reached by the application of a method considered appropriate. Here the method of trial and error is not a 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.
If one wants to call entrepreneurial action an application of the method of trial and error, one must not forget that the correct solution is easily recognizable as such. It is the emergence of a surplus of proceeds over costs. Profit tells that consumers approve; loss that they disapprove.
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 the market. But the characteristic market of the socialist system is that the producers' goods are controlled by one agency; they are neither bought nor sold and there are no "prices" for them. Thus there cannot be any question of comparing input and output by the methods of arithmetic.
We do not assert that the capitalist mode of economic calculation guarantees the absolutely best solution of the allocation of factors of production. Perfect solutions are out of reach of mortal men.
What the operation of a market not sabotaged by the interference of compulsion and coercion can bring about is merely the best solution accessible to the human mind. As soon as any man discovers a discrepancy between the real state of production and a realizable better state, the profit motive pushes him toward the utmost effort to realize his plans. The sale of his products will show whether he was right or wrong. This is the only important respect in which one can call the market economy a system of trial and error.
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 or loss is not feasible.
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- *The Quasi-market. It is nothing short of a full acknowledgment of the irrefutability of the economists' analysis of the socialists' plans that the Intellectual leaders of socialism are now busy designing schemes for a socialist system in which the market and market prices for the factors of production are to be preserved. They are now eager to justify socialism by pointing out that it is possible to preserve these institutions even under socialism.
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What these neo-socialists suggest is paradoxical. They want to abolish private control of the means of the production, market prices and competition. But they want to organize the socialist utopia in such a way that people could act as if these things were present. Nothing will change except the ownership of the capital invested. Society will be substituted for the shareholders; the people will henceforth pocket the dividends. That is all.
The cardinal fallacy in this and all kindred proposals is that they consider the structure of industrial production and the allocation of capital to the various branches as rigid, and do not take into consideration the necessity of altering the structure to adjust to changing conditions.
The entrepreneurs establish corporations, enlarge or reduce their size, dissolve them or merge them; they buy and sell shares and bonds of existing corporations; they grant and recover credits; they perform all those acts the totality of which is the capital and money market. It is these transactions of promoters and speculators that direct production into those channels in which it satisfies the most urgent wants of consumers. These transactions constitute the market. If one eliminates them, one does not preserve any part of the market.
Our problem does not refer to the managerial activities; it concerns the allocation of capital. The question is: In which branches should production be increased or restricted, in which branches should the objective of production be altered, what new branches inaugurated? Those who confuse entrepreneurship and management close their eyes to the economic problem.
Those suggesting a quasi-market have never wanted to preserve the free stock and commodity exchanges, the trading in futures and the bankers and money lenders. But one cannot play speculation and investment. Investors expose their own destiny; this makes them responsible to the consumers, the ultimate bosses. If one relieves investors of this responsibility, one deprives them of their very character.
All the hazards of this insecurity fall only upon society, the exclusive owner of all resources. If the director were without hesitation to allocate the funds available to those who bid most, he would simply put a premium upon audacity, carelessness and unreasonable optimism. He must reserve to himself the decision on how society's funds should be utilized. But then we are back again where we started.
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- *Differential equations: In devising imaginary construction of an evenly rotating economy we assume that all the factors of production [will then be] employed in such a way that each of them renders the mostly highly valued services it can possibly render. No further change in the employment of any of these factors could improve the state of want-satisfaction. This situation — in which no further changes in the disposition of the factors of production are to be resorted to — is described [by the mathematical economists] by systems of differential equations.
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But for utilization of the equations describing the [desired] state of equilibrium, a knowledge of the gradation of the values of consumers' goods in this state of equilibrium is required. This gradation is one of the elements of these equations assumed as known. Yet the director knows only his present valuations. He believes that, with regard to his present valuations, the allocation of the factors of production is unsatisfactory and wants to change it. But he knows nothing about how he himself will value on the day the equilibrium will be reached.
It was a serious mistake to believe that the state of equilibrium could be computed by mathematical operations on the basis of the knowledge of conditions in a non-equilibrium state. There is therefore no need to stress the point that the fabulous number of equations which one would have to solve each day anew for a practical utilization of the method would make the whole idea absurd.
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- *The employment of the means of production can be continued either by private owners or by the social apparatus of coercion and compulsion.
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In the first case there is a market, there are market prices for all factors of production, and economic calculation is possible. In the second case all these things are absent. We do not deal with the acts of the omnipresent and omniscient Deity, but with the actions of men endowed with a human mind only. Such a mind cannot plan without economic calculation.
[The fourth article will discuss forms of government intervention in the market which are short of "all-out" socialism.]
Socialism in DisguiseIt Creeps Up in Many Tempting MasquesPrivate ownership of the means of production (market economy) and public ownership of the means of production (socialism) can be neatly distinguished. Each of these two systems of society's economic organization is open to precise and unambiguous description and definition.
The dualism of the market and the government's power of compulsion suggests various [other] ideas. Should it not be a task of government to interfere and to correct the operation of the market? Is it necessary to put up with the alternative of capitalism or socialism? Are there not perhaps other realizable systems of social organization which are neither communism nor pure and unhampered market economy?
Thus people have contrived a variety of third systems. Their authors allege that these systems are non-socialist because they aim to preserve private ownership of the means of production and that they are not capitalistic because they eliminate the "deficiencies" of the market economy.
The task of economics is to analyze. With regard to this interventionism it has only one question to ask: How does it work? We do not raise the question whether such interference is good or bad. We merely ask whether or not it can attain those ends which those advocating and resorting to it are trying to attain.
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- *[The following are merely two examples of the many forms of government interference discussed by von Mises.]
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Interference with production. We deal here with those measures which are primarily intended to divert production from the ways it would take in an unhampered market economy.
Restriction of production means that the government either forbids or makes more expensive the production, or distribution of definite articles, or the application of definite modes of production, transportation or distribution. The effect of its interference is that people are prevented from using their knowledge, their labor and their material means in the way in which they would earn the highest returns. Such interference makes people poorer.
Wealth is produced by expending a certain quantity of the factors of production. Curtailing this quantity does not increase but decreases the amount of goods produced.
Economics does not contend that restriction is a bad system of production. It asserts that it is not a system of production at all but rather a system of quasi-consumption. The enormous popularity which restriction enjoys in our day is due to the fact that people do not recognize its consequences. It is important to emphasize that what produces wealth and well-being is production and not restriction.
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- *Interference with prices. Interference with the structure of the market means that the authority aims at fixing prices or commodities and services and interest rates at a height different from what the unhampered market would have determined. In resorting to such measures the government wants to favor either the buyer — as in the case of maximum prices — or the seller — as in the case of minimum prices.
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The characteristic feature of the market price is that it equalizes supply and demand. But if the government fixes prices at a height different from what the market would have fixed if left alone, this equilibrium of demand and supply is disrupted.
Then there are — with maximum prices — potential buyers who cannot buy although they are ready to pay the price fixed by the authority, or even a higher price. Then there are — with minimum prices — potential sellers who cannot sell although they are ready to sell at the price fixed by the authority, or even at a lower price.
There emerges a tendency to shift production activities from the production of goods affected by the maximum prices into the production of other goods. This outcome is manifestly contrary to the intentions of the government; it considered these commodities so vital that it singled them out to make it possible even for poor people to be amply supplied with them. But the result of interference is that production drops — or stops altogether.
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- *Interventionism [government interference with the market] cannot lead to a permanent system of social organization.
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All varieties of interference with the market phenomena not only fall to achieve the ends aimed at by their authors and supporters, but bring about a state of affairs which — from the point of view of their authors' and advocates' valuations — is less desirable than the previous state of affairs which they were designed to alter.
If one wants to correct their manifest unsuitableness by supplementing the first acts of intervention with more and more acts, one must go farther and farther until the market economy has been destroyed and socialism has been substituted for it.
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- *As long as the United States clings to the market economy and does not adopt the system of full government control of business, the socialist economies of western Europe will still be in a position to calculate. Their conduct of business still lacks the characteristic feature of socialist conduct; it is still based on economic calculation. It is therefore very different from what it would become if all the world turned toward socialism.
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Optimists hope that at least those nations which have in the past developed the capitalist market economy and its civilization will cling to it. It is vain to speculate about the outcome of the great ideological conflict between the principles of private ownership and public ownership, of individualism and totalitarianism. All that we can know beforehand can be condensed in the following three statements:
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Nothing suggests the belief that progress toward more satisfactory conditions is inevitable or a relapse into very unsatisfactory conditions impossible.
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Men must choose between the market economy and socialism. They cannot evade deciding between these alternatives by adopting a "middle-of-the-road" position, whatever name they give it.
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In abolishing economic calculation the general adoption of socialism would result in complete chaos and the disintegration of social cooperation under the divisions of labor. ...
Quarterly Journal of Austrian Economics 19, no. 4 (Winter 2016)
ABSTRACT: When individuals save more and invest directly in projects there results capital accumulation and growth. When individuals save more in order to add to their cash holdings, consumer goods are liberated that can be used for capital accumulation causing also economic growth. At first sight, the processes seem similar. But are there differences? And if so, what are they? In this article and responding to Pătruți (2016), we will first emphasize that cash building does not necessarily stem from saving. Second, we will argue that cash building by saving does not necessarily imply a longer time period for capital accumulation to materialize. Third, we will criticize the argument that hoarding would be suboptimal vis-à-vis direct investment. Finally, we will analyze the differences between cash building by saving and saving through investing.
KEYWORDS: Austrian school, capital theory, structure of production, investment, interest, hoardingJEL CLASSIFICATION: B13, B53, E14, E22, E31, E41, E43, O40
Quarterly Journal of Austrian Economics 19, no. 4 (Winter 2016)
ABSTRACT: As the first application of the praxeological discipline of “Cratics” (Taghizadegan and Otto, 2015), a theory of the supply and demand of bads is developed. On this foundation, a violence cycle theory will be introduced in analogy to the praxeological business cycle theory (according to Ludwig von Mises). Central to this approach are the subjective perceptions of threats and possible bluffs regarding the backing of those threats. Such a violence cycle theory can explain the stability of structures of violence and reveal new interpretations of the “long peace” hypothesis.
KEYWORDS: Austrian school, praxeology, catallactics, coercionJEL CLASSIFICATION: B53Those actions and things which render a marginal utility to men can be described as goods. In analogy, those actions and things which cause to expect a “marginal disutility” can be described as bads. Catallactics, i.e., the economics of direct and indirect exchange, can describe the process of the interaction of men who mutually promise and transfer goods to each other. In this case, concrete exchange relations are documented in the form of prices, reflecting subjective preferences and promises. The supplier of a good communicates the following promise:
I promise to give the good A to a person who offers me, at least, X in return.
A potential counterparty, however, communicates:
I promise to give, at most, X to a person who offers me the good A.
The exchange, i.e. the contracting, follows as the implementation of the given promises.
Similarly, coercive interactions as described by the discipline of cratics (cf. Taghizadegan and Otto, 2015), contain promises as an essential element. In analogy to catallactics, we can distinguish suppliers and counterparties regarding bads. The supplier of a bad pursues a marginal utility on his part by making the counterparty act in a certain way through promising a bad in case of that counterparty’s refusal. Critical herein is the specific and subjective expectation of the ensuing damage, the marginal disutility, rather than some objectively quantifiable harm. In particular, the expected disutility depends on the counterparty’s situation. The promise, i.e. the threat, to kick a paraplegic’s leg might lead to a smaller expectation of disutility than is the case with a non-paraplegic person.
A threat can be considered as an “offer” of a bad. It is an offer only in an extended sense, since it can be rejected by the counterparty—but not without incurring costs. The actual interaction, however, runs contrary to a catallactic process: In catallactics, the offering party endeavors to contract in order to obtain a certain good in exchange for another good. In cratics, contracting implies the unilateral transfer of the good in order to avoid the bad. Non-contracting on the part of the counterparty implies to keep the good and to “test” the validity of the threat to execute the bad. The “supplier” of the bad makes the following promise:
I promise to not execute the bad B on those who, at least, provide me with good G in return.
The “consumer” of a bad is a party that acknowledges the validity of the threat and therefore gives in to it. Thus, the term “bad” might be somewhat counterintuitive, however, it helps to establish the mirror-inverted analogy to catallactics. The consumer of a good ascribes a higher marginal utility to this good than to the asked exchange good and therefore wishes to transact. The “consumer” of a bad expects a higher marginal disutility from the bad than from giving up the demanded good. Herein, the “consumer” confirms the (validity of the) bad and encourages the “supplier” of the bad to provide more thereof, much like a catallactic consumer encourages a supplier to offer more of the same good. In effect, the “consumer” of the bad communicates the following promise:
I promise to give G if the bad B is not done to me.
Goods are offered in the hope of meeting demand—meaning, a willingness to pay more than the costs, i.e. the marginal disutility from employing the factors of production. Bads are offered based on the expectation that, for the “consumer,” the willingness to evade the bad is inferior to the marginal utility of the good. The willingness to evade therein denotes the amount of utility or value that the counterparty is willing to risk in order to evade the respective bad. Namely, the “consumer” risks that his costs to evade the bad exceed the costs of the bad itself. In effect, a high willingness to pay implies a large demand for goods, or a large willingness to contract, whereas high willingness to evade implies low demand for bads, or a low willingness to contract. In catallactics, the willingness to evade is irrelevant, since evasion costs are typically zero. In cratics, the willingness to pay—i.e., the readiness to contract—amounts to a willingness to obey, to give in to threats.
In analogy to the turnover of goods, the turnover of bads can be illustrated with analytical functions. Such supply and demand functions, to be sure, do not reflect reality in an exact manner, but rather serve to illustrate certain mechanisms: the higher the willingness to pay for a certain good, the more suppliers can expect turnover and will therefore join the market. In the case of bads, the tendency is the same: The higher the willingness to pay (willingness to obey), the more bads will be offered, whereas the higher the willingness to evade, the less bads remain as effective threats on the “market.”
Needless to say that this analogy must not be misunderstood. The “market” for bads is no market at all. At this point another analogous term would be necessary. The term “market” is derived from the Latin word mercatus, which in turn stems from merx: a product or good. Bads in Latin would be malae merces, so that one could form the concept of a malmarket, but that would probably be too much of a play of words. Let us stay with the Greek language: catallactic for a market order, cratic for a coercive order, whereby the study of the first is called catallactics while the study of the second is denoted as cratics. This contrast resembles Franz Oppenheimer’s (1924) juxtaposition of the political and the economic means—the former would be cratic, the latter would be catallactic.
Back to the dynamics of the willingness to evade, where we can observe two extreme cases: A zero willingness to evade would mean to give up all values without resistance. There would be a maximum of bads, but a minimum of actual violence. As soon as “buyers” with a zero willingness to evade are discovered by “producers” of bads, the former—reluctantly—nurture the production of bads, which may entirely drive out the production of goods.
Let us clarify that example conceptually: “Production” of bads means the intention, preparation and propagation of harm to other people to the benefit of the “producer” at the lowest cost possible. In this case, a threatening appearance could constitute a “factor of production.” When a bully runs into a classmate who has no willingness to evade, an angry look alone could be enough to be recognized as the offer of a bad, whereupon the transfer of snacks may follow without resistance, amounting to the immediate contracting in this coercive exchange. This would typically lead to a marginal rise of the production of bads, both because the producer of bads will be encouraged to further employ his “production factor,” and because successors may appear who recognize how easy it is to obtain other people’s goods. If, in a given “market,” all the “buyers of the bads,” i.e., those who give away the demanded goods, exhibited zero willingness to evade, the production of goods would not be profitable anymore, because even the smallest bads would lead to their uncompensated transfer. Such a society would break apart very quickly, because all those “buyers” would run out of resources. A short period of absolute non-violence—during which violence was not necessary to break the will of the “buyers”—would yield to a period of violence among the producers of bads.
In contrast, a maximum willingness to evade would require the highest degree of violence for coercive exchange. Every threat would immediately be checked for its “backing.” The “demand” for bads would be reduced to a minimum because the potential “buyers” preferred to risk the bad. A maximum willingness to evade may have two reasons: A maximum distrust in threats, and/or an absolute firmness with regard to one’s principles, whereby one would risk everything in order to avoid giving up one’s principles and values. In catallactics, analogous reasons would explain a minimum willingness to pay for offered goods: A maximum distrust in promises on the market, and/or an absolute firmness with regard to one’s principles, which do not allow for a gain in utility through exchange (hostility against trade, defeatism etc.).
A cratic “buyer” expects that the cost of the evasion is higher than the demanded payment (buying into the threat). A catallactic buyer expects that the gain in utility through the offered goods is higher than the loss in utility through the demanded payment. The cratic “price” amounts to the demanded payment (loss of utility) to evade the threatened bads. The higher the demanded price and the higher the willingness to evade, the less the “demand.”
In the field of catallactics, interventions in prices and quantities are known that have a cratic character by themselves. Namely, they are efforts to replace particular exchange relations of goods by means of the threat of bads. Every imperative or prohibition represents a cratic exchange: An “offer” (the threat) of bads is linked to an action or non-action preferred by the coercive party. At first sight, again, the analogy between omissions (caused by prohibitions) and services (preferred actions as goods) might seem overstretched. However, the objective character of the action to be performed or refrained from is a technical, not an economic question. An economic judgment of actions according to their technical content would violate the value neutrality principle, and amount to an arrogation of knowledge, respectively. In contrast, in the disciplines of medicine and religion, to name only two striking examples, action cannot easily be distinguished from non-action. In addition, catallactic offers can aim at a non-action, such as an offer of money to a street musician in exchange to stopping the performance.
Following these introductory remarks, let us now proceed to the core of this work, the analogy to business cycle theory. Namely, broadly speaking, the cratic character of offers or threats is not always obvious. Bluffs (or deceptions) might have the same effect as price and quantity interventions. A particularly important field of such deceptive interventions is described by the business cycle theory according to the Austrian school of economics (see Mises, 1912). It describes the periodical emergence of an economic boom, followed by a bust. The reason for this typical pattern is a credit expansion beyond the level of real savings, which is revealed in suppressed interest rates. Such interest rates would be untenable and, in particular, would cause illiquidity, were they not enabled by cratic interventions (compulsory wealth transfers, privileges such as those arising from central banking, contract breaches without consequences, etc.).
This distortion of interest rates is, on the one hand, a price intervention, and, on the other hand, a deception. The lowered interest rate has a similar effect as a maximum price coercively set at a level below the market price. In this case, demand is higher than supply. The interest rate is the price for savings; the demand for savings—thus indebtedness—rises; the supply of real savings—the propensity to save—decreases. This would cause a supply gap, if the created circulatory credit had not filled that gap. But since the circulatory credit is based on the assumption that bank deposits will not be withdrawn, it is a deception regarding the true extent of available savings. During phases of credit expansion arising from artificially low interest rates (a “maximum rate of interest fixed below the market rate”), consumption and investment are booming at the same time. The overestimated savings and thus resources considered as disposable are unbacked promises. The insufficient backing within the financial system will be uncovered through a bank run, a run on illiquid banks, which without bailouts would have to default on their depositors. In the economy, an insufficient backing of promises with resources will be visible through unexpected price increases, which cause the illiquidity of entrepreneurs who are now unable to finish their projects.
An analogous, systematic discrepancy between promise and backing—namely, between threat and capability to execute—exists in the field of cratics. An actor can, very easily, issue threats that exceed what he himself is capable and willing to execute. In the same way, entrepreneurs can make incorrect estimations about their own liquidity. Whenever such miscalculations accumulate, cycle patterns appear. In his “General Theory of Error Cycles,” Jörg-Guido Hülsmann describes such accumulations of errors as illusions of legitimacy (Hülsmann, 1998). When, in the above schoolyard example, at some point in time it becomes common practice to hand over one’s snacks to the bully, the need to “back” his threat disappears. One day he could lose his physical ability to supply the bads—punching disobedient schoolmates. As long as this ability is not checked, the bully can still collect the goods—until the day when a person again takes a risk and the illusion of the powerful bully bursts.
This pattern of deceptions and bursting illusions resembles the business cycle. The illusion starts a phase of apparent stability that actually appears to be particularly peaceful and free from violence: the threat boom. The issuer of threats is peaceful at this stage—he might even thank the classmates for handing over their snacks and return half of them. At this stage, the contracting of bads is high. Let us remember: The contracting of bads does not imply a preference for such bads (they are, after all, bad). However, it does imply the willingness to engage in cratic exchange, which consists of the delivery of goods or the execution or omission of actions in exchange for the non-execution of the threat. After the revelation of the incapacity to execute the threats, the stage of apparent voluntariness is followed by an explosive correction: The willingness to contract falls extremely rapidly. Even if the bully seeks rapid execution, he now detects that his power is “illiquid”: it does not suffice to meet the suddenly accumulating challenges. While, during the boom, the physical overpowering of an individual was sufficient, now the physical overpowering of larger groups becomes necessary. The threat boom ends with a correction of the level of coercion, in which the power of the aggressor competes directly with the resistance of the victims. Now the schoolyard exhibits a high level of violence. Actually, it is a period of the reduction of (implicit) violence in which unsustainable cratic relations finally yield to catallactic relations. Clueless teachers might intervene to stop the violence, by sanctioning the challenging pupils. Thereby, the correction might be postponed, creating the impression that the bully stood up against the challenges to the backing of his threats. In the worst case, the teachers intervene for the purpose of a superficial reduction of violence by artificially legitimizing the bully’s claim: “The wiser head gives in!” Through this, another threat boom could follow, where the bully could increase his demands even more—after all, the wiser head has to give in! Apparent peacefulness would increase again, up to the point where someone decides to challenge the bully again.
Coercive rule as a systematic implementation of cratic exchange is possible either through a physical superiority of the rulers or through the illusion of superiority, as De la Boëtie observed a long time ago:
He who thus domineers over you has only two eyes, only two hands, only one body, no more than is possessed by the least man among the infinite numbers dwelling in your cities; he has indeed nothing more than the power that you confer upon him to destroy you. (La Boëtie, 1550)
The paradox of prolonged apparent peacefulness of coercive rule can thus be explained through the violence cycle theory presented here. That puts the observation in its true light—that open violence may have decreased throughout the last centuries. One of the most detailed expositions of this development is Steven Pinker’s (2011). He reasoned that in the course of history the “better angels” within human nature have prevailed against the “inner demons”—leading to modern man being more civilized. The presented empirical evidence seems conclusive: The violence among individuals as well as between states (wars) seems to have decreased.
Two of the many reasons that Pinker proposes for this development are of direct concern to the field of cratics: On the one hand, he argues, the growth of Leviathan—the centralized state monopoly on the use of force—has displaced the violence between smaller units, while on the other hand, commercialization has made people more peaceful. The latter argument finds confirmation in the fact that catallactic transactions are able to replace cratic transactions: After all, for each bilateral action he envisions, man can choose whether to employ the cratic or the catallactic mode. The former argument finds, at best, partial confirmation. Phases of cratic legitimacy may indeed have a pacifying effect. This idea goes back to Thomas Hobbes and can be confirmed by praxeological analysis—but with serious reservations that lead to conclusions which differ completely from those drawn by Hobbes and Pinker.
Indeed, the violence cycle has a paradoxical effect which complicates its quantitative assessment—just like the business cycle. The possible “evaluation of the backing” of promises of violence can lead to violent corrections after peaceful periods, a cratic recession, during which the violence is bid up dramatically. This explains the conclusion of Hobbes that such “evaluations of the backing” should be completely avoided, which can only succeed through the subjects’ complete renunciation to challenge the government. Otherwise a civil war would be imminent:
For those men that are so remissly governed that they dare take up arms to defend or introduce an opinion are still at war; and their condition, not peace, but only a cessation of arms for fear of one another; and they live, as it were, in the procincts of battle continually. It belonged therefore to him that hath the sovereign power to be judge, or constitute all judges of opinions and doctrines, as a thing necessary to peace; thereby to prevent discord and civil war.” (Hobbes, 1651, chapter XVIII)
The fallacy lies in considering the high potential of violence during the cratic recession as the natural state—just like the fear of the high “clean-up costs” of economic recessions, which usually show a steep rise in unemployment and insolvencies. In fact, however, the recession is a corrective process, revealing the discrepancies between economic actions and economic realities which had accumulated during the artificial boom. Hobbes sees fear of violence as the only chance for pacification and dismisses catallactic alternatives, the possibility for people to reach complementary or inverse goals by peaceful means without harming each other. This leads to an interventionist perspective on politics, seeking a monopoly of fear, analogous to economic policy claiming the monopoly of trust for the state, as the supposed guardian of money and contracts. Hobbes’ concept of man is, accordingly, biased:
Of all passions, that which inclineth men least to break the laws is fear. Nay, excepting some generous natures, it is the only thing (when there is appearance of profit or pleasure by breaking the laws) that makes men keep them. (Hobbes, 1651, chapter XXVII)
If fear were really the main reason for rule-consistent behavior, the costs of violence would be uneconomically high for Leviathan: The sanctions for breaches of law would have to be backed to a degree where the related costs would reach the level of income from cratic action. In the short term, it may be possible to compensate for a lower likelihood of revelation of violence with more draconian penalties. But in this way the legitimacy further decreases and thereby also the subjects’ “willingness to contract” (willingness to obey). These dynamics are missed by Hobbes, as well as the observation that in times of long and far-reaching peace obtained through a highly stable coercive setup (i.e, a high level of implicit fear and obedience), the probability of a “black swan” of massive violent corrections—or, more generally, reactions—is growing: in particular, our violence cycle theory suggests a correlation between the intensity of violent reactions and the lengths and intensities of the respective preceding coercive periods, that is of those periods within a certain culture or society that are characterized by a stable coercive setup. Following Nassim Taleb, the distribution of the intensity of violent outbursts indicates a fat tail (Taleb, 2012); accordingly, we assume a fat-tail distribution regarding the length (and intensity) of preceding coercive periods. Hence, we also agree with Taleb’s criticism of Pinker, particularly regarding the evaluation of our present-day situation. On a side note, to be sure, Taleb’s analysis does not distinguish between the internal and external type of a violent outburst (civil war versus interstate war). Indeed, we argue that a violent reaction does not necessarily have to affect the coercing party or institution, as would typically be the case in a civil war. Rather, we hold that interstate wars have consistently been employed by coercing institutions as a means to divert internal backlashes.
With threat boom and threat bust as the two elements of a cycle, the total enacted violence across such a cycle—or in economically more precise terms: the total volume of contracted and enacted bads—may be considerably higher than it would be without the cycle, or with a less pronounced one. Analogously, the growth in prosperity over the entire economic cycle is lower than it would be without boom-and-bust sequences. This is so both because the boom constitutes a distortion in which goods are misallocated—meaning, allocated not in accordance with the preferences and plans of the people—and because the bust, while it might correct this distortion, typically produces highly damaging side effects in the process, which would not have been “required” with a less pronounced or non-existing cycle.
However, this perspective does not only apply for archaic or low-level regimes of fear but also for modern regimes of legitimacy. Indeed, Hobbes praised fear, which he correctly recognized as a stabilizing element of cratic structures, as a corollary of freedom:
Fear and liberty are consistent: as when a man throweth his goods into the sea for fear the ship should sink, he doth it nevertheless very willingly, and may refuse to do it if he will; it is therefore the action of one that was free: so a man sometimes pays his debt, only for fear of imprisonment, which, because nobody hindered him from. (Hobbes, 1651, chapter XXI)
Similaly, legitimacy is used as a synonym for freedom in modern cratic systems, for example under the terms “rule of law” and “democracy.” However, whereas in catallactics unbacked promises can be corrected sooner and on a smaller scale, because the self-interest of the people serves as a corrective, cratic promises can expand to a higher degree. The potential “black swan” consists in a sudden implosion of legitimacy. In effect, the legitimization of cratic exchange reduces its costs below the otherwise necessary level and leads to the preponderance of the political (cratic) means over the economic (catallactic) means. The resulting preponderance of supply and contracting of bads leads to an allocation of means which, on average, corresponds less to the preferences and plans of the people than would be the case without such legitimization and the resulting violence cycle.
There is a similar problem in case of interstate violence. Peaceful coexistence is not only stabilized by mutual threat potential, but also by perceived legitimacy of predominance, respectively transfer of sovereignty. Praxeological analysis, however, shows that these seemingly stable arrangements are more fragile than is generally perceived, because these arrangements themselves sow the seeds of “corrective catastrophes.”
The problem of “black swans” in case of the threat potential through weapons of mass destruction is a matter of common knowledge. Nassim Taleb probably had precisely this in mind when criticizing Pinker:
Ancestral man had no nuclear weapons, so it is downright foolish to assume the statistics of conflicts in the 14th century can apply to the 21st. A mean person with a stick is categorically different from a mean person with a nuclear weapon, so the emphasis should be on the weapon and not exclusively on the psychological make-up of the person. (Taleb, 2012)
Let us translate this into the language of cratics: Frequent evaluations of the backings of geopolitical arrangements through small scale skirmishes may at first exhibit a higher rate of violence, while in the long term they could harbor a lower potential of violence than a peace order (or the order of a cold war), the backing of which can only be evaluated through the use of nuclear weapons. We have survived the 20th century without mutual destruction, but to deduce therefrom the superiority of a peace order based on massive threat potential would be a statistical fallacy, as Taleb observed. The fallacy of the “survivor bias” fits in every sense of the word: The world has frequently been on the brink of catastrophe. We have survived; that is why we can praise modernity as the best of all worlds, which, as Pinker empirically claims, may show less violence and war than earlier epochs. If that lottery had turned out differently, there would be hardly anyone left to sing such praises. A mere 100 years ago, a similar analysis would also have praised an apparent age of peace:
Panelists in 1912 could have produced compelling evidence documenting the decline of great power war. The previous century had been the most peaceful on record, continuing the decline in great power war over the previous three centuries. There had been zero great power wars for nearly four decades, a 50% decline over the last two centuries, and zero general wars involving all of the great powers for 97 years. This was the longest period of great power peace in the last four centuries of the modern European system.” (Levy and Thompson, 2013, p. 412)
As well, in the case of interpersonal violence, a low level of violence can have causes other than the development of so-called angelic behavior—unless one praises obedience as an angelic virtue and condemns human freedom as a satanic temptation. Cratic structures which enforce obedience through physical superiority, rather than through habit and legitimization, correspond to the phenomenon of stationary bandits, which Mancur Olsen (1993) analyzed economically. Olson concludes that the monopolization of the use of violence should minimize such violence. The stationary bandit replaces non-stationary bandits and contents himself with less, though continuous, prey. Our analysis, however, indicates that this compensation is not certain: The same rationality leads to a lower and thus cheaper backing of threats for a stationary bandit. On the one hand, this enables, ceteris paribus, a higher level of exploitation. On the other hand, since criminals (who also operate cratically) are the first ones who evaluate the backing of threats, a lower degree of backing by the “primary, stationary bandit” may imply that the quality of his “service” (security) relates very poorly to his cost level (appropriation of goods). In extreme cases, the population may be harassed to an insupportable degree through unbacked threats, while at the same time left completely and utterly at the mercy of criminals who operate with backed threats. In such a setup, peacefulness may purely result from defenselessness. The officials seem to get along with forms and stamps; weapons are hardly used. But behind this facade of peacefulness grows a black swan of cognitive dissonance that is expressed at first through declining trust and increasing resentment. It is difficult to predict the behavior of people who have been peaceful only due to apathy and blindness, when they suddenly fear for their survival. Explosions of violence at the end of such a cycle cannot be excluded. In effect, this is the risk of pacification through fear or legitimization of cratic threats. Ultimately, a level of violence at which threats are challenged and thus evaluated more often might be higher in the short term, but should be lower in the long term—even in the case where, during a long threat boom, people get accustomed to “angelic peacefulness.”
The threat boom is not only characterized by the fact that one day a correction is due, which can lead to an explosion of violence (revolutions, civil wars, uprisings), but also by the fact that it leads to a systematic overestimation regarding how well the existing order corresponds to the preferences of the people. It is similar to an economic boom: The order books and supermarkets are full, the companies are flourishing, but the markets are distorted—less and less of what the people intrinsically demand is produced while, rather, value destruction takes place. Scarce and therefore valuable resources are transformed into less valuable things. Similarly, during a threat boom, behind a facade of legitimacy, hidden exploitation takes place. Of course, “value” and “exploitation” are normative concepts. Expressed in a value neutral way, it boils down to a situation in which actions are legitimized as valuable and just, and are thus encouraged, which, after revelation of the consequences, are regarded as destructive and exploitive in hindsight. The problem lies precisely in this encouragement, thus in the dynamics: A hidden tension between aspirations and reality is growing.
The violence cycle theory facilitates a critical analysis of the succession of periods of war and peace. Furthermore, it allows a new interpretation of the prevailing civilization and reduction of inter-personal violence in large parts of the world throughout modernity. Cratic analysis also nourishes the debate about an ethical justification of state violence with new insights, e.g., through a critical examination of the possibilities and conditions for a minimization of violence.
The violence cycle theory is more than a mere analogy to the business cycle theory. The business cycle is not a necessary result of monetary expansion, as Hülsmann has shown. Monetary expansion is usually linked to a cycle of erroneous trust by entrepreneurs in the institutional framework and distorted market signals. Hülsmann argues:
The mere fact that the quantity of money changes does not prevent the entrepreneurs from judging correctly what influence it will exercise on market prices. (Hülsmann, 1998, p. 4)
He concludes that the business cycle theory is “not generally and apodictically valid.” Thus, a more general theory is needed, even to explain the business cycle in the first place—the business cycle is not an explicans, but an explicandum, on which the cratic cycle theory may shed additional light. Trust in unbacked promises, misled by coercion, may play a larger role than previously thought. Of course, trust is a subjective category and does not allow for deterministic or quantitative predictions. Misguided booms, based on unbacked promises or threats, are not necessarily corrected; if gullibility increases at the same pace, they may go on forever. If they are corrected, they tend to collapse; disillusionment is self-reinforcing.
Hopefully, these introductory considerations help to show the potential of further application of “cratics,” i.e., the praxeology of coercion and violence, in the fields of ethics, political science and history.
Quarterly Journal of Austrian Economics 19, no. 3 (Fall 2016): 288–296
This is a book about the general applicability of economics and how it “affects all walks of life” (from the back-cover blurb). No less than 23 endorsing statements are printed at the front end of the book, including praise from luminaries such as James Buchanan, Vernon Smith, Gordon Tullock and Israel Kirzner. Nassim Taleb also chips in. Given the way the book is described, one may perhaps expect a Becker or Landsburg kind of book which applies economics to unusual settings, generating new insight. However, the book is very different from this. Instead, Boettke delivers a set of highly personal statements in the form of 22 informal essays, most of which have been previously published, and which describe his “love affair with economics” (p. xv). Perhaps because of the way in which the book has been conceived and put together, there is a good deal of repetition; indeed, the book could have been compressed to something shorter and more succinct (my preference would have been for a deeper examination of the differences between “mainline” and “mainstream” economics; more about which later). However, Boettke writes in an engaging and often journalistic way, so the book is an easy read. He is also good at coming up with fancy and helpful 2x2 matrices to organize the material; in fact, while reading through the book, the thought struck me more than once Boettke could have been an excellent management writer.
However, while Boettke’s book is highly personal, it actually, but perhaps less intentionally, gives a portrait of a specific way of thinking about Austrian economics as well as practicing it. We may call this the “Masonian way,” not just because George Mason University is where our author is institutionally located, but also because of his institution-building efforts in that place. To be sure, parts of the book are dedicated to traditional Austrian projects, such as criticizing Keynesian economics, and I doubt any Austrian will found much to disagree with in these parts. However, Boettke has long more or less explicitly argued that there is a specific way of doing Austrian economics which (at least to this outside observer) seems to be an amalgam of, on the substantive side, traditional Austrian economics (perhaps more with a leaning towards Hayek and Kirzner than Mises and Rothbard), the economics of governance as represented by Oliver Williamson and Elinor Ostrom; public choice economics á la Buchanan and Tullock; on the philosophical side “Continental” influences, notably ideas from hermeneutics and phenomenology; and on the methods side, fundamentally anthropological empiricism.Note that Boettke’s approach to Austrian economics is one among other approaches. For example, see Salerno (2002) for a very different approach to modern Austrian economics.
Because of Boettke’s institution-building efforts and general influence in parts of the Austrian community, it appears that a number of other Austrians, mainly (but not exclusively) associated with George Mason University, buy into the Boettkian worldview. It is therefore of interest to look more closely into this view. The present book serves as a handy guide.
The Quarterly Journal of Austrian Economics
Vol. 19 | No. 3 | 288–296Fall 2016
Book ReviewLiving Economics: Yesterday, Today, and TomorrowPeter BoettkeOakland, Calif.: Independent Institute, 2012, 456 pp.
Nicolai J. Foss
Nicolai J. Foss (nicolai.foss@unibocconi.it) is a professor of Organization Theory and Human Ressource Management at the Bocconi University, Milan, Italy.
This is a book about the general applicability of economics and how it “affects all walks of life” (from the back-cover blurb). No less than 23 endorsing statements are printed at the front end of the book, including praise from luminaries such as James Buchanan, Vernon Smith, Gordon Tullock and Israel Kirzner. Nassim Taleb also chips in. Given the way the book is described, one may perhaps expect a Becker or Landsburg kind of book which applies economics to unusual settings, generating new insight. However, the book is very different from this. Instead, Boettke delivers a set of highly personal statements in the form of 22 informal essays, most of which have been previously published, and which describe his “love affair with economics” (p. xv). Perhaps because of the way in which the book has been conceived and put together, there is a good deal of repetition; indeed, the book could have been compressed to something shorter and more succinct (my preference would have been for a deeper examination of the differences between “mainline” and “mainstream” economics; more about which later). However, Boettke writes in an engaging and often journalistic way, so the book is an easy read. He is also good at coming up with fancy and helpful 2x2 matrices to organize the material; in fact, while reading through the book, the thought struck me more than once that Boettke could have been an excellent management writer.
However, while Boettke’s book is highly personal, it actually, but perhaps less intentionally, gives a portrait of a specific way of thinking about Austrian economics as well as practicing it. We may call this the “Masonian way,” not just because George Mason University is where our author is institutionally located, but also because of his institution-building efforts in that place. To be sure, parts of the book are dedicated to traditional Austrian projects, such as criticizing Keynesian economics, and I doubt any Austrian will found much to disagree with in these parts. However, Boettke has long more or less explicitly argued that there is a specific way of doing Austrian economics which (at least to this outside observer) seems to be an amalgam of, on the substantive side, traditional Austrian economics (perhaps more with a leaning towards Hayek and Kirzner than Mises and Rothbard), the economics of governance as represented by Oliver Williamson and Elinor Ostrom; public choice economics á la Buchanan and Tullock; on the philosophical side “Continental” influences, notably ideas from hermeneutics and phenomenology; and on the methods side, fundamentally anthropological empiricism.Note that Boettke’s approach to Austrian economics is one among other approaches. For example, see Salerno (2002) for a very different approach to modern Austrian economics.
Because of Boettke’s institution-building efforts and general influence in parts of the Austrian community, it appears that a number of other Austrians, mainly (but not exclusively) associated with George Mason University, buy into the Boettkian worldview. It is therefore of interest to look more closely into this view. The present book serves as a handy guide.
INTELLECTUAL HERITAGE AND THE BOETTKE MELANGEThe Boettke worldview involves holding certain key economists in very high esteem, to the point of idolizing them. For example one chapter is titled “The Genius of Mises and the Brilliance of Kirzner.”Of course, there are also intellectual villains or at least opponents, in Boettke’s account, particularly Abba Lerner and John Maynard Keynes. Boettke seems to hold James Buchanan and Kenneth Boulding in particularly high esteem. Indeed, in the Boettkian Pantheon Buchanan seems to be Zeus, placed on a higher level than Mises and Rothbard; while Kirzner and Hayek are gods that are close to Buchanan. Small-god status is assumed by, for example, Ostrom.
A particular place is reserved for the late Don Lavoie, who before his passing in 2001 served as a sort of local guru to the emerging Masonian Austrian community. The particular importance of Lavoie, we are told (chapter 12), was that he made it clear that the philosophical roots of Austrian economics lies in Continental Europe, meaning phenomenological and hermeneutical traditions rather than analytical philosophy. Boettke does not go into great detail here, but there is mention of Husserl and Gadamer. The problem, of course, is that “Continental Philosophy” is extremely varied and the label is not terribly informative. Additionally, there are those, particularly Robert Nozick and Uskali Mäki, who have actually addressed key Austrian ideas from the perspective of analytical philosophy.
There is nothing wrong with idolizing important economists. This is a good way of building group identity, based on the examples, lives and teaching and writing of those economists. Importantly, the particular economists that are idolized in Boettke’s books serve, of course, as the main inspirations for what we may call the “Boettke mélange,” a combination of Austrian economics, public choice theory, economics of governance, and “continental philosophy.” It is not a clear concoction we are talking about here, for it is not transparent, for example, what is the really the shared ground between Oliver Williamson and Ludwig von Mises. Indeed, what does one do with a committed equilibrium economist like Harold Demsetz in this mélange?
What keeps the mélange together, Boettke says, is a commitment to “two fundamental observations of commercial society: (1) individual pursuit of their self-interest, and (2) complex social order that aligns interests with the general interest” (p. xvii). Unfortunately, this way of describing it desperately lacks discriminating power: Numerous other economists, including many that Boettke presumably would think of “mainstream,” “neoclassical,” “formalists,” etc. would subscribe to these two tenets without feeling any particular commitment to Austrian principles. In an attempt to further characterize the nature and content of the mélange, Boettke turns to a distinction between ”mainline economics” and ”mainstream economics.”
MAINLINE AND MAINSTREAM ECONOMICSThis distinction is a key theme in Boettke’s book. It is discussed, sometimes using different terminology, many times. It is clearly a distinction that Boettke invests in and believes is of crucial importance. I first learned of it sixteen years ago when Boettke and I were both on the Ph.D. committee of Frederic Sautet in Paris. We discussed it through the evening in the central-Paris apartment of Pascal Salin (Sautet’s advisor in France). I remember being skeptical of the distinction back then, and I still am. Let me explain.
“Mainline economics” is, according to Boettke, sound, basic economics; it is the Good Guys-stuff:
The mainline of economics, in my narrative is to be contrasted with the ‘mainstream’ of economic thought. Mainline is defined by a set of positive propositions about social order that were held in common from Adam Smith onward, but mainstream economics is a sociological concept related to what is currently fashionable among the scientific elite of the profession (p. xvii).
In terms of names, mainliners are the economists/philosophers of the Scottish Enlightenment, the Austrians, the public choicers, as well as new institutionalist economists, such as Coase, Demsetz, North, Williamson, et al.
There are several problems with the way Boettke presents and elaborates on the distinction. First, “mainline economics” is characterized in a way that is perhaps best, and hopefully not too unfairly, described as “bland.” It seldom goes much beyond things like “markets work,” “individuals make choices,” “the unintended consequences of those choices are usually beneficial (if the rules are “right”), or, “an exchange is an exchange is an exchange.” Additional potential content is suggested by the inclusion of verbal economists Demsetz, Coase, Ostrom, Stigler and Williamson, as well as the quite formalistic Jack Hirshleifer, in the mainline economics club. Thus, one suspects that mainline economics is also about property rights, governance structures, search behavior, and so on, but it is not really made clear (at least in this book) how such insights fit into the broader Boettkian program. One is then left with a fairly non-specific characterization of mainline economics. An obvious problem with this is that any mainstream (so-called) economist can simply retort that mainstream economics has done much to identify the exact conditions under which mainline economics—which he would see as essentially loose, verbal, normatively-laden basic/commonsense economics—hold true. Boettke may reply that the key differential is the attention to process, but again, this only characterizes part of mainline economics, and a mainstream economist is not going to be impressed by the way “process” is handled in mainline economics anyway.Interestingly, in developing the process theme as a critique of mainstream economics, Boettke relies heavily on the work of a mainstream economist, namely Franklin Fisher (1983). Apparently, formalism is acceptable when it yields negative conclusions about the mainstream.
Second, the characterization of mainstream economics is sometimes quite dated. The examples in the book are mainly general equilibrium theory. But, as Boettke points out in one place in the book (drawing on the work of Abu Rizvi), general equilibrium economics does not at all hold the sway over the profession that it did in the 1960s and 1970s. Thus, he recognizes that in fields such as industrial organization, partial equilibrium game theoretical models have taken over. Our economist will have no truck with such theorizing, however. This gives rise to a third problem.
Third, the separation between mainline and mainstream economics involves a distinction between verbally stated, highly abstract, basic principles of economics and formal modeling of specific mechanisms in specific settings (e.g., specific manifestations of the “agency problem” and how it can be (partially) resolved by contractual means). “Models” do not appear to have a role in mainline economics, except as thought experiments á la the Coase theorem or the Misesian evenly rotating economy. The kind of partial, mathematical formalizations of a mechanism that could potentially be at work in the real world do not seem to be part of the Masonian understanding of economics. However, this kind of work is what takes up the bulk of the space in the economics journals.
Boettke contrasts mainline economics with recent formal economics, what he calls “formalistic historicism” (p. 325), a (mostly game-theoretical) way of doing economics where “any particular proposition can be proved using one language (formal) (p. 327). However, formal economists may reply, and I think rightly so, that although their work is specific, focused and formal, they certainly accept the basic principles of the logic of choice; they are not historicists. Additionally, they may counter that their theoretical work addresses the workings of mechanisms that will be at work in certain kind of contexts. If the context (incentives, institutions) is the “right” one, people will behave as predicted by the model. This is not “historicism,” it is simply the ceteris paribus clause at work. I do not think Boettke has presented a compelling argument why it is fundamentally un-Austrian or at variance with so-called mainline economics to engage in such work.
Moreover, consider Boettke’s own view of what successful empirical Austrian economics entails, namely “analytical narratives”: “The analytical narrative entails the application of Austrian economics as a tool of interpretation of ethnographic data. This approach emphasizes the open-endedness of choice as opposed to the close-endedness required by formalistic interpretations of rational choice.… The person as chooser returns with both human character and particular circumstances.” (p. 328). This sounds nice, but it is somewhat unclear what it actually means. I think it simply means applying basic logic of choice to historical explanation, and this is supported by Boettke explaining that the “analytical narrative makes the aprioristically deduced pure logic of choice the handmaiden of institutionally focused ethnographic research” (p. 211).
If used retrospectively, as a tool of interpretation and organizing data, choice theory is indeed so flexible that it can “emphasize the open-endedness of choice.” Any behavior can be explained as somehow rational ex post; a particular explanation is concocted that makes sense out of what we observed in terms of the incentives and other “particular circumstances” that confronted “the person as chooser.” This is uncontroversial. But there are problems here. Remember that Boettke is very critical of mainstream formal economics modeling of particular mechanisms in particular settings, which he criticizes as being “formal historicism.” But such formal economics modeling is still based on key principles that inform a class of models or indeed all of mainstream economics, such as maximizing some objective function. As Buchanan has explained, this is one way to make the pure logic of choice concrete. The difference then is that the Boettkian applies praxeology to concrete historical analysis, while mainstreamers apply what can be seen as a particular way of focusing the pure logic of choice to modeling particular mechanisms. Viewed thusly, the differences between applied mainline economics and mainstream economics do not seem that major. If anything, the latter seems more generalizable and predictive.
To illustrate, consider Masonian Peter Leeson’s (2007) paper in the Journal of Political Economy, a leading mainstream outlet. This is a well-crafted piece that certainly throws light on the understanding of pirate organization and the economic forces that made buccaneering successful for some time. Is it specifically Austrian? No. Could it, in principle, have written by other economists with a good command of price theory, insight in the economics of governance and the like? Yes.
A SUCCESSFUL PROJECT?Ultimately, Masonian economics as described by Boettke is not likely to be successful, if by “success” we mean sustained, high-level impact on the economics profession. First, because it does not play by the current rule book. Second, because it offers little specific that is not already somehow part of the mainstream. And third, because it deliberately abstains from engaging in policy-related work on a concrete level. As Boettke says, the “role of the economist is not a savior to society; he or she is not a technical expert to be relied upon to fix ill through social engineering. No, the role of the economist is the far humbler one; that of a student of society and teacher of the basic principles of the discipline” (p. 56). Quite apart from the point that for some strange reason economists are not allowed to teach the non-basic principles of the discipline, this seems overly defeatist. Imagine that you find yourself in the shoes of Austrian economist, Stephen Littlechild, around 1980, having been tasked by the Thatcher government to engage in denationalizing the UK electricity industry, a project that one suspects many Austrians would be sympathetic to. To engage in this socially highly beneficial piece of “social engineering” you surely have to engage in a good deal of highly technical and involved economics (and econometrics) and rely on “technical experts.”
In sum, while there are many excellent points being made in this book—which in many ways is an enjoyable read—I remain skeptical of the fundamental aims of the Boettke project. This is rooted in my overall conviction that the Austrian tradition is not best preserved and furthered by being hostile to mainstream economics (see also Salerno, 2004). A modus vivendi is possible, in which Austrians regard formal, mainstream economics as less general and more contingent than the pure principles of fundamental Austrian economics, but nevertheless theory that is worth doing. (I realize that readers of this journal may disagree here). In fact, Austrian economics may in certain key respects be furthered by a formal approach.For a thoughtful discussion, see Hudik (2015). But that, to borrow a phrase, will be the subject of a future paper.
REFERENCES
Fisher, Franklin M. 1983. Disequilibrium Foundations of Equilibrium Economics. Cambridge: Cambridge University Press.
Hudik, Marek. 2015. “’Mises and Hayek Mathematized’: Toward Mathematical Austrian Economics.” In The Next Generation of Austrian Economics: Essays in Honor of Joseph T. Salerno. Auburn, Ala.: Ludwig von Mises Institute.
Leeson, P. 2007. “An-arrgh-chy: The Law and Economics of Pirate Organization,” Journal of Political Economy 115: 1049–1094.
Salerno, Joseph T. 2002. “The Rebirth of Austrian Economics—In Light of Austrian Economics,” Quarterly Journal of Austrian Economics 5: 111–128.
Salerno, Joseph T. 2004. “Introduction to the Second Edition of Man, Economy and State with Power and Market.” In Man, Economy, and State with Power and Market. Auburn, Ala.: Ludwig von Mises Institute.
Planning for Freedom and Sixteen Other Essays and Addresses[Ludwig von Mises, Planning for Freedom and Sixteen Other Essays and Addresses (1950; South Holland, Ill.: Libertarian Press, 1980), chap. 6, pp. 72–75.] “Inflation and Price Control”
- The Futility of Price ControlUnder socialism production is entirely directed by the orders of the central board of production management. The whole nation is an “industrial army” (a term used by Karl Marx in the Communist Manifesto) and each citizen is bound to obey his superior’s orders. Everybody has to contribute his share to the execution of the overall plan adopted by the Government.
In the free economy no production czar tells a man what he should do. Everybody plans and acts for himself. The coordination of the various individuals’ activities, and their integration into a harmonious system for supplying the consumers with the goods and services they demand, is brought about by the market process and the price structure it generates.
The market steers the capitalistic economy. It directs each individual’s activities into those channels in which he best serves the wants of his fellow-men. The market alone puts the whole social system of private ownership of the means of production and free enterprise in order and provides it with sense and meaning.
There is nothing automatic or mysterious in the operation of the market. The only forces determining the continually fluctuating state of the market are the value judgments of the various individuals and their actions as directed by these value judgments. The ultimate factor in the market is the striving of each man to satisfy his needs and wants in the best possible way. Supremacy of the market is tantamount to the supremacy of the consumers. By their buying, and by their abstention from buying, the consumers determine not only the price structure, but no less what should be produced and in what quantity and quality and by whom. They determine each entrepreneur’s profit or loss, and thereby who should own the capital and run the plants. They make poor men rich and rich men poor. The profit system is essentially production for use, as profits can be earned only by success in supplying consumers in the best and cheapest way with the commodities they want to use.
From this it becomes clear what government tampering with the price structure of the market means. It diverts production from those channels into which the consumers want to direct it into other lines. Under a market not manipulated by government interference there prevails a tendency to expand the production of each article to the point at which a further expansion would not pay because the price realized would not exceed costs. If the government fixes a maximum price for certain commodities below the level which the unhampered market would have determined for them and makes it illegal to sell at the potential market price, production involves a loss for the marginal producers. Those producing with the highest costs go out of the business and employ their production facilities for the production of other commodities, not affected by price ceilings. The government’s interference with the price of a commodity restricts the supply available for consumption. This outcome is contrary to the intentions which motivated the price ceiling. The government wanted to make it easier for people to obtain the article concerned. But its intervention results in shrinking of the supply produced and offered for sale.
If this unpleasant experience does not teach the authorities that price control is futile and that the best policy would be to refrain from any endeavors to control prices, it becomes necessary to add to the first measure, restricting merely the price of one or of several consumers’ goods, further measures. It becomes necessary to fix the prices of the factors of production required for the production of the consumers’ goods concerned. Then the same story repeats itself on a remoter plane. The supply of those factors of production whose prices have been limited shrinks. Then again the government must expand the sphere of its price ceilings. It must fix the prices of the secondary factors of production required for the production of those primary factors. Thus the government must go farther and farther. It must fix the prices of all consumers’ goods and of all factors of production, both material factors and labor, and it must force every entrepreneur and every worker to continue production at these prices and wage rates. No branch of production must be omitted from this all-round fixing of prices and wages and this general order to continue production. If some branches were to be left free, the result would be a shifting of capital and labor to them and a corresponding fall in the supply of the goods whose prices the government has fixed. However, it is precisely these goods which the government considers as especially important for the satisfaction of the needs of the masses.
But when such a state of all-round control of business is achieved, the market economy has been replaced by a system of centralized planning, by socialism. It is no longer the consumers but the government who decides what should be produced and in what quantity and quality. The entrepreneurs are no longer entrepreneurs. They have been reduced to the status of shop managers — or Betriebsführer, as the Nazis said — and are bound to obey the orders issued by the government’s central board of production management. The workers are bound to work in the plants to whom the authorities have assigned them; their wages are determined by authoritarian decrees. The government is supreme. It determines each citizen’s income and standard of living. It is totalitarian.
Price control is contrary to purpose if it is limited to some commodities only. It cannot work satisfactorily within a market economy. The endeavors to make it work must needs enlarge the sphere of the commodities subject to price control until the prices of all commodities and services are regulated by authoritarian decree and the market ceases to work.
Either production can be directed by the prices fixed on the market by the buying or the abstention from buying on the part of the public; or it can be directed by the government’s offices. There is no third solution available. Government control of a part of prices only results in a state of affairs which — without any exception — everybody considers as absurd and contrary to purpose. Its inevitable result is chaos and social unrest.
Economic Policy: Thoughts for Tomorrow and Today[Ludwig von Mises, Economic Policy: Thoughts for Tomorrow and Today (1979; Washington, D.C.: Regnery Gateway, 2006), Lecture 3, pp. 37–54.]“Interventionism”
A famous, very often quoted phrase says: “That government is best, which governs least.” I do not believe this to be a correct description of the functions of a good government. Government ought to do all the things for which it is needed and for which it was established. Government ought to protect the individuals within the country against the violent and fraudulent attacks of gangsters, and it should defend the country against foreign enemies. These are the functions of government within a free system, within the system of the market economy.
Under socialism, of course, the government is totalitarian, and there is nothing outside its sphere and its jurisdiction. But in the market economy the main task of the government is to protect the smooth functioning of the market economy against fraud or violence from within and from outside the country.
People who do not agree with this definition of the functions of government may say: “This man hates the government.” Nothing could be farther from the truth. If I should say that gasoline is a very useful liquid, useful for many purposes, but that I would nevertheless not drink gasoline because I think that would not be the right use for it, I am not an enemy of gasoline, and I do not hate gasoline. I only say that gasoline is very useful for certain purposes, but not fit for other purposes. If I say it is the government’s duty to arrest murderers and other criminals, but not its duty to run the railroads or to spend money for useless things, then I do not hate the government by declaring that it is fit to do certain things but not fit to do other things.
It has been said that under present-day conditions we no longer have a free market economy. Under present-day conditions we have something called the “mixed economy.” And for evidence of our “mixed economy,” people point to the many enterprises which are operated and owned by the government. The economy is mixed, people say, because there are, in many countries, certain institutions — like the telephone, telegraph, and railroads — which are owned and operated by the government.
That some of these institutions and enterprises are operated by the government is certainly true. But this fact alone does not change the character of our economic system. It does not even mean there is a “little socialism” within the otherwise nonsocialist, free market economy. For the government, in operating these enterprises, is subject to the supremacy of the market, which means it is subject to the supremacy of the consumers. The government — if it operates, let us say, post offices or railroads — has to hire people who have to work in these enterprises. It also has to buy the raw materials and other things that are needed for the conduct of these enterprises. And on the other hand, it “sells” these services or commodities to the public. Yet, even though it operates these institutions using the methods of the free economic system, the result, as a rule, is a deficit. The government, however, is in a position to finance such a deficit — at least the members of the government and of the ruling party believe so.
It is certainly different for an individual. The individual’s power to operate something with a deficit is very limited. If the deficit is not very soon eliminated, and if the enterprise does not become profitable (or at least show that no further deficit losses are being incurred), the individual goes bankrupt and the enterprise must come to an end.
But for the government, conditions are different. The government can run at a deficit, because it has the power to tax people. And if the taxpayers are prepared to pay higher taxes in order to make it possible for the government to operate an enterprise at a loss — that is, in a less efficient way than it would be done by a private institution — and if the public will accept this loss, then of course the enterprise will continue.
In recent years, governments have increased the number of nationalized institutions and enterprises in most countries to such an extent that the deficits have grown far beyond the amount that could be collected in taxes from the citizens. What happens then is not the subject of today’s lecture. It is inflation, and I shall deal with that tomorrow. I mentioned this only because the mixed economy must not be confused with the problem of interventionism, about which I want to talk tonight.
What is interventionism? Interventionism means that the government does not restrict its activity to the preservation of order, or — as people used to say a hundred years ago — to “the production of security.” Interventionism means that the government wants to do more. It wants to interfere with market phenomena.
If one objects and says the government should not interfere with business, people very often answer: “But the government necessarily always interferes. If there are policemen on the street, the government interferes. It interferes with a robber looting a shop or it prevents a man from stealing a car.” But when dealing with interventionism and defining what is meant by interventionism, we are speaking about government interference with the market. (That the government and the police are expected to protect the citizens, which includes businessmen, and of course their employees, against attacks on the part of domestic or foreign gangsters, is in fact a normal, necessary expectation of any government. Such protection is not an intervention, for the government’s only legitimate function is, precisely, to produce security.)
What we have in mind when we talk about interventionism is the government’s desire to do more than prevent assaults and fraud. Interventionism means that the government not only fails to protect the smooth functioning of the market economy, but that it interferes with the various market phenomena; it interferes with prices, with wage rates, interest rates, and profits.
The government wants to interfere in order to force businessmen to conduct their affairs in a different way than they would have chosen if they had obeyed only the consumers. Thus, all the measures of interventionism by the government are directed toward restricting the supremacy of consumers. The government wants to arrogate to itself the power, or at least a part of the power, which, in the free market economy, is in the hands of the consumers.
Let us consider one example of interventionism, very popular in many countries and tried again and again by many governments, especially in times of inflation. I refer to price control.
Governments usually resort to price control when they have inflated the money supply and people have begun to complain about the resulting rise in prices. There are many famous historical examples of price control methods that failed, but I shall refer to only two of them because, in both these cases, the governments were really very energetic in enforcing or trying to enforce their price controls.
The first famous example is the case of the Roman Emperor Diocletian, very well-known as the last of those Roman emperors who persecuted the Christians. The Roman emperor in the second part of the third century had only one financial method, and this was currency debasement. In those primitive ages, before the invention of the printing press, even inflation was, let us say, primitive. It involved debasement of the coinage, especially the silver. The government mixed more and more copper into the silver until the color of the silver coins was changed and the weight was reduced considerably. The result of this coinage debasement and the associated increase in the quantity of money was an increase in prices, followed by an edict to control prices. And Roman emperors were not very mild when they enforced a law; they did not consider death too mild a punishment for a man who had asked for a higher price. They enforced price control, but they failed to maintain the society. The result was the disintegration of the Roman Empire and the system of the division of labor.
Then, 1500 years later, the same currency debasement took place during the French Revolution. But this time a different method was used. The technology for producing money was considerably improved. It was no longer necessary for the French to resort to debasement of the coinage: they had the printing press. And the printing press was very efficient. Again, the result was an unprecedented rise in prices. But in the French Revolution maximum prices were not enforced by the same method of capital punishment which the Emperor Diocletian had used. There had also been an improvement in the technique of killing citizens. You all remember the famous Doctor J.I. Guillotin (1738–1814), who advocated the use of the guillotine. Despite the guillotine the French also failed with their laws of maximum prices. When Robespierre himself was carted off to the guillotine the people shouted, “There goes the dirty Maximum.”
I wanted to mention this, because people often say: “What is needed in order to make price control effective and efficient is merely more brutality and more energy.” Now certainly, Diocletian was very brutal, and so was the French Revolution. Nevertheless, price control measures in both ages failed entirely.
Now let us analyze the reasons for this failure. The government hears people complain that the price of milk has gone up. And milk is certainly very important, especially for the rising generation, for children. Consequently, the government declares a maximum price for milk, a maximum price that is lower than the potential market price would be. Now the government says: “Certainly we have done everything needed in order to make it possible for poor parents to buy as much milk as they need to feed their children.”
But what happens? On the one hand, the lower price of milk increases the demand for milk; people who could not afford to buy milk at a higher price are now able to buy it at the lower price which the government has decreed. And on the other hand some of the producers, those producers of milk who are producing at the highest cost — that is, the marginal producers — are now suffering losses, because the price which the government has decreed is lower than their costs. This is the important point in the market economy. The private entrepreneur, the private producer, cannot take losses in the long run. And as he cannot take losses in milk, he restricts the production of milk for the market. He may sell some of his cows for the slaughter house, or instead of milk he may sell some products made out of milk, for instance sour cream, butter, or cheese.
Thus the government’s interference with the price of milk will result in less milk than there was before, and at the same time there will be a greater demand. Some people who are prepared to pay the government-decreed price cannot buy it. Another result will be that anxious people will hurry to be first at the shops. They have to wait outside. The long lines of people waiting at shops always appear as a familiar phenomenon in a city in which the government has decreed maximum prices for commodities that the government considers as important. This has happened everywhere when the price of milk was controlled. This was always prognosticated by economists. Of course, only by sound economists, and their number is not very great.
But what is the result of the government’s price control? The government is disappointed. It wanted to increase the satisfaction of the milk drinkers. But actually it has dissatisfied them. Before the government interfered, milk was expensive, but people could buy it. Now there is only an insufficient quantity of milk available. Therefore, the total consumption of milk drops. The children are getting less milk, not more. The next measure to which the government now resorts, is rationing. But rationing only means that certain people are privileged and are getting milk while other people are not getting any at all. Who gets milk and who does not, of course, is always very arbitrarily determined. One order may determine, for example, that children under four years old should get milk, and that children over four years, or between the age of four and six should get only half the ration which children under four years receive.
Whatever the government does, the fact remains, there is only a smaller amount of milk available. Thus people are still more dissatisfied than they were before. Now the government asks the milk producers (because the government does not have enough imagination to find out for itself): “Why do you not produce the same amount of milk you produced before?” The government gets the answer: “We cannot do it, since the costs of production are higher than the maximum price which the government has established.” Now the government studies the costs of the various items of production, and it discovers one of the items is fodder.
“Oh,” says the government, “the same control we applied to milk we will now apply to fodder. We will determine a maximum price for fodder, and then you will be able to feed your cows at a lower price, at a lower expenditure. Then everything will be all right; you will be able to produce more milk and you will sell more milk.”
But what happens now? The same story repeats itself with fodder, and as you can understand, for the same reasons. The production of fodder drops and the government is again faced with a dilemma. So the government arranges new hearings, to find out what is wrong with fodder production. And it gets an explanation from the producers of fodder precisely like the one it got from the milk producers. So the government must go a step farther, since it does not want to abandon the principle of price control. It determines maximum prices for producers’ goods which are necessary for the production of fodder. And the same story happens again.
The government at the same time starts controlling not only milk, but also eggs, meat, and other necessities. And every time the government gets the same result, everywhere the consequence is the same. Once the government fixes a maximum price for consumer goods, it has to go farther back to producers’ goods, and limit the prices of the producers’ goods required for the production of the price-controlled consumer goods. And so the government, having started with only a few price controls, goes farther and farther back in the process of production, fixing maximum prices for all kinds of producers’ goods, including of course the price of labor, because without wage control, the government’s “cost control” would be meaningless.
Moreover, the government cannot limit its interference into the market to only those things which it views as vital necessities, like milk, butter, eggs, and meat. It must necessarily include luxury goods, because if it did not limit their prices, capital and labor would abandon the production of vital necessities and would turn to producing those things which the government considers unnecessary luxury goods. Thus, the isolated interference with one or a few prices of consumer goods always brings about effects — and this is important to realize — which are even less satisfactory than the conditions that prevailed before.
Before the government interfered, milk and eggs were expensive; after the government interfered they began to disappear from the market. The government considered those items to be so important that it interfered; it wanted to increase the quantity and improve the supply. The result was the opposite: the isolated interference brought about a condition which — from the point of view of the government — is even more undesirable than the previous state of affairs which the government wanted to alter. And as the government goes farther and farther, it will finally arrive at a point where all prices, all wage rates, all interest rates, in short everything in the whole economic system, is determined by the government. And this, clearly, is socialism.
What I have told you here, this schematic and theoretical explanation, is precisely what happened in those countries which tried to enforce a maximum price control, where governments were stubborn enough to go step by step until they came to the end. This happened in the First World War in Germany and England.
Let us analyze the situation in both countries. Both countries experienced inflation. Prices went up, and the two governments imposed price controls. Starting with a few prices, starting with only milk and eggs, they had to go farther and farther. The longer the war went on, the more inflation was generated. And after three years of war, the Germans — systematically as always — elaborated a great plan. They called it the Hindenburg Plan: everything in Germany considered to be good by the government at that time was named after Hindenburg.
The Hindenburg Plan meant that the whole German economic system should be controlled by the government: prices, wages, profits ... everything. And the bureaucracy immediately began to put this into effect. But before they had finished, the debacle came: the German empire broke down, the entire bureaucratic apparatus disappeared, the revolution brought its bloody results — things came to an end.
In England they started in the same way, but after a time, in the spring of 1917, the United States entered the war and supplied the British with sufficient quantities of everything. Therefore the road to socialism, the road to serfdom, was interrupted.
Before Hitler came to power, Chancellor Brüning again introduced price control in Germany for the usual reasons. Hitler enforced it, even before the war started. For in Hitler’s Germany there was no private enterprise or private initiative. In Hitler’s Germany there was a system of socialism which differed from the Russian system only to the extent that the terminology and labels of the free economic system were still retained. There still existed “private enterprises,” as they were called. But the owner was no longer an entrepreneur, the owner was called a “shop manager” (Betriebsführer).
The whole of Germany was organized in a hierarchy of führers; there was the Highest Führer, Hitler of course, and then there were führers down to the many hierarchies of smaller führers. And the head of an enterprise was the Betriebsführer. And the workers of the enterprise were named by a word that, in the Middle Ages, had signified the retinue of a feudal lord: the Gefolgschaft. And all of these people had to obey the orders issued by an institution which had a terribly long name: Reichsführerwirtschaftsministerium,Führer of the Reich’s, i.e., the empire’s, Ministry of Economics. at the head of which was the well-known fat man, named Goering, adorned with jewelry and medals.
And from this body of ministers with the long name came all the orders to every enterprise: what to produce, in what quantity, where to get the raw materials and what to pay for them, to whom to sell the products and at what prices to sell them. The workers got the order to work in a definite factory, and they received wages which the government decreed. The whole economic system was now regulated in every detail by the government.
The Betriebsführer did not have the right to take the profits for himself; he received what amounted to a salary, and if he wanted to get more he would, for example, say: “I am very sick, I need an operation immediately, and the operation will cost 500 Marks,” then he had to ask the führer of the district (the Gauführer or Gauleiter) whether he had the right to take out more than the salary which was given to him. The prices were no longer prices, the wages were no longer wages, they were all quantitative terms in a system of socialism.
Now let me tell you how that system broke down. One day, after years of fighting, the foreign armies arrived in Germany. They tried to preserve this government-directed economic system, but the brutality of Hitler would have been necessary to preserve it and, without this, it did not work.
And while this was going on in Germany, Great Britain — during the Second World War — did precisely what Germany did. Starting with the price control of some commodities only, the British government began step by step (in the same way Hitler had done in peacetime, even before the start of the war) to control more and more of the economy until, by the time the war ended, they had reached something that was almost pure socialism.
Great Britain was not brought to socialism by the Labour government which was established in 1945. Great Britain became socialist during the war, through the government of which Sir Winston Churchill was the prime minister. The Labour government simply retained the system of socialism which the government of Sir Winston Churchill had already introduced. And this in spite of great resistance by the people.
The nationalizations in Great Britain did not mean very much; the nationalization of the Bank of England was merely nominal, because the Bank of England was already under the complete control of the government. And it was the same with the nationalization of the railroads and the steel industry. The “war socialism,” as it was called — meaning the system of interventionism proceeding step by step — had already virtually nationalized the system.
The difference between the German and British systems was not important since the people who operated them had been appointed by the government and in both cases they had to obey the government’s orders in every respect. As I said before, the system of the German Nazis retained the labels and terms of the capitalistic free market economy. But they meant something very different: there were now only government decrees.
This was also true for the British system. When the Conservative party in Britain was returned to power, some of those controls were removed. In Great Britain we now have attempts from one side to retain controls and from the other side to abolish them. (But one must not forget that, in England, conditions are very different from conditions in Russia.) The same is true for other countries which depend on the importation of food and raw materials and therefore have to export manufactured goods. For countries depending heavily on export trade, a system of government control simply does not work.
Thus, as far as there is economic freedom left (and there is still substantial freedom in some countries, such as Norway, England, Sweden), it exists because of the necessity to retain export trade. Earlier, I chose the example of milk, not because I have a special preference for milk, but because practically all governments — or most of them — in recent decades, have regulated milk, egg or butter prices.
I want to refer, in a few words, to another example, and that is rent control. If the government controls rents, one result is that people who would otherwise have moved from bigger apartments to smaller ones when their family conditions changed, will no longer do so. For example, consider parents whose children left home when they came into their twenties, married or went into other cities to work. Such parents used to change their apartments and take smaller and cheaper ones. This necessity disappeared when rent controls were imposed.
In Vienna, Austria, in the early twenties, where rent control was well-established, the amount of money that the landlord received for an average apartment under rent control was not more than twice the price of a ticket for a ride on the city-owned street cars. You can imagine that people did not have any incentive to change their apartments. And, on the other hand, there was no construction of new houses. Similar conditions prevailed in the United States after the Second World War and are continuing in many cities to this day.
One of the main reasons why many cities in the United States are in such great financial difficulty is that they have rent control and a resulting shortage of housing. So the government has spent billions for the building of new houses. But why was there such a housing shortage? The housing shortage developed for the same reasons that brought milk shortages when there was milk price control. That means: when the government interferes with the market, it is more and more driven towards socialism.
And this is the answer to those people who say: “We are not socialists, we do not want the government to control everything. We realize this is bad. But why should not the government interfere a little bit with the market? Why shouldn’t the government do away with some things which we do not like?”
These people talk of a “middle-of-the-road” policy. What they do not see is that the isolated interference, which means the interference with only one small part of the economic system, brings about a situation which the government itself — and the people who are asking for government interference — find worse than the conditions they wanted to abolish: the people who are asking for rent control are very angry when they discover there is a shortage of apartments and a shortage of housing.
But this shortage of housing was created precisely by government interference, by the establishment of rents below the level people would have had to pay in a free market.
The idea that there is a third system — between socialism and capitalism, as its supporters say — a system as far away from socialism as it is from capitalism but that retains the advantages and avoids the disadvantages of each — is pure nonsense. People who believe there is such a mythical system can become really poetic when they praise the glories of interventionism. One can only say they are mistaken. The government interference which they praise brings about conditions which they themselves do not like.
One of the problems I will deal with later is protectionism. The government tries to isolate the domestic market from the world market. It introduces tariffs which raise the domestic price of a commodity above the world market price, making it possible for domestic producers to form cartels. The cartels are then attacked by the government declaring: “Under these conditions, anti-cartel legislation is necessary.”
This is precisely the situation with most of the European governments. In the United States, there are yet other reasons for antitrust legislation and the government’s campaign against the specter of monopoly.
It is absurd to see the government — which creates by its own intervention the conditions making possible the emergence of domestic cartels — point its finger at business, saying: “There are cartels, therefore government interference with business is necessary.” It would be much simpler to avoid cartels by ending the government’s interference with the market — an interference which makes these cartels possible.
The idea of government interference as a “solution” to economic problems leads, in every country, to conditions which, at the least, are very unsatisfactory and often quite chaotic. If the government does not stop in time, it will bring on socialism.
Nevertheless, government interference with business is still very popular. As soon as someone does not like something that happens in the world, he says: “The government ought to do something about it. What do we have a government for? The government should do it.” And this is a characteristic remnant of thought from past ages, of ages preceding modern freedom, modern constitutional government, before representative government or modern republicanism.
For centuries there was the doctrine — maintained and accepted by everyone — that a king, an anointed king, was the messenger of God; he had more wisdom than his subjects, and he had supernatural powers. As recently as the beginning of the nineteenth century, people suffering from certain diseases expected to be cured by the royal touch, by the hand of the king. Doctors were usually better; nevertheless, they had their patients try the king.
This doctrine of the superiority of a paternal government, of the supernatural and superhuman powers of the hereditary kings gradually disappeared — or at least we thought so. But it came back again. There was a German professor named Werner Sombart (I knew him very well), who was known the world over, who was an honorary doctor of many universities and an honorary member of the American Economic Association. That professor wrote a book, which is available in an English translation, published by the Princeton University Press. It is available also in a French translation, and probably also in Spanish — at least I hope it is available, because then you can check what I am saying. In this book, published in our century, not in the Dark Ages, Werner Sombart, a professor of economics, simply says: “The Führer, our Führer” — he means, of course, Hitler — “gets his orders directly from God, the Führer of the Universe.”
I spoke of this hierarchy of the führers earlier, and in this hierarchy. I mentioned Hitler as the “Supreme Führer.” ... But there is, according to Werner Sombart, a still higher Führer, God, the Führer of the universe. And God, he wrote, gives His orders directly to Hitler. Of course, Professor Sombart said very modestly: “We do not know how God communicates with the Führer. But the fact cannot be denied.”
Now, if you hear that such a book can be published in the German language, the language of a nation which was once hailed as “the nation of philosophers and poets,” and if you see it translated into English and French, then you will not be astonished at the fact that even a little bureaucrat considers himself wiser and better than the citizens and wants to interfere with everything, even though he is only a poor little bureaucrat, and not the famous Professor Werner Sombart, honorary member of everything.
Is there a remedy against such happenings? I would say, yes, there is a remedy. And this remedy is the power of the citizens; they have to prevent the establishment of such an autocratic regime that arrogates to itself a higher wisdom than that of the average citizen. This is the fundamental difference between freedom and serfdom.
The socialist nations have arrogated to themselves the term democracy. The Russians call their own system a People’s Democracy; they probably maintain that the people are represented in the person of the dictator. I think that one dictator, Juan Perón here in Argentina, was given a good answer when he was forced into exile in 1955. Let us hope that all other dictators, in other nations, will be accorded a similar response.
Epistemological Problems of Economics[Ludwig von Mises, Epistemological Problems of Economics, 3rd ed. (1933; Auburn, Ala.: Mises Institute, 2003), chap. 4: “On the Development of the Subjective Theory of Value,” pp. 155–61.]1. The Delimitation of the “Economic”Investigations concerning the money prices of goods and services constituted the historical starting point of the reflections that led to the development of economic theory. What first opened the way to success in these inquiries was the observation that money plays “merely” an intermediary role and that through its interposition goods and services are, in the last analysis, exchanged against goods and services. This discovery led to the further realization that the theory of direct exchange, which makes use of the fiction that all acts of exchange are conducted without the intervention of any medium, must be given logical priority over the theory of money and credit, i.e., the theory of indirect exchange, which is effected by means of money.
Still further possibilities were disclosed when it was realized that acts of interpersonal exchange are not essentially different from those which the individual makes within his own household without reaching beyond it into the social sphere. Hence, every allocation of goods — even those in the processes of production — is an exchange, and consequently the basic law of economic action can be comprehended also in the conduct of the isolated farmer. Thus, the foundation was laid for the first correct formulation and satisfactory solution of the problem of the delimitation of “economic” action from “noneconomic” action.
This problem had been approached previously in two different ways, each of which necessarily rendered its solution considerably more difficult. Classical economics had not succeeded in overcoming the difficulties posed by the apparent paradox of value. It had to construct its theory of value and price formation on the basis of exchange value and to start from the action of the businessman, because it was not able to base its system on the valuations of the marginal consumers. The specific conduct of the businessman is directed toward the attainment of the greatest possible monetary profit. Since the classical economists beheld in this phenomenon the essence of economic conduct, they had to distinguish accordingly between “economic” and “noneconomic” action. As soon as the transition was made to the subjective theory of value, this distinction, because it contradicts the basic thought of the whole system, could not but prove totally unserviceable and indeed nothing short of absurd. Of course, it took a long time before it was recognized as such.
If the distinction between the “economic” and the “noneconomic” proved untenable when formulated in terms of the motives and immediate goals of the actor, the attempt to base it on differences among the objects of action fared no better. Material things of the external world are exchanged not only against other things of this kind; they are exchanged also against other — “immaterial” — goods like honor, fame, and recognition. If one wishes to remove these actions from the province of the “economic,” then a new difficulty arises. For a great many of the acts in which material goods are exchanged serve one or both parties to the transaction merely as a preliminary means for the attainment of such “immaterial” satisfactions. However, every attempt to draw a sharp distinction here necessarily led to barren scholastic discussions which entangled themselves in immanent contradictions — discussions such as the successors of the classical economists devoted to the related endeavors to delimit the concepts of a “good” and “productivity.” But even if one wished to disregard this problem completely, one could not ignore the fact that human action exhibits an indissoluble homogeneity and that action involving the exchange of material goods against immaterial goods differs in no significant respect from action involving the exchange of material goods alone.
Two propositions follow from the subjective theory of value that make a precise separation between the “economic” and the “noneconomic,” such as the older economics sought, appear impracticable. First, there is the realization that the economic principle is the fundamental principle of all rational action, and not just a particular feature of a certain kind of rational action. All rational action is therefore an act of economizing. Secondly, there is the realization that every conscious, i.e., meaningful, action is rational. Only the ultimate goals — the values or ends — at which action aims are beyond rationality and, indeed, always and without exception must be. It was no longer compatible with subjectivism to equate “rational” and “irrational” with “objectively practical” and “objectively impractical.” It was no longer permissible to contrast “correct” action as “rational” to “incorrect” action, i.e., action diverted through misunderstanding ignorance, or negligence from employing the best means available to attain the ends sought. Nor was it henceforth possible to call an action irrational in which values like honor, piety, or political goals are taken into consideration. Max Weber’s attempt to separate rational action from other action on the basis of such distinctions was the last of its kind. It was necessarily doomed to failure.
If, however, all conscious conduct is an act of rational economizing, then one must be able to exhibit the fundamental economic categories involved in every action, even in action that is called “noneconomic” in popular usage. And, in fact, it is not difficult to point out in every conceivable human — that is, conscious — action the fundamental categories of catallactics, namely, value, good, exchange, price, and costs. Not only does the science of ethics show this, but even everyday popular usage gives us ample demonstrations of it. One has only to consider, for example, how, outside the domain customarily designated as that of science, terms and phrases are used that have these categories as their specific denotation.
- Preferring as the Basic Element in Human ConductAll conscious conduct on the part of men involves preferring an A to a B. It is an act of choice between two alternative possibilities that offer themselves. Only these acts of choice, these inner decisions that operate upon the external world, are our data. We comprehend their meaning by constructing the concept of importance. If an individual prefers A to B, we say that, at the moment of the act of choice, A appeared more important to him (more valuable, more desirable) than B.
We are also wont to say that the need for A was more urgent than the need for B. This is a mode of expression that, under certain circumstances, may be quite expedient. But as an hypostatization of what was to be explained, it became a source of serious misunderstandings. It was forgotten that we are able to infer the need only from the action. Hence, the idea of an action not in conformity with needs is absurd. As soon as one attempts to distinguish between the need and the action and makes the need the criterion for judging the action, one leaves the domain of theoretical science, with its neutrality in regard to value judgments. It is necessary to recall here that we are dealing with the theory of action, not with psychology, and certainly not with a system of norms, which has the task of differentiating between good and evil or between value and worthlessness. Our data are actions and conduct. It may be left undecided how far and in what way our science needs to concern itself with what lies behind them, that is, with actual valuations and volitions. For there can be no doubt that its subject matter is given action and only given action. Action that ought to be, but is not, does not come within its purview.
This best becomes clear to us if we consider the task of catallactics. Catallactics has to explain how market prices arise from the action of parties to the exchange of goods. It has to explain market prices as they are, not as they should be. If one wishes to do justice to this task, then in no way may one distinguish between “economic” and “noneconomic” grounds of price determination or limit oneself to constructing a theory that would apply only to a world that does not exist. In Böhm-Bawerk’s famous example of the planter’s five sacks of grain, there is no question of a rank order of objective correctness, but of a rank order of subjective desires.
The boundary that separates the economic from the noneconomic is not to be sought within the compass of rational action. It coincides with the line that separates action from nonaction. Action takes place only where decisions are to be made, where the necessity exists of choosing between possible goals, because all goals either cannot be achieved at all or not at the same time. Men act because they are affected by the flux of time. They are therefore not indifferent to the passage of time. They act because they are not fully satisfied and satiated and because by acting they are able to enhance the degree of their satisfaction. Where these conditions are not present — as in the case of “free” goods, for example — action does not take place.
- Eudaemonism and the Theory of ValueThe most troublesome misunderstandings with which the history of philosophical thought has been plagued concern the terms “pleasure” and “pain.” These misconceptions have been carried over into the literature of sociology and economics and have caused harm there too.
Before the introduction of this pair of concepts, ethics was a doctrine of what ought to be. It sought to establish the goals that man should adopt. The realization that man seeks satisfaction by acts both of commission and of omission opened the only path that can lead to a science of human action. If Epicurus sees in
the final goal of action, we can behold in it, if we wish, the state of complete satisfaction and freedom from desire at which human action aims without ever being able to attain it. Crude materialistic thinking seeks to circumscribe it in visions of Paradise and Cockaigne. Whether this construction may, in fact, be placed on Epicurus’ words remains, of course, uncertain, in view of the paucity of what has been handed down of his writings.
Doubtless it did not happen altogether without the fault of Epicurus and his school that the concepts of pleasure and pain were taken in the narrowest and coarsely materialistic sense when one wanted to misconstrue the ideas of hedonism and eudaemonism. And they were not only misconstrued; they were deliberately misrepresented, caricatured, derided, and ridiculed. Not until the seventeenth century did appreciation of the teachings of Epicurus again begin to be shown. On the foundations provided by it arose modern utilitarianism, which for its part soon had to contend anew with the same misrepresentations on the part of its opponents that had confronted its ancient forerunner. Hedonism, eudaemonism, and utilitarianism were condemned and outlawed, and whoever did not wish to run the risk of making the whole world his enemy had to be scrupulously intent upon avoiding the suspicion that he inclined toward these heretical doctrines. This must be kept in mind if one wants to understand why many economists went to great pains to deny the connection between their teachings and those of utilitarianism.
Even Böhm-Bawerk thought that he had to defend himself against the reproach of hedonism. The heart of this defense consists in his statement that he had expressly called attention already in the first exposition of his theory of value to his use of the word “well-being” in its broadest sense, in which it “embraces not only the self-centered interests of a Subject, but everything that seems to him worth aiming at.”Cf. [Eugen von] Böhm-Bawerk, Kapital und Kapitalzins, Part II, vol. 1, p. 236, footnote. Böhm-Bawerk did not see that in saying this he was adopting the same purely formal view of the character of the basic eudaemonistic concepts of pleasure and pain — treating them as indifferent to content — that all advanced utilitarians have held. One need only compare with the words quoted from Böhm-Bawerk the following dictum of Jacobi:
We originally want or desire an object not because it is agreeable or good, but we call it agreeable or good because we want or desire it; and we do this because our sensuous or supersensuous nature so requires. There is, thus, no basis for recognizing what is good and worth wishing for outside of the faculty of desiring — i.e., the original desire and the wish themselves.According to Fr. A. Schmid, quoted by Jodl, Geschichte der Ethik (2nd ed.), vol. 2, p. 661.
We need not go further into the fact that every ethic, no matter how strict an opponent of eudaemonism it may at first appear to be, must somehow clandestinely smuggle the idea of happiness into its system. As Böhm-Bawerk has shown, the case is no different with “ethical” economics.Cf. Böhm-Bawerk’s comments on Schmoller, Kapital und Kapitalzins, p. 239, footnote. That the concepts of pleasure and pain contain no reference to the content of what is aimed at, ought, indeed, scarcely to be still open to misunderstanding.
Once this fact is established, the ground is removed from all the objections advanced by “ethical” economics and related schools. There may be men who aim at different ends from those of the men we know, but as long as there are men — that is, as long as they do not merely graze like animals or vegetate like plants, but act because they seek to attain goals — they will necessarily always be subject to the logic of action, the investigation of which is the task of our science. In this sense that science is universally human, and not limited by nationality, bound to a particular time, or contingent upon any social class. In this sense too it is logically prior to all historical and descriptive research.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 4: “A First Analysis of the Category of Analysis,” pp. 92–98.]1. Ends and MeansThe result sought by an action is called its end, goal, or aim. One uses these terms in ordinary speech also to signify intermediate ends, goals, or aims; these are points which acting man wants to attain only because he believes that he will reach his ultimate end, goal, or aim in passing beyond them. Strictly speaking the end, goal, or aim of any action is always the relief from a felt uneasiness.
A means is what serves to the attainment of any end, goal, or aim. Means are not in the given universe; in this universe there exist only things. A thing becomes a means when human reason plans to employ it for the attainment of some end and human action really employs it for this purpose. Thinking man sees the serviceableness of things, i.e., their ability to minister to his ends, and acting man makes them means. It is of primary importance to realize that parts of the external world become means only through the operation of the human mind and its offshoot, human action. External objects are as such only phenomena of the physical universe and the subject matter of the natural sciences. It is human meaning and action which transform them into means. Praxeology does not deal with the external world, but with man’s conduct with regard to it. Praxeological reality is not the physical universe, but man’s conscious reaction to the given state of this universe. Economics is not about things and tangible material objects; it is about men, their meanings and actions. Goods, commodities, and wealth and all the other notions of conduct are not elements of nature; they are elements of human meaning and conduct. He who wants to deal with them must not look at the external world; he must search for them in the meaning of acting men.
Praxeology and economics do not deal with human meaning and action as they should be or would be if all men were inspired by an absolutely valid philosophy and equipped with a perfect knowledge of technology. For such notions as absolute validity and omniscience there is no room in the frame of a science whose subject matter is erring man. An end is everything which men aim at. A means is everything which acting men consider as such.
It is the task of scientific technology and therapeutics to explode errors in their respective fields. It is the task of economics to expose erroneous doctrines in the field of social action. But if men do not follow the advice of science, but cling to their fallacious prejudices, these errors are reality and must be dealt with as such. Economists consider foreign exchange control as inappropriate to attain the ends aimed at by those who take recourse to it. However, if public opinion does not abandon its delusions and governments consequently resort to foreign exchange control, the course of events is determined by this attitude. Present-day medicine considers the doctrine of the therapeutic effects of mandrake as a fable. But as long as people took this fable as truth, mandrake was an economic good and prices were paid for its acquisition. In dealing with prices economics does not ask what things are in the eyes of other people, but only what they are in the meaning of those intent upon getting them. For it deals with real prices, paid and received in real transactions, not with prices as they would be if men were different from what they really are.
Means are necessarily always limited, i.e., scarce with regard to the services for which man wants to use them. If this were not the case, there would not be any action with regard to them. Where man is not restrained by the insufficient quantity of things available, there is no need for any action.
It is customary to call the end the ultimate good and the means goods. In applying this terminology economists mainly used to think as technologists and not as praxeologists. They differentiated between free goods and economic goods. They called free goods things available in superfluous abundance which man does not need to be economize. Such goods are, however, not the object of any action. They are general conditions of human welfare; they are parts of the natural environment in which man lives and acts. Only the economic goods are the substratum of action. They alone are dealt with in economics.
Economic goods which in themselves are fitted to satisfy human wants directly and whose serviceableness does not depend on the cooperation of other economic goods, are called consumers’ goods or goods of the first order. Means which can satisfy wants only indirectly when complemented by cooperation of other goods are called producers’ goods or factors of production or goods of a remoter or higher order. The services rendered by a producers’ good consist in bringing about, by the cooperation of complementary producers’ goods, a product. This product may be a consumers’ good; it may be a producers’ good which when combined with other producers’ goods will finally bring about a consumers’ good. It is possible to think of the producers’ goods as arranged in orders according to their proximity to the consumers’ good for whose production they can be used. Those producers’ goods which are nearest to the production of a consumers’ good are ranged in the second order, and accordingly those which are used for the production of goods of the second order in the third order and so on.
The purpose of such an arrangement of goods in orders is to provide a basis for the theory of value and prices of the factors of production. It will be shown later how the valuation and the prices of the goods of higher orders are dependent on the valuation and the prices of the goods of lower orders produced by their expenditure. The first and ultimate valuation of external things refers only to consumers’ goods. All other things are valued according to the part they play in the production of consumers’ goods.
It is therefore not necessary actually to arrange producers’ goods in various orders from the second to the nth. It is no less superfluous to enter into pedantic discussions of whether a concrete good has to be called a good of the lowest order or should rather be attributed to one of the higher orders. Whether raw coffee beans or roast coffee beans or ground coffee or coffee prepared for drinking or only coffee prepared and mixed with cream and sugar are to be called a consumers’ good ready for consumption is of no importance. It is immaterial which manner of speech we adopt. For with regard to the problem of valuation, all that we say about a consumers’ good can be applied to any good of a higher order (except those of the highest order) if we consider it as a product.
An economic good does not necessarily have to be embodied in a tangible thing. Nonmaterial economic goods are called services.
- The Scale of ValueActing man chooses between various opportunities offered for choice. He prefers one alternative to others.
It is customary to say that acting man has a scale of wants or values in his mind when he arranges his actions. On the basis of such a scale he satisfies what is of higher value, i.e., his more urgent wants, and leaves unsatisfied what is of lower value, i.e., what is a less urgent want. There is no objection to such a presentation of the state of affairs. However, one must not forget that the scale of values or wants manifests itself only in the reality of action. These scales have no independent existence apart from the actual behavior of individuals. The only source from which our knowledge concerning these scales is derived is the observation of a man’s actions. Every action is always in perfect agreement with the scale of values or wants because these scales are nothing but an instrument for the interpretation of a man’s acting.
Ethical doctrines are intent upon establishing scales of value according to which man should act but does not necessarily always act. They claim for themselves the vocation of telling right from wrong and of advising man concerning what he should aim at as the supreme good. They are normative disciplines aiming at the cognition of what ought to be. They are not neutral with regard to facts; they judge them from the point of view of freely adopted standards.
This is not the attitude of praxeology and economics. They are fully aware of the fact that the ultimate ends of human action are not open to examination from any absolute standard. Ultimate ends are ultimately given, they are purely subjective, they differ with various people and with the same people at various moments in their lives. Praxeology and economics deal with the means for the attainment of ends chosen by the acting individuals. They do not express any opinion with regard to such problems as whether or not sybaritism is better than asceticism. They apply to the means only one yardstick, viz., whether or not they are suitable to attain the ends at which the acting individuals aim.
The notions of abnormality and perversity therefore have no place in economics. It does not say that a man is perverse because he prefers the disagreeable, the detrimental, and the painful to the agreeable, the beneficial, and the pleasant. It says only that he is different from other people; that he likes what others detest; that he considers useful what others want to avoid; that he takes pleasure in enduring pain which others avoid because it hurts them. The polar notions normal and perverse can be used anthropologically for the distinction between those who behave as most people do and outsiders and atypical exceptions; they can be applied biologically for the distinction between those whose behavior preserves the vital forces and those whose behavior is self-destructive; they can be applied in an ethical sense for the distinction between those who behave correctly and those who act otherwise than they should. However, in the frame of a theoretical science of human action, there is no room for such a distinction. Any examination of ultimate ends turns out to be purely subjective and therefore arbitrary.
Value is the importance that acting man attaches to ultimate ends. Only to ultimate ends is primary and original value assigned. Means are valued derivatively according to their serviceableness in contributing to the attainment of ultimate ends. Their valuation is derived from the valuation of the respective ends. They are important for man only as far as they make it possible for him to attain some ends.
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.
Neither is value in words and in doctrines. It is reflected in human conduct. It is not what a man or groups of men say about value that counts, but how they act. The bombastic oratory of moralists and the inflated pompousness of party programs are significant as such. But they influence the course of human events only as far as they really determine the actions of men.
- The Scale of NeedsNotwithstanding all declarations to the contrary, the immense majority of men aim first of all at an improvement of the material conditions of well-being. They want more and better food, better homes and clothes, and a thousand other amenities. They strive after abundance and health. Taking these goals as given, applied physiology tries to determine what means are best suited to provide as much satisfaction as possible. It distinguishes, from this point of view, between man’s “real” needs and imaginary and spurious appetites. It teaches people how they should act and what they should aim at as a means.
The importance of such doctrines is obvious. From his point of view the physiologist is right in distinguishing between sensible action and action contrary to purpose. He is right in contrasting judicious methods of nourishment from unwise methods. He may condemn certain modes of behavior as absurd and opposed to “real” needs. However, such judgments are beside the point for a science dealing with the reality of human action. Not what a man should do, but what he does, counts for praxeology and economics. Hygiene may be right or wrong in calling alcohol and nicotine poisons. But economics must explain the prices of tobacco and liquor as they are, not as they would be under different conditions.
There is no room left in the field of economics for a scale of needs different from the scale of values as reflected in man’s actual behavior. Economics deals with real man, weak and subject to error as he is, not with ideal beings, omniscient and perfect as only gods could be.
- Action as an ExchangeAction is an attempt to substitute a more satisfactory state of affairs for a less satisfactory one. We call such a willfully induced alteration an exchange. A less desirable condition is bartered for a more desirable. What gratifies less is abandoned in order to attain something that pleases more. That which is abandoned is called the price paid for the attainment of the end sought. The value of the price paid is called costs. Costs are equal to the value attached to the satisfaction which one must forego in order to attain the end aimed at.
The difference between the value of the price paid (the costs incurred) and that of the goal attained is called gain or profit or net yield. Profit in this primary sense is purely subjective, it is an increase in the acting man’s happiness, it is a psychical phenomenon that can be neither measured nor weighed. There is a more and a less in the removal of uneasiness felt; but how much one satisfaction surpasses another one can only be felt; it cannot be established and determined in an objective way. A judgment of value does not measure, it arranges in a scale of degrees, it grades. It is expressive of an order of preference and sequence, but not expressive of measure and weight. Only the ordinal numbers can be applied to it, but not the cardinal numbers.
It is vain to speak of any calculation of values. Calculation is possible only with cardinal numbers. The difference between the valuation of two states of affairs is entirely psychical and personal. It is not open to any projection into the external world. It can be sensed only by the individual. It cannot be communicated or imparted to any fellow man. It is an intensive magnitude.
Physiology and psychology have developed various methods by means of which they pretend to have attained a substitute for the unfeasible measurement of intensive magnitudes. There is no need for economics to enter into an examination of these rather questionable makeshifts. Their supporters themselves realize that they are not applicable to value judgments. But even if they were, they would not have any bearing on economic problems. For economics deals with action as such, and not with the psychical facts that result in definite actions.
It happens again and again that an action does not attain the end sought. Sometimes the result, although inferior to the end aimed at, is still an improvement when compared with the previous state of affairs; then there is still a profit, although a smaller one than that expected. But it can happen that the action produces a state of affairs less desirable than the previous state it was intended to alter. Then the difference between the valuation of the result and the costs incurred is called loss.
Theory and History[Ludwig von Mises, Theory and History (1957; Auburn, Ala.: Mises Institute, 1985), chap. 1: “Judgments of Value,” pp. 19–25.]1. Judgments of Value and Propositions of ExistencePropositions asserting existence (affirmative existential propositions) or nonexistence (negative existential propositions) are descriptive. They assert something about the state of the whole universe or of parts of the universe. With regard to them questions of truth and falsity are significant. They must not be confounded with judgments of value.
Judgments of value are voluntaristic. They express feelings, tastes, or preferences of the individual who utters them. With regard to them there cannot be any question of truth and falsity. They are ultimate and not subject to any proof or evidence.
Judgments of value are mental acts of the individual concerned. As such they must be sharply distinguished from the sentences by means of which an individual tries to inform other people about the content of his judgments of value. A man may have some reason to lie about his valuations. We may describe this state of affairs in the following way: Every judgment of value is in itself also a fact of the actual state of the universe and as such may be the topic of existential propositions. The sentence “I prefer Beethoven to Lehar” refers to a judgment of value. If looked upon as an existential proposition, it is true if I really prefer Beethoven and act accordingly and false if I in fact prefer Lehar and for some reasons lie about my real feelings, taste, or preferences. In an analogous way the existential proposition “Paul prefers Beethoven to Lehar” may be true or false. In declaring that with regard to a judgment of value there cannot be any question of truth or falsity, we refer to the judgment as such and not to the sentences communicating the content of such a judgment of value to other people.
- Valuation and ActionA judgment of value is purely academic if it does not impel the man who utters it to any action. There are judgments which must remain academic because it is beyond the power of the individual to embark upon any action directed by them. A man may prefer a starry sky to the starless sky, but he cannot attempt to substitute the former state which he likes better for the latter he likes less.
The significance of value judgments consists precisely in the fact that they are the springs of human action. Guided by his valuations, man is intent upon substituting conditions that please him better for conditions which he deems less satisfactory. He employs means in order to attain ends sought.
Hence the history of human affairs has to deal with the judgments of value that impelled men to act and directed their conduct. What happened in history cannot be discovered and narrated without referring to the various valuations of the acting individuals. It is not the task of the historian qua historian to pass judgments of value on the individuals whose conduct is the theme of his inquiries. As a branch of knowledge history utters existential propositions only. But these existential propositions often refer to the presence or absence of definite judgments of value in the minds of the acting individuals. It is one of the tasks of the specific understanding of the historical sciences to establish what content the value judgments of the acting individuals had.
It is a task of history, for example, to trace back the origin of India’s caste system to the values which prompted the conduct of the generations who developed, perfected, and preserved it. It is its further task to discover what the consequences of this system were and how these effects influenced the value judgments of later generations. But it is not the business of the historian to pass judgments of value on the system as such, to praise or to condemn it. He has to deal with its relevance for the course of affairs, he has to compare it with the designs and intentions of its authors and supporters and to depict its effects and consequences. He has to ask whether or not the means employed were fit to attain the ends the acting individuals sought.
It is a fact that hardly any historian has fully avoided passing judgments of value. But such judgments are always merely incidental to the genuine tasks of history. In uttering them the author speaks as an individual judging from the point of view of his personal valuations, not as a historian.
- The Subjectivity of ValuationAll judgments of value are personal and subjective. There are no judgments of value other than those asserting I prefer, I like better, I wish.
It cannot be denied by anybody that various individuals disagree widely with regard to their feelings, tastes, and preferences and that even the same individuals at various instants of their lives value the same things in a different way. In view of this fact it is useless to talk about absolute and eternal values.
This does not mean that every individual draws his valuations from his own mind. The immense majority of people take their valuations from the social environment into which they were born, in which they grew up, that moulded their personality and educated them. Few men have the power to deviate from the traditional set of values and to establish their own scale of what appears to be better and what appears to be worse.
What the theorem of the subjectivity of valuation means is that there is no standard available which would enable us to reject any ultimate judgment of value as wrong, false, or erroneous in the way we can reject an existential proposition as manifestly false. It is vain to argue about ultimate judgments of value as we argue about the truth or falsity of an existential proposition. As soon as we start to refute by arguments an ultimate judgment of value, we look upon it as a means to attain definite ends. But then we merely shift the discussion to another plane. We no longer view the principle concerned as an ultimate value but as a means to attain an ultimate value, and we are again faced with the same problem. We may, for instance, try to show a Buddhist that to act in conformity with the teachings of his creed results in effects which we consider disastrous. But we are silenced if he replies that these effects are in his opinion lesser evils or no evils at all compared to what would result from nonobservance of his rules of conduct. His ideas about the supreme good, happiness, and eternal bliss are different from ours. He does not care for those values his critics are concerned with, and seeks for satisfaction in other things than they do.
- The Logical and Syntactical Structure of Judgments of ValueA judgment of value looks upon things from the point of view of the man who utters it. It does not assert anything about things as they are. It manifests a man’s affective response to definite conditions of the universe as compared with other definite conditions.
Value is not intrinsic. It is not in things and conditions but in the valuing subject. It is impossible to ascribe value to one thing or state of affairs only. Valuation invariably compares one thing or condition with another thing or condition. It grades various states of the external world. It contrasts one thing or state, whether real or imagined, with another thing or state, whether real or imagined, and arranges both in a scale of what the author of the judgment likes better and what less.
It may happen that the judging individual considers both things or conditions envisaged as equal. He is not concerned whether there is A or B. Then his judgment of value expresses indifference. No action can result from such a neutral disposition.
Sometimes the utterance of a judgment of value is elliptical and makes sense only if appropriately completed by the hearer. “I don’t like measles” means “I prefer the absence of measles to its presence.” Such incompleteness is the mark of all references to freedom. Freedom invariably means freedom from (absence of) something referred to expressly or implicitly. The grammatical form of such judgments may be qualified as negative. But it is vain to deduce from this idiomatic attire of a class of judgments of value any statements about their content and to blame them for an alleged negativism. Every judgment of value allows of a formulation in which the more highly valued thing or state is logically expressed in both a positive and a negative way, although sometimes a language may not have developed the appropriate term. Freedom of the press implies the rejection or negation of censorship. But, stated explicitly, it means a state of affairs in which the author alone determines the content of his publication as distinct from a state in which the police has a right to interfere in the matter.
Action necessarily involves the renunciation of something to which a lower value is assigned in order to attain or to preserve something to which a higher value is assigned. Thus, for instance, a definite amount of leisure is renounced in order to reap the product of a definite amount of labor. The renunciation of leisure is the means to attain a more highly valued thing or state.
There are men whose nerves are so sensitive that they cannot endure an unvarnished account of many facts about the physiological nature of the human body and the praxeological character of human action. Such people take offense at the statement that man must choose between the most sublime things, the loftiest human ideals, on the one hand, and the wants of his body on the other. They feel that such statements detract from the nobility of the higher things. They refuse to notice the fact that there arise in the life of man situations in which he is forced to choose between fidelity to lofty ideals and such animal urges as feeding.
Whenever man is faced with the necessity of choosing between two things or states, his decision is a judgment of value no matter whether or not it is uttered in the grammatical form commonly employed in expressing such judgments.
Planning for Freedom and Sixteen Other Essays and Addresses[Ludwig von Mises, Planning for Freedom and Sixteen Other Essays and Addresses (1952; South Holland, Ill.: Libertarian Press, 1980), chap. 10, pp. 150–61.]“Wages, Unemployment and Inflation”
Our economic system — the market economy or capitalism — is a system of consumers’ supremacy. The customer is sovereign; he is, says a popular slogan, “always right.” Businessmen are under the necessity of turning out what the consumers ask for and they must sell their wares at prices which the consumers can afford and are prepared to pay. A business operation is a manifest failure if the proceeds from the sales do not reimburse the businessman for all he has expended in producing the article. Thus the consumers in buying at a definite price determine also the height of the wages that are paid to all those engaged in the industries.
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Wages Ultimately Paid By the ConsumersIt follows that an employer cannot pay more to an employee than the equivalent of the value the latter’s work, according to the judgment of the buying public, adds to the merchandise. (This is the reason why the movie star gets much more than the charwoman.) If he were to pay more, he would not recover his outlays from the purchasers; he would suffer losses and would finally go bankrupt. In paying wages, the employer acts as a mandatory of the consumers, as it were. It is upon the consumers that the incidence of the wage payments falls. As the immense majority of the goods produced are bought and consumed by people who are themselves receiving wages and salaries, it is obvious that in spending their earnings the wage earners and employees themselves are foremost in determining the height of the compensation they and those like them will get.
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What Makes Wages RiseThe buyers do not pay for the toil and trouble the worker took nor for the length of time he spent in working. They pay for the products. The better the tools are which the worker uses in his job, the more he can perform in an hour, the higher is, consequently, his remuneration. What makes wages rise and renders the material conditions of the wage earners more satisfactory is improvement in the technological equipment. American wages are higher than wages in other countries because the capital invested per head of the worker is greater and the plants are thereby in the position to use the most efficient tools and machines. What is called the American way of life is the result of the fact that the United States has put fewer obstacles in the way of saving and capital accumulation than other nations. The economic backwardness of such countries as India consists precisely in the fact that their policies hinder both the accumulation of domestic capital and the investment of foreign capital. As the capital required is lacking, the Indian enterprises are prevented from employing sufficient quantities of modern equipment, are therefore producing much less per man-hour, and can only afford to pay wage rates which, compared with American wage rates, appear as shockingly low.
There is only one way that leads to an improvement of the standard of living for the wage-earning masses, viz., the increase in the amount of capital invested. All other methods, however popular they may be, are not only futile, but are actually detrimental to the well-being of those they allegedly want to benefit.
- What Causes UnemploymentThe fundamental question is: is it possible to raise wage rates for all those eager to find jobs above the height they would have attained on an unhampered labor market?
Public opinion believes that the improvement in the conditions of the wage earners is an achievement of the unions and of various legislative measures. It gives to unionism and to legislation credit for the rise in wage rates, the shortening of hours of work, the disappearance of child labor, and many other changes. The prevalence of this belief made unionism popular and is responsible for the trend in labor legislation of the last two decades. As people think that they owe to unionism their high standard of living, they condone violence, coercion, and intimidation on the part of unionized labor and are indifferent to the curtailment of personal freedom inherent in the union-shop and closed-shop clauses. As long as these fallacies prevail upon the minds of the voters, it is vain to expect a resolute departure from the policies that are mistakenly called progressive.
Yet this popular doctrine misconstrues every aspect of economic reality. The height of wage rates at which all those eager to get jobs can be employed depends on the marginal productivity of labor. The more capital — other things being equal — is invested, the higher wages climb on the free labor market, i.e., on the labor market not manipulated by the government and the unions. At these market wage rates all those eager to employ workers can hire as many as they want. At these market wage rates all those who want to be employed can get a job. There prevails on a free labor market a tendency toward full employment. In fact, the policy of letting the free market determine the height of wage rates is the only reasonable and successful full-employment policy. If wage rates, either by union pressure and compulsion or by government decree, are raised above this height, lasting unemployment of a part of the potential labor force develops.
- Credit Expansion No Substitute for CapitalThese opinions are passionately rejected by the union bosses and their followers among politicians and the self-styled intellectuals. The panacea they recommend to fight unemployment is credit expansion and inflation, euphemistically called “an easy money policy.”
As has been pointed out above, an addition to the available stock of capital previously accumulated makes a further improvement of the industries’ technological equipment possible, thus raises the marginal productivity of labor and consequently also wage rates. But credit expansion, whether it is effected by issuing additional banknotes or by granting additional credits on bank accounts subject to check, does not add anything to the nation’s wealth of capital goods. It merely creates the illusion of an increase in the amount of funds available for an expansion of production. Because they can obtain cheaper credit, people erroneously believe that the country’s wealth has thereby been increased and that therefore certain projects that could not be executed before are now feasible. The inauguration of these projects enhances the demand for labor and for raw materials and makes wage rates and commodity prices rise. An artificial boom is kindled.
Under the conditions of this boom, nominal wage rates which before the credit expansion were too high for the state of the market and therefore created unemployment of a part of the potential labor force are no longer too high and the unemployed can get jobs again. However, this happens only because under the changed monetary and credit conditions prices are rising or, what is the same expressed in other words, the purchasing power of the monetary unit drops. Then the same amount of nominal wages, i.e., wage rates expressed in terms of money, means less in real wages, i.e., in terms of commodities that can be bought by the monetary unit. Inflation can cure unemployment only by curtailing the wage earner’s real wages. But then the unions ask for a new increase in wages in order to keep pace with the rising cost of living and we are back where we were before, i.e., in a situation in which large-scale unemployment can only be prevented by a further expansion of credit.
This is what happened in this country as well as in many other countries in the last years. The unions, supported by the government, forced the enterprises to agree to wage rates that went beyond the potential market rates, i.e., the rates which the public was prepared to refund to the employers in purchasing their products. This would have inevitably resulted in rising unemployment figures. But the government policies tried to prevent the emergence of serious unemployment by credit expansion, i.e., inflation. The outcome was rising prices, renewed demands for higher wages and reiterated credit expansion; in short, protracted inflation.
- Inflation Cannot Go On EndlesslyBut finally the authorities become frightened. They know that inflation cannot go on endlessly. If one does not stop in time the pernicious policy of increasing the quantity of money and fiduciary media, the nation’s currency system collapses entirely. The monetary unit’s purchasing power sinks to a point which for all practical purposes is not better than zero. This happened again and again, in this country with the Continental Currency in 1781, in France in 1796, in Germany in 1923. It is never too early for a nation to realize that inflation cannot be considered as a way of life and that it is imperative to return to sound monetary policies. In recognition of these facts the administration and the Federal Reserve authorities some time ago discontinued the policy of progressive credit expansion.
It is not the task of this short article to deal with all the consequences which the termination of inflationary measures brings about. We have only to establish the fact that the return to monetary stability does not generate a crisis. It only brings to light the malinvestments and other mistakes that were made under the hallucination of the illusory prosperity created by the easy money. People become aware of the faults committed and, no longer blinded by the phantom of cheap credit, begin to readjust their activities to the real state of the supply of material factors of production. It is this — certainly painful, but unavoidable — readjustment that constitutes the depression.
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The Policy Of The UnionsOne of the unpleasant features of this process of discarding chimeras and returning to a sober estimate of reality concerns the height of wage rates. Under the impact of the progressive inflationary policy the union bureaucracy acquired the habit of asking at regular intervals for wage raises, and business, after some sham resistance, yielded. As a result these rates were at the moment too high for the state of the market and would have brought about a conspicuous amount of unemployment. But the ceaselessly progressive inflation very soon caught up with them. Then the unions asked again for new raises and so on.
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The Purchasing Power ArgumentIt does not matter what kind of justification the unions and their henchmen advance in favor of their claims. The unavoidable effects of forcing the employers to remunerate work done at higher rates than those the consumers are willing to restore to them in buying the products are always the same: rising unemployment figures.
At the present juncture the unions try to take up the old, a hundred times refuted purchasing power fable. They declare that putting more money into the hands of the wage earners — by raising wage rates, by increasing the benefits to the unemployed and by embarking upon new public works — would enable the workers to spend more and thereby stimulate business and lead the economy out of the recession into prosperity. This is the spurious pro-inflation argument to make all people happy through printing paper bills. Of course, if the quantity of the circulating media is increased, those into whose pockets the new fictitious wealth comes — whether they are workers or farmers or any other kind of people — will increase their spending. But it is precisely this increase in spending that inevitably brings about a general tendency of all prices to rise or, what is the same expressed in a different way, a drop in the monetary unit’s purchasing power. Thus the help that an inflationary action could give to the wage earners is only of a short duration. To perpetuate it, one would have to resort again and again to new inflationary measures. It is clear that this leads to disaster.
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Wage Raises As Such Not InflationaryThere is a lot of nonsense said about these things. Some people assert that wage raises are “inflationary.” But they are not in themselves inflationary. Nothing is inflationary except inflation, i.e., an increase in the quantity of money in circulation and credit subject to check (check-book money). And under present conditions nobody but the government can bring an inflation into being. What the unions can generate by forcing the employers to accept wage rates higher than the potential market rates is not inflation and not higher commodity prices, but unemployment of a part of the people anxious to get a job. Inflation is a policy to which the government resorts in order to prevent the large-scale unemployment the unions’ wage raising would otherwise bring about.
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The Dilemma of Present-Day PoliciesThe dilemma which this country — and no less many other countries — has to face is very serious. The extremely popular method of raising wage rates above the height the unhampered labor market would have established would produce catastrophic mass unemployment if inflationary credit expansion were not to rescue it. But inflation has not only very pernicious social effects. It cannot go on endlessly without resulting in the complete breakdown of the whole monetary system.
Public opinion, entirely under the sway of the fallacious labor union doctrines, sympathizes more or less with the union bosses’ demand for a considerable rise in wage rates. As conditions are today, the unions have the power to make the employers submit to their dictates. They can call strikes and, without being restrained by the authorities, resort with impunity to violence against those willing to work. They are aware of the fact that the enhancement of wage rates will increase the number of jobless. The only remedy they suggest is more ample funds for unemployment compensation and a more ample supply of credit, i.e., inflation. The government, meekly yielding to a misguided public opinion and worried about the outcome of the impending election campaign, has unfortunately already begun to reverse its attempts to return to a sound monetary policy. Thus we are again committed to the pernicious methods of meddling with the supply of money. We are going on with the inflation that with accelerated speed makes the purchasing power of the dollar shrink. Where will it end? This is the question which Mr. Reuther and all the rest never ask.
Only stupendous ignorance can call the policies adopted by the self-styled progressives “pro-labor” policies. The wage earner like every other citizen is firmly interested in the preservation of the dollar’s purchasing power. If, thanks to his union, his weekly earnings are raised above the market rate, he must very soon discover that the upward movement in prices not only deprives him of the advantages he expected, but besides makes the value of his savings, of his insurance policy and of his pension rights dwindle. And, still worse, he may lose his job and will not find another.
- Insincerity In The Fight Against InflationAll political parties and pressure groups protest that they are opposed to inflation. But what they really mean is that they do not like the unavoidable consequences of inflation, viz., the rise in living costs. Actually they favor all policies that necessarily bring about an increase in the quantity of the circulating media. They ask not only for an easy money policy to make the unions’ endless wage boosting possible but also for more government spending and — at the same time — for tax abatement through raising the exemptions.
Duped by the spurious Marxian concept of irreconcilable conflicts between the interests of the social classes, people assume that the interests of the propertied classes alone are opposed to the unions’ demand for higher wage rates. In fact, the wage earners are no less interested in a return to sound money than any other group or class. A lot has been said in the last months about the harm fraudulent officers have inflicted upon the union membership. But the havoc done to the workers by the unions’ excessive wage boosting is much more detrimental.
It would be an exaggeration to contend that the tactics of the unions are the sole threat to monetary stability and to a reasonable economic policy. Organized wage earners are not the only pressure group whose claims menace today the stability of our monetary system. But they are the most powerful and most influential of these groups and the primary responsibility rests with them.
- The Importance of Sound Monetary PoliciesCapitalism has improved the standard of living of the wage earners to an unprecedented extent. The average American family enjoys today amenities of which, only a hundred years ago, not even the richest nabobs dreamed. All this well-being is conditioned by the increase in savings and capital accumulated; without these funds that enable business to make practical use of scientific and technological progress the American worker would not produce more and better things per hour of work than the Asiatic coolies, would not earn more and would, like them, wretchedly live on the verge of starvation. All measures which — like our income and corporation tax system — aim at preventing further capital accumulation or even at capital decumulation are therefore virtually anti-labor and anti-social.
One further observation must still be made about this matter of saving and capital formation. The improvement of well-being brought about by capitalism made it possible for the common man to save and thus to become in a modest way himself a capitalist. A considerable part of the capital working in American business is the counterpart of the savings of the masses. Millions of wage earners own saving deposits, bonds and insurance policies. All these claims are payable in dollars and their worth depends on the soundness of the nation’s money. To preserve the dollar’s purchasing power is also from this point of view a vital interest of the masses. In order to attain this end, it is not enough to print upon the bank notes the noble maxim In God We Trust. One must adopt an appropriate policy.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 21: “Work and Wages,” pp. 589–98.]3. WagesLabor is a scarce factor of production. As such it is sold and bought on the market. The price paid for labor is included in the price allowed for the product or the services if the performer of the work is the seller of the product or the services. If bare labor is sold and bought as such, either by an entrepreneur engaged in production for sale or by a consumer eager to use the services rendered for his own consumption, the price paid is called wages.
For acting man his own labor is not merely a factor of production but also the source of disutility; he values it not only with regard to the mediate gratification expected but also with regard to the disutility it causes. But for him, as for everyone, other people’s labor as offered for sale on the market is nothing but a factor of production. Man deals with other people’s labor in the same way that he deals with all scarce material factors of production. He appraises it according to the principles he applies in the appraisal of all other goods. The height of wage rates is determined on the market in the same way in which the prices of all commodities are determined. In this sense we may say that labor is a commodity. The emotional associations which people, under the influence of Marxism, attach to this term do not matter. It suffices to observe incidentally that the employers deal with labor as they do with commodities because the conduct of the consumers forces them to proceed in this way.
It is not permissible to speak of labor and wages in general without resorting to certain restrictions. A uniform type of labor or a general rate of wages do not exist. Labor is very different in quality, and each kind of labor renders specific services. Each is appraised as a complementary factor for turning out definite consumers’ goods and services. Between the appraisal of the performance of a surgeon and that of a stevedore there is no direct connection. But indirectly each sector of the labor market is connected with all other sectors. An increase in the demand for surgical services, however great, will not make stevedores flock into the practice of surgery. Yet the lines between the various sectors of the labor market are not sharply drawn. There prevails a continuous tendency for workers to shift from their branch to other similar occupations in which conditions seem to offer better opportunities. Thus finally every change in demand or supply in one sector affects all other sectors indirectly. All groups indirectly compete with one another. If more people enter the medical profession, men are withdrawn from kindred occupations who again are replaced by an inflow of people from other branches and so on. In this sense there exists a connexity between all occupational groups however different the requirements in each of them may be. There again we are faced with the fact that the disparity in the quality of work needed for the satisfaction of wants is greater than the diversity in men’s inborn ability to perform work.
Connexity exists not only between different types of labor and the prices paid for them but no less between labor and the material factors of production. Within certain limits labor can be substituted for material factors of production and vice versa. The extent that such substitutions are resorted to depends on the height of wage rates and the prices of material factors.
The determination of wage rates — like that of the prices of material factors of production — can be achieved only on the market. There is no such thing as nonmarket wage rates, just as there are no nonmarket prices. As far as there are wages, labor is dealt with like any material factor of production and sold and bought on the market. It is usual to call the sector of the market of producers’ goods on which labor is hired the labor market. As with all other sectors of the market, the labor market is actuated by the entrepreneurs intent upon making profits. Each entrepreneur is eager to buy all the kinds of specific labor he needs for the realization of his plans at the cheapest price. But the wages he offers must be high enough to take the workers away from competing entrepreneurs. The upper limit of his bidding is determined by anticipation of the price he can obtain for the increment in salable goods he expects from the employment of the worker concerned. The lower limit is determined by the bids of competing entrepreneurs who themselves are guided by analogous considerations. It is this that economists have in mind in asserting that the height of wage rates for each kind of labor is determined by its marginal productivity. Another way to express the same truth is to say that wage rates are determined by the supply of labor and of material factors of production on the one hand and by the anticipated future prices of the consumers’ goods.
This catallactic explanation of the determination of wage rates has been the target of passionate but entirely erroneous attacks. It has been asserted that there is a monopoly of the demand for labor. Most of the supporters of this doctrine think that they have sufficiently proved their case by referring to some incidental remarks of Adam Smith concerning “a sort of tacit but constant and uniform combination” among employers to keep wages down.Cf. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (Basle, 1791), vol. 1, Bk. I, chap. 8, p. 100. Adam Smith himself seems to have unconsciously given up the idea. Cf. W.H. Hutt, The Theory of Collective Bargaining (London, 1930), pp. 24–25. Others refer in vague terms to the existence of trade associations of various groups of businessmen. The emptiness of all this talk is evident. However, the fact that these garbled ideas are the main ideological foundation of labor unionism and the labor policy of all contemporary governments makes it necessary to analyze them with the utmost care.
The entrepreneurs are in the same position with regard to the sellers of labor as they are with regard to the sellers of the material factors of production. They are under the necessity of acquiring all factors of production at the cheapest price. But if in the pursuit of this endeavor some entrepreneurs, certain groups of entrepreneurs, or all entrepreneurs offer prices or wage rates which are too low, i.e., do not agree with the state of the unhampered market, they will succeed in acquiring what they want to acquire only if entrance into the ranks of entrepreneurship is blocked through institutional barriers. If the emergence of new entrepreneurs or the expansion of the activities of already operating entrepreneurs is not prevented, any drop in the prices of factors of production not consonant with the structure of the market must open new chances for the earning of profits. There will be people eager to take advantage of the margin between the prevailing wage rate and the marginal productivity of labor. Their demand for labor will bring wage rates back to the height conditioned by labor’s marginal productivity. The tacit combination among the employers to which Adam Smith referred, even if it existed, could not lower wages below the competitive market rate unless access to entrepreneurship required not only brains and capital (the latter always available to enterprises promising the highest returns), but in addition also an institutional title, a patent, or a license, reserved to a class of privileged people.
It has been asserted that a job-seeker must sell his labor at any price, however low, as he depends exclusively on his capacity to work and has no other source of income. He cannot wait and is forced to content himself with any reward the employers are kind enough to offer him. This inherent weakness makes it easy for the concerted action of the masters to lower wage rates. They can, if need be, wait longer, as their demand for labor is not so urgent as the worker’s demand for subsistence. The argument is defective. It takes it for granted that the employers pocket the difference between the marginal-productivity wage rate and the lower monopoly rate as an extra monopoly gain and do not pass it on to the consumers in the form of a reduction in prices. For if they were to reduce prices according to the drop in costs of production, they, in their capacity as entrepreneurs and sellers of the products, would derive no advantage from cutting wages. The whole gain would go to the consumers and thereby also to the wage-earners in their capacity as buyers; the entrepreneurs themselves would be benefited only as consumers. However, to retain the extra profit resulting from the “exploitation” of the workers’ alleged poor bargaining power would require concerted action on the part of employers in their capacity as sellers of the products. It would require a universal monopoly of all kinds of production activities which can be created only by an institutional restriction of access to entrepreneurship.
The essential point of the matter is that the alleged monopolistic combination of the employers about which Adam Smith and a great part of public opinion speak would be a monopoly of demand. But we have already seen that such alleged monopolies of demand are in fact monopolies of supply of a particular character. The employers would be in a position enabling them to lower wage rates by concerted action only if they were to monopolize a factor indispensable for every kind of production and to restrict the employment of this factor in a monopolistic way. As there is no single material factor indispensable for every kind of production, they would have to monopolize all material factors of production. This condition would be present only in a socialist community, in which there is neither a market nor prices and wage rates.
Neither would it be possible for the proprietors of the material factors of production, the capitalists and the landowners, to combine in a universal cartel against the interests of the workers. The characteristic mark of production activities in the past and in the foreseeable future is that the scarcity of labor exceeds the scarcity of most of the primary, nature-given material factors of production. The comparatively greater scarcity of labor determines the extent to which the comparatively abundant primary natural factors can be utilized. There is unused soil, there are unused mineral deposits and so on because there is not enough labor available for their utilization. If the owners of the soil that is tilled today were to form a cartel in order to reap monopoly gains, their plans would be frustrated by the competition of the owners of the submarginal land. The owners of the produced factors of production in their turn could not combine in a comprehensive cartel without the cooperation of the owners of the primary factors.
Various other objections have been advanced against the doctrine of the monopolistic exploitation of labor by a tacit or avowed combine of employers. It has been demonstrated that at no time and at no place in the unhampered market economy can the existence of such cartels be discovered. It has been shown that it is not true that the job-seekers cannot wait and are therefore under the necessity of accepting any wage rates, however low, offered to them by the employers. It is not true that every unemployed worker is faced with starvation; the workers too have reserves and can wait; the proof is that they really do wait. On the other hand waiting can be financially ruinous to the entrepreneurs and capitalists too. If they cannot employ their capital, they suffer losses. Thus all the disquisitions about an alleged “employers’ advantage” and “workers’ disadvantage” in bargaining are without substance.All these and many other points are carefully analyzed by Hutt, Theory of Collective Bargaining, pp. 35–72.
But these are secondary and accidental considerations. The central fact is that a monopoly of the demand for labor cannot and does not exist in an unhampered market economy. It could originate only as an outgrowth of institutional restrictions of access to entrepreneurship.
Yet one more point must be stressed. The doctrine of the monopolistic manipulation of wage rates by the employers speaks of labor as if it were a homogeneous entity. It deals with such concepts as demand for “labor in general” and supply of “labor in general.” But such notions have, as has been pointed out already, no counterpart in reality. What is sold and bought on the labor market is not “labor in general,” but definite specific labor suitable to render definite services. Each entrepreneur is in search of workers who are fitted to accomplish those specific tasks which he needs for the execution of his plans. He must withdraw these specialists from the employments in which they happen to work at the moment. The only means he has to achieve this is to offer them higher pay. Every innovation which an entrepreneur plans — the production of a new article, the application of a new process of production, the choice of a new location for a specific branch or simply the expansion of production already in existence either in his own enterprise or in other enterprises — requires the employment of workers hitherto engaged somewhere else. The entrepreneurs are not merely faced with a shortage of “labor in general,” but with a shortage of those specific types of labor they need for their plants. The competition among the entrepreneurs in bidding for the most suitable hands is no less keen than their competition in bidding for the required raw materials, tools, and machines and in their bidding for capital on the capital and loan market. The expansion of the activities of the individual firms as well as of the whole society is not only limited by the amount of capital goods available and of the supply of “labor in general.” In each branch of production it is also limited by the available supply of specialists. This is, of course, only a temporary obstacle which vanishes in the long run when more workers, attracted by the higher pay of the specialists in comparatively undermanned branches, will have trained themselves for the special tasks concerned. But in the changing economy such a scarcity of specialists emerges anew daily and determines the conduct of employers in search for workers.
Every employer must aim at buying the factors of production needed, inclusive of labor, at the cheapest price. An employer who paid more than agrees with the market price of the services his employees render him, would be soon removed from his entrepreneurial position. On the other hand an employer who tried to reduce wage rates below the height consonant with the marginal productivity of labor would not recruit the type of men that the most efficient utilization of his equipment requires. There prevails a tendency for wage rates to reach the point at which they are equal to the price of the marginal product of the kind of labor in question. If wage rates drop below this point, the gain derived from the employment of every additional worker will increase the demand for labor and thus make wage rates rise again. If wage rates rise above this point, the loss incurred from the employment of every worker will force the employers to discharge workers. The competition of the unemployed for jobs will create a tendency for wage rates to drop.
- Catallactic UnemploymentIf a job-seeker cannot obtain the position he prefers, he must look for another kind of job. If he cannot find an employer ready to pay him as much as he would like to earn, he must abate his pretensions. If he refuses, he will not get any job. He remains unemployed.
What causes unemployment is the fact that — contrary to the above-mentioned doctrine of the worker’s inability to wait — those eager to earn wages can and do wait. A job-seeker who does not want to wait will always get a job in the unhampered market economy in which there is always unused capacity of natural resources and very often also unused capacity of produced factors of production. It is only necessary for him either to reduce the amount of pay he is asking for or to alter his occupation or his place of work.
There were and still are people who work only for some time and then live for another period from the savings they have accumulated by working. In countries in which the cultural state of the masses is low, it is often difficult to recruit workers who are ready to stay on the job. The average man there is so callous and inert that he knows of no other use for his earnings than to buy some leisure time. He works only in order to remain unemployed for some time.
It is different in the civilized countries. Here the worker looks upon unemployment as an evil. He would like to avoid it provided the sacrifice required is not too grievous. He chooses between employment and unemployment in the same way in which he proceeds in all other actions and choices: he weighs the pros and cons. If he chooses unemployment, this unemployment is a market phenomenon whose nature is not different from other market phenomena as they appear in a changing market economy. We may call this kind of unemployment market-generated or catallactic unemployment.
The various considerations which may induce a man to decide for unemployment can be classified in this way:
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The individual believes that he will find at a later date a remunerative job in his dwelling place and in an occupation which he likes better and for which he has been trained. He seeks to avoid the expenditure and other disadvantages involved in shifting from one occupation to another and from one geographical point to another. There may be special conditions increasing these costs. A worker who owns a homestead is more firmly linked with the place of his residence than people living in rented apartments. A married woman is less mobile than an unmarried girl. Then there are occupations which impair the worker’s ability to resume his previous job at a later date. A watchmaker who works for some time as a lumberman may lose the dexterity required for his previous job. In all these cases the individual chooses temporary unemployment because he believes that this choice pays better in the long run.
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There are occupations the demand for which is subject to considerable seasonal variations. In some months of the year the demand is very intense, in other months it dwindles or disappears altogether. The structure of wage rates discounts these seasonal fluctuations. The branches of industry subject to them can compete on the labor market only if the wages they pay in the good season are high enough to indemnify the wage earners for the disadvantages resulting from the seasonal irregularity in demand. Then many of the workers, having saved a part of their ample earnings in the good season, remain unemployed in the bad season.
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The individual chooses temporary unemployment for considerations which in popular speech are called noneconomic or even irrational. He does not take jobs which are incompatible with his religious, moral, and political convictions. He shuns occupations the exercise of which would impair his social prestige. He lets himself be guided by traditional standards of what is proper for a gentleman and what is unworthy. He does not want to lose face or caste.
Unemployment in the unhampered market is always voluntary. In the eyes of the unemployed man, unemployment is the minor of two evils between which he has to choose. The structure of the market may sometimes cause wage rates to drop. But, on the unhampered market, there is always for each type of labor a rate at which all those eager to work can get a job. The final wage rate is that rate at which all job-seekers get jobs and all employers as many workers as they want to hire. Its height is determined by the marginal productivity of each type of work.
Wage rate fluctuations are the device by means of which the sovereignty of the consumers manifests itself on the labor market. They are the measure adopted for the allocation of labor to the various branches of production. They penalize disobedience by cutting wage rates in the comparatively overmanned branches and recompense obedience by raising wage rates in the comparatively undermanned branches. They thus submit the individual to a harsh social pressure. It is obvious that they indirectly limit the individual’s freedom to choose his occupation. But this coercion is not rigid. It leaves to the individual a margin in the limits of which he can choose between what suits him better and what less. Within this orbit he is free to act of his own accord. This amount of freedom is the maximum of freedom that an individual can enjoy in the framework of the social division of labor, and this amount of coercion is the minimum of coercion that is indispensable for the preservation of the system of social cooperation. There is only one alternative left to the catallactic pressure exercised by the wages system: the assignment of occupations and jobs to each individual by the peremptory decrees of an authority, a central board planning all production activities. This is tantamount to the suppression of all freedom.
It is true that under the wages system the individual is not free to choose permanent unemployment. But no other imaginable social system could grant him a right to unlimited leisure. That man cannot avoid submitting to the disutility of labor is not an outgrowth of any social institution. It is an inescapable natural condition of human life and conduct.
It is not expedient to call catallactic unemployment in a metaphor borrowed from mechanics “frictional” unemployment. In the imaginary construction of the evenly rotating economy there is no unemployment because we have based this construction on such an assumption. Unemployment is a phenomenon of a changing economy. The fact that a worker discharged on account of changes occurring in the arrangement of production processes does not instantly take advantage of every opportunity to get another job but waits for a more propitious opportunity is not a consequence of the tardiness of the adjustment to the change in conditions, but is one of the factors slowing down the pace of this adjustment. It is not an automatic reaction to the changes which have occurred, independent of the will and the choices of the job-seekers concerned, but the effect of their intentional actions. It is speculative, not frictional.
Catallactic unemployment must not be confused with institutional unemployment. Institutional unemployment is not the outcome of the decisions of the individual job-seekers. It is the effect of interference with the market phenomena intent upon enforcing by coercion and compulsion wage rates higher than those the unhampered market would have determined. The treatment of institutional unemployment belongs to the analysis of the problems of interventionism.
Money, Method, and The Market Process[Ludwig von Mises, Money, Method, and the Market Process: Essays by Ludwig von Mises, ed. Richard Ebeling (1942; Boston: Kluwer, 1990), chap. 1, pp. 3–15.]“Social Science and Natural Science”
IThe foundations of the modern social sciences were laid in the eighteenth century. Up to this time we find history only. Of course, the writings of the historians are full of implications which purport to be valid for all human action irrespective of time and milieu, and even when they do not explicitly set forth such theses they necessarily base their grasp of the facts and their interpretation on assumptions of this type. But no attempt was made to clarify these tacit suppositions by special analysis.
On the other hand the belief prevailed that in the field of human action no other criterion could be used than that of good and bad. If a policy did not attain its end, its failure was ascribed to the moral insufficiency of man or to the weakness of the government. With good men and strong governments everything was considered feasible.
Then in the eighteenth century came a radical change. The founders of Political Economy discovered regularity in the operation of the market. They discovered that to every state of the market a certain state of prices corresponded and that a tendency to restore this state made itself manifest whenever anything tried to alter it. This insight opened a new chapter in science. People came to realize with astonishment that human actions were open to investigation from other points of view than that of moral judgment. They were compelled to recognize a regularity which they compared to that with which they were already familiar in the field of the natural sciences.
Since the days of Cantillon, Hume, the Physiocrats and Adam Smith, economic theory has made continuous — although not steady — progress. In the course of this development it has become much more than a theory of market operations within the frame of a society based on private ownership of the means of production. It has for some time been a general theory of human action, of human choice and preference.
IIThe elements of social cognition are abstract and not reducible to any concrete images that might be apprehended by the senses. To make them easier to visualize one likes to have recourse to metaphorical language. For some time the biological metaphors were very popular. There were writers who overworked this metaphor to ridiculous extremes. It will suffice to cite the name of Lilienfeld.Cf. for instance Paul von Lilienfeld La Pathologie Sociale (Paris, 1896).
Today the mechanistic metaphor is much more in use. The theoretical basis for its application is to be found in the positivist view of social science. Positivism blithely waved aside everything which history and economics taught. History, in its eyes, is simply no science; economics a special kind of metaphysics. In place of both, Positivism postulates a social science which has to be built up by the experimental method as ideally applied in Newtonian physics. Economics has to be experimental, mathematical and quantitative. Its task is to measure, because science is measurement. Every statement must be open to verification by facts.
Every proposition of this positivist epistemology is wrong.
The social sciences in general and economics in particular cannot be based on experience in the sense in which this term is used by the natural sciences. Social experience is historical experience. Of course every experience is the experience of something passed. But what distinguishes social experience from that which forms the basis of the natural sciences is that it is always the experience of a complexity of phenomena. The experience to which the natural sciences owe all their success is the experience of the experiment. In the experiments the different elements of change are observed in isolation. The control of the conditions of change provides the experimenter with the means of assigning to each effect its sufficient cause. Without regard to the philosophical problem involved he proceeds to amass “facts.” These facts are the bricks which the scientist uses in constructing his theories. They constitute the only material at his disposal. His theory must not be in contradiction with these facts. They are the ultimate things.
The social sciences cannot make use of experiments. The experience with which they have to deal is the experience of complex phenomena. They are in the same position as acoustics would be if the only material of the scientist were the hearing of a concerto or the noise of a waterfall. It is nowadays fashionable to style the statistical bureaus laboratories. This is misleading. The material which statistics provides is historical, that means the outcome of a complexity of forces. The social sciences never enjoy the advantage of observing the consequences of a change in one element only, other conditions being equal.
It follows that the social sciences can never use experience to verify their statements. Every fact and every experience with which they have to deal is open to various interpretations. Of course, the experience of a complexity of phenomena can never prove or disprove a statement in the way in which an experiment proves or disproves. We do not have any historical experience whose import is judged identically by all people. There is no doubt that up to now in history only nations which have based their social order on private ownership of the means of production have reached a somewhat high stage of welfare and civilization. Nevertheless, nobody would consider this as an incontestable refutation of socialist theories. In the field of the natural sciences there are also differences of opinion concerning the interpretation of complex facts. But here freedom of explanation is limited by the necessity of not contradicting statements satisfactorily verified by experiments. In the interpretation of social facts no such limits exist. Everything could be asserted about them provided that we are not confined within the bounds of principles of whose logical nature we intend to speak later. Here however we already have to mention that every discussion concerning the meaning of historical experience imperceptibly passes over into a discussion of these principles without any further reference to experience. People may begin by discussing the lesson to be learnt from an import duty or from the Russian Soviet system; they will very quickly be discussing the general theory of interregional trade or the no less pure theory of socialism and capitalism.
The impossibility of experimenting means concomitantly the impossibility of measurement. The physicist has to deal with magnitudes and numerical relations, because he has the right to assume that certain invariable relations between physical properties subsist. The experiment provides him with the numerical value to be assigned to them. In human behavior there are no such constant relations, there is no standard which could be used as a measure and there are no experiments which could establish uniformities of this type.
What the statistician establishes in studying the relations between prices and supply or between supply and demand is of historical importance only. If he determines that a rise of 10 per cent in the supply of potatoes in Atlantis in the years between 1920 and 1930 was followed by a fall in the price of potatoes by 8 percent, he does not say anything about what happened or may happen with a change in the supply of potatoes in another country or at another time. Such measurements as that of elasticity of demand cannot be compared with the physicist’s measurement, e.g., specific density or weight of atoms. Of course everybody realizes that the behavior of men concerning potatoes and every other commodity is variable. Different individuals value the same things in a different way, and the valuation changes even with the same individual with changing conditions. We cannot categorize individuals in classes which react in the same way, and we cannot determine the conditions which evoke the same reaction. Under these circumstances we have to realize that the statistical economist is an historian and not an experimenter. For the social sciences, statistics constitutes a method of historical research.
In every science the considerations which result in the formulation of an equation are of a non-mathematical character. The formulation of the equation has a practical importance because the constant relations which it includes are experimentally established and because it is possible to introduce specific known values in the function to determine those unknown. These equations thus lie at the basis of technological designing; they are not only the consummation of the theoretical analysis but also the starting point of practical work. But in economics, where there are no constant relations between magnitudes, the equations are void of practical application. Even if we could dispose of all qualms concerning their formulation we would still have to realize that they are without any practical use.
But the chief objection which must be raised to the mathematical treatment of economic problems comes from another ground: it really does not deal with the actual operations of human actions but with a fictitious concept that the economist builds up for instrumental purposes. This is the concept of static equilibrium.
For the sake of grasping the consequences of change and the nature of profit in a market economy the economist constructs a fictitious system in which there is no change. Today is like yesterday and tomorrow will be like today. There is no uncertainty about the future, and activity therefore does not involve risk. But for the allowance to be made of interest, the sum of the prices of the complementary factors of production exactly equals the price of the product, which means there is no room left for profit. But this fictitious concept is not only unrealizable in actual life; it cannot even be consistently carried to its ultimate conclusions. The individuals in this fictitious world would not act, they would not have to make choices, they would just vegetate. It is true that economics, exactly because it cannot make experiments, is bound to apply this and other fictitious concepts of a similar type. But its use should be restricted to the purposes which it is designed to serve. The purpose of the concept of static equilibrium is the study of the nature of the relations between costs and prices and thereby of profits. Outside of this it is inapplicable, and occupation with it vain.
Now all that mathematics can do in the field of economic studies is to describe static equilibrium. The equations and the indifference curves deal with a fictitious state of things, which never exists anywhere. What they afford is a mathematical expression of the definition of static equilibrium. Because mathematical economists start from the prejudice that economics has to be treated in mathematical terms they consider the study of static equilibrium as the whole of economics. The purely instrumental character of this concept has been overshadowed by this preoccupation.
Of course, mathematics cannot tell us anything about the way by which this static equilibrium could be reached. The mathematical determination of the difference between any actual state and the equilibrium state is not a substitute for the method by which the logical or non-mathematical economists let us conceive the nature of those human actions which necessarily would bring about equilibrium provided that no further change occurs in the data.
Occupation with static equilibrium is a misguided evasion of the study of the main economic problems. The pragmatic value of this equilibrium concept should not be underrated, but it is an instrument for the solution of one problem only. In any case the mathematical elaboration of static equilibrium is mere by-play in economics.
The case is similar with the use of curves. We may represent the price of a commodity as the point of intersection of two curves, the curve of demand and the curve of supply. But we have to realize that we do not know anything about the shape of these curves. We know a posteriori the prices, which we assume to be the points of intersection, but we do not know the form of the curve either in advance or for the past. The representation of the curves is therefore nothing more than a didactic means of rendering the theory graphic and hence more easily comprehensible.
The mathematical economist is prone to consider the price either as a measurement of value or as equivalent to the commodity. To this we have to say that prices are not measured in money but that they are the amount of money exchanged for a commodity. The price is not equivalent to the commodity. A purchase takes place only when the buyer values the commodity higher than the price, and the seller values it lower than the price. Nobody has the right to abstract from this fact and to assume an equivalence where there is a difference in valuation. When either one of the parties considers the price as the equivalent of the commodity no transaction takes place. In this sense we may say every transaction is for both parties a “bargain.”
IIIPhysicists consider the objects of their study from without. They have no knowledge of what is going on in the interior, in the “soul,” of a falling stone. But they have the opportunity to observe the falling of the stone in experiments and thereby to discover what they call the laws of falling. From the results of such experimental knowledge they build up their theories proceeding from the special to the more general, from the concrete to the more abstract.
Economics deals with human actions, not as it is sometimes said, with commodities, economic quantities or prices. We do not have the power to experiment with human actions. But we have, being human ourselves, a knowledge of what goes on within acting men. We know something about the meaning which acting men attach to their actions. We know why men wish to change the conditions of their lives. We know something about that uneasiness which is the ultimate incentive of the changes which they bring about. A perfectly satisfied man or a man who although unsatisfied did not see any means of improvement would not act at all.
Thus the economist is, as Cairnes says, at the outset of his researches already in possession of the ultimate principles governing the phenomena which form the subject of his study, whereas mankind has no direct knowledge of ultimate physical principles. Herein lies the radical difference between the social sciences (moral sciences, Geisteswissenschaften) and the natural sciences. What makes natural science possible is the power to experiment; what makes social science possible is the power to grasp or to comprehend the meaning of human action.
We have to distinguish two quite different kinds of this comprehension of the meaning of action: we conceive and we understand.
We conceive the meaning of an action, that is to say, we take an action to be such. We see in the action the endeavor to reach a goal by the use of means. In conceiving the meaning of an action we consider it as a purposeful endeavor to reach some goal, but we do not regard the quality of the ends proposed and of the means applied. We conceive activity as such, its logical (praxeological) qualities and categories. All that we do in this conceiving is by deductive analysis to bring to light everything which is contained in the first principle of action and to apply it to different kinds of thinkable conditions. This study is the object of the theoretical science of human action (praxeology) and in particular of its hitherto most developed branch, economics (economic theory).
Economics therefore is not based on or derived (abstracted) from experience. It is a deductive system, starting from the insight into the principles of human reason and conduct. As a matter of fact all our experience in the field of human action is based on and conditioned by the circumstance that we have this insight in our mind. Without this a priori knowledge and the theorems derived from it we could not at all realize what is going on in human activity. Our experience of human action and social life is predicated on praxeological and economic theory.
It is important to be aware of the fact that this procedure and method are not peculiar only to scientific investigation but are the mode of ordinary daily apprehension of social facts. These aprioristic principles and the deductions from them are applied not only by the professional economist but by everybody who deals with economic facts or problems. The layman does not proceed in a way significantly different from that of the scientist; only he sometimes is less critical, less scrupulous in examining every step in the chain of his deductions and therefore sometimes more subject to error. One need only observe any discussion on current economic problems to realize that its course turns very soon towards a consideration of abstract principles without any reference to experience. You cannot, for instance, discuss the Soviet system without falling back on the general principles both of capitalism and socialism. You cannot discuss a wage and hours bill without falling back on the theory of wages, profits, interests and prices, that means the general theory of a market society. The “pure fact” — let us set aside the epistemological question whether there is such a thing — is open to different interpretations. These interpretations require elucidation by theoretical insight.
Economics is not only not derived from experience, it is even impossible to verify its theorems by appeal to experience. Every experience of a complex phenomenon, we must repeat, can be and is explained in different ways. The same facts, the same statistical figures are claimed as confirmations of contradictory theories.
It is instructive to compare the technique of dealing with experience in the social sciences with that in the natural sciences. We have many books on economics which, after having developed a theory, annex chapters in which an attempt is made to verify the theory developed by an appeal to the facts. This is not the way which the natural scientist takes. He starts from facts experimentally established and builds up his theory in using them. If his theory allows a deduction that predicts a state of affairs not yet discovered in experiments he describes what kind of experiment would be crucial for his theory; the theory seems to be verified if the result conforms to the prediction. This is something radically and significantly different from the approach taken by the social sciences.
To confront economic theory with reality we do not have to try to explain in a superficial way facts interpreted differently by other people so that they seem to verify our theory. This dubious procedure is not the way in which reasonable discussion can take place. What we have to do is this: we have to inquire whether the special conditions of action which we have implied in our reasoning correspond to those we find in the segment of reality under consideration. A theory of money (or rather of indirect exchange) is correct or not without reference to the question of whether the actual economic system under examination employs indirect exchange or only barter.
The method applied in these theoretical aprioristic considerations is the method of speculative constructions. The economist — and likewise the layman in his economic reasoning — builds up an image of a non-existent state of things. The material for this construction is drawn from an insight into the conditions of human action. Whether the state of affairs which these speculative constructions depict corresponds or could correspond to reality is irrelevant for their instrumental efficiency. Even unrealizable constructions can render valuable service in giving us the opportunity to conceive what makes them unrealizable and in what respect they differ from reality. The speculative construction of a socialist community is indispensable for economic reasoning notwithstanding the question of whether such a society could or could not be realized.
One of the best known and most frequently applied speculative constructions is that of a state of static equilibrium mentioned above. We are fully aware that this state can never be realized. But we cannot study the implications of changes without considering a changeless world. No modern economist will deny that the application of this speculative concept has rendered invaluable service in elucidating the character of entrepreneur’s profits and losses and the relation between costs and prices.
All our economic reasoning operates with these speculative concepts. It is true that the method has its dangers; it easily lends itself to errors. But we have to use it because it is the only method available. Of course, we have to be very careful in using it.
To the obvious question, how a purely logical deduction from aprioristic principles can tell us anything about reality, we have to reply that both human thought and human action stem from the same root in that they are both products of the human mind. Correct results from our aprioristic reasoning are therefore not only logically irrefutable, but at the same time applicable with all their apodictic certainty to reality provided that the assumptions involved are given in reality. The only way to refuse a conclusion of economics is to demonstrate that it contains a logical fallacy. It is another question whether the results obtained apply to reality. This again can be decided only by the demonstration that the assumptions involved have or do not have any counterpart in the reality which we wish to explain.
The relation between historical experience — for every economic experience is historical in the sense that it is the experience of something past — and economic theory is therefore different from that generally assumed. Economic theory is not derived from experience. It is on the contrary the indispensable tool for the grasp of economic history. Economic history can neither prove nor disprove the teachings of economic theory. It is on the contrary economic theory which makes it possible for us to conceive the economic facts of the past.
IVBut to orient ourselves in the world of human actions we need to do more than merely conceive the meaning of human action. Both the acting man and the purely observing historian have not only to conceive the categories of action as economic theory does; they have besides to understand (verstehen) the meaning of human choice.
This understanding of the meaning of action is the specific method of historical research. The historian has to establish the facts as far as possible by the use of all the means provided both by the theoretical sciences of human action — praxeology and its hitherto most developed part, economics — and by the natural sciences. But then he has to go farther. He has to study the individual and unique conditions of the case in question. Individuum est ineffabile. Individuality is given to the historian, it is exactly that which cannot be exhaustively explained or traced back to other entities. In this sense individuality is irrational. The purpose of specific understanding as applied by the historical disciplines is to grasp the meaning of individuality by a psychological process. It establishes the fact that we face something individual. It fixes the valuations, the aims, the theories, the beliefs and the errors, in a word, the total philosophy of the acting individuals and the way in which they envisaged the conditions under which they had to act. It puts us into the milieu of the action. Of course this specific understanding cannot be separated from the philosophy of the interpreter. That degree of scientific objectivity which can be reached in the natural sciences and in the aprioristic sciences of logic and praxeology can never be attained by the moral or historical sciences (Geisteswissenschaften) in the field of the specific understanding. You can understand in different ways. History can be written from different points of view. The historians may agree in everything that can be established in a rational way and nevertheless widely disagree in their interpretations. History therefore has always to be rewritten. New philosophies demand a new representation of the past.
The specific understanding of the historical sciences is not an act of pure rationality. It is the recognition that reason has exhausted all its resources and that we can do nothing more than to try as well as we may to give an explanation of something irrational which is resistant to exhaustive and unique description. These are the tasks which the understanding has to fulfill. It is, notwithstanding, a logical tool and should be used as such. It should never be abused for the purpose of smuggling into the historical work obscuranticism, mysticism and similar elements. It is not a free charter for nonsense.
It is necessary to emphasize this point because it sometimes happens that the abuses of a certain type of historicism are justified by an appeal to a wrongly interpreted “understanding.” The reasoning of logic, praxeology and of the natural sciences can under no circumstances be invalidated by the understanding. However strong the evidence supplied by the historical sources may be, and however understandable a fact may be from the point of view of theories contemporaneous with it, if it does not fit into our rationale, we cannot accept it. The existence of witches and the practice of witchcraft are abundantly attested by legal proceedings; yet we will not accept it. Judgments of many tribunals are on record asserting that people have depreciated a country’s currency by upsetting the balance of payments; yet we will not believe that such actions have such effects.
It is not the task of history to reproduce the past. An attempt to do so would be vain and would require a duplication not humanly possible. History is a representation of the past in terms of concepts. The specific concepts of historical research are type concepts. These types of the historical method can be built up only by the use of the specific understanding and they are meaningful only in the frame of the understanding to which they owe their existence. Therefore not every type-concept which is logically valid can be considered as useful for the purpose of understanding. A classification is valid in a logical sense if all the elements united in one class are characterized by a common feature. Classes do not exist in actuality, they are always a product of the mind which in observing things discovers likenesses and differences. It is another question whether a classification which is logically valid and based on sound considerations can be used for the explanation of given data. There is for instance no doubt that a type or class “Fascism” which includes not only Italian Fascism but also German Nazism, the Spanish system of General Franco, the Hungarian system of Admiral Horthy and some other systems can be constructed in a logically valid way and that it can be contrasted to a type called “Bolshevism,” which includes the Russian Bolshevism and the system of Bela Kun in Hungary and of the short Soviet episode of Munich. But whether this classification and the inference from it which sees the world of the last twenty years divided into the two parties, Fascists and Bolsheviks, is the right way to understand present-day political conditions is open to question. You can understand this period of history in a quite different way by using other types. You may distinguish Democracy and Totalitarianism, and then let the type Democracy include the Western Capitalist system and the type Totalitarianism include both Bolshevism and what the other classification terms Fascism. Whether you apply the first or the second typification depends on the whole mode in which you see things. The understanding decides upon the classification to be used, and not the classification upon the understanding.
The type-concepts of the historical or moral sciences (Geisteswissenschaften) are not statistical averages. Most of the features used for classification are not subject to numerical determination, and this alone renders it impossible to construct them as statistical averages. These type-concepts (in German one uses the term Ideal-Typus in order to distinguish them from the type-concepts of other sciences, especially of the biological ones) ought not to be confused with the praxeological concepts used for the conceiving of the categories of human action. For instance: the concept “entrepreneur” is used in economic theory to signify a specific function, that is the provision for an uncertain future. In this respect everybody has to some extent to be considered as an entrepreneur. Of course, it is not the task of this classification in economic theory to distinguish men, but to distinguish functions and to explain sources of profit or loss. Entrepreneur in this sense is the personification of the function which results in profit or loss. In economic history and in dealing with current economic problems the term “entrepreneur” signifies a class of men who are engaged in business but who may in many other respects differ so much that the general term entrepreneur seems to be meaningless and is used only with a special qualification, for instance big (medium-sized, small) business, “Wall Street,” armaments business, German business, etc. The type entrepreneur as used in history and politics can never have the conceptual exactitude which the praxeological concept entrepreneur has. You never meet in life men who are nothing else than the personification of one function only.For the sake of completeness we have to remark that there is a third use of the term entrepreneur in law which has to be carefully distinguished from the two mentioned above.
VThe preceding remarks justify the conclusion that there is a radical difference between the methods of the social sciences and those of the natural sciences. The social sciences owe their progress to the use of their particular methods and have to go further along the lines which the special character of their object require. They do not have to adopt the methods of the natural sciences.
It is a fallacy to recommend to the social sciences the use of mathematics and to believe that they could in this way be made more “exact.” The application of mathematics does not render physics more exact or more certain. Let us quote Einstein’s remark: “As far as mathematical propositions refer to reality they are not certain and as far as they are certain they do not refer to reality.” It is different with praxeological propositions. These refer with all their exactitude and certainty to the reality of human action. The explanation of this phenomenon lies in the fact that both — the science of human action and human action itself — have a common root, i.e., human reason. It would be a mistake to assume that the quantitative approach could render them more exact. Every numerical expression is inexact because of the inherent limitations of human powers of measurement. For the rest we have to refer to what has been said above on the purely historical character of quantitative expressions in the field of the social sciences.
The reformers who wish to improve the social sciences by adopting the methods of the natural sciences sometimes try to justify their efforts by pointing to the backward state of the former. Nobody will deny that the social sciences and especially economics are far from being perfect. Every economist knows how much remains to be done. But two considerations must be kept in mind. First, the present unsatisfactory state of social and economic conditions has nothing to do with an alleged inadequacy in economic theory. If people do not use the teachings of economics as a guide for their policies they cannot blame the discipline for their own failure. Second, if it may some day be necessary to reform economic theory radically this change will not take its direction along the lines suggested by the present critics. The objections of these are thoroughly refuted forever.
The Ultimate Foundation of Economic Science[Ludwig von Mises, The Ultimate Foundation of Economic Science: An Essay on Method (1962; Kansas City: Sheed Andrews and McMeel, 1978), section “Some Preliminary Observations Concerning Praxelogy,” pp. 3–6.]3. On EconomicsThe study of economics has been again and again led astray by the vain idea that economics must proceed according to the pattern of other sciences. The mischief done by such misconstructions cannot be avoided by admonishing the economist to stop casting longing glances upon other fields of knowledge or even to ignore them entirely. Ignorance, whatever subject it may concern, is in no case a quality that could be useful in the search for truth. What is needed to prevent a scholar from garbling economic studies by resorting to the methods of mathematics, physics, biology, history or jurisprudence is not slighting and neglecting these sciences, but, on the contrary, trying to comprehend and to master them. He who wants to achieve anything in praxeology must be conversant with mathematics, physics, biology, history, and jurisprudence, lest he confuse the tasks and the methods of the theory of human action with the tasks and the methods of any of these other branches of knowledge. What was wrong with the various Historical Schools of economics was first of all that their adepts were merely dilettantes in the field of history. No competent mathematician can fail to see through the fundamental fallacies of all varieties of what is called mathematical economics and especially of econometrics. No biologist was ever fooled by the rather amateurish organicism of such authors as Paul de Lilienfeld.
When I once expressed this opinion in a lecture, a young man in the audience objected. “You are asking too much of an economist,” he observed; “nobody can force me to employ my time in studying all these sciences.” My answer was: “Nobody asks or forces you to become an economist.”
- The Starting Point of Praxeological ThinkingThe a priori knowledge of praxeology is entirely different — categorially different — from the a priori knowledge of mathematics or, more precisely, from mathematical a priori knowledge as interpreted by logical positivism. The starting point of all praxeological thinking is not arbitrarily chosen axioms, but a self-evident proposition, fully, clearly and necessarily present in every human mind. An unbridgeable gulf separates those animals in whose minds this cognition is present from those in whose minds it is not fully and clearly present. Only to the former is the appellation man accorded. The characteristic feature of man is precisely that he consciously acts. Man is homo agens, the acting animal.
All — apart from zoology — that has ever been scientifically stated to distinguish man from nonhuman mammals is implied in the proposition: man acts. To act means: to strive after ends, that is, to choose a goal and to resort to means in order to attain the goal sought.
The essence of logical positivism is to deny the cognitive value of a priori knowledge by pointing out that all a priori propositions are merely analytic. They do not provide new information, but are merely verbal or tautological, asserting what has already been implied in the definitions and premises. Only experience can lead to synthetic propositions. There is an obvious objection against this doctrine, viz., that this proposition that there are no synthetic a priori propositions is in itself a — as the present writer thinks, false — synthetic a priori proposition, for it can manifestly not be established by experience.
The whole controversy is, however, meaningless when applied to praxeology. It refers essentially to geometry. Its present state, especially its treatment by logical positivism, has been deeply influenced by the shock that Western philosophy received from the discovery of non-Euclidian geometries. Before Bolyai and Lobachevsky, geometry was, in the eyes of the philosophers, the paragon of perfect science; it was assumed that it provided unshakable certainty forever and for everybody. To proceed also in other branches of knowledge more geometrico was the great ideal of truth-seekers. All traditional epistemological concepts began to totter when the attempts to construct non-Euclidian geometries succeeded.
Yet praxeology is not geometry. It is the worst of all superstitions to assume that the epistemological characteristics of one branch of knowledge must necessarily be applicable to any other branch. In dealing with the epistemology of the sciences of human action, one must not take one’s cue from geometry, mechanics, or any other science.
The assumptions of Euclid were once considered as self-evidently true. Present-day epistemology looks upon them as freely chosen postulates, the starting point of a hypothetical chain of reasoning. Whatever this may mean, it has no reference at all to the problems of praxeology.
The starting point of praxeology is a self-evident truth, the cognition of action, that is, the cognition of the fact that there is such a thing as consciously aiming at ends. There is no use cavilling about these words by referring to philosophical problems that have no bearing upon our problem. The truth of this cognition is as self-evident and as indispensable for the human mind as is the distinction between A and non-A. ...
- The Two Branches of the Sciences of Human Action[Ibid., chap. 2: “The Activistic Basis of Knowledge, pp. 41–45.]There are two branches of the sciences of human action, praxeology on the one hand, history on the other hand.
Praxeology is a priori. It starts from the a priori category of action and develops out of it all that it contains. For practical reasons praxeology does not as a rule pay much attention to those problems that are of no use for the study of the reality of man’s action, but restricts its work to those problems that are necessary for the elucidation of what is going on in reality. Its intent is to deal with action taking place under conditions that acting man has to face. This does not alter the purely aprioristic character of praxeology. It merely circumscribes the field that the individual praxeologists customarily choose for their work. They refer to experience only in order to separate those problems that are of interest for the study of man as he really is and acts from other problems that offer a merely academic interest. The answer to the question whether or not definite theorems of praxeology apply to a definite problem of action depends on the establishment of the fact whether or not the special assumptions that characterize this theorem are of any value for the cognition of reality. To be sure, it does not depend on the answer to the question whether or not these assumptions correspond to the real state of affairs that the praxeologists want to investigate. The imaginary constructions that are the main — or, as some people would rather say, the only — mental tool of praxeology describe conditions that can never be present in the reality of action. Yet they are indispensable for conceiving what is going on in this reality. Even the most bigoted advocates of an empiricist interpretation of the methods of economics employ the imaginary construction of an evenly rotating economy (static equilibrium), although such a state of human affairs can never be realized.[Ludwig von Mises, Human Action (1949, Auburn, Ala.: Mises Institute, 1998), pp. 237 ff.]
Following in the wake of Kant’s analyses, philosophers raised the question: How can the human mind, by aprioristic thinking, deal with the reality of the external world? As far as praxeology is concerned, the answer is obvious. Both, a priori thinking and reasoning on the one hand and human action on the other, are manifestations of the human mind. The logical structure of the human mind creates the reality of action. Reason and action are congeneric and homogeneous, two aspects of the same phenomenon. In this sense we may apply to praxeology the dictum of Empedocles
Some authors have raised the rather shallow question how a praxeologist would react to an experience contradicting theorems of his aprioristic doctrine. The answer is: in the same way in which a mathematician will react to the “experience” that there is no difference between two apples and seven apples or a logician to the “experience” that A and non-A are identical. Experience concerning human action presupposes the category of human action and all that derives from it. If one does not refer to the system of the praxeological a priori, one must not and cannot talk of action, but merely of events that are to be described in terms of the natural sciences. Awareness of the problems with which the sciences of human action are concerned is conditioned by familiarity with the a priori categories of praxeology. Incidentally, we may also remark that any experience in the field of human action is specifically historical experience, i.e., the experience of complex phenomena, which can never falsify any theorem in the way a laboratory experiment can do with regard to the statements of the natural sciences.
Up to now the only part of praxeology that has been developed into a scientific system is economics. A Polish philosopher, Tadeusz Kotarbinski, is trying to develop a new branch of praxeology, the praxeological theory of conflict and war as opposed to the theory of cooperation or economics.[Tadeusz] Kotarbinski, “Considérations sur la théorie générale de la lutte,” Appendix to Z Zagadnien Ogólnej Teorii Walki (Warsaw, 1938), pp. 65–92; the same author, “Idée de la methodologie générale praxeologie,” Travaux du IXe Congrés International de Philosophie (Paris, 1937), vol. 4, pp. 190–94. The theory of games has no reference whatever to the theory of action. Of course, playing a game is action, but so is smoking a cigarette or munching a sandwich. See below, pp. 87 ff.
The other branch of the sciences of human action is history. It comprehends the totality of what is experienced about human action. It is the methodically arranged record of human action, the description of the phenomena as they happened, viz., in the past. What distinguishes the descriptions of history from those of the natural sciences is that they are not interpreted in the light of the category of regularity. When the physicist says: if A encounters B, C results, he wants, whatever philosophers may say, to assert that C will emerge whenever or wherever A will encounter B under analogous conditions. When the historian refers to the battle of Cannae, he knows that he is talking about the past and that this particular battle will never be fought again.
Experience is a uniform mental activity. There are not two different branches of experience, one resorted to in the natural sciences, the other in historical research. Every act of experience is a description of what happened in terms of the observer’s logical and praxeological equipment and his knowledge of the natural sciences. It is the observer’s attitude that interprets the experience by adding it to his own already previously accumulated store of experienced facts. What distinguishes the experience of the historian from that of the naturalist and the physicist is that he searches for the meaning that the event had or has for those who were either instrumental in bringing it about or were affected by its happening.
The natural sciences do not know anything about final causes. For praxeology finality is the fundamental category. But praxeology abstracts from the concrete content of the ends men are aiming at. It is history that deals with the concrete ends. For history the main question is: What was the meaning the actors attached to the situation in which they found themselves and what was the meaning of their reaction, and, finally, what was the result of these actions? The autonomy of history or, as we may say, of the various historical disciplines consists in their dedication to the study of meaning.
It is perhaps not superfluous to emphasize again and again that when historians say “meaning,” they refer to the meaning individual men—the actors themselves and those affected by their actions or the historians — saw in the actions. History as such has nothing in common with the point of view of philosophies of history that pretend to know the meaning that God or a quasi-God — such as the material productive forces in the scheme of Marx — attaches to the various events.
- The Logical Character of PraxeologyPraxeology is a priori. All its theorems are products of deductive reasoning that starts from the category of action. The questions whether the judgments of praxeology are to be called analytic or synthetic and whether or not its procedure is to be qualified as “merely” tautological are of verbal interest only.
What praxeology asserts with regard to human action in general is strictly valid without any exception for every action. There is action and there is the absence of action, but there is nothing in between. Every action is an attempt to exchange one state of affairs for another, and everything that praxeology affirms with regard to exchange refers strictly to it. In dealing with every action we encounter the fundamental concepts end and means, success or failure, profit or loss, costs. An exchange can be either direct or indirect, i.e., effected through the interposition of an intermediary stage. Whether a definite action was indirect exchange has to be determined by experience. But if it was indirect exchange, then all that praxeology says about indirect exchange in general strictly applies to it.
Every theorem of praxeology is deduced by logical reasoning from the category of action. It partakes of the apodictic certainty provided by logical reasoning that starts from an a priori category.
Into the chain of praxeological reasoning the praxeologist introduces certain assumptions concerning the conditions of the environment in which an action takes place. Then he tries to find out how these special conditions affect the result to which his reasoning must lead. The question whether or not the real conditions of the external world correspond to these assumptions is to be answered by experience. But if the answer is in the affirmative, all the conclusions drawn by logically correct praxeological reasoning strictly describe what is going on in reality. ...
- The Problem of Quantitative Definiteness[Mises, Ultimate Foundation of Economic Science, chap. 4: “Certainty and Uncertainty,” pp. 62–63, 70–72.]Laboratory experiments and observation of external phenomena enable the natural sciences to proceed with measurement and the quantification of knowledge. Referring to this fact, one used to style these sciences as the exact sciences and to belittle the lack of exactitude in the sciences of human action.
Today nobody any longer denies that on account of the insufficiency of our senses measurement is never perfect and precise in the full sense of these terms. It is only more or less approximate. Besides, the Heisenberg principle shows that there are relations that man cannot measure at all. There is no such thing as quantitative exactitude in our description of natural phenomena. However, the approximations that measurement of physical and chemical objects can provide are by and large sufficient for practical purposes. The orbit of technology is an orbit of approximate measurement and approximate quantitative definiteness.
In the sphere of human action there are no constant relations between any factors. There is consequently no measurement and no quantification possible. All measurable magnitudes that the sciences of human action encounter are quantities of the environment in which man lives and acts. They are historical facts, e.g., facts of economic or of military history, and are to be clearly distinguished from the problems with which the theoretical science of action — praxeology and especially also its most developed part, economics — deals.
Deluded by the idea that the sciences of human action must ape the technique of the natural sciences, hosts of authors are intent upon a quantification of economics. They think that economics ought to imitate chemistry, which progressed from a qualitative to a quantitative state.[Joseph] Schumpeter, Das Wesen und der Hauptinhalt der theoretischen Nationalökonomie (Leipzig, 1908), pp. 606 ff.; [Wesley] Mitchell, “Quantitative Analysis in Economic Theory,” American Economic Review, vol. 15, 1 ff.; [Gustav] Cassel, On Quantitative Thinking in Economics (Oxford, 1935); and a daily increasing flood of books and articles. Their motto is the positivistic maxim: Science is measurement. Supported by rich funds, they are busy reprinting and rearranging statistical data provided by governments, by trade associations, and by corporations and other enterprises. They try to compute the arithmetical relations among various of these data and thus to determine what they call, by analogy with the natural sciences, correlations and functions. They fail to realize that in the field of human action statistics is always history and that the alleged “correlations” and “functions” do not describe anything else than what happened at a definite instant of time in a definite geographical area as the outcome of the actions of a definite number of people.Mises, Human Action, pp. 347ff. As a method of economic analysis econometrics is a childish play with figures that does not contribute anything to the elucidation of the problems of economic reality. ...
- The Examination of Praxeological TheoremsThe epistemologist who starts his lucubrations from the analysis of the methods of the natural sciences and whom blinders prevent from perceiving anything beyond this field tells us merely that the natural sciences are the natural sciences and that what is not natural science is not natural science. About the sciences of human action he does not know anything, and therefore all that he utters about them is of no consequence.
It is not a discovery made by these authors that the theories of praxeology cannot be refuted by experiments nor confirmed by their successful employment in the construction of various gadgets. These facts are precisely one aspect of our problem.
The positivist doctrine implies that nature and reality, in providing the sense data that the protocol sentences register, write their own story upon the white sheet of the human mind. The kind of experience to which they refer in speaking of verifiability and refutability is, as they think, something that does not depend in any way on the logical structure of the human mind. It provides a faithful image of reality. On the other hand, they suppose, reason is arbitrary and therefore liable to error and misinterpretation.
This doctrine not only fails to make allowance for the fallibility of our apprehension of sense objects; it does not realize that perception is more than just sensuous apprehension, that it is an intellectual act performed by the mind. In this regard both associationism and Gestalt psychology agree. There is no reason to ascribe to the operation the mind performs in the act of becoming aware of an external object a higher epistemological dignity than to the operation the mind performs in describing its own ways of procedure.
In fact, nothing is more certain for the human mind than what the category of human action brings into relief. There is no human being to whom the intent is foreign to substitute by appropriate conduct one state of affairs for another state of affairs that would prevail if he did not interfere. Only where there is action are there men.
What we know about our own actions and about those of other people is conditioned by our familiarity with the category of action that we owe to a process of self-examination and introspection as well as of understanding of other peoples’ conduct. To question this insight is no less impossible than to question the fact that we are alive.
He who wants to attack a praxeological theorem has to trace it back, step by step, until he reaches a point in which, in the chain of reasoning that resulted in the theorem concerned, a logical error can be unmasked. But if this regressive process of deduction ends at the category of action without having discovered a vicious link in the chain of reasoning, the theorem is fully confirmed. Those positivists who reject such a theorem without having subjected it to this examination are no less foolish than those seventeenth-century astronomers were who refused to look through the telescope that would have shown them that Galileo was right and they were wrong. ...
- The Case of the Sciences of Human Action[Mises, Ultimate Foundation of Economic Science, chap. 7: “The Epistemological Roots of Monism,” pp. 120–24.]However, this essay does not deal with theology or metaphysics and the rejection of their doctrines by positivism. It deals with positivism’s attack upon the sciences of human action.
The fundamental doctrine of positivism is the thesis that the experimental procedures of the natural sciences are the only method to be applied in the search for knowledge. As the positivists see it, the natural sciences, entirely absorbed by the more urgent task of elucidating the problems of physics and chemistry, have in the past neglected and may also in the near future neglect to pay attention to the problems of human action. But, they add, there cannot be any doubt that once the men imbued with a scientific outlook and trained in the exact methods of laboratory work have the leisure to turn toward the study of such “minor” issues as human behavior, they will substitute authentic knowledge of all these matters for the worthless palaver that is now in vogue. “Unified science” will solve all the problems involved and will inaugurate a blissful age of “social engineering” in which all human affairs will be handled in the same satisfactory way in which modern technology supplies electric current.
Some rather significant steps on the way to this result, pretend the less cautious harbingers of this creed, have already been made by behaviorism (or, as Neurath preferred to call it, behavioristics). They point to the discovery of tropisms and to that of conditioned reflexes. Progressing further with the aid of the methods that brought about these achievements, science will one day be able to make good all the promises of positivism. It is a vain conceit of man to presume that his conduct is not entirely determined by the same impulses that determine the behavior of plants and of dogs.
Against all this impassioned talk we have to stress the hard fact that the natural sciences have no intellectual tool to deal with ideas and with finality.
An assured positivist may hope that one day physiologists may succeed in describing in terms of physics and chemistry all the events that resulted in the production of definite individuals and in modifying their inborn substance during their lives. We may neglect raising the question whether such knowledge would be sufficient to explain fully the behavior of animals in any situation they may have to face. But it cannot be doubted that it would not enable the student to deal with the way in which a man reacts to external stimuli. For this human reaction is determined by ideas, a phenomenon the description of which is beyond the reach of physics, chemistry, and physiology. There is no explanation in terms of the natural sciences of what causes hosts of people to remain faithful to the religious creed in which they were brought up and others to change their faith, why people join or desert political parties, why there are different schools of philosophy and different opinions concerning a multiplicity of problems.
- The Fallacies of PositivismConsistently aiming at an improvement of the conditions under which men have to live, the nations of Western and Central Europe and their scions settled in overseas territories have succeeded in developing what is called — and more often smeared as — Western bourgeois civilization. Its foundation is the economic system of capitalism, the political corollary of which is representative government and freedom of thought and interpersonal communication. Although continually sabotaged by the folly and the malice of the masses and the ideological remnants of the precapitalistic methods of thinking and acting, free enterprise has radically changed the fate of man. It has reduced mortality rates and prolonged the average length of life, thus multiplying population figures. It has, in an unprecedented way, raised the standard of living of the average man in those nations that did not too severely impede the acquisitive spirit of enterprising individuals. All people, however fanatical they may be in their zeal to disparage and to fight capitalism, implicitly pay homage to it by passionately clamoring for the products it turns out.
The wealth capitalism has brought to mankind is not an achievement of a mythical force called progress. Neither is it an achievement of the natural sciences and of the application of their teachings for the perfection of technology and therapeutics. No technological and therapeutical improvements can be practically utilized if the material means for its utilization have not been previously made available by saving and capital accumulation. The reason why not everything about the production and the use of which technology provides information can be made accessible to everybody is the insufficiency of the supply of capital accumulated. What transformed the stagnant conditions of the good old days into the activism of capitalism was not changes in the natural sciences and in technology, but the adoption of the free enterprise principle. The great ideological movement that started with the Renaissance, continued in the Enlightenment, and in the nineteenth century culminated in Liberalism produced both capitalism — the free market economy — and its political corollary or — as the Marxians have to say, its political “superstructure” — representative government and the individuals’ civic rights: freedom of conscience, of thought, of speech, and of all other methods of communication. It was in the climate created by this capitalistic system of individualism that all the modern intellectual achievements thrived. Never before had mankind lived under conditions like those of the second part of the nineteenth century, when, in the civilized countries, the most momentous problems of philosophy, religion, and science could be freely discussed without any fear of reprisals on the part of the powers that be. It was an age of productive and salutary dissent.
A countermovement evolved, but not from a regeneration of the discredited sinister forces that in the past had made for conformity. It sprouted from the authoritarian and dictatorial complex deeply inwrought in the souls of the many who were benefited by the fruits of freedom and individualism without having contributed anything to their growing and ripening. The masses do not like those who surpass them in any regard. The average man envies and hates those who are different.
What pushes the masses into the camp of socialism is, even more than the illusion that socialism will make them richer, the expectation that it will curb all those who are better than they themselves are. The characteristic feature of all utopian plans from that of Plato down to that of Marx is the rigid petrification of all human conditions. Once the “perfect” state of social affairs is attained, no further changes ought to be tolerated. There will no longer be any room left for innovators and reformers.
In the intellectual sphere the advocacy of this intolerant tyranny is represented by positivism. Its champion, Auguste Comte, did not contribute anything to the advancement of knowledge. He merely drafted the scheme of a social order under which, in the name of progress, science, and humanity, any deviation from his own ideas was to be prohibited.
The intellectual heirs of Comte are the contemporary positivists. Like Comte himself, these, advocates of “Unified Science,” of panphysicalism, of “logical” or “empirical positivism,” and of “scientific” philosophy did not themselves contribute to the advancement of the natural sciences. The future historians of physics, chemistry, biology, and physiology will not have to mention their names and their work. All that “Unified Science” brought forward was to recommend the proscription of the methods applied by the sciences of human action and their replacement by the methods of the experimental natural sciences. It is not remarkable for that which it contributed, but only for that which it wants to see prohibited. Its protagonists are the champions of intolerance and of a narrow-minded dogmatism.
Historians have to understand the political, economic, and intellectual conditions that brought about positivism, old and new. But the specific historical understanding of the milieu out of which definite ideas developed can neither justify nor reject the teachings of any school of thought. It is the task of epistemology to unmask the fallacies of positivism and to refute them. ...
- The Misinterpretation of the Universe[Mises, Ultimate Foundation of Economic Science, chap. 8: “Positivism and the Crisis of Western Civilization,” pp. 125–28.]The way in which the philosophy of logical positivism depicts the universe is defective. It comprehends only what can be recognized by the experimental methods of the natural sciences. It ignores the human mind as well as human action.
It is usual to justify this procedure by pointing out that man is only a tiny speck in the infinite vastness of the universe and that the whole history of mankind is but a fleeting episode in the endless flux of eternity. Yet the importance and significance of a phenomenon defies such a merely quantitative appraisal. Man’s place in that part of the universe about which we can learn something is certainly modest only. But as far as we can see, the fundamental fact about the universe is that it is divided into two parts, which — employing terms suggested by some philosophers, but without their metaphysical connotation — we may call res extensa, the hard facts of the external world, and res cogitans, man’s power to think. We do not know how the mutual relations of these two spheres may appear in the vista of a superhuman intelligence. For man their distinction is peremptory. Perhaps it is only the inadequacy of our mental powers that prevents us from recognizing the substantial homogeneousness of what appears to us as mind and as matter. But certainly no palaver about “unified science” can convert the metaphysical character of monism into an unassailable theorem of experiential knowledge. The human mind cannot help distinguishing two realms of reality, its own sphere and that of external events. And it must not relegate the manifestations of the mind to an inferior rank, as it is only the mind that enables man to cognize and to produce a mental representation of what it is.
Positivism’s world view distorts the fundamental experience of mankind, for which the power to perceive, to think, and to act is an ultimate fact clearly distinguishable from all that happens without the interference of purposive human action. It is vain to talk about experience without reference to the factor that enables man to have experience.
- The Misinterpretation of the Human ConditionAs all brands of positivism see it, the eminent role man plays on the earth is the effect of his progress in the cognition of the interconnectedness of natural — i.e., not specifically mental and volitional — phenomena and in its utilization for technological and therapeutical behavior. Modern industrial civilization, the spectacular affluence it has produced, and the unprecedented increase in population figures it has made possible are the fruits of the progressive advancement of the experimental natural sciences. The main factor in improving the lot of mankind is science, i.e., in the positivistic terminology, the natural sciences. In the context of this philosophy society appears as a gigantic factory and all social problems as technological problems to be solved by “social engineering.” What, for example, is lacking to the so-called underdeveloped countries is, in the light of this doctrine, the “know-how,” sufficient familiarity with scientific technology.
It is hardly possible to misinterpret mankind’s history more thoroughly. The fundamental fact that enabled man to elevate his species above the level of the beasts and the horrors of biological competition was the discovery of the principle of the higher productivity of cooperation under a system of the division of labor, that great cosmic principle of becoming. What improved and still improves the fecundity of human efforts is the progressive accumulation of capital goods without which no technological innovation could ever be practically utilized. No technological computation and calculation would be possible in an environment that would not employ a generally used medium of exchange, money. Modern industrialization, the practical employment of the discoveries of the natural sciences, is intellectually conditioned by the operation of a market economy in which prices, in terms of money, for the factors of production are established and thus the opportunity is given to the engineer to contrast the costs and the proceeds to be expected from alternative projects. The quantification of physics and chemistry would be useless for technological planning if there were no economic calculation.About the problems of economic calculation, see Mises, Human Action, pp. 201–32 and 691–711. What is lacking to the underdeveloped nations is not knowledge, but capital.This answers also the often raised question why the ancient Greeks did not construct steam engines although their physics gave them the theoretical knowledge required. They did not conceive the primary importance of saving and capital formation.
The popularity and the prestige that the experimental methods of the natural sciences enjoy in our age and the dedication of ample funds for the conduct of laboratory research are attendant phenomena of capitalism’s progressive accumulation of capital. What transformed the world of horse-drawn carriages, sailing ships, and windmills step by step into a world of airplanes and electronics was the laissez-faire principle of Manchesterism. Large savings, continuously in search of the most profitable investment opportunities, are providing the resources needed for rendering the accomplishments of the physicists and chemists utilizable for the improvement of business activities. What is called economic progress is the joint effect of the activities of the three progressive groups — or classes — of the savers, the scientist-inventors, and the entrepreneurs, operating in a market economy as far as it is not sabotaged by the endeavors of the nonprogressive majority of the routinists and the public policies supported by them.
What begot all those technological and therapeutical achievements that characterize our age was not science, but the social and political system of capitalism. Only in the climate of huge capital accumulation could experimentalism develop from a pastime of geniuses like Archimedes and Leonardo da Vinci into a well-organized systematic pursuit of knowledge. The much decried acquisitiveness of the promoters and speculators was intent upon applying the accomplishments of scientific research to the improvement of the masses’ standard of living. In the ideological environment of our age, which, driven by a fanatical hatred of the “bourgeois,” is anxious to substitute the “service” principle for the “profit” principle, technological innovation is more and more directed toward the fabrication of efficient instruments of war and destruction.
The research activities of the experimental natural sciences are in themselves neutral with regard to any philosophical and political issue. But they can thrive and become beneficial for mankind only where there prevails a social philosophy of individualism and freedom.
In stressing the fact that the natural sciences owe all their achievements to experience, positivism merely repeated a truism which since the demise of Naturphilosophie nobody any longer disputed. In disparaging the methods of the sciences of human action, it paved the way for the forces that are sapping the foundations of Western civilization.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 10: “Exchange within Society,” pp. 195–98.]1. Autistic Exchange and Interpersonal ExchangeAction always is essentially the exchange of one state of affairs for another state of affairs. If the action is performed by an individual without any reference to cooperation with other individuals, we may call it autistic exchange. An instance: the isolated hunter who kills an animal for his own consumption; he exchanges leisure and a cartridge for food.
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. Where there is no intentional mutuality, where an action is performed without any design of being benefited by a concomitant action of other men, there is no interpersonal exchange, but autistic exchange. It does not matter whether the autistic action is beneficial or detrimental to other people or whether it does not concern them at all. A genius may perform his task for himself, not for the crowd; however, he is an outstanding benefactor of mankind. The robber kills the victim for his own advantage; the murdered man is by no means a partner in this crime, he is merely its object; what is done, is done against him.
Hostile aggression was a practice common to man’s nonhuman forebears. Conscious and purposeful cooperation is the outcome of a long evolutionary process. Ethnology and history have provided us with interesting information concerning the beginning and the primitive patterns of interpersonal exchange. Some consider the custom of mutual giving and returning of presents and stipulating a certain return present in advance as a precursory pattern of interpersonal exchange.Gustav Cassel, The Theory of Social Economy, trans. S.L. Banon (new ed; London, 1932), p. 371. Others consider dumb barter as the primitive mode of trade. However, to make presents in the expectation of being rewarded by the receiver’s return present or in order to acquire the favor of a man whose animosity could be disastrous, is already tantamount to interpersonal exchange. The same applies to dumb barter which is distinguished from other modes of bartering and trading only through the absence of oral discussion.
It is the essential characteristic of the categories of human action that they are apodictic and absolute and do not admit of any gradation. There is action or nonaction, there is exchange or nonexchange; everything which applies to action and exchange as such is given or not given in every individual instance according to whether there is or there is not action and exchange. In the same way the boundaries between autistic exchange and interpersonal exchange are sharply distinct. Making one-sided presents without the aim of being rewarded by any conduct on the part of the receiver or of third persons is autistic exchange. The donor acquires the satisfaction which the better condition of the receiver gives to him. The receiver gets the present as a God-sent gift. But if presents are given in order to influence some people’s conduct, they are no longer one-sided, but a variety of interpersonal exchange between the donor and the man whose conduct they are designed to influence. Although the emergence of interpersonal exchange was the result of a long evolution, no gradual transition is conceivable between autistic and interpersonal exchange. There were no intermediary modes of exchange between them. The step which leads from autistic to interpersonal exchange was no less a jump into something entirely new and essentially different than was the step from automatic reaction of the cells and nerves to conscious and purposeful behavior, to action.
- Contractual Bonds and Hegemonic BondsThere are two different kinds of social cooperation: cooperation by virtue of contract and coordination, and cooperation by virtue of command and subordination or hegemony.
Where and as far as cooperation is based on contract, the logical relation between the cooperating individuals is symmetrical. They are all parties to interpersonal exchange contracts. John has the same relation to Tom as Tom has to John. Where and as far as cooperation is based on command and subordination, there is the man who commands and there are those who obey his orders. The logical relation between these two classes of men is asymmetrical. There is a director and there are people under his care. The director alone chooses and directs; the others — the wards — are mere pawns in his actions.
The power that calls into life and animates any social body is always ideological might, and the fact that makes an individual a member of any social compound is always his own conduct. This is no less valid with regard to a hegemonic societal bond. It is true, people are as a rule born into the most important hegemonic bonds, into the family and into the state, and this was also the case with the hegemonic bonds of older days, slavery and serfdom, which disappeared in the realm of Western civilization. But no physical violence and compulsion can possibly force a man against his will to remain in the status of the ward of a hegemonic order. What violence or the threat of violence brings about is a state of affairs in which subjection as a rule is considered more desirable than rebellion. Faced with the choice between the consequences of obedience and of disobedience, the ward prefers the former and thus integrates himself into the hegemonic bond. Every new command places this choice before him again. In yielding again and again he himself contributes his share to the continuous existence of the hegemonic societal body. Even as a ward in such a system he is an acting human being, i.e., a being not simply yielding to blind impulses, but using his reason in choosing between alternatives.
What differentiates the hegemonic bond from the contractual bond is the scope in which the choices of the individuals determine the course of events. As soon as a man has decided in favor of his subjection to a hegemonic system, he becomes, within the margin of this system’s activities and for the time of his subjection, a pawn of the director’s actions. Within the hegemonic societal body and as far as it directs its subordinates’ conduct, only the director acts. The wards act only in choosing subordination; having once chosen subordination they no longer act for themselves, they are taken care of.In the frame of a contractual society the individual members exchange definite quantities of goods and services of a definite quality. In choosing subjection in a hegemonic body a man neither gives nor receives anything that is definite. He integrates himself into a system in which he has to render indefinite services and will receive what the director is willing to assign to him. He is at the mercy of the director. The director alone is free to choose. Whether the director is an individual or an organized group of individuals, a directorate, and whether the director is a selfish maniacal tyrant or a benevolent paternal despot is of no relevance for the structure of the whole system.
The distinction between these two kinds of social cooperation is common to all theories of society. Ferguson described it as the contrast between warlike nations and commercial nation; Saint Simon as the contrast between pugnacious nations and peaceful or industrial nations;Cf. Adam Ferguson, An Essay on the History of Civil Society (new ed; Basel, 1789), p. 208. Herbert Spencer as the contrast between societies of individual freedom and those of a militant structure;Cf. Herbert Spencer, The Principles of Sociology (New York, 1914), vol. 3, pp. 575–611. Sombart as the contrast between heroes and peddlers.Cf. Werner Sombart, Haendler und Helden (Munich, 1915). The Marxians distinguish between the “gentile organization” of a fabulous state of primitive society and the eternal bliss of socialism on the one hand and the unspeakable degradation of capitalism on the other hand.Cf. Frederick Engels, The Origin of the Family, Private Property and the State (New York, 1942), p. 144. The Nazi philosophers distinguish the counterfeit system of bourgeois security from the heroic system of authoritarian Führertum. The valuation of both systems is different with the various sociologists. But they fully agree in the establishment of the contrast and no less in recognizing that no third principle is thinkable and feasible.
Western civilization as well as the civilization of the more advanced Eastern peoples are achievements of men who have cooperated according to the pattern of contractual coordination. These civilizations, it is true, have adopted in some respects bonds of hegemonic structure. The state as an apparatus of compulsion and coercion is by necessity a hegemonic organization. So is the family and its household community. However, the characteristic feature of these civilizations is the contractual structure proper to the cooperation of the individual families. There once prevailed almost complete autarky and economic isolation of the individual household units. When interfamilial exchange of goods and services was substituted for each family’s economic self-sufficiency, it was, in all nations commonly considered civilized, a cooperation based on contract. Human civilization as it has been hitherto known to historical experience is preponderantly a product of contractual relations.
Any kind of human cooperation and social mutuality is essentially an order of peace and conciliatory settlement of disputes. In the domestic relations of any societal unit, be it a contractual or a hegemonic bond, there must be peace. Where there are violent conflicts and as far as there are such conflicts, there is neither cooperation nor societal bonds. Those political parties which in their eagerness to substitute the hegemonic system for the contractual system point at the rottenness of peace and of bourgeois security, extol the moral nobility of violence and bloodshed and praise war and revolution as the eminently natural methods of interhuman relations, contradict themselves. For their own utopias are designed as realms of peace. The Reich of the Nazis and the commonwealth of the Marxians are planned as societies of undisturbed peace. They are to be created by pacification, i.e., the violent subjection of all those not ready to yield without resistance. In a contractual world various states can quietly coexist. In a hegemonic world there can only be one Reich or commonwealth and only one dictator. Socialism must choose between a renunciation of the advantages of division of labor encompassing the whole earth and all peoples and the establishment of a world-embracing hegemonic order. It is this fact that made Russian Bolshevism, German Nazism, and Italian Fascism “dynamic,” i.e., aggressive. Under contractual conditions empires are dissolved into a loose league of autonomous member nations. The hegemonic system is bound to strive after the annexation of all independent states.
The contractual order of society is an order of right and law. It is a government under the rule of law (Rechtsstaat) as differentiated from the welfare state (Wohlfahrtsstaat) or paternal state. Right or law is the complex of rules determining the orbit in which individuals are free to act. No such orbit is left to wards of a hegemonic society. In the hegemonic state there is neither right nor law; there are only directives and regulations which the director may change daily and apply with what discrimination he pleases and which the wards must obey. The wards have one freedom only: to obey without asking questions.
Socialism[Ludwig von Mises, Socialism (1922; Indianapolis, Ind.: Liberty Classics, 1981), chap. 18: “Society,” pp. 256–78.]1. The Nature of SocietyThe idea of human destiny dominates all the more ancient views of social existence. Society progresses towards a goal fore-ordained by the deity. Whoever thinks in this way is logically correct if, in speaking of progress and retrogression, of revolution and counterrevolution, of action and reaction he lays on these concepts the emphasis adopted by so many historians and politicians. History is judged according as it brings mankind nearer to the goal or carries it farther away.
Social science, however, begins at the point where one frees oneself from such habits, and indeed from all valuation. Social science is indeed teleological in the sense in which every causal study of the will must be. But its concept of purpose is wholly comprised in the causal explanation. For social science causality remains the fundamental principle of cognition, the maintenance of which must not be impaired even by teleology.[Hermann] Cohen, Logik der reinen Erkenntnis, 2nd ed. (Berlin, 1914), p. 359. Since it does not evaluate purposes, it cannot speak of evolution to a higher plane, in the sense let us say, of Hegel and Marx. For it is by no means proved that all evolution leads upwards, or that every later stage is a higher one. No more, of course, can it agree with the pessimistic philosophers of history, who see in the historical process a decline, a progressive approach to a bad end. To ask what are the driving forces of historical evolution is to ask what is the nature of society and the origin and causes of the changes in social conditions. What society is, how it originates, how it changes — these alone can be the problems which scientific sociology sets itself.
That the social life of men resembles the biological process is an observation of ancient date. It lies at the basis of the famous legend of Menenius Agrippa, handed down to us by Livy. Social science did itself little good when, inspired by the triumph of Biology in the nineteenth century, voluminous works developed this analogy to the point of absurdity. What is the use of calling the products of human activity “social intercellular substance”?As is done by [Paul von] Lilienfeld, La pathologie sociale (Paris, 1896), p. 95. When a government takes a loan from the House of Rothschild organic sociology conceives the process as follows: “La maison Rothschild agit, dans cette occasion, parfaitement en analogie avec l’action d’un groupe de cellules qui, dans le corps humain, coopèrent à la production du sang nécessaire à l’alimentation du cerveau dans l’espoir d’en être indemnisées par une réaction des cellules de la substance grise dont ils ont besoin pour s’activer de nouveau et accumuler de nouvelles énergies.” (“The House of Rothschild’s operation, on such an occasion, is precisely similar to the action of a group of human body cells which cooperate in the production of the blood necessary for nourishing the brain, in the hope of being compensated by a reaction of the gray matter cells which they need to reactivate and to accumulate new energies.”) (Ibid., p. 104.) This is the method which claims that it stands on “firm ground” and explores “the Becoming of Phenomena step by step, proceeding from the simpler to the more complex.” See Lilienfeld, Zur Verteidigung der organischen Methode in der Soziologie (Berlin, 1898), p. 75. Who was enlightened when scholars disputed which organ of the social body corresponded to the central nervous system? The best comment on this form of sociological study was the remark of an economist, to the effect that anyone who compared money with blood and the circulation of money with the circulation of blood would be making the same contribution to economics as would be made to biology by a man who compared blood with money and the blood-circulation with the circulation of money. Modern biology has borrowed from social science some of its most important concepts — that of evolution, of the division of labour, and of the struggle for existence. But it has not stopped short at metaphorical phrases and conclusions by analogy; rather has it proceeded to make profitable use of what it had gained. On the other hand biological-sociology did nothing but play a futile word-spinning game with the ideas it borrowed back. The romantic movement, with its “organic” theory of the state has done even less to clear up our knowledge of social interrelations. Because it deliberately cold-shouldered the most important achievement of social science up to that date — the system of classical Political Economy — it was unable to utilize the doctrine of the division of labour, that part of the classical system which must be the starting point of all sociology, as it is of modern biology.It is characteristic that just the romantics stress excessively society’s organic character, whereas liberal social philosophy has never done so. Quite understandably. A social theory which was genuinely organic did not need to stress obtrusively this attribute of its system.
Comparison with the biological organism should have taught sociology one thing: that the organism can only be conceived as a system of organs. This, however, merely means that the essence of the organism is the division of labour. Only division of labour makes the parts become members; it is in the collaboration of the members that we recognize the unity of the system, the organism.Cohen, Logik der reinen Erkenntnis, p. 349. This is true of the life of plants and animals as well as of society. As far as the principle of the division of labour is concerned, the social body may be compared with the biological. The division of labour is the tertium comparationis (basis for comparison) of the old simile.
The division of labour is a fundamental principle of all forms of life.[Oscar] Hertwig, Allgemeine Biologie, 4th ed. (Jena, 1912), pp. 500 ff; Hertwig, Zur Abwehr des ethischen, des sozialen und des politischen Darwinismus (Jena, 1918), pp. 69 ff. It was first detected in the sphere of social life when political economists emphasized the meaning of the division of labour in the social economy. Biology then adopted it, at the instigation in the first place of Milne Edwards in 1827. The fact that we can regard the division of labour as a general law must not, however, prevent us from recognizing the fundamental differences between division of labour in the animal and vegetable organism on the one hand and division of labour in the social life of human beings on the other. Whatever we imagine to be the origin, evolution, and meaning of the physiological division of labour, it clearly does not shed any light on the nature of the sociological division of labour. The process that differentiates and integrates homogeneous cells is completely different from that which led to the growth of human society out of self-sufficient individuals. In the second process, reason and will play their part in the coalescence, by which the previously independent units form a larger unit and become parts of a whole, whereas the intervention of such forces in the first process is inconceivable.
Even where creatures such as ants and bees come together in “animal communities,” all movements and changes take place instinctively and unconsciously. Instinct may very well have operated at the beginning and in the earliest stages of social formation also. Man is already a member of a social body when he appears as a thinking, willing creature, for the thinking man is inconceivable as a solitary individual. “Only amongst men does man become a man” (Fichte). The development of human reason and the development of human society are one and the same process. All further growth of social relations is entirely a matter of will. Society is the product of thought and will. It does not exist outside thought and will. Its being lies within man, not in the outer world. It is projected from within outwards.
Society is co-operation; it is community in action.
To say that Society is an organism, means that society is division of labour.[Jean] Izoulet, La cité moderne (Paris, 1894), pp. 35 ff. To do justice to this idea we must take into account all the aims which men set themselves and the means by which these are to be attained. It includes every inter-relation of thinking and willing man. Modern man is a social being, not only as one whose material needs could not be supplied in isolation, but also as one who has achieved a development of reason and of the perceptive faculty that would have been impossible except within society. Man is inconceivable as an isolated being, for humanity exists only as a social phenomenon and mankind transcended the stage of animality only in so far as co-operation evolved the social relationships between the individuals. Evolution from the human animal to the human being was made possible by and achieved by means of social cooperation and by that alone. And therein lies the interpretation of Aristotle’s dictum that man is the ζvονπsλιτιχον (the living body politic).
- The Division of Labour as the Principle of Social DevelopmentWe are still far from understanding the ultimate and most profound secret of life, the principle of the origin of organisms. Who knows whether we shall ever discover it? All we know today is that when organisms are formed, something which did not exist before is created out of individuals. Vegetable and animal organisms are more than conglomerations of single cells, and society is more than the sum of the individuals of which it is composed. We have not yet grasped the whole significance of this fact. Our thoughts are still limited by the mechanical theory of the conservation of energy and of matter, which is never able to tell us how one can become two. Here again, if we are to extend our knowledge of the nature of life, understanding of the social organization will have to precede that of the biological.
Historically division of labour originates in two facts of nature: the inequality of human abilities and the variety of the external conditions of human life on the earth. These two facts are really one: the diversity of Nature, which does not repeat itself but creates the universe in infinite, inexhaustible variety. The special nature of our inquiry, however, which is directed towards sociological knowledge, justifies us in treating these two aspects separately.
It is obvious that as soon as human action becomes conscious and logical it must be influenced by these two conditions. They are indeed such as almost to force the division of labour on mankind.[Émile] Durkheim, De la division du travail social (Paris, 1893), pp. 294 ff. endeavours (following Comte and against Spencer) to prove that the division of labour prevails not because, as the economists think, it increases output but as a result of the struggle for existence. The denser the social mass the sharper the struggle for existence. This forces individuals to specialize in their work, as otherwise they would not be able to maintain themselves. But Durkheim overlooks the fact that the division of labour makes this possible only because it makes labour more productive. Durkheim comes to reject the theory of the importance of the greater productivity in the division of labour through a false conception of the fundamental idea of utilitarianism and of the law of the satiation of wants (ibid., 218 ff., 257 ff.). His view that civilization is called forth by changes in the volume and density of society is untenable. Population grows because labour becomes more productive and is able to nourish more people, not vice versa. Old and young, men and women co-operate by making appropriate use of their various abilities. Here also is the germ of the geographical division of labour; man goes to the hunt and woman to the spring to fetch water. Had the strength and abilities of all individuals and the external conditions of production been everywhere equal the idea of division of labour could never have arisen. Man would never of himself have hit upon the idea of making the struggle for existence easier by co-operation in the division of labour. No social life could have arisen among men of equal natural capacity in a world which was geographically uniform.On the important part played by the local variety of productive conditions in the origin of the division of labour see [Karl] von den Steinen, Unter den Naturvölkern Zentralbrasiliens, 2nd ed. (Berlin, 1897), pp. 196 ff. Perhaps men would have joined together to cope with tasks which were beyond the strength of individuals, but such alliances do not make a society. The relations they create are transient, and endure only for the occasion that brings them about. Their only importance in the origin of social life is that they create a rapprochement between men which brings with it mutual recognition of the difference in the natural capacities of individuals and thus in turn gives rise to the division of labour.
Once labour has been divided, the division itself exercises a differentiating influence. The fact that labour is divided makes possible further cultivation of individual talent and thus co-operation becomes more and more productive. Through co-operation men are able to achieve what would have been beyond them as individuals, and even the work which individuals are capable of doing alone is made more productive. But all this can only be grasped fully when the conditions which govern increase of productivity under co-operation are set out with analytical precision.
The theory of the international division of labour is one of the most important contributions of Classical Political Economy. It shows that as long as — for any reasons — movements of capital and labour between countries are prevented, it is the comparative, not the absolute, costs of production which govern the geographical division of labour.[David] Ricardo, Principles of Political Economy and Taxation, in Works, ed. John Ramsay MacCulloch, 2nd. (London, 1852), pp. 76 ff.; [John Stuart] Mill, Principles of Political Economy (People’s ed.; London, 1867), pp. 348 ff.; [C.F.] Bastable, The Theory of International Trade, 3rd ed. (London, 1900), pp. 16 ff. When the same principle is applied to the personal division of labour it is found that the individual enjoys an advantage in co-operating not only with people superior to himself in this or that capacity but also with those who are inferior to himself in every relevant way. If, through his superiority to B, A needs three hours’ labour for the production of one unit of commodity p compared with B’s five, and for the production of commodity q two hours against B’s four, then A will gain if he confines his labour to producing q and leaves B to produce p. If each gives sixty hours to producing both p and q, the result of A’s labour is 20p + 30q, of B’s 12p + 15q, and for both together 32p + 45q. If however, A confines himself to producing q alone he produces sixty units in 120 hours, whilst B, if he confines himself to producing p, produces in the same time twenty-four units. The result of the activity is then 24p + 60q, which, as p has for A a substitution value of 3:2q and for B one of 5:4q, signifies a larger production than 32p + 45q. Therefore it is obvious that every expansion of the personal division of labour brings advantages to all who take part in it. He who collaborates with the less talented, less able, and less industrious individuals gains an advantage equally as the man who associated with the more talented, more able, and more industrious. The advantage of the division of labour is mutual; it is not limited to the case where work is done which the solitary individual could never have carried out.
The greater productivity of work under the division of labour is a unifying influence. It leads men to regard each other as comrades in a joint struggle for welfare, rather than as competitors in a struggle for existence. It makes friends out of enemies, peace out of war, society out of individuals.“Trade makes the human race, which originally has only the unity of the species, into a really unitary society.” See Heymann Steinthal, Allgemeine Ethik (Berlin, 1885), p. 208. Trade, however, is nothing more than a technical aid of the division of labour. On the division of labour in the sociology of Thomas Aquinas see Edmund Schreiber, Die volkswirtschaftlichen Anschauungen der Scholastik seit Thomas von Aquin (Jena, 1913), pp. 19 ff.
- Organism and OrganizationOrganism and organization are as different from each other as life is from a machine, as a flower which is natural from one which is artificial. In the natural plant each cell lives its own life for itself while functioning reciprocally with the others. What we call living is just this self-existence and self-maintenance. In the artificial plant the separate parts are members of the whole only as far as the will of him, who united them, has been effective. Only to the extent to which this will is effective are the parts within the organization inter-related. Each part occupies only the place given to it, and leaves that place, so to speak, only on instructions. Within this framework the parts can live, that is, exist for themselves, only in so far as the creator has put them alive into his creation. The horse which the driver has harnessed to the cart lives as a horse. In the organization, the “team,” the horse is just as foreign to the vehicle as is an engine to the car it drives. The parts may use their life in opposition to the organization, as, for instance, when the horse runs away with the carriage or the tissue out of which the artificial flower is made disintegrates under chemical action. Human organization is no different. Like society it is a result of will. But in this case the will no more produces a living social organism than the flower-maker produces a living rose. The organization holds together as long as the creating will is effective, no longer. The parts which compose the organization merge into the whole only so far as the will of the creator can impose itself upon them and their life can be fixed in the organization. In the battalion on parade there is one will, the will of the commander. Everything else so far as it functions within the organization is lifeless machinery. In this destruction of the will, or that portion of it which does not serve the purpose of the body of troops, lies the essence of military drill. The soldier in the phalangial order, fighting in line, in which the body of troops must be nothing more than an organization — is drilled. Within the mass there is no life. Whatever life the individual lives is by the side of, or outside the body of troops — against it perhaps, but never in it. Modern warfare, based on the skirmisher’s personal enterprise, has to make use of the individual soldier, of his thought and his will. So the army no longer simply drills the soldier. It seeks to educate him.
Organization is an association based on authority, organism is mutuality. The primitive thinker always sees things as having been organized from outside, never as having grown themselves, organically. He sees the arrow which he has carved, he knows how it came into existence and how it was set in motion. So he asks of everything he sees, who made it and who sets it in motion. He inquires after the creation of every form of life, the authors of every change in nature, and discovers an animistic explanation. Thus the Gods are born. Man sees the organized community with its contrast of rulers and ruled, and, accordingly, he tries to understand life as an organization, not as an organism. Hence the ancient conception of the head as the master of the body, and the use of the same term “head” for the chief of the organization.
In recognizing the nature of the organism and sweeping away the exclusiveness of the concept of organization, science made one of its great steps forward. With all deference to earlier thinkers one may say that in the domain of Social Science this was achieved mainly in the eighteenth century, and that Classical Political Economy and its immediate precursors played the chief part. Biology took up the good work, flinging off all animistic and vitalistic beliefs. For modern biology the head is no longer the crown, the ruler of the body. In the living body there is no longer leader and followers, a contrast of sovereign and subjects, of means and purpose. There are only members, organs.
To seek to organize society is just as crazy as it would be to tear a living plant to bits in order to make a new one out of the dead parts. An organization of mankind can only be conceived after the living social organism has been killed. The collectivist movements are therefore fore-doomed to failure. It may be possible to create an organization embracing all mankind. But this would always be merely an organization, side by side with which social life would continue. It could be altered and destroyed by the forces of social life, and it certainly would be destroyed from the moment it tried to rebel against these forces. To make Collectivism a fact one must first kill all social life, then build up the collectivist state. The Bolshevists are thus quite logical in wishing to dissolve all traditional social ties, to destroy the social edifice built up through countless centuries, in order to erect a new structure on the ruins. Only they overlook the fact that isolated individuals, between whom no kind of social relations exist, can no longer be organized.
Organizations are possible only as long as they are not directed against the organic or do it any injury. All attempts to coerce the living will of human beings into the service of something they do not want must fail. An organization cannot flourish unless it is founded on the will of those organized and serves their purposes.
- The Individual and SocietySociety is not mere reciprocity. There is reciprocity amongst animals, for example when the wolf eats the lamb or when the wolf and she-wolf mate. Yet we do not speak of animal societies or of a society of wolves. Wolf and lamb, wolf and she-wolf, are indeed members of an organism — the organism of Nature. But this organism lacks the specific characteristic of the social organism: it is beyond the reach of will and action. For the same reason, the relation between the sexes is not, as such, a social relation. When a man and a woman come together they follow the law which assigns to them their place in Nature. Thus far they are ruled by instinct. Society exists only where willing becomes a co-willing and action co-action. To strive jointly towards aims which alone individuals could not reach at all, or not with equal effectiveness — that is society.Therefore, too, one must reject the idea of Guyau, which derives the social bond directly from bi-sexuality. See [Jean-Marie] Guyau, Sittlichkeit ohne Pflicht, trans. [Elisabeth] Schwarz (Leipzig, 1909), pp. 113 ff.
Therefore, Society is not an end but a means, the means by which each individual member seeks to attain his own ends. That society is possible at all is due to the fact that the will of one person and the will of another find themselves linked in a joint endeavour. Community of work springs from community of will. Because I can get what I want only if my fellow citizen gets what he wants, his will and action become the means by which I can attain my own end. Because my willing necessarily includes his willing, my intention cannot be to frustrate his will. On this fundamental fact all social life is built up.Fouillée argues as follows against the utilitarian theory of society, which calls society a “moyen universal” (“universal means”) (Belot): “Tout moyen n’a qu’une valeur provisoire; le jour où un instrument dont je me servais me devient inutile ou nuisible, je le mets de côté. Si la société n’ est qu’un moyen, le jour où, exceptionellement, elle se trouvera contraire à mes fins, je me delivrerai des lois sociales et moyens. sociaux. ... Aucune considération sociale ne pourra empêcher la révolte de l’individu tant qu’on ne lui aura pas montré que la société est établie pour des fins qui sont d’abord et avant tout ses vraies fins à lui-même et qui, de plus, ne sont pas simplement des fins de plaisir ou d’intérêt, l’intérêt n’étant que le plaisir différé et attendu pour l’avenir ... L’idée d’intérét est précisément ce qui divise les hommes, malgré les rapprochements qu’elle peut produire lorsqu’il y a convergence d’intérêts sur certains points.” (“Every means has only a temporary value; the day when a means ceases to serve me or becomes harmful to me, I cast it aside. If society is only a means, the day when, by some special circumstances, it is found to act contrary to my ends, I will free myself from its social laws and social means. ... No social consideration can prevent an individual from rebelling when it has not been demonstrated to him that society exists for ends which are primarily and above all his own true ends and, further, which are not simply for the ends of pleasure or self-interest, self-interest being only pleasure postponed and expected in the future. ... The idea of self-interest is precisely what divides men, in spite of the cooperation it can produce when self-interests coincide in certain instances.”) [Alfred] Fouillée, Humanitaires et libertaires au point de vue Sociologique et moral (Paris, 1914), pp. 146 ff.; see also [Jean-Marie] Guyau, Die englische Ethik der Gegenwart, trans. Peusner (Leipzig, 1914), pp. 372 ff. Fouillée does not see that the provisional value which society gets as a means, lasts as long as the conditions of human life, given by nature, continue unchanged and as long as man continues to recognize the advantages of human co-operation. The “eternal,” not merely provisional, existence of society follows from the eternity of the conditions on which it is built up. Those in power may demand of social theory that it should serve them by preventing the individual from revolting against society, but this is by no means a scientific demand. Besides no social theory could, as easily as the utilitarian, induce the social individual to enrol himself voluntarily in the social union. But when an individual shows that he is an enemy of society there is nothing left for society to do but make him harmless.
The principle of the division of labour revealed the nature of the growth of society. Once the significance of the division of labour had been grasped, social knowledge developed at an extraordinary pace, as we see from a comparison between Kant and those who came after him. The doctrine of the division of labour as put forward by eighteenth-century economists, was far from fully developed when Kant wrote. It had yet to be made precise by the Ricardian Theory of International Trade. But the Doctrine of the Harmony of Interests had already anticipated its far-reaching application to social theory. Kant was untouched by these ideas. His only explanation of society, therefore, is that there is an impulse in human beings to form a society, and a second contrary impulse that seeks to split up society. The antagonism of these two tendencies is used by Nature to lead men towards the ultimate goal to which it wishes to lead them.[Immanuel] Kant, “Idee zu einer allgemeinen Geschichte in weltbürgerlicher Absicht” (Collected Works), vol. 1, pp. 227 ff. It is difficult to imagine a more threadbare idea than such an attempt to explain society by the interplay of two impulses, the impulse “to socialize oneself” and the impulse “to isolate oneself.” Obviously it goes no farther than the attempt to explain the effects of opium from the virtus dormitiva, cuius est natura sensus assupire (the sleep-inducing property whose nature is to dull the senses).
Once it has been perceived that the division of labour is the essence of society, nothing remains of the antithesis between individual and society. The contradiction between individual principle and social principle disappears.
- The Development of the Division of LabourIn so far as the individual becomes a social being under the influence of blind instinct, before thought and will are fully conscious, the formation of society cannot be the subject of sociological inquiry. But this does not mean that Sociology must shift the task of explaining the origins of society on to another science, accepting the social web of mankind as a given fact. For if we decide — and this is the immediate consequence of equating society and division of labour — that the structure of society was incomplete at the appearance of the thinking and willing human being and that the constructive process is continuous throughout history, then we must seek a principle which makes this evolution intelligible to us. The economic theory of the division of labour gives us this principle. It has been said that the happy accident which made possible the birth of civilization was the fact that divided labour is more productive than labour without division. The division of labour extends by the spread of the realization that the more labour is divided the more productive it is. In this sense the extension of the division of labour is economic progress: it brings production nearer to its goal — the greatest possible satisfaction of wants, and this progress is sociological progress also, for it involves the intensification of the social relation.
It is only in this sense, and if all teleological or ethical valuation is excluded, that it is legitimate to use the expression “progress” sociologically in historical inquiry. We believe that we can observe a certain tendency in the changes of social conditions and we examine each single change separately, to see whether and how far this assumption is compatible with it. It may be that we make various assumptions of this kind, each of which corresponds in like measure to experience. The problem next arises of the relations between these assumptions, whether they are independent of each other or whether they are connected internally. We should then have to go further, and define the nature of the connection. But all that this amounts to is a study, free from valuation and based on a hypothesis, of the course of successive changes.
If we disregard those theories of evolution that are naively built up on value judgments, we shall find, in the majority of the theories claiming to interpret social evolution, two outstanding defects which render them unsatisfactory. The first is that their evolutionary principle is not connected with society as such. Neither Comte’s law of the three stages of the human mind nor Lamprecht’s five stages of social-psychical development gives any clue to the inner and necessary connection between evolution of the mind and evolution of society. We are shown how society behaves when it has entered a new stage, but we want to know more, namely by what law society originates and transforms itself. The changes which we see as social changes are treated by such theories as facts acting on society from outside; but we need to understand them as the workings of a constant law. The second defeat is that all these theories are “stage” theories (Stufentheorien). For the stage-theories there is really no such thing as evolution, that is, no continuous change in which we can recognize a definite trend. The statements of these theories do not go beyond establishing a definite sequence of events; they give no proof of the causal connection between the stages constituting the sequence. At best they succeed in establishing parallels between the sequence of events in different nations. But it is one thing to divide human life into childhood, youth, maturity, and old age, it is another to reveal the law which governs the growth and decay of the organism. A certain arbitrariness attaches to every theory of stages. The delimitation of the stages always fluctuates.
Modern German economic history has undoubtedly done right in making the division of labour the basis of its theory of evolution. But it has not been able to free itself from the old traditional scheme of development by stages. Its theory is still a stage-theory. Thus Bücher distinguishes the stage of the closed domestic economy (pure production for one’s own use, barterless economy), the stage of town economy (production for clients, the stage of direct exchange), and the stage of national economy (production for markets, the stage of the circulation of goods).[Karl] Bücher, Die Entstehung der Volkswirtschaft, First collection, 10th ed. (Tübingen, 1917), p. 91. Schmoller differentiates the periods of village economy, town economy, territorial economy, and state economy.[Gustav] Schmoller, Grundriss der allgemeinen Volkswirtschaftslehre (Munich, 1920), vol. 2, pp. 760 ff. Philippovich distinguishes closed domestic economy and trade economy, and within trade economy he finds the period of the locally limited trade, the period of trade controlled by the state and limited to the state area, and the period of free trade (developed national economy, Capitalism).[Eugen von] Philippovich, Grundriss der politischen Ökonomie, 11th ed. (Tübingen, 1916), vol. 1, pp. 11 ff. Against these attempts to force evolution into a general scheme many grave objections have been raised. We need not discuss what value such classification may have in revealing the characteristics of clearly defined historical epochs and how far they may be admitted as aids to description. At any rate they should be used with great discretion. The barren dispute over the economic life of the nations of antiquity shows how easily such classifying may lead to our mistaking the shadow of scholastic word-splitting for the substance of historical reality. For sociological study the stage theories are useless.On the stages theory see also my Grundprobleme der Nationalökonomie (Jena, 1933), pp. 106 ff. They mislead us in regard to one of the most important problems of history — that of deciding how far historical evolution is continuous. The solution of this problem usually takes the form either of an assumption, that social evolution — which it should be remembered is the development of the division of labour — has moved in an uninterrupted line, or by the assumption that each nation has progressed step-by-step over the same ground. Both assumptions are beside the point. It is absurd to say that evolution is uninterrupted when we can clearly discern periods of decay in history, periods when the division of labour has retrogressed. On the other hand, the progress achieved by individual nations by reaching a higher stage of the division of labour is never completely lost. It spreads to other nations and hastens their evolution. The fall of the ancient world undoubtedly put back economic evolution for centuries. But more recent historical research has shown that the ties connecting the economic civilization of antiquity with that of the Middle Ages were much stronger than people used to assume. The Exchange Economy certainly suffered badly under the storm of the great migration of peoples, but it survived them. The towns on which it depended, were not entirely ruined, and a link was soon made between the remnants of town-life and the new development of traffic by barter.[Alphons] Dopsch, Wirtschaftliche und soziale Grundlagen der europäischen Kulturentwicklung (Vienna, 1918), vol. 1, pp. 91 ff. In the civilization of the towns a fragment of the social achievements of antiquity was preserved and carried over into the life of the Middle Ages.
Progress in the division of labour depends entirely on a realization of its advantages, that is, of its higher productivity. The truth of this first became fully evident through the free-trade doctrines of the physiocrats and the classical eighteenth-century political economy. But in rudiments it is found in all arguments favouring peace, wherever peace is praised, or war condemned. History is a struggle between two principles, the peaceful principle, which advances the development of trade, and the militarist-imperialist principle, which interprets human society not as a friendly division of labour but as the forcible repression of some of its members by others. The imperialistic principle continually regains the upper hand. The liberal principle cannot maintain itself against it until the inclination for peaceful labour inherent in the masses shall have struggled through to full recognition of its own importance as a principle of social evolution. Wherever the imperialistic principle is in force peace can only be local and temporary: it never lasts longer than the facts which created it. The mental atmosphere with which Imperialism surrounds itself is little suited to the promotion of the growth of the division of labour within state frontiers; it practically prohibits the extension of the division of labour beyond the political-military barriers which separate the states. The division of labour needs liberty and peace. Only when the modern liberal thought of the eighteenth century had supplied a philosophy of peace and social collaboration was the basis laid for the astonishing development of the economic civilization of that age — an age branded by the latest imperialistic and socialistic doctrines as the age of crass materialism, egotism and capitalism.
Nothing could be more perverted than the conclusions drawn in this connection by the materialistic conception of history, which represents the development of social ideology as dependent on the stage of technical evolution which has been attained. Nothing is more erroneous than Marx’s well-known saying: “The handmill produces a society with feudal lords, the steam-mill a society with industrial capitalists.”[Karl] Marx, Das Elend der Philosophie, p. 92. In the formulations which Marx later on gave to his conception of history he avoided the rigidity of this earliest version. Behind such indefinite expressions as “productive forces” and “conditions of production” are hidden the critical doubts which Marx may meanwhile have experienced. But obscurity, opening the way to multitudinous interpretations, does not make an untenable theory tenable. It is not even formally correct. To try and explain social evolution through the evolution of technique is merely to side-track the problem without in any way solving it. For on such a conception, how are we to explain technical evolution itself?
Ferguson showed that the development of technique depends on social conditions, and that each age gets as far in technique as is permitted by the stages it has reached in the social division of labour.[Adam] Ferguson, Abhandlung über die Geschichte der bürgerlichen Gesellschaft, trans. Dorn (Jena, 1904), pp. 237 ff.; also [Paul] Barth, Die Philosophie der Geschichte als Soziologie, 2nd ed. (Leipzig, 1915), Part 1, pp. 578 ff. Technical advances are possible only where the division of labour has prepared the way for their application. The mass manufacturing of shoes presupposes a society in which the production of shoes for hundreds of thousands or millions of human beings can be united in a few enterprises. In a society of self-sufficing peasants there is no possible use for the steam mill. Only the division of labour could inspire the idea of placing mechanical forces at the service of manufacture.All that remains of the materialist conception of history, which appeared with the widest possible claims, is the discovery that all human and social action is decisively influenced by the scarcity of goods and the disutility of labour. But the Marxists can least admit just this, for all they say about the future socialist order of society disregards these two economic conditions.
To trace the origin of everything concerned with society in the development of the division of labour has nothing in common with the gross and naive materialism of the technological and other materialistic theories of history. Nor does it by any means signify, as disciples of the idealistic philosophy are apt to maintain, an inadmissible limitation of the concept of social relations. Neither does it restrict society to the specifically material. That part of social life which lies beyond the economic is indeed the ultimate aim, but the ways which lead to it are governed by the law of all rational action; wherever they come into question there is economic action.
- Changes in the Individual in SocietyThe most important effect of the division of labour is that it turns the independent individual into a dependent social being. Under the division of labour social man changes, like the cell which adapts itself to be part of an organism. He adapts himself to new ways of life, permits some energies and organs to atrophy and develops others. He becomes one-sided. The whole tribe of romantics, the unbending laudatores temporis acti (praisers of time past), have deplored this fact. For them the man of the past who developed his powers “harmoniously” is the ideal: an ideal which alas no longer inspires our degenerate age. They recommend retrogression in the division of labour, hence their praise of agricultural labour, by which they always mean the almost self-sufficing peasant.Adam Müller says about “the vicious tendency to divide labour in all branches of private industry and in government business too,” that man needs “an all round, I might say a sphere-round field of activity.” If the “division of labour in large cities or industrial or mining provinces cuts up man, the completely free man, into wheels, rollers, spokes, shafts, etc., forces on him an utterly one-sided scope in the already one-sided field of the provisioning of one single want, how can one then demand that this fragment should accord with the whole complete life and with its law, or with legality; how should the rhombuses, triangles, and figures of all kinds accord separately with the great sphere of political life and its law?” See Adam Müller, Ausgewählte Abhandlungen, ed. Baxa (Jena, 1921), p. 46.
Here, again the modern socialist outdoes the rest. Marx promises that in the higher phase of the communist society “the enslaving subjection of individuals under the division of labour, and with this also the contrast between mental and bodily labour, shall have disappeared.”[Karl] Marx, Zur Kritik des sozialdemokratischen Parteiprogramms von Gotha (New York, 1920), p. 17. Innumerable passages in his writings show how falsely Marx conceived the nature of labour in industry. Thus he thought also that “the division of labour in the mechanical factory” is characterized by “having lost every specialized character. ... The automatic factory abolishes the specialist and the one-track mind.” And he blames Proudhon, “who did not understand even this one revolutionary side of the automatic factory.” Marx, Das Elend der Philosophie, p. 129. Account will be taken of the human “need for change.” “Alternation of mental and bodily labour” will “safeguard man’s harmonious development.”[August] Bebel, Die Frau und der Sozialismus, pp. 283 ff.
We have already dealt with this illusion. Were it possible to achieve all human aims with only that amount of labour which does not itself cause any discomfort but at the same time relieves the sensation of displeasure that arises from doing nothing, then labour would not be an economic object at all. To satisfy needs would not be work but play. This, however, is not possible. Even the self-sufficient worker, for the most part, must labour far beyond the point where the effort is agreeable. One may assume that work is less unpleasant to him than to the worker who is tied to a definite task, as he finds at the beginning of each job he tackles fresh sensations of pleasure in the activity itself. If, nevertheless, man has given himself up more and more to the division of labour, it is because he has recognized that the higher productivity of labour thus specialized more than repays him for the loss of pleasure. The extent of the division of labour cannot be curtailed without reducing the productivity of labour. This is true of all kinds of labour. It is an illusion to believe that one can maintain productivity and reduce the division of labour.
Abolition of the division of labour would be no remedy for the injuries inflicted on the individual, body and soul, by specialized labour, unless we are prepared to set back social development. It is for the individual himself to set about becoming a complete human being. The remedy lies in reforming consumption, not in “reforming” labour. Play and sport, the pleasure of art, reading are the obvious way of escape.
It is futile to look for the harmoniously developed man at the outset of economic evolution. The almost self-sufficient economic subject as we know him in the solitary peasant of remote valleys shows none of that noble, harmonious development of body, mind, and feeling which the romantics ascribe to him. Civilization is a product of leisure and the peace of mind that only the division of labour can make possible. Nothing is more false than to assume that man first appeared in history with an independent individuality and that only during the evolution which led to the Great Society did he lose, together with material freedom, his spiritual independence. All history, evidence and observation of the lives of primitive peoples is directly contrary to this view. Primitive man lacks all individuality in our sense. Two South Sea Islanders resemble each other far more closely than two twentieth-century Londoners. Personality was not bestowed upon man at the outset. It has been acquired in the course of evolution of society.Durkheim, De la division du travail social, pp. 452 ff.
- Social RegressionSocial evolution — in the sense of evolution of the division of labour — is a will-phenomenon: it depends entirely on the human will. We do not consider whether one is justified in regarding every advance in the division of labour and hence in the intensification of the social bond, as a rise to a higher stage; we must ask whether such a development is a necessary phenomenon. Is an ever greater development of society the content of history? Is it possible for society to stand still or retrogress?
We must reject a priori any assumption that historical evolution is provided with a goal by any “intention,” or “hidden plan” of Nature, such as Kant imagined and Hegel and Marx had in mind; but we cannot avoid the inquiry whether a principle might not be found to demonstrate that continuous social growth is inevitable. The first principle that offers itself to our attention is the principle of natural selection. More highly developed societies attain greater material wealth than the less highly developed; therefore they have more prospect of preserving their members from misery and poverty. They are also better equipped to defend themselves from the enemy. One must not be misled by the observation that richer and more civilized nations were often crushed in war by nations less wealthy and civilized. Nations in an advanced stage of social evolution have always been able at least to resist a superior force of less developed nations. It is only decaying nations, civilizations inwardly disintegrated, which have fallen a prey to nations on the upgrade. Where a more highly organized society has succumbed to the attack of a less developed people, the victors have in the end been culturally submerged, accepting the economic and social order, and even the language and faith of the conquered race.
The superiority of the more highly developed societies lies not only in their material welfare but also quantitatively in the number of their members and qualitatively in the greater solidity of their internal structure. For this, precisely, is the key to higher social development: the widening of the social range, the inclusion in the division of labour of more human beings and its stronger grip on each individual. The more highly developed society differs from the less developed in the closer union of its members; this precludes the violent solution of internal conflict and forms externally a closed defensive front against any enemy. In less developed societies, where the social bond is still weak, and between the separate parts of which there exists a confederation for the purposes of war rather than true solidarity based on joint work and economic co-operation — disagreement breaks out more easily and more quickly than in highly developed societies. For the military confederation has no firm and lasting hold upon its members. By its very nature it is merely a temporary bond which is upheld by the prospect of momentary advantage, but dissolves as soon as the enemy has been defeated and the scramble for the booty sets in. In fighting against the less developed societies the more developed ones have always found that their greatest advantage lay in the lack of unity in the enemy’s ranks. Only temporarily do the nations in a lower state of organization manage to co-operate for great military enterprises. Internal disunity has always dispersed their armies quickly. Take for example the Mongol raids on the Central European civilization of the thirteenth century or the efforts of the Turks to penetrate into the West. The superiority of the industrial over the military type of society, to use Herbert Spencer’s expression, consists largely in the fact that associations which are merely military always fall to pieces through internal disunity.The romantic-militarist notion of the military superiority of the nations which have made little progress in Capitalism, completely refuted afresh by the World War, arises from the view that what tells in a fight is man’s physical strength alone. This, however, is not completely true, even of the fights of the Homeric Age. Not physical but mental power decides a fight. On these mental powers depend the fighters’ tactics and the way he is armed. The A B C of the art of warfare is to have the superiority at the decisive moment, though otherwise one may be numerically weaker than the enemy. The A B C of the preparation for war is to set up armies as strong as possible and to provide them with all war materials in the best way. One has to stress this only because people are again endeavouring to obscure these connections, by trying to differentiate between the military and economic-political causes of victory and defeat in war. It always has been and always will be the fact, that victory or defeat is decided by the whole social position of the combatants before their armies meet in battle.
But there is another circumstance which advances further social development. It has been shown that it is to the interest of all members of society that the social range should be extended. For a highly developed social organism it is by no means a matter of indifference whether or not nations outside its range continue to lead a self-sufficient existence on a lower plane of social evolution. It is to the interest of the more advanced organism to draw the less advanced into the area of its economic and social community, even though its persistence in remaining on a lower plane makes it politically and militarily innocuous, and even though no immediate advantages are likely to accrue from the occupation of its territory, in which, presumably, the natural conditions of production are unfavourable. We have seen that it is always an advantage to widen the range of workers in a society that divides labour, so that even a more efficient people may have an interest in co-operating with a less efficient. This is what so often drives nations of a high social development to expand their field of economic activity by absorbing hitherto inaccessible territories. The opening up of the backward regions of the Near and Far East, of Africa and America, cleared the way for a world-wide economic community, so that shortly before the World War we were in sight of realizing the dream of an œcumenical society. Has the war merely interrupted this development for a brief period or has it utterly destroyed it? Is it conceivable that this development can cease, that society can even retrogress?
This problem cannot be approached except in connection with another: the problem of the death of nations. It is customary to talk of nations aging and dying, of young and old communities. The comparison is lame — as are all comparisons — and in discussing such things we are well advised to discard metaphorical phrases. What is the core of the problem that here presents itself?
It is clear that we must not confuse it with another not less difficult problem, the problem of the changes of the national quality. A thousand or fifteen hundred years ago the Germans spoke a different language from that of today, but we should not think of saying, on that account, that German medieval culture was “dead.” On the contrary we see in the German culture an uninterrupted evolutionary chain, stretching (without mentioning lost monuments of literature) from the “Heliand,” and Otfried’s Gospels to the present day. We do indeed say of the Pomeranians and Prussians, who in the course of centuries have been assimilated by the German colonists, that they have died out, yet we shall hardly maintain that as nations they grew “old.” To carry through the simile one would have to talk of nations that had died young. We are not concerned with national transformation; our problem is different. Neither does the decay of states come into the question, for this phenomenon sometimes appears as a sequence to the aging nations and sometimes independently of it. The fall of the ancient state of Poland had nothing to do with any decay of Polish civilization or of the Polish people. It did not stop the social development of Poland.
The facts which are present in practically all the examples brought forward of the aging of a culture are: a decline in population, a diminution of welfare, and the decay of the towns. The historical significance of all these phenomena becomes clear as soon as we conceive of the aging of nations as the retrogression of the social division of labour and of society. The decline of the ancient world for instance, was a social retrogression. The decline of the Roman Empire was only a result of the disintegration of ancient society which after reaching a high level of division of labour sank back into an almost moneyless economy. Thus towns were depopulated and thus, also, did the population of the countryside diminish and want and misery set in simply because an economic order working on a lower level in respect of the social division of labour is less productive. Technical skill was gradually lost, artistic talent decayed, scientific thought was slowly extinguished. The word which most aptly describes this process is disintegration. The Classical culture died because Classical society retrogressed.On the decline of Ancient Greek Civilization see [Vilfredo] Pareto, Les Systèmes Socialistes (Paris, 1902), vol. 1, pp. 155 ff.
The death of nations is the retrogression of the social relation, the retrogression of the division of labour. Whatever may have been the cause in individual cases, it has always been the cessation of the disposition to social co-operation which actually effected the decline. This may once have seemed an incomprehensible riddle to us, but now that we watch with terror the process at work in our own experience we come nearer to understanding it, though we still fail to recognize the deepest, most ultimate causes of the change.
It is the social spirit, the spirit of social co-operation, which forms, develops, and upholds societies. Once it is lost, the society falls apart again. The death of a nation is social retrogression, the decline from the division of labour to self-sufficiency. The social organism disintegrates into the cells from which it began. Man remains, but society dies.Izoulet, La Cité moderne, pp. 488 ff.
There is no evidence that social evolution must move steadily upwards in a straight line. Social standstill and social retrogression are historical facts which we cannot ignore. World history is the graveyard of dead civilizations, and in India and Eastern Asia we see large-scale examples of civilization at a standstill.
Our literary and artistic cliques whose exaggerated opinion of their own trifling productions contrast so vividly with the modesty and self-criticism of the really great artists, say that it does not matter much whether economic evolution continues so long as inner culture is intensified. But all inner culture requires external means for its realization, and these external means can be attained only by economic effort. When the productivity of labour decays through the retrogression of social co-operation the decay of inner culture follows.
All the older civilizations were born and grew up without being fully conscious of the basic laws of cultural evolution and the significance of division of labour and co-operation. In the course of their development they had often to combat tendencies and movements inimical to civilization. Often they triumphed over these, but sooner or later they fell. They succumbed to the spirit of disintegration. Through the social philosophy of Liberalism men became conscious of the laws of social evolution for the first time, and for the first time clearly recognized the basis of civilization and cultural progress. Those were days when hopes for the future ran high. Unimagined vistas seemed to be opening up. But it was not to be. Liberalism had to meet the opposition of militaristic-nationalist and, above all, of socialist-communist doctrines which tended to bring about social dissolution. The nationalist theory calls itself organic, the socialist theory calls itself social, but in reality both are disorganizing and anti-social in their effect.
Of all accusations against the system of Free Trade and Private Property, none is more foolish than the statement that it is anti-social and individualistic and that it atomizes the body social. Trade does not disintegrate, as romantic enthusiasts for the autarky of small portions of the earth’s surface assert; it unites. The division of labour is what first makes social ties: it is the social element pure and simple. Whoever advocates the economic self-sufficiency of nations and states, seeks to disintegrate the ecumenical society; whoever seeks to destroy the social division of labour within a nation by means of class war is anti-social.
A decline of the ecumenical society, which has been slowly forming itself during the last two hundred years under the influence of the gradual germination of the liberal idea, would be a world catastrophe absolutely without parallel in history as we know it. No nation would be spared. Who then would rebuild the shattered world?
- Private Property and Social EvolutionThe division of individuals into owners and non-owners is an outcome of the division of labour.
The second great sociological achievement of Classical Political Economy and the “individualistic” social theory of the eighteenth century was to recognize the social function of private property. From the older point of view property was always considered more or less a privilege of the Few, a raid upon the common stock, an institution regarded ethically as an evil, if sometimes as an inevitable one. Liberalism was the first to recognize that the social function of private ownership in the means of production is to put the goods into the hands of those who know best how to use them, into the hands, that is, of the most expert managers. Nothing therefore is more foreign to the essence of property than special privileges for special property and protection for special producers. Any kind of constraint such as exclusive rights and other privileges of producers, are apt to obstruct the working of the social function of property. Liberalism fights such institutions as vigorously as it opposes every attempt to limit the freedom of the worker.
The owner takes nothing away from anyone. No one can say that he goes short because of another’s abundance. It is flattering the envious instincts of the masses to give them a calculation of how much more the poor man would have to dispose of, if property were equally distributed. What is overlooked is the fact that the volume of production and of the social income are not fixed and unchangeable but depend essentially upon the distribution of property. If this is interfered with, there is danger that property may fall into the hands of those not so competent to maintain it, those whose foresight is less, whose disposal of their means is less productive; this would necessarily reduce the amount produced.“The laws, in creating property, have created wealth, but with respect to poverty, it is not the work of the laws — it is the primitive condition of the human race. The man who lives only from day to day, is precisely the man in a state of nature. ... The laws, in creating property, have been benefactors to those who remain in the original poverty. They participate more or less in the pleasures, advantages and resources of civilized society,” [Jeremy] Bentham, Principles of the Civil Code, ed. Bowring (Edinburgh, 1843), vol. 1, p. 309. The ideas of distributive Communism are atavistic, harking back to the times before social relations existed or reached their present stage of development, when the yield of production was correspondingly much lower. The landless man of an economic order based on production without exchange is quite logical in making the redistribution of fields the goal of his ambition. But the modern proletarian misunderstands the nature of social production when he hankers after a similar redistribution.
Liberalism combats the socialist ideal of transferring the means of production to the hands of organized society with the argument that socialist production would give a lower yield. Against this the Socialism of the Hegelian school seeks to prove that the evolution of history leads inevitably to the abolition of private ownership in the means of production.
It was the view of Lassalle that “the course of all legal history consists, generally speaking, in an ever greater limitation of the property of the individual, and in placing more and more objects outside private ownership.” The tendency to enlarge the freedom of property which is read into historical evolution is only apparent. However much the “idea of the increasingly rapid reduction of the sphere of private property as a principle working in the cultural and historical development of law could be held to be paradoxical,” yet, according to Lassalle it survived the most detailed examination. Unfortunately Lassalle produced no details of the examination of this idea. According to his own words he “honoured it (the idea) with a few very superficial glances instead.”[Ferdinand] Lassalle, Das System der erworbenen Rechte, 2nd ed. (Leipzig, 1880), Vol. 1, pp. 217 ff. Neither has anyone since Lassalle’s time undertaken to provide a proof. But even if the attempt had been made, this fact would by no means have demonstrated the necessity of the development in question. The conceptual constructions of speculative jurisprudence steeped in the Hegelian spirit serve at best to exhibit historical tendencies of evolution in the past. That the evolutionary tendency thus discovered must necessarily continue to develop is a thoroughly arbitrary assumption. Only if it could be shown that the force behind evolution was still active would the hypothetical proof which is needed be adduced. The Hegelian Lassalle did nothing of the kind. For him, the matter is disposed of when he realizes “that this progressive reduction of the sphere of private property is based on nothing else than the positive development of human liberty.”Ibid., pp. 222 ff. Having fitted his law of evolution into the great Hegelian scheme of historical evolution, he had done all that his school could ask.
Marx saw the faults in the Hegelian scheme of evolution. He too holds it to be an indisputable truth that the course of history leads from private property to common property. But unlike Hegel and Lassalle he does not deal with the idea of property and the juristic concept of property. Private property “in its political-economic tendencies” is drifting towards its dissolution, “but only by a development independent of it, of which it is unconscious, which is taking place against its will, and is conditioned by the nature of the question; only by creating the proletariat qua proletariat, the misery that is conscious of its spiritual and physical misery, the dehumanization that is conscious of its dehumanization.”[Karl] Marx, Die heilige Familie. Aus dem literarischen Nachlass yon Karl Marx, Friedrich Engels und Ferdinand Lassalle, ed. Mehring (Stuttgart, 1902), vol. 2, p. 132. Thus the doctrine of the class struggle is introduced as the driving element of historical evolution.
Human Action[Mises, Human Action, Part Two: Action Within the Framework of Society, chap. 8: “Human Society,” pp. 143–45, 157–65.]1. Human CooperationSociety is concerted action, cooperation.
Society is the outcome of conscious and purposeful behavior. This does not mean that individuals have concluded contracts by virtue of which they have founded human society. The actions which have brought about social cooperation and daily bring it about anew do not aim at anything else than cooperation and coadjuvancy with others for the attainment of definite singular ends. The total complex of the mutual relations created by such concerted actions is called society. It substitutes collaboration for the — at least conceivable — isolated life of individuals. Society is division of labor and combination of labor. In his capacity as an acting animal man becomes a social animal.
Individual man is born into a socially organized environment. In this sense alone we may accept the saying that society is — logically or historically — antecedent to the individual. In every other sense this dictum is either empty or nonsensical. The individual lives and acts within society. But society is nothing but the combination of individuals for cooperative effort. It exists nowhere else than in the actions of individual men. It is a delusion to search for it outside the actions of individuals. To speak of a society’s autonomous and independent existence, of its life, its soul, and its actions is a metaphor which can easily lead to crass errors.
The questions whether society or the individual is to be considered as the ultimate end, and whether the interests of society should be subordinated to those of the individuals or the interests of the individuals to those of society are fruitless. Action is always action of individual men. The social or societal element is a certain orientation of the actions of individual men. The category end makes sense only when applied to action. Theology and the metaphysics of history may discuss the ends of society and the designs which God wants to realize with regard to society in the same way in which they discuss the purpose of all other parts of the created universe. For science, which is inseparable from reason, a tool manifestly unfit for the treatment of such problems, it would be hopeless to embark upon speculations concerning these matters.
Within the frame of social cooperation there can emerge between members of society feelings of sympathy and friendship and a sense of belonging together. These feelings are the source of man’s most delightful and most sublime experiences. They are the most precious adornment of life; they lift the animal species man to the heights of a really human existence. However, they are not, as some have asserted, the agents that have brought about social relationships. They are fruits of social cooperation, they thrive only within its frame; they did not precede the establishment of social relations and are not the seed from which they spring.
The fundamental facts that brought about cooperation, society, and civilization and transformed the animal man into a human being are the facts that work performed under the division of labor is more productive than isolated work and that man’s reason is capable of recognizing this truth. But for these facts men would have forever remained deadly foes of one another, irreconcilable rivals in their endeavors to secure a portion of the scarce supply of means of sustenance provided by nature. Each man would have been forced to view all other men as his enemies; his craving for the satisfaction of his own appetites would have brought him into an implacable conflict with all his neighbors. No sympathy could possibly develop under such a state of affairs.
Some sociologists have asserted that the original and elementary subjective fact in society is a “consciousness of kind.”F.H. Giddings, The Principles of Sociology (New York, 1926), p. 17. Others maintain that there would be no social systems if there were no “sense of community or of belonging together.”F.M. MacIver, Society (New York, 1937), pp. 6–7. One may agree, provided that these somewhat vague and ambiguous terms are correctly interpreted. We may call consciousness of kind, sense of community, or sense of belonging together the acknowledgment of the fact that all other human beings are potential collaborators in the struggle for survival because they are capable of recognizing the mutual benefits of cooperation, while the animals lack this faculty. However, we must not forget that the primary facts that bring about such consciousness or such a sense are the two mentioned above. In a hypothetical world in which the division of labor would not increase productivity, there would not be any society. There would not be any sentiments of benevolence and good will.
The principle of the division of labor is one of the great basic principles of cosmic becoming and evolutionary change. The biologists were right in borrowing the concept of the division of labor from social philosophy and in adapting it to their field of investigation. There is division of labor between the various parts of any living organism. There are, furthermore, organic entities composed of collaborating animal individuals; it is customary to call metaphorically such aggregations of the ants and bees “animal societies.” But one must never forget that the characteristic feature of human society is purposeful cooperation; society is an outcome of human action, i.e., of a conscious aiming at the attainment of ends. No such element is present, as far as we can ascertain, in the processes which have resulted in the emergence of the structure-function systems of plant and animal bodies and in the operation of the societies of ants, bees, and hornets. Human society is an intellectual and spiritual phenomenon. It is the outcome of a purposeful utilization of a universal law determining cosmic becoming, viz., the higher productivity of the division of labor. As with every instance of action, the recognition of the laws of nature is put into the service of man’s efforts to improve his conditions. ...
- The Division of LaborThe fundamental social phenomenon is the division of labor and its counterpart human cooperation.
Experience teaches man that cooperative action is more efficient and productive than isolated action of self-sufficient individuals. The natural conditions determining man’s life and effort are such that the division of labor increases output per unit of labor expended. These natural facts are:
First: the innate inequality of men with regard to their ability to perform various kinds of labor. Second: the unequal distribution of the nature-given, nonhuman opportunities of production on the surface of the earth. One may as well consider these two facts as one and the same fact, namely, the manifoldness of nature which makes the universe a complex of infinite varieties. If the earth’s surface were such that the physical conditions of production were the same at every point and if one man were as equal to all other men as is a circle to another with the same diameter in Euclidian geometry, division of labor would not offer any advantages for acting man.
There is still a third fact, viz., that there are undertakings whose accomplishment exceeds the forces of a single man and requires the joint effort of several. Some of them require an expenditure of labor which no single man can perform because his capacity to work is not great enough. Others again could be accomplished by individuals; but the time which they would have to devote to the work would be so long that the result would only be attained late and would not compensate for the labor expended. In both cases only joint effort makes it possible to attain the end sought.
If only this third condition were present, temporary cooperation between men would have certainly emerged. However, such transient alliances to cope with specific tasks which are beyond the strength of an individual would not have brought about lasting social cooperation. Undertakings which could be performed only in this way were not very numerous at the early stages of civilization. Moreover, all those concerned may not often agree that the performance in question is more useful and urgent than the accomplishment of other tasks which they could perform alone. The great human society enclosing all men in all of their activities did not originate from such occasional alliances. Society is much more than a passing alliance concluded for a definite purpose and ceasing as soon as its objective is realized, even if the partners are ready to renew it should an occasion present itself.
The increase in productivity brought about by the division of labor is obvious whenever the inequality of the participants is such that every individual or every piece of land is superior at least in one regard to the other individuals or pieces of land concerned. If A is fit to produce in 1 unit of time 6 p or 4 q and B only 2 p, but 8 q, they both, when working in isolation, will produce together 4 p + 6 q; when working under the division of labor, each of them producing only that commodity in whose production he is more efficient than his partner, they will produce 6 p + 8 q. But what will happen, if A is more efficient than B not only in the production of p but also in the production of q?
This is the problem which Ricardo raised and solved immediately.
- The Ricardian Law of AssociationRicardo expounded the law of association in order to demonstrate what the consequences of the division of labor are when an individual or a group, more efficient in every regard, cooperates with an individual or a group less efficient in every regard. He investigated the effects of trade between two areas, unequally endowed by nature, under the assumption that the products, but not the workers and the accumulated factors of future production (capital goods), can freely move from each area into the other. The division of labor between two such areas will, as Ricardo’s law shows, increase the productivity of labor and is therefore advantageous to all concerned, even if the physical conditions of production for any commodity are more favorable in one of these two areas than in the other. It is advantageous for the better endowed area to concentrate its efforts upon the production of those commodities for which its superiority is greater, and to leave to the less endowed area the production of other goods in which its own superiority is less. The paradox that it is more advantageous to leave more favorable domestic conditions of production unused and to procure the commodities they could produce from areas in which conditions for their production are less favorable, is the outcome of the immobility of labor and capital, to which the more favorable places of production are inaccessible.
Ricardo was fully aware of the fact that his law of comparative cost, which he expounded mainly in order to deal with a special problem of international trade, is a particular instance of the more universal law of association.
If A is in such a way more efficient than B that he needs for the production of 1 unit of the commodity p 3 hours compared with B’s 5, and for the production of 1 unit of q 2 hours compared with B’s 4, then both will gain if A confines himself to producing q and leaves B to produce p. If each of them gives 60 hours to producing p and 60 hours to producing q, the result of A’s labor is 20 p + 30 q; of B’s, 12 p +15 q; and for both together, 32 p + 45 q. If, however, A confines himself to producing q alone, he produces 60 q in 120 hours, while B, if he confines himself to producing p, produces in the same time 24 p. The result of their activities is then 24 p + 60 q, which, as p has for A a substitution ratio of 3/2 q and for B one of 5/4 q,signifies a larger output than 32 p + 45 q. Therefore it is manifest that the division of labor brings advantages to all who take part in it. Collaboration of the more talented, more able, and more industrious with the less talented, less able, and less industrious results in benefit for both. The gains derived from the division of labor are always mutual.
The law of association makes us comprehend the tendencies which resulted in the progressive intensification of human cooperation. We conceive what incentive induced people not to consider themselves simply as rivals in a struggle for the appropriation of the limited supply of means of subsistence made available by nature. We realize what has impelled them and permanently impels them to consort with one another for the sake of cooperation. Every step forward on the way to a more developed mode of the division of labor serves the interests of all participants. In order to comprehend why man did not remain solitary, searching like the animals for food and shelter for himself only and at most also for his consort and his helpless infants, we do not need to have recourse to a miraculous interference of the Deity or to the empty hypostasis of an innate urge toward association. Neither are we forced to assume that the isolated individuals or primitive hordes one day pledged themselves by a contract to establish social bonds. The factor that brought about primitive society and daily works toward its progressive intensification is human action that is animated by the insight into the higher productivity of labor achieved under the division of labor.
Neither history nor ethnology nor any other branch of knowledge can provide a description of the evolution which has led from the packs and flocks of mankind’s nonhuman ancestors to the primitive, yet already highly differentiated, societal groups about which information is provided in excavations, in the most ancient documents of history, and in the reports of explorers and travelers who have met savage tribes. The task with which science is faced in respect of the origins of society can only consist in the demonstration of those factors which can and must result in association and its progressive intensification. Praxeology solves the problem. If and as far as labor under the division of labor is more productive than isolated labor, and if and as far as man is able to realize this fact, human action itself tends toward cooperation and association; man becomes a social being not in sacrificing his own concerns for the sake of a mythical Moloch, society, but in aiming at an improvement in his own welfare. Experience teaches that this condition — higher productivity achieved under the division of labor — is present because its cause — the inborn inequality of men and the inequality in the geographical distribution of the natural factors of production — is real. Thus we are in a position to comprehend the course of social evolution.
Current Errors Concerning the Law of AssociationPeople cavil much about Ricardo’s law of association, better known under the name law of comparative cost. The reason is obvious. This law is an offense to all those eager to justify protection and national economic isolation from any point of view other than the selfish interests of some producers or the issues of war-preparedness.
Ricardo’s first aim in expounding this law was to refute an objection raised against freedom of international trade. The protectionist asks: What under free trade will be the fate of a country in which the conditions for any kind of production are less favorable than in all other countries? Now, in a world in which there is free mobility not only for products, but no less for capital goods and for labor, a country so little suited for production would cease to be used as the seat of any human industry. If people fare better without exploiting the — comparatively unsatisfactory — physical conditions of production offered by this country, they will not settle here and will leave it as uninhabited as the polar regions, the tundras and the deserts. But Ricardo deals with a world whose conditions are determined by settlement in earlier days, a world in which capital goods and labor are bound to the soil by definite institutions. In such a milieu free trade, i.e., the free mobility of commodities only, cannot bring about a state of affairs in which capital and labor are distributed on the surface of the earth according to the better or poorer physical opportunities afforded to the productivity of labor. Here the law of comparative cost comes into operation. Each country turns toward those branches of production for which its conditions offer comparatively, although not absolutely, the most favorable opportunities. For the inhabitants of a country it is more advantageous to abstain from the exploitation of some opportunities which — absolutely and technologically — are more propitious and to import commodities produced abroad under conditions which — absolutely and technologically — are less favorable than the unused domestic resources. The case is analogous to that of a surgeon who finds it convenient to employ for the cleaning of the operating-room and the instruments a man whom he excels in this performance also and to devote himself exclusively to surgery, in which his superiority is higher.
The theorem of comparative cost is in no way connected with the value theory of classical economics. It does not deal with value or with prices. It is an analytic judgment; the conclusion is implied in the two propositions that the technically movable factors of production differ with regard to their productivity in various places and are institutionally restricted in their mobility. The theorem, without prejudice to the correctness of its conclusions, can disregard problems of valuation because it is free to resort to a set of simple assumptions. These are: that only two products are to be produced; that these products are freely movable; that for the production of each of them two factors are required; that one of these factors (it may be either labor or capital goods) is identical in the production of both, while the other factor (a specific property of the soil) is different for each of the two processes; that the greater scarcity of the factor common to both processes determines the extent of the exploitation of the different factor. In the frame of these assumptions, which make it possible to establish substitution ratios between the expenditure of the common factor and the output, the theorem answers the question raised.
The law of comparative cost is as independent of the classical theory of value as is the law of returns, which its reasoning resembles. In both cases we can content ourselves with comparing only physical input and physical output. With the law of returns we compare the output of the same product. With the law of comparative costs we compare the output of two different products. Such a comparison is feasible because we assume that for the production of each of them, apart from one specific factor, only nonspecific factors of the same kind are required.
Some critics blame the law of comparative cost for this simplification of assumptions. They believe that the modern theory of value would require a reformulation of the law in conformity with the principles of subjective value. Only such a formulation could provide a satisfactory conclusive demonstration. However, they do not want to calculate in terms of money. They prefer to resort to those methods of utility analysis which they consider a means for making value calculations in terms of utility. It will be shown in the further progress of our investigation that these attempts to eliminate monetary terms from economic calculation are delusive. Their fundamental assumptions are untenable and contradictory and all formulas derived from them are vicious. No method of economic calculation is possible other than one based on money prices as determined by the market.
The meaning of the simple assumptions underlying the law of comparative cost is not precisely the same for the modern economists as it was for the classical economists. Some adherents of the classical school considered them as the starting point of a theory of value in international trade. We know now that they were mistaken in this belief. Besides, we realize that with regard to the determination of value and of prices there is no difference between domestic and foreign trade. What makes people distinguish between the home market and markets abroad is only a difference in the data, i.e., varying institutional conditions restricting the mobility of factors of production and of products.
If we do not want to deal with the law of comparative cost under the simplified assumptions applied by Ricardo, we must openly employ money calculation. We must not fall prey to the illusion that a comparison between the expenditure of factors of production of various kinds and of the output of products of various kinds can be achieved without the aid of money calculation. If we consider the case of the surgeon and his handyman we must say: If the surgeon can employ his limited working time for the performance of operations for which he is compensated at $50 per hour, it is to his interest to employ a handyman to keep his instruments in good order and to pay him $2 per hour, although this man needs 3 hours to accomplish what the surgeon could do in 1 hour. In comparing the conditions of two countries we must say: If conditions are such that in England the production of 1 unit of each of the two commodities a and b requires the expenditure of 1 working day of the same kind of labor, while in India with the same investment of capital for a 2 days and for b 3 days are required, and if capital goods and a and b are freely movable from England to India and vice versa, while there is no mobility of labor, wage rates in India in the production of a must tend to be 50 percent, and in the production of b 33 1/3 per cent, of the English rates. If the English rate is 6 shillings, the rates in India would be the equivalent of 3 shillings in the production of a and the equivalent of 2 shillings in the production of b. Such a discrepancy in the remuneration of labor of the same kind cannot last if there is mobility of labor on the domestic Indian labor market. Workers would shift from the production of b into the production of a; their migration would tend to lower the remuneration in the a industry and to raise it in the b industry. Finally Indian wage rates would be equal in both industries. The production of a would tend to expand and to supplant English competition. On the other hand the production of b would become unprofitable in India and would have to be discontinued, while it would expand in England. The same reasoning is valid if we assume that the difference in the conditions of production consists also or exclusively in the amount of capital investment needed.
It has been asserted that Ricardo’s law was valid only for his age and is of no avail for our time which offers other conditions. Ricardo saw the difference between domestic trade and foreign trade in differences in the mobility of capital and labor. If one assumes that capital, labor, and products are movable, then there exists a difference between regional and interregional trade only as far as the cost of transportation comes into play. Then it is superfluous to develop a theory of international trade as distinguished from national trade. Capital and labor are distributed on the earth’s surface according to the better or poorer conditions which the various regions offer to production. There are areas more densely populated and better equipped with capital, there are others less densely populated and poorer in capital supply. There prevails on the whole earth a tendency toward an equalization of wage rates for the same kind of labor.
Ricardo, however, starts from the assumption that there is mobility of capital and labor only within each country, and not between the various countries. He raises the question what the consequences of the free mobility of products must be under such conditions. (If there is no mobility of products either, then every country is economically isolated and autarkic, and there is no international trade at all.) The theory of comparative cost answers this question. Now, Ricardo’s assumptions by and large held good for his age. Later, in the course of the nineteenth century, conditions changed. The immobility of capital and labor gave way; international transfer of capital and labor became more and more common. Then came a reaction. Today capital and labor are again restricted in their mobility. Reality again corresponds to the Ricardian assumptions.
However, the teachings of the classical theory of interregional trade are above any change in institutional conditions. They enable us to study the problems involved under any imaginable assumptions.
- The Effects of the Division of LaborThe division of labor is the outcome of man’s conscious reaction to the multiplicity of natural conditions. On the other hand it is itself a factor bringing about differentiation. It assigns to the various geographic areas specific functions in the complex of the processes of production. It makes some areas urban, others rural; it locates the various branches of manufacturing, mining, and agriculture in different places. Still more important, however, is the fact that it intensifies the innate inequality of men. Exercise and practice of specific tasks adjust individuals better to the requirements of their performance; men develop some of their inborn faculties and stunt the development of others. Vocational types emerge, people become specialists.
The division of labor splits the various processes of production into minute tasks, many of which can be performed by mechanical devices. It is this fact that made the use of machinery possible and brought about the amazing improvements in technical methods of production. Mechanization is the fruit of the division of labor, its most beneficial achievement, not its motive and fountain spring. Power-driven specialized machinery could be employed only in a social environment under the division of labor. Every step forward on the road toward the use of more specialized, more refined, and more productive machines requires a further specialization of tasks.
- The Individual Within SocietyIf praxeology speaks of the solitary individual, acting on his own behalf only and independent of fellow men, it does so for the sake of a better comprehension of the problems of social cooperation. We do not assert that such isolated autarkic human beings have ever lived and that the social stage of man’s history was preceded by an age of independent individuals roaming like animals in search of feed. The biological humanization of man’s nonhuman ancestors and the emergence of the primitive social bonds were effected in the same process. Man appeared on the scene of earthly events as a social being. The isolated asocial man is a fictitious construction.
Seen from the point of view of the individual, society is the great means for the attainment of all his ends. The preservation of society is an essential condition of any plans an individual may want to realize by any action whatever. Even the refractory delinquent who fails to adjust his conduct to the requirements of life within the societal system of cooperation does not want to miss any of the advantages derived from the division of labor. He does not consciously aim at the destruction of society. He wants to lay his hands on a greater portion of the jointly produced wealth than the social order assigns to him. He would feel miserable if antisocial behavior were to become universal and its inevitable outcome, the return to primitive indigence, resulted.
It is illusory to maintain that individuals in renouncing the alleged blessings of a fabulous state of nature and entering into society have foregone some advantages and have a fair claim to be indemnified for what they have lost. The idea that anybody would have fared better under an asocial state of mankind and is wronged by the very existence of society is absurd. Thanks to the higher productivity of social cooperation the human species has multiplied far beyond the margin of subsistence offered by the conditions prevailing in ages with a rudimentary degree of the division of labor. Each man enjoys a standard of living much higher than that of his savage ancestors. The natural condition of man is extreme poverty and insecurity. It is romantic nonsense to lament the passing of the happy days of primitive barbarism. In a state of savagery the complainants would either not have reached the age of manhood, or if they had, they would have lacked the opportunities and amenities provided by civilization. Jean Jacques Rousseau and Frederick Engels, if they had lived in the primitive state which they describe with nostalgic yearning, would not have enjoyed the leisure required for their studies and for the writing of their books.
One of the privileges which society affords to the individual is the privilege of living in spite of sickness or physical disability. Sick animals are doomed. Their weakness handicaps them in their attempts to find food and to repel aggression on the part of other animals. Deaf, nearsighted, or crippled savages must perish. But such defects do not deprive a man of the opportunity to adjust himself to life in society. The majority of our contemporaries are afflicted with some bodily deficiencies which biology considers pathological. Our civilization is to a great extent the achievement of such men. The eliminative forces of natural selection are greatly reduced under social conditions. Hence some people say that civilization tends to deteriorate the hereditary qualities of the members of society.
Such judgments are reasonable if one looks at mankind with the eyes of a breeder intent upon raising a race of men equipped with certain qualities. But society is not a stud-farm operated for the production of a definite type of men. There is no “natural” standard to establish what is desirable and what is undesirable in the biological evolution of man. Any standard chosen is arbitrary, purely subjective, in short a judgment of value. The terms racial improvement and racial degeneration are meaningless when not based on definite plans for the future of mankind.
It is true, civilized man is adjusted to life in society and not to that of a hunter in virgin forests.
Selected Writings of Ludwig von Mises[In Selected Writings of Ludwig von Mises, vol. 3: The Political Economy of International Reform and Reconstruction, ed. Richard M. Ebeling (1946; Indianapolis, Ind.: Liberty Fund, 2000), pp. 119–32.]“The Main Issues in Present-Day Monetary Controversies”Introductory Remarks
This is not a systematic presentation of the problems of money and credit. Neither is it a complete exposition of the theories and doctrines dealt with. The aim of this paper is merely to enumerate certain topics that should not be neglected in a discussion of money and credit.
I. The Purchasing Power ControversyA. Is Money “Neutral”?
The older economists believed that — other things being equal — changes in the supply or demand of money make all commodity prices and wage rates simultaneously rise or fall in exact proportion to these changes. The price “level” changes, but the relations among the prices of individual commodities and services remain the same. Those mathematical economists whose theorizing culminates in the formulation of an equation of exchange still maintain this thesis.
Modern economic analysis rejects this assumption. The changes in the supply or demand of money do not affect all individuals at the same time and to the same extent. In the case of inflation, for instance, the additional quantity of money does not find its way at first into the pockets of all individuals, nor does every individual of those benefited first with the increase in the quantity of money get the same amount; and not every individual reacts to the same additional quantity in the same way. Consequently, the prices of various commodities and services rise neither at the same time nor to the same extent. The nonsimultaneous appearance and unevenness of the price changes brought about by increases in the quantity of money results in a shift of income and wealth from some groups of the population to other groups. Monetary fluctuations are not neutral, even apart from their repercussions on all contracts stipulating some form of deferred payments. Monetary changes are a source of economic and social change.
B. Are Changes in the Purchasing Power of Money Measurable?
Even if we were prepared to leave out consideration of the nonsimultaneous appearance and unevenness of the price changes brought about by changes in the supply of or demand for money, we must realize that the index-number method does not provide a faithful criterion for the measurement of changes in the purchasing power of the monetary unit. Economic conditions are not rigid; they are — also apart from any changes occurring in monetary matters — continuously changing. New commodities appear, old commodities disappear. The quality of the various commodities is subject to change. Tastes, wants, and desires are changing and with them the valuation of the various goods offered on the market. A motorcar of 1920 and a motorcar of 1940 are entirely different things. Twenty-five years ago, where were vitamins, refrigerators, and talking pictures? How different is the role played today in the average American household by canned food, rayon, and radio sets? How much do clothes and shoes change from one year to the next? Even standard foods like milk, butter, meat, and vegetables have in the last decades improved in quality to such an extent that it is impermissible to take them as equivalent with those marketed in the past. A method which tacitly assumes that nothing else had changed in the economic system than the available quantity of money is utterly illusory. The chairman of our committee has provided us with the results of an investigation undertaken in his corporation. According to this information, only a fraction of the products manufactured today are of the same kind as the goods manufactured a few years ago. This is a typical case, more or less representative for all American processing industries.
Besides, mathematics provides us with various methods for the computation of averages from a given set of figures. Each of these methods has, with regard to the problem in question, some merits and some defects. Each of them yields different results. As it is impossible to declare one of these methods as the only adequate one and to discard all the others as manifestly unsuitable, it is obvious that the index-number approach does not provide an indisputable and uncontested solution that could command general acceptance.
C. Is It Possible to Adjust Monetary Manipulation to a Nonarbitrary Standard?
The advocates of a manipulated currency pretend to aim at the stability of the monetary unit’s purchasing power. They fail, however, to realize that in a changing economic world, the concept of a stable purchasing power is devoid of any real meaning.
There are three main objections to be raised against the proposals for a manipulated currency.
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The various methods suggested for a measurement of changes in the monetary unit’s purchasing power are arbitrary. Their results are contested by all those whose material interests would be hurt if they were to be used as a basis of monetary manipulation. In advocating the application of a certain index-number system, the results of which happen at the moment to provide a quasi-scientific justification of their particular interests, every pressure group and political party will always be in a position to cite the doctrine of some economists and statisticians. On the other hand, their adversaries will quote dissenting opinions of no less renowned experts. There is no means to free a tabular standard from the faults of purely arbitrary and party-ridden bias.
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It is impossible to know beforehand to what extent and at what date a definite amount of inflation or deflation (an increase or a reduction in the quantity of money and credit) will increase or reduce the prices of various commodities and services.
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Apart from other deficiencies, the proposals for stabilization are faulty because they are based on the idea of money’s neutrality. They all suggest methods to undo changes in the purchasing power of money that have already had their effects. If there has been an inflation, they wish to deflate to the same extent and vice versa. They do not realize that by this procedure, they do not undo the social consequences of monetary changes (that is, the shift of income and wealth from some groups to others), but simply add to them the social consequences of a new change. If a man has been hurt by being run over by an automobile, it is no remedy to let the car go back over him in the opposite direction.
D. The Case Against Flexible Foreign Exchange Parities
If the purchasing power of an individual country’s domestic currency changes, while the other countries’ currencies do not change at all or not to the same extent, foreign trade is affected. As a rule, foreign exchange rates are adjusted at an early stage of the inflationary or deflationary process to the new state of the domestic money supply, even while the prices of some commodities and services still lag behind and are not fully adjusted for a time. As long as the inflationary or deflationary changes have not exhausted all their effects on the structure of prices, the comparatively low or high state of some prices results — in the case of inflation — in encouraging exports and discouraging imports. From the viewpoint of mercantilist fallacies, a fall of the domestic monetary unit’s purchasing power is, therefore, considered as a very fortunate occurrence.
What really happens is this: The country exports more than it did before, and it gets, as compensation for these increased exports, a smaller amount of foreign products. Exports are, as it were, subsidized and imports penalized to the burden of the natives. The inflation is, by and large, tantamount to a tax imposed upon the domestic consumers in order to cheapen the consumption of domestic products by foreigners.
Nowadays, currency devaluation is mostly advocated as a remedy against the rigidity of wage rates. People are afraid of fighting openly the inappropriate policies of labor unions. They resort to an indirect attack. They hope that currency devaluation will, notwithstanding the rise of domestic commodity prices, not raise money wage rates and thus reduce real wage rates. Lord Keynes believes that “a gradual and automatic lowering or real wages as a result of rising prices” would not be “strongly resisted” by labor. He does not see that wage rates are rigid only on the downside, not on the upside, too.
E. The Case for the Gold Standard
The gold standard is not perfect. No human institution is.
The main argument in favor of the gold standard is that it renders the formation of the monetary unit’s purchasing power independent of arbitrary action on the part of governments, political parties, and pressure groups. It places a check upon inflationary policies, and is the only standard which can possibly become an international, a world standard.
II. The Credit ControversyA. The Banking Principle
Some economists of the “Banking School” ventured to deny flatly that changes in the quantity of money available can affect prices and interest rates. They introduced into their reasoning the idea of monetary “hoards” as a deus ex machina. The amount of money kept in these mythical hoards changes in such a way as to neutralize automatically changes in the quantity of money. A surplus of money is swallowed by these hoards; a deficiency of money is made good by a restriction of the amount hoarded. This fable has long since been abandoned.
The bulk of the older Banking School economists and all contemporary representatives of this school do not deny that an increase in the quantity of money (metallic money, government paper money, irredeemable bank notes, and deposit currency) must — other things being equal — result in a general rise of prices. The core of their teachings is: Short-term credits granted by commercial banks in the form of bank notes or deposits created for this purpose do not affect prices and interest rates, provided they do not exceed “the needs of trade.” Such loans provide the debtor with the funds required for the production and the marketing of goods. They are self-liquidating. If the purchased raw materials are made up and sold, or if the buyer of products settles his balance, the loan is paid off, and the bank notes or deposits disappear again. An actual need has brought them into existence. With the cessation of this need, they go off the stage. The amount of credit of this type which the market can absorb is determined by the volume of production and business activity. It is beyond the power of the banks to alter this volume. No credit expansion is to be feared if the banks strictly abide by the rule to limit their lending to satisfy the demand of producers or merchants for short-term credit.
The reasoning of the Banking School misses the essential problem. It is obvious that no credit expansion takes place if the banks keep the total amount of their lending at the same level. But if a new bank enters the field or if an existing bank embarks upon the granting of additional credit above the amount of its previous credits, credit expansion results.
It is not true that the volume of credit that the banks are in a position to grant, if strictly abiding by the aforementioned rules, is independent of the bank’s policy. The market is always in a position to absorb a surplus of credit supply. An increase in the supply of credit brings about a tendency toward a lowering of the rate of interest. With the lower rate of interest, many projects appear attractive that did not appear so with a higher rate. The lowering of the rate of interest encourages the expansion of precisely those business activities that — according to the banking doctrine — are viewed as proper instances for the granting of bank credit. Thus the credit expansion automatically increases the “needs of trade.” It stimulates business activities because it cheapens the exchange of future purchasing power for present purchasing power. While the supply of capital goods remained unaltered, there is now a greater demand for them on the part of business. Prices must, consequently, rise. A boom starts.
B. The Currency Principle
The “Currency School” intended to provide an explanation of the recurrence of economic crises. Its proponents first observed that the root cause of the depression is the preceding boom and substituted for the study of crises the study of the trade cycle.
Their reasoning ran this way: If the British banks expanded credit while conditions in the other countries remained unchanged, British prices would begin to rise, and these on the world market would lag behind them. Consequently, there would be an excess of British imports over exports. As the surplus of imported goods could not be paid for by shipping bank notes, the importers would have to export gold. Hence, gold would be withdrawn from the banks; their reserves would dwindle. This “external drain” would force upon the banks a restriction of their lending activities. The artificial boom would come to an end and give way to a depression.
The main fault of the Currency School was that it dealt with bank notes only and did not realize that deposits subject to check are only technically different from bank notes, while their economic significance is equal to that of bank notes. This failure vitiated the British Bank Act of 1844. But it is easy to rectify this error by a simple extension of the theory.
C. Austrian Theory of the Trade Cycle
Currency theory did not consider the problem of the consequences of credit expansion within an isolated country or of a synchronous credit expansion in all countries. It did not enter into a discussion of the way in which the market and the whole apparatus of production and distribution react to credit expansion. This task was accomplished by Austrian theory.
The rate of interest established on a market not hampered by credit expansion, says Austrian theory, separates those business projects that can be carried out under the existing state of the supply of capital goods and consumers’ preferences from those that cannot. With the lowering of the rate of interest brought about by credit expansion, the entrepreneurs embark upon projects for the realization of which the available amount of factors of production does not suffice.It is necessary to keep in mind that interest rates, in the course of a credit expansion, are — with the exception of the very beginning of the process — not always low when compared with the level which business used to consider as normal. But they are always low when measured by the standard that they would have to reach in a period of progressive inflation and its corollary, a general rise of prices, since they would have to include at such a time a compensation for the depreciation of the money unit going on in the period of the loan. They are deceived by the appearance of a nonexistent richness in the supply of material factors of production. They behave like a master builder who has overestimated the amount of building material available, has used up too much for the foundations and cannot complete his plan on account of a lack of material. Some of the new projects will never be finished; others, when finished, will be useless for lack of the plants producing the required complementary producers’ goods; others will not yield an adequate return on the capital invested.
It is true, the banks (or the governments) are in a position to prolong the boom for some time by injecting progressively increasing quantities of bank notes and deposits into the market. But the artificially created prosperity cannot last forever. Sooner or later it must come to an end. There are only two alternatives:
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The banks do not stop and go on expanding credit at a progressively accelerated pace. But the spell of inflation breaks once the public has the conviction that the banks and the authorities are resolved not to stop. If no limit of the inflation and, consequently, of the general rise of prices can be foreseen, a general Flucht in die Sachwerte starts. Everybody becomes aware of the fact that to hold cash and deposit balances with the banks involves loss, and that he does better to buy and store goods. Everybody is anxious to get rid of money and to exchange it for some other commodities, no matter how much he must pay for them. Prices are running away, and the purchasing power of the monetary unit drops to zero. The national currency system cracks up.
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As a rule, the banks do not let things go so far. They stop sooner by restricting credit. Then the day of reckoning dawns. The illusions disappear, people begin again to see reality as it is. The blunders committed in the boom become visible.
In every case, the slump is unavoidable. There is no means to make permanent a boom created by credit expansion and inflation.
The slump does not destroy values, but merely illusions. It does not make people poorer, it merely makes them aware of the impoverishment brought about by the malinvestment of the boom. It is not the depression that is an evil, but the preceding boom. The depression is the process of adjustment of economic conditions to the real market state-of-affairs. The fall in prices and wage rates is the preliminary step toward recovery and future real prosperity. He who wants to prevent the recurrence of economiccrises must prevent the resumption of credit expansion.
In short, credit expansion is doomed to failure at any rate. There is no means to substitute fictitious capital created by monetary and credit manipulation for nonexisting capital goods. The only method to increase a nation’s wealth and income is to save and to accumulate more real capital goods.
The rate of interest is a market phenomenon. In the long run, its height does not depend on the supply of money and credit. It is determined by the difference in the valuation of present goods and future goods. An increase in the supply of money and credit only temporarily lowers the rate of interest. In bringing about malinvestments, it finally results in a reduction in the amount of capital goods available. The economy has to pay heavily for the orgy of the artificial boom.
D. The Socialists’ Rejection of Austrian Theory
In the eyes of the socialists, there is no such thing as a scarcity of material factors of production. Mankind could enjoy a life in plenty. Scarcity is merely an outcome of the capitalist mode of production and distribution. Economic crises are an evil inherent in capitalism. They have nothing at all to do with the endeavors to expand credit and to lower the rate of interest by bank manipulation.
The consistent supporters of these tenets blithely assert that interest is a purely monetary phenomenon that could not exist in a barter economy. (Such were, for instance, the ideas of Silvio Gesell, the minister of finance of the short-lived communist Soviet regime in Munich; Lord Keynes is full of praise for Gesell and calls him an “unduly neglected prophet.”) Others are less outspoken and cling to a more cautious language. But a faulty doctrine does not gain anything from the fact that its advocates lack the courage to profess frankly all the conclusions which must be drawn logically from the principles they have espoused.
Whoever does not share the opinion that the rate of interest is only a monetary phenomenon is under the necessity to demonstrate the mechanism by which that level of the rate of interest, which corresponds to the whole structure of market conditions, reestablishes itself when temporarily disarranged by an easy money policy. The only solution of this problem provided up to now is that of the Austrian theory.
All those economists who want to explain the trade cycle as being caused by factors other than credit expansion must admit that no boom could arise if the amount of money and credit available were not increased. This implies that they cannot help admitting the fundamental thesis of Austrian theory.
E. Salvation Through Credit Manipulation
Consistent supporters of the doctrine that the rate of interest is a monetary phenomenon only and that there is no harm in the endeavors to abolish it by credit manipulation cannot help approving plans to establish the millennium by a reform of the monetary and banking system. The best known of the older projects of this type was that of the French socialist Proudhon, the man who coined the phrase “Property is theft.”
Such ideas are very popular with many successful businessmen. The Belgian Ernest Solvay advocated “social compatabilism,” a system hardly distinguished from that of Proudhon. More than twenty years ago, Thomas A. Edison and Henry Ford suggested that the construction of roads be financed by the issue of additional paper money in order to avoid the payment of interest to the banks or the public.
The present-day variety of this old superstition is embodied in the doctrine of unbalanced budgets and government spending. As far as the government procures the means required for spending by taxing the citizens and by borrowing from the public, its spending curtails individuals’ capacity to invest to the same extent that it increases that of the government. As far as the government borrows from the commercial banks or issues additional paper money, it embarks upon credit expansion and inflation.In the early stages of every instance of credit expansion and inflation, there is always optimism. People do not want to pay attention to the warning voices of economists. They stubbornly insist that their present situation has nothing in common with the boom periods of the past, and that the theorists are wrong in predicting the breakdown of the “prosperity.” But when the crisis comes, people become desperate; then they impeach not the faulty monetary and credit policies but the capitalist system as such.
III. The Foreign Exchange ControversyA. Purchasing Power Parity Theory
The exchange ratio between two different kinds of money tends to correspond to the exchange ratio between each of them and commodities and services. It is usual to call this ratio the static or natural ratio. If this exchange ratio between two kinds of money is disturbed, people will start operations — buying and selling — in order to profit from existing discrepancies. These transactions tend to reestablish the natural ratio.
It does not make any difference whether the two kinds of money are used in the same country simultaneously (as was the case under the old parallel gold and silver standard) or whether each country uses one of them only. The natural rate of foreign exchange is determined by the purchasing power of each of the two kinds of money.
If a payment has to be effected in a distant place, the transaction is burdened with the cost of shipping the money. These costs are avoided if claims and debts of various people in the two places can be cleared. If complete settlement of all payments due can be achieved in this way, no actual shipping of money is required. If an unsettled surplus turns up, it must be settled by transfers from place to place.The balance of payments does not determine the exchange ratio. It only determines how much of the cost of shipping money can be saved. If the two places or countries in question use the same precious metal as the standard, the balance of payments determines the fluctuations of the rate-of-exchange within the rigid limits set by the cost of shipping money (gold points or shipping points).
B. Balance of Payment Theory
Balance of payment theory asserts that foreign exchange rates are determined by the balance of payments.
This doctrine fails to realize that the amount of foreign trade depends on the structure of prices. If Atlantis imports from Thule a commodity A, for the unit of which two ducats must be paid in Atlantis, the commodity must be sold in Thule at the equivalent of two ducats in its local currency, that is, ten florins. If, without any inflation in Thule, the price of the ducat goes up to three florins, the importation of A must drop or stop altogether because at the price of fifteen florins, the demand for A in Thule shrinks or disappears altogether. A rise of foreign exchange rates that does not correspond to a rise of domestic prices (a fall of the purchasing power of the domestic currency) thus has the tendency to render the country’s balance of payment “favorable.”
But, object the supporters of balance of payment theory, things are certainly different if A is a vital necessity for the citizens of Thule. Then, they must import A, no matter how much its price goes up. This, too, is a fallacy. If the individual citizens of Thule spend more florins for the purchase of A, they must, if there is no domestic inflation, restrict their buying of other commodities, either domestic or imported. In the first case, the prices of these domestic commodities drop, and they become available forexport. In the second case, the amount of foreign exchange that would have been absorbed by the importation of other goods becomes available for the purchase of A.
If there is domestic inflation in Thule, then — and only then — a rise of the price of A (in florins) will not hinder the importation of A, as soon as the price of A (in Thule) is affected by the general rise of prices.
C. The Requirements of Foreign Exchange Stability
There is but one means to keep a nation’s domestic currency at par with gold and the sound currency of other countries: to abstain from credit expansion and inflation.
The Theory of Money and Credit[Ludwig von Mises, The Theory of Money and Credit (1952; Indianapolis, Ind.: LibertyClassics, 1980), chap. 7: “The Concept of the Value of Money,” pp. 117–22.]1. Subjective and Objective Factors in the Theory of the Value of MoneyThe central element in the economic problem of money is the objective exchange value of money, popularly called its purchasing power. This is the necessary starting point of all discussion; for it is only in connection with its objective exchange value that those peculiar properties of money that have differentiated it from commodities are conspicuous.
This must not be understood to imply that subjective value is of less importance in the theory of money than elsewhere. The subjective estimates of individuals are the basis of the economic valuation of money just as of that of other goods. And these subjective estimates are ultimately derived, in the case of money as in the case of other economic goods, from the significance attaching to a good or complex of goods as the recognized necessary condition for the existence of a utility, given certain ultimate aims on the part of some individual.See [Eugen von] Böhm-Bawerk, Kapital und Kapitalzins, 3d ed. (Innsbruck, 1909–12], pp. 211 ff. Nevertheless, while the utility of other goods depends on certain external facts (the objective use-value of the commodity) and certain internal facts (the hierarchy of human needs), that is, on conditions that do not belong to the category of the economic at all but are partly of a technological and partly of a psychological nature, the subjective value of money is conditioned by its objective exchange value, that is, by a characteristic that falls within the scope of economics.
In the case of money, subjective use-value and subjective exchange value coincide.See [Correa Moylan] Walsh, The Fundamental Problem in Monetary Science (New York, 1903), p. 11; and in like manner, [Arthur] Spiethoff, “Die Quantitätstheorie insbesondere in ihrer Verwertbarkeit als Haussetheorie,” Festgaben für Adolf Wagner (Leipzig, 1905), p. 256. Both are derived from objective exchange value, for money has no utility other than that arising from the possibility of obtaining other economic goods in exchange for it. It is impossible to conceive of any function of money, qua money, that can be separated from the fact of its objective exchange value. As far as the use-value of a commodity is concerned, it is immaterial whether the commodity also has exchange value or not; but for money to have use-value, the existence of exchange value is essential.
This peculiarity of the value of money can also be expressed by saying that, as far as the individual is concerned, money has no use-value at all, but only subjective exchange value. This, for example, is the practice of RauSee [Karl Heinrich]Rau, Grundsätze der Volkswirtschaftslehre, 6th ed. (Leipzig, 1855), p. 80. and Böhm-Bawerk.See Böhm-Bawerk, Kapital und Kapitalzins, Part II, p. 275. And similarly in [Friedrich von] Wieser, Der natürliche Wert, p. 45; “Der Geldwert und seine Veränderungen,” Schriften des Vereins für Sozialpolitik 132: 507. Whether the one or the other phraseology is employed, scientific investigation of the characteristic will lead to the same conclusions. There is no reason to enter upon a discussion of this point, especially since the distinction between value in use and value in exchange no longer holds the important place in the theory of value that it used to have.See Böhm-Bawerk, Kapital und Kapitalzins, Part II, pp. 273 ff.; [Joseph] Schumpeter, Wesen und Hauptinhalt der theoretischen Nationalökonomie (Leipzig, 1908), p. 108. All that we are concerned with is to show that the task of economics in dealing with the value of money is a bigger one than its task in dealing with the value of commodities. When explaining the value of commodities, the economist can and must be content to take subjective use-value for granted and leave investigation of its origins to the psychologist; but the real problem of the value of money only begins where it leaves off in the case of commodity values, viz., at the point of tracing the objective determinants of its subjective value, for there is no subjective value of money without objective exchange value. It is not the task of the economist, but of the natural scientist, to explain why corn is useful to man and valued by him; but it is the task of the economist alone to explain the utility of money. Consideration of the subjective value of money without discussion of its objective exchange value is impossible. In contrast to commodities, money would never be used unless it had an objective exchange value or purchasing power. The subjective value of money always depends on the subjective value of the other economic goods that can be obtained in exchange for it. Its subjective value is in fact a derived concept. If we wish to estimate the significance that a given sum of money has, in view of the known dependence upon it of a certain satisfaction, we can do this only on the assumption that the money possesses a given objective exchange value. “The exchange value of money is the anticipated use-value of the things that can be obtained with it.”Wieser, Der natürliche Wert, p. 46. Whenever money is valued by anybody it is because he supposes it to have a certain purchasing power.
It might possibly be objected that the mere possession by money of an undefined amount of objective exchange value is not alone sufficient to guarantee the possibility of using it as a medium of exchange; that it is also necessary that this purchasing power should be present in a certain degree, neither too great nor too small, but such that the proportion between the value of the units of money and that of the units of commodity is a convenient one for carrying through the ordinary exchange transactions of daily life; that even if it were true that half of the money in a country could perform the same service as the whole stock if the value of the monetary unit were doubled, yet it is doubtful if a similar proposition could be asserted of the case in which its value was increased a millionfold, or diminished to one-millionth, in inverse correspondence with changes in the quantity of it, since such a currency would hardly be capable of fulfilling the functions of a common medium of exchange so well as the currencies in actual use; that we should try to imagine a commodity money of which a whole ton, or one of which only a thousandth of a milligram was equivalent to a dollar, and think of the inconveniences, the insuperable obstacles in fact, which the employment of such a medium would inevitably place in the way of commerce.
However true this may be, the question of the actual dimensions of the exchange ratio between money and commodities and of the size of the monetary unit is not an economic problem. It is a question that belongs to discussion of the technical conditions that make any particular good suitable for use as money. The relative scarcity of the precious metals, great enough to give them a high objective exchange value but not so great as that of the precious stones or radium and therefore not great enough to make their exchange value too high, must indeed be reckoned, along with such of their other characteristics as their practically unlimited divisibility, their malleability, and their powers of resistance to destructive external influences, as among the factors that were once decisive in causing them to be recognized as the most marketable goods and consequently to be employed as money. But nowadays, as monetary systems have developed, the particular level of value of the precious metals no longer has any important bearing on their use as money. The modern organization of the clearing system and the institution of fiduciary media have made commerce independent of the volume and weight of the monetary material.
- The Objective Exchange Value of MoneyIt follows from what has been said that there can be no discussion of the problem of the value of money without consideration of its objective exchange value. Under modern conditions, objective exchange value, which Wieser also calls Verkehrswert (or value in business transactions), is the most important kind of value, because it governs the social and not merely the individual aspect of economic life. Except in its explanation of the fundamentals of value theory, economics deals almost exclusively with objective exchange value.Ibid., p. 52. And while this is true to some extent of all goods, including those which are useful apart from any exchange value which they possess, it is still truer of money.
“The objective exchange value of goods is their objective significance in exchange, or, in other words, their capacity in given circumstances to procure a specific quantity of other goods as an equivalent in exchange.”Böhm-Bawerk, Kapital und Kapitalzins, Part II, pp. 214 f. It should be observed that even objective exchange value is not really a property of the goods themselves, bestowed on them by nature, for in the last resort it also is derived from the human process of valuing individual goods. But the exchange ratios that are established between different goods in commercial transactions, and are determined by the collective influence of the subjective valuations of all the persons doing business in the market, present themselves to separate individuals, who usually have an infinitesimal influence on the determination of the ratios, as accomplished facts, which in most cases have to be accepted unconditionally. It has thus been easy for false abstraction from this state of affairs to give rise to the opinion that each good comes to the market endowed with a definite quantity of value independent of the valuations of individuals.See [Karl] Helfferich, Das Geld, 6th ed. (Leipzig, 1923), pp. 301 f. From this point of view, goods are not exchanged for one another, by human beings; they simply exchange.
Objective exchange value, as it appears in the subjective theory of value, has nothing except its name in common with the old idea developed by the Classical School of a value in exchange inherent in things themselves. In the value theory of Smith and Ricardo, and in that of their successors, value in exchange plays the leading part. These theories attempt to explain all the phenomena of value by starting from value in exchange, which they interpret as labor value or cost-of-production value. For modern value theory their terminology can claim only a historical importance, and a confusion of the two concepts of exchange value need no longer be feared. This removes the objections that have recently been made to the continued use of the expression “objective exchange value.”Thus Schumpeter, Wesen und Hauptinhalt der theoretischen Nationalökonomie, p. 109.
If the objective exchange value of a good is its power to command a certain quantity of other goods in exchange, its price is this actual quantity of other goods. It follows that the concepts of price and objective exchange value are by no means identical. “But it is, nevertheless, true that both obey the same laws. For when the law of price declares that a good actually commands a particular price, and explains why it does so, it of course implies that the good is able to command this price, and explains why it is able to do so. The law of price comprehends the law of exchange value.”See Böhm-Bawerk, Kapital und Kapitalzins, Part II, p. 217.By “the objective exchange value of money” we are accordingly to understand the possibility of obtaining a certain quantity of other economic goods in exchange for a given quantity of money; and by “the price of money” this actual quantity of other goods. It is possible to express the exchange value of a unit of money in units of any other commodity and speak of the commodity price of money; but in actual life this phraseology and the concept it expresses are unknown. For nowadays money is the sole indicator of prices. ...
- The Dependence of the Subjective Valuation of Money on the Existence of Objective Exchange Value[Mises, The Theory of Money and Credit, chap. 8: “The Determinants of the Objective Exchange Value, or Purchasing Power of Money,” pp. 129–44.]According to modern value theory, price is the resultant of the interaction in the market of subjective valuations of commodities and price-goods. From beginning to end, it is the product of subjective valuations. Goods are valued by the individuals exchanging them, according to their subjective use-values, and their exchange ratios are determined within that range where both supply and demand are in exact quantitative equilibrium. The law of price stated by Menger and Böhm-Bawerk provides a complete and numerically precise explanation of these exchange ratios; it accounts exhaustively for all the phenomena of direct exchange. Under bilateral competition, market price is determined within a range whose upper limit is set by the valuations of the lowest bidder among the actual buyers and the highest offerer among the excluded would-be sellers, and whose lower limit is set by the valuations of the lowest offerer among the actual sellers and the highest bidder among the excluded would-be buyers.
This law of price is just as valid for indirect as for direct exchange. The price of money, like other prices, is determined in the last resort by the subjective valuations of buyers and sellers. But, as has been said already, the subjective use-value of money, which coincides with its subjective exchange value, is nothing but the anticipated use-value of the things that are to be bought with it. The subjective value of money must be measured by the marginal utility of the goods for which the money can be exchanged.See pp. 99. Also Böhm-Bawerk, Kapital und Kapitalzins, Part II, p. 274; Wieser, Der natürliche Wert, p. 46. (Eng. trans. The Theory of Natural Value.)
It follows that a valuation of money is possible only on the assumption that the money has a certain objective exchange value. Such a point d’appui is necessary before the gap between satisfaction and “useless” money can be bridged. Since there is no direct connection between money as such and any human want, individuals can obtain an idea of its utility and consequently of its value only by assuming a definite purchasing power. But it is easy to see that this supposition cannot be anything but an expression of the exchange ratio ruling at the time in the market between the money and commodities.See Wieser, “Der Geldwert und seine Veränderungen,” Schriften des Vereins für Sozialpolitik 132:513 ff.
Once an exchange ratio between money and commodities has been established in the market, it continues to exercise an influence beyond the period during which it is maintained; it provides the basis for the further valuation of money. Thus the past objective exchange value of money has a certain significance for its present and future valuation. The money prices of today are linked with those of yesterday and before, and with those of tomorrow and after.
But this alone will not suffice to explain the problem of the element of continuity in the value of money; it only postpones the explanation. To trace back the value that money has today to that which it had yesterday, the value that it had yesterday to that which it had the day before, and so on, is to raise the question of what determined the value of money in the first place. Consideration of the origin of the use of money and of the particular components of its value that depend on its monetary function suggests an obvious answer to this question. The first value of money was clearly the value which the goods used as money possessed (thanks to their suitability for satisfying human wants in other ways) at the moment when they were first used as common media of exchange. When individuals began to acquire objects, not for consumption, but to be used as media of exchange, they valued them according to the objective exchange value with which the market already credited them by reason of their “industrial” usefulness, and only as an additional consideration on account of the possibility of using them as media of exchange. The earliest value of money links up with the commodity value of the monetary material. But the value of money since then has been influenced not merely by the factors dependent on its “industrial” uses, which determine the value of the material of which the commodity money is made, but also by those which result from its use as money. Not only its supply and demand for industrial purposes, but also its supply and demand for use as a medium of exchange, have influenced the value of gold from that point of time onward when it was first used as money.See [Karl] Knies, Geld und Kredit (Berlin, 1885), vol. 1, p. 324.
- The Necessity for a Value Independent of the Monetary Function Before an Object Can Serve as MoneyIf the objective exchange value of money must always be linked with a preexisting market exchange ratio between money and other economic goods (since otherwise individuals would not be in a position to estimate the value of the money), it follows that an object cannot be used as money unless, at the moment when its use as money begins, it already possesses an objective exchange value based on some other use. This provides both a refutation of those theories which derive the origin of money from a general agreement to impute fictitious value to things intrinsically valuelessThus [John] Locke, Some Considerations of the Consequences of the Lowering of Interest and Raising the Value of Money, 2d ed. (London, 1696), p. 31. and a confirmation of Menger’s hypothesis concerning the origin of the use of money.
This link with a preexisting exchange value is necessary not only for commodity money, but equally for credit money and fiat money.See [Guillermo] Subercaseaux, Essai sur la nature du papier monnaie (Paris, 1909), pp. 17 f. No fiat money could ever come into existence if it did not satisfy this condition. Let us suppose that, among those ancient and modern kinds of money about which it may be doubtful whether they should be reckoned as credit money or fiat money, there have actually been representatives of pure fiat money. Such money must have come into existence in one of two ways. It may have come into existence because money substitutes already in circulation, that is, claims payable in money on demand, were deprived of their character as claims, and yet still used in commerce as media of exchange. In this case, the starting point for their valuation lay in the objective exchange value that they had at the moment when they were deprived of their character as claims. The other possible case is that in which coins that once circulated as commodity money are transformed into fiat money by cessation of free coinage (either because there was no further minting at all or because minting was continued only on behalf of the Treasury), no obligation of conversion being de jure or de facto assumed by anybody, and nobody having any grounds for hoping that such an obligation ever would be assumed by anybody. Here the starting point for the valuation lies in the objective exchange value of the coins at the time of the cessation of free coinage.
Before an economic good begins to function as money it must already possess exchange value based on some other cause than its monetary function. But money that already functions as such may remain valuable even when the original source of its exchange value has ceased to exist. Its value then is based entirely on its function as common medium of exchange.See [Georg] Simmel, Philosophie des Geldes, 2d ed. (Leipzig, 1907), pp. 115 f.; but, above all, Wieser, “Der Geldwert und seine Veränderungen,” p. 513.
- The Significance of Preexisting Prices in the Determination of Market Exchange RatiosFrom what has just been said, the important conclusion follows that a historically continuous component is contained in the objective exchange value of money.
The past value of money is taken over by the present and transformed by it; the present value of money passes on into the future and is transformed in its turn. In this there is a contrast between the determination of the exchange value of money and that of the exchange value of other economic goods. All preexisting exchange ratios are quite irrelevant so far as the actual levels of the reciprocal exchange ratios of other economic goods are concerned. It is true that if we look beneath the concealing monetary veil to the real exchange ratios between goods we observe a certain continuity. Alterations in real prices occur slowly as a rule. But this stability of prices has its cause in the stability of the price determinants, not in the law of price determination itself. Prices change slowly because the subjective valuations of human beings change slowly. Human needs, and human opinions as to the suitability of goods for satisfying those needs, are no more liable to frequent and sudden changes than are the stocks of goods available for consumption, or the manner of their social distribution. The fact that today’s market price is seldom very different from yesterday’s is to be explained by the fact that the circumstances that determined yesterday’s price have not greatly changed overnight, so that today’s price is a resultant of nearly identical factors. If rapid and erratic variations in prices were usually encountered in the market, the conception of objective exchange value would not have attained the significance that it is actually accorded both by consumer and producer.
In this sense, reference to an inertia of prices is unobjectionable, although the errors of earlier economists should warn us of the real danger that the use of terms borrowed from mechanics may lead to a “mechanical” system, that is, to one that abstracts erroneously from the subjective valuations of individuals. But any suggestion of a causal relationship between past and present prices must be decisively rejected.
It is not disputed that there are institutional forces in operation which oppose changes in prices that would be necessitated by changes in valuations, and which are responsible when changes in prices that would have been caused by changes in supply and demand are postponed and when small or transitory changes in the relations between supply and demand lead to no corresponding change in prices at all. It is quite permissible to speak of an inertia of prices in this sense. Even the statement that the closing price forms the starting point for the transactions of the next marketSee [Gustav von] Schmoller, Grundriss der allgemeinen Volkswirtschaftslehre (Leipzig, 1902), vol. 2, p. 110. may be accepted if it is understood in the sense suggested above. If the general conditions that determined yesterday’s price have altered but little during the night, today’s price should be but little different from that of yesterday, and in practice it does not seem incorrect to make yesterday’s the starting point. Nevertheless, there is no causal connection between past and present prices as far as the relative exchange ratios of economic goods (not including money) are concerned. The fact that the price of beer was high yesterday cannot be of the smallest significance as far as today’s price is concerned — we need only think of the effect upon the prices of alcoholic drinks that would follow a general triumph of the Prohibition movement. Anybody who devotes attention to market activities is daily aware of alterations in the exchange ratios of goods, and it is quite impossible for anybody who is well acquainted with economic phenomena to accept a theory which seeks to explain price changes by a supposed constancy of prices.
It may incidentally be remarked that to trace the determination of prices back to their supposed inertia, as even Zwiedineck in his pleadings for this assumption is obliged to admit, is to resign at the outset any hope of explaining the ultimate causes of prices and to be content with explanations from secondary causes.See [Otto von] Zwiedineck, “Kritisches und Positives zur Preislehre,” Zeitschrift für die gesamte Staatswissenschaft, Vol. 65, pp. 200 ff. It must unreservedly be admitted that an explanation of the earliest forms of exchange transaction that can be shown to have existed — a task to the solution of which the economic historian has so far contributed but little would show that the forces that counteract sudden changes in prices were once stronger than they are now. But it must positively be denied that there is any sort of connection between those early prices and those of the present day; that is, if there really is anybody who believes it possible to maintain the assertion that the exchange ratios of economic goods (not the money prices) that prevail today on the German stock exchanges are in any sort of causal connection with those that were valid in the days of Hermann or Barbarossa. If all the exchange ratios of the past were erased from human memory, the process of market-price determination might certainly become more difficult, because everybody would have to construct a new scale of valuations for himself; but it would not become impossible. In fact, people the whole world over are engaged daily and hourly in the operation from which all prices result: the decision as to the relative significance enjoyed by specific quantities of goods as conditions for the satisfaction of wants.
It is so far as the money prices of goods are determined by monetary factors, that a historically continuous component is included in them, without which their actual level could not be explained. This component, too, is derived from exchange ratios which can be entirely explained by reference to the subjective valuations of the individuals taking part in the market, even though these valuations were not originally grounded upon the specifically monetary utility alone of these goods. The valuation of money by the market can only start from a value possessed by the money in the past, and this relationship influences the new level of the objective exchange value of money. The historically transmitted value is transformed by the market without regard to what has become its historical content.See Wieser, “Der Geldwert und seine Veränderungen,” p. 513. But it is not merely the starting point for today’s objective exchange value of money; it is an indispensable element in its determination. The individual must take into account the objective exchange value of money, as determined in the market yesterday, before he can form an estimate of the quantity of money that he needs today. The demand for money and the supply of it are thus influenced by the value of money in the past; but they in their turn modify this value until they are brought into equilibrium.
- The Applicability of the Marginal-Utility Theory to MoneyDemonstration of the fact that search for the determinants of the objective exchange value of money always leads us back to a point where the value of money is not determined in any way by its use as a medium of exchange, but solely by its other functions, prepares the way for developing a complete theory of the value of money on the basis of the subjective theory of value and its peculiar doctrine of marginal utility.
Until now the subjective school has not succeeded in doing this. In fact, among the few of its members who have paid any attention at all to the problem there have been some who have actually attempted to demonstrate its insolubility. The subjective theory of value has been helpless in face of the task here confronting it.
There are two theories of money which, whatever else we may think of them, must be acknowledged as having attempted to deal with the whole problem of the value of money.
The objective theories of value succeeded in introducing a formally unexceptionable theory of money into their systems, which deduces the value of money from its cost of production.See [Nassau William] Senior, Three Lectures on the Value of Money (London, 1840; 1931), pp. 1 ff.; Three Lectures on the Cost of Obtaining Money (London, 1830; 1931), pp. 1 ff. It is true that the abandonment of this monetary theory is not merely to be ascribed to those shortcomings of the objective theory of value in general which led to its supersession by the theory of the modern school. Apart from this fundamental weakness, the cost-of-production theory of the value of money exhibited one feature that was an easy target for criticism. While it certainly provided a theory of commodity money (even if only a formally correct one), it was unable to deal with the problem of credit money and fiat money. Nevertheless, it was a complete theory of money insofar as it did at least attempt to give a full explanation of the value of commodity money.
The other similarly complete theory of the value of money is that version of the quantity theory associated with the name of Davanzati.See [Bernardo] Davanzati, Lezioni delle monete, 1588 (in Scrittori classici italiani di economia politica, Parte Antica (Milan, 1804), vol. 2, p. 32. Locke and, above all, Montesquieu (De l’Ësprit des lois, edition Touquet [Paris, 1821], vol. 2, pp. 458 f.) share this view. See [H. Parker] Willis, “The History and Present Application of the Quantity Theory,” Journal of Political Economy 4 (1896): 419 ff. According to this theory, all the things that are able to satisfy human wants are conventionally equated with all the monetary metal. From this, since what is true of the whole is also true of its parts, the exchange ratios between commodity units and units of money can be deduced. Here we are confronted with a hypothesis that is not in any way supported by facts. To demonstrate its untenability once more would nowadays be a waste of time. Nevertheless, it must not be overlooked that Davanzati was the first who attempted to present the problem as a whole and to provide a theory that would explain not merely the variations in an existing exchange ratio between money and other economic goods, but also the origin of this ratio.
The same cannot be said of other versions of the quantity theory. These all tacitly assume a certain value of money as given, and absolutely refuse to investigate further into the matter. They overlook the fact that what is required is an explanation of what determines the exchange ratio between money and commodities, and not merely of what causes changes in this ratio. In this respect, the quantity theory resembles various general theories of value (many versions of the doctrine of supply and demand, for example), which have not attempted to explain price as such but have been content to establish a law of price variations.See [Emil] Zuckerkandl, Zur Theorie des Preises (Leipzig, 1889), p. 124. These forms of the quantity theory are in fact nothing but the application of the law of supply and demand to the problem of the value of money. They introduce into monetary theory all the strong points of this doctrine; and of course all its weak points as well.See Wieser, “Der Geldwert und seine Veränderungen,” p. 514.
The revolution in economics since 1870 has not yet been any more successful in leading to an entirely satisfactory solution of this problem. Of course, this does not mean that the progress of the science has left no trace on monetary theory in general and on the theory of the value of money in particular. It is one of the many services of the subjective theory of value to have prepared the way for a deeper understanding of the nature and value of money. The investigations of Menger have placed the theory on a new basis. But till now one thing has been neglected. Neither Menger nor any of the many investigators who have tried to follow him have even so much as attempted to solve the fundamental problem of the value of money. Broadly speaking, they have occupied themselves with checking and developing the traditional views and here and there expounding them more correctly and precisely, but they have not provided an answer to the question: What are the determinants of the objective exchange value of money? Menger and Jevons have not touched upon the problem at all. CarverSee [T. N.] Carver, “The Value of the Money Unit,” Quarterly Journal of Economics 11 (1897): 429 f. and KinleySee [David] Kinley, Money (New York, 1909), pp. 123 ff. have contributed nothing of real importance to its solution. WalrasSee [Léon] Walras, Théorie de la Monnaie (Lausanne, 1886), pp. 25 ff. and KemmererSee [Edwin] Kemmerer, Money and Credit Instruments in Their Relation to General Prices (New York, 1907), pp. 11ff. assume a given value of money and develop what is merely a theory of variations in the value of money. Kemmerer, it is true, approaches very close to a solution of the problem but passes it by.
Wieser expressly refers to the incomplete nature of the previous treatment. In his criticism of the quantity theory he argues that the law of supply and demand in its older form, the application of which to the problem of money constitutes the quantity theory, has a very inadequate content, since it gives no explanation at all of the way in which value is really determined or of its level at any given time, but confines itself without any further explanation merely to stating the direction in which value will move in consequence of variations in supply or demand; that is, in an opposite direction to changes in the former and in the same direction as changes in the latter. He further argues that it is no longer possible to rest content with a theory of the economic value of money which deals so inadequately with the problem; that since the supersession of the old law of supply and demand as applied to commodities, the case for which it was originally constructed, a more searching law must also be sought to apply to the case of money.See Wieser, “Der Geldwert und seine Veränderungen,” pp. 514 ff. But Wieser does not deal with the problem whose solution he himself states to be the object of his investigation, for in the further course of his argument he declares that the concepts of supply of money and demand for money as a medium of exchange are useless for his purpose and puts forward a theory which attempts to explain variations in the objective exchange value of money (objektive innere Tauschwert des Geldes)[See p. 124 n. H.E.B.] by reference to the relationship that exists in an economic community between money income and real income. For while it is true that reference to the ratio between money income and real income may well serve to explain variations in the objective exchange value of money, Wieser nowhere makes the attempt to evolve a complete theory of money — an attempt which, admittedly, the factors of supply and demand being excluded from consideration, would be certain to fail. The very objection that he raises against the old quantity theory, that it affirms nothing concerning the actual determination of value or the level at which it must be established at any time, must also be raised against his own doctrine; and this is all the more striking inasmuch as it was Wieser who, by revealing the historical element in the purchasing power of money, laid the foundation for the further development of the subjective theory of the value of money.
The unsatisfactory results offered by the subjective theory of value might seem to justify the opinion that this doctrine and especially its proposition concerning the significance of marginal utility must necessarily fall short as a means of dealing with the problem of money. Characteristically enough, it was a representative of the new school, Wicksell, who first expressed this opinion. Wicksell considers that the principle which lies at the basis of all modern investigation into the theory of value, namely, the concept of marginal utility, may well be suited to explaining the determination of exchange ratios between one commodity and another, but that it has practically no significance at all, or at most an entirely secondary significance, in explaining the exchange ratios between money and other economic goods. Wicksell, however, does not appear to detect any sort of objection to the marginal-utility theory in this assertion. According to his argument, the objective exchange value of money is not determined at all by the processes of the market in which money and the other economic goods are exchanged. If the money price of a single commodity or group of commodities is wrongly assessed in the market, then the resulting maladjustments of the supply and demand and the production and consumption of this commodity or group of commodities will sooner or later bring about the necessary correction. If, on the other hand, all commodity prices, or the average price level, should for any reason be raised or lowered, there is no factor in the circumstances of the commodity market that could bring about a reaction. Consequently, if there is to be any reaction at all against a price assessment that is either too high or too low it must in some way or other originate outside the commodity market. In the further course of his argument, Wicksell arrives at the conclusion that the regulator of money prices is to be sought in the relations of the commodity market to the money market, in the broadest sense of the term. The cause which influences the demand for raw materials, labor, the use of land, and other means of production, and thus indirectly determines the upward or downward movement of commodity prices, is the ratio between the money rate of interest (Darlehnszins) and the “natural” or equilibrium rate of interest (natürliche Kapitalzins), by which we are to understand that rate of interest which would be determined by supply and demand if real capital was itself lent directly without the intermediation of money.See [Knut] Wicksell, Geldzins und Güterpreise (Jena, 1898), pp. iv ff, 16 ff.
Wicksell imagines that this argument of his provides a theory of the determination of the objective exchange value of money. In fact, however, all that he attempts to prove is that forces operate from the loan market on the commodity market which prevent the objective exchange value of money from rising too high or falling too low. He never asserts that the rate of interest on loans determines the actual level of this value in any way; in fact, to assert this would be absurd. But if we are to speak of a level of money prices that is “too high” or “too low,” we must first state how the ideal level with which the actual level is compared has been established. It is in no way sufficient to show that the position of equilibrium is returned to after any disturbance, if the existence of this position of equilibrium is not first explained. Indubitably, this is the primary problem, and its solution leads directly to that of the other; without it, further inquiry must remain unfruitful, for the state of equilibrium can only be maintained by those forces which first established it and continue to reestablish it. If the circumstances of the loan market can provide no explanation of the genesis of the exchange ratio subsisting between money and other economic goods, then neither can they help to explain why this ratio does not alter. The objective exchange value of money is determined in the market where money is exchanged for commodities and commodities for money. To explain its determination is the task of the theory of the value of money. But Wicksell is of the opinion that “the laws of the exchange of commodities contain in themselves nothing that could determine the absolute level of money prices.”Ibid., p. 35. This amounts to a denial of all possibility of scientific investigation in this sphere.
Helfferich also is of the opinion that there is an insurmountable obstacle in the way of applying the marginal-utility theory to the problem of money; for while the marginal-utility theory attempts to base the exchange value of goods on the degree of their utility to the individual, the degree of utility of money to the individual quite obviously depends on its exchange value, since money can have utility only if it has exchange value, and the degree of the utility is determined by the level of the exchange value. Money is valued subjectively according to the amount of consumable goods that can be obtained in exchange for it, or according to what other goods have to be given in order to obtain the money needed for making payments. The marginal utility of money to any individual, that is, the marginal utility derivable from the goods that can be obtained with the given quantity of money or that must be surrendered for the required money, presupposes a certain exchange value of the money; so the latter cannot be derived from the former.See [Karl] Helfferich, Das Geld, 6th ed. (Leipzig, 1923), p. 577.
Those who have realized the significance of historically transmitted values in the determination of the objective exchange value of money will not find great difficulty in escaping from this apparently circular argument. It is true that valuation of the monetary unit by the individual is possible only on the assumption that an exchange ratio already exists in the market between the money and other economic goods. Nevertheless, it is erroneous to deduce from this that a complete and satisfactory explanation of the determination of the objective exchange value of money cannot be provided by the marginal-utility theory. The fact that this theory is unable to explain the objective exchange value of money entirely by reference to its monetary utility; that to complete its explanation, as we were able to show, it is obliged to go back to that original exchange value which was based not on a monetary function at all but on other uses of the object that was to be used as money — this must not in any way be reckoned to the discredit of the theory, for it corresponds exactly to the nature and origin of the particular objective exchange value under discussion. To demand of a theory of the value of money that it should explain the exchange ratio between money and commodities solely with reference to the monetary function, and without the assistance of the element of historical continuity in the value of money, is to make demands of it that run quite contrary to its nature and its proper task.
The theory of the value of money as such can trace back the objective exchange value of money only to that point where it ceases to be the value of money and becomes merely the value of a commodity. At this point the theory must hand over all further investigation to the general theory of value, which will then find no further difficulty in the solution of the problem. It is true that the subjective valuation of money presupposes an existing objective exchange value; but the value that has to be presupposed is not the same as the value that has to be explained; what has to be presupposed is yesterday’s exchange value, and it is quite legitimate to use it in an explanation of that of today. The objective exchange value of money which rules in the market today is derived from day’s under the influence of the subjective valuations of the individuals frequenting the market, just as yesterday’s in its turn was derived under the influence of subjective valuations from the objective exchange value possessed by the money the day before yesterday.
If in this way we continually go farther and farther back we must eventually arrive at a point where we no longer find any component in the objective exchange value of money that arises from valuations based on the function of money as a common medium of exchange; where the value of money is nothing other than the value of an object that is useful in some other way than as money. But this point is not merely an instrumental concept of theory; it is an actual phenomenon of economic history, making its appearance at the moment when indirect exchange begins.
Before it was usual to acquire goods in the market, not for personal consumption, but simply in order to exchange them again for the goods that were really wanted, each individual commodity was only accredited with that value given by the subjective valuations based on its direct utility. It was not until it became customary to acquire certain goods merely in order to use them as media of exchange that people began to esteem them more highly than before, on account of this possibility of using them in indirect exchange. The individual valued them in the first place because they were useful in the ordinary sense, and then additionally because they could be used as media of exchange. Both sorts of valuation are subject to the law of marginal utility. Just as the original starting point of the value of money was nothing but the result of subjective valuations, so also is the present-day value of money.
But Helfferich manages to bring forward yet another argument for the inapplicability of the marginal-utility theory to money. Looking at the economic system as a whole, it is clear that the notion of marginal utility rests on the fact that, given a certain quantity of goods, only certain wants can be satisfied and only a certain set of utilities provided. With given wants and a given set of means, the marginal degree of utility is determined also. According to the marginal-utility theory, this fixes the value of the goods in relation to the other goods that are offered as an equivalent in exchange, and fixes it in such a manner that that part of the demand that cannot be satisfied with the given supply is excluded by the fact that it is not able to offer an equivalent corresponding to the marginal utility of the good demanded. Now Helfferich objects that while the existence of a limited supply of any goods except money is in itself sufficient to imply the limitation of their utility also, this is not true of money. The utility of a given quantity of money depends directly upon the exchange value of the money, not only from the point of view of the individual, but also for society as a whole. The higher the value of the unit in relation to other goods, the greater will be the quantity of these other goods that can be paid for by means of the same sum of money. The value of goods in general results from the limitation of the possible utilities that can be obtained from a given supply of them, and while it is usually higher according to the degree of utility which is excluded by the limitation of supply, the total utility of the supply itself cannot be increased by an increase in its value; but in the case of money, the utility of a given supply can be increased at will by an increase in the value of the unit.Ibid., p. 578.
The error in this argument is to be found in its regarding the utility of money from the point of view of the community instead of from that of the individual. Every valuation must emanate from somebody who is in a position to dispose in exchange of the object valued. Only those who have a choice between two economic goods are able to form a judgment as to value, and they do this by preferring the one to the other. If we start with valuations from the point of view of society as a whole, we tacitly assume the existence of a socialized economic organization in which there is no exchange and in which the only valuations are those of the responsible official body. Opportunities for valuation in such a society would arise in the control of production and consumption, as, for example, in deciding how certain production goods were to be used when there were alternative ways of using them. But in such a society there would be no room at all for money. Under such conditions, a common medium of exchange would have no utility and consequently no value either. It is therefore illegitimate to adopt the point of view of the community as a whole when dealing with the value of money. All consideration of the value of money must obviously presuppose a state of society in which exchange takes place and must take as its starting point individuals acting as independent economic agents within such a society,Dr. B. M. Anderson, pp. 100–10 of his excellent work The Value of Money (New York, 1917), has objected to the theory set forth above that instead of a logical analysis it provides merely a temporal regressus. Nevertheless, all the acute objections that he manages to bring forward are directed only against the argument that finds a historical component in the exchange ratios subsisting between commodities, an argument with which I also [see pp. 133ff. above] am in definite disagreement. But Dr. Anderson recognizes the logical foundation of my theory when he declares, “I shall maintain that value from some source other than the monetary employment is an essential precondition of the monetary employment” (p. 126). that is to say, individuals engaged in valuing things.
Money, Method, and the Money Process[Ludwig von Mises, Money, Method, and the Market Process: Essays by Ludwig von Mises, ed. Richard M. Ebeling (1938; Boston: Kluwer, 1990), chap. 5, pp. 69–77.]“The Non-Neutrality of Money”The monetary economists of the sixteenth and seventeenth centuries succeeded in dissipating the popular fallacies concerning an alleged stability of money. The old error disappeared, but a new one originated, the illusion of money’s neutrality.
Of course, classical economics did its best to dispose of these mistakes. David Hume, the founder of British Political Economy, and John Stuart Mill, the last in the line of classical economists, both dealt with the problem in a masterful way. And then we should not forget Cairnes, who in his essay on the course of depreciation paved the way for a realistic view of the issue involved.
Notwithstanding these first steps towards a more correct grasp, modern economists incorporated the fallacy of money neutrality into their system of thought.
The reasoning of modern marginal utility economics begins from the assumption of a state of pure barter. The mechanism of exchanging commodities and of market transactions is considered on the supposition that direct exchange alone prevails. The economists depict a purely hypothetical entity, a market without indirect exchange, without a medium of exchange, without money. There is no doubt that this method is the only possible one, that the elimination of money is necessary and that we cannot do without this concept of a market with direct exchange only. But we have to realize that it is a hypothetical concept which has no counterpart in reality. The actual market is necessarily a market of indirect exchange and money transactions.
From this assumption of a market without money, the fallacious idea of neutral money is derived. The economists were so fond of the tool which this hypothetical concept provided that they overestimated the extent of its applicability. They began to believe that all problems of catallactics could be analyzed by means of this fictitious concept. In accordance with this view, they considered that the main work of economic analysis was the study of direct exchange. After that all that was left was to introduce the monetary terms into the formulas obtained. But this was, in their eyes, a work of only secondary importance, because, as they were convinced, the introduction of monetary terms did not affect the substantial operation of the mechanism they had described. The functioning of the market mechanism as demonstrated by the concept of pure barter was not affected by monetary factors.
Of course, the economists knew that the exchange ratio between money and commodities was subject to change. But they believed — and this is exactly the essence of the fallacy of money’s neutrality — that these changes in purchasing power were brought about simultaneously in the whole market and that they affected all commodities to the same extent. The most striking expression of this point of view is to be found in the current metaphorical use of the term “level” in reference to prices. Changes in the supply or demand of money — other things remaining equal — make all prices and wages simultaneously rise or fall. The purchasing power of the monetary unit changes, but the relations among the prices of individual commodities remain the same.
Of course, economists have developed for more than a hundred years the method of index numbers in order to measure changes in purchasing power in a world where the ratios between the prices of individual commodities are in continuous transition. But in doing so, they did not give up the assumption that the consequences of a change in the supply or demand of money were a proportional and simultaneous modification of prices. The method of index numbers was designed to provide them with a means of distinguishing between the consequences of those changes in prices which take their origins from the side of the demand for or supply of individual commodities and those which start from the side of demand for or supply of money.
The erroneous assumption of money neutrality is at the root of all endeavors to establish the formula of a so-called equation of exchange. In dealing with such an equation the mathematical economist assumes that something— one of the elements of the equation — changes and that corresponding changes in the other values must needs follow. These elements of the equation are not items in the individual’s economy, but items of the whole economic system, and consequently the changes occur not with individuals but with the whole economic system, with the Volkswirtschaft as a whole. Proceeding thus, the economists apply unawares for the treatment of monetary problems a method radically different from the modern catallactic method. They revert to the old manner of reasoning which doomed to failure the work of older economists. In those early days philosophers dealt in their speculations with universal concepts, such as mankind and other generic notions. They asked: What is the value of gold or of iron, that is: value in general, for all times and for all people, and again gold or iron in general, all the gold or iron available or even not yet mined. They could not succeed in this way; they discovered only alleged autinomies which were insoluble for them.
All the successful achievements of modern economic theory have to be ascribed to the fact that we have learned to proceed in a different way. We realize that individuals acting in the market are never presented with the choice between all the gold existing and all the iron existing. They do not have to decide whether gold or iron is more useful for mankind as a whole, but they have to choose between two limited quantities both of which they cannot have together. They decide which of these two alternatives is more favorable for them under the conditions and at the moment when they make their decision. These acts of choice performed by individuals faced with alternatives are the ultimate causes of the exchange ratios established in the market. We have to direct our attention to these acts of choice and are not at all interested in the metaphysical and purely academic, nay, vain question of which commodity in general appears more useful in the eyes of a superhuman intelligence surveying earthly conditions from a transcendental point of view.
Monetary problems are economic problems and have to be dealt with in the same way as all other economic problems. The monetary economist does not have to deal with universal entities like volume of trade meaning total volume of trade or quantity of money meaning all the money current in the whole economic system. Still less can he make use of the nebulous metaphor “velocity of circulation.” He has to realize that the demand for money arises from the preferences of individuals within a market society. Because everybody wishes to have a certain amount of cash, sometimes more, sometimes less, there is a demand for money. Money is never simply in the economic system, in the Volkswirtschaft, money is never simply circulating. All the money available is always in the cash holdings of somebody. Every piece of money may one day — sometimes oftener, sometimes more seldom — pass from one man’s cash holding to another man’s. But at every moment it is owned by somebody and is a part of his cash holdings. The decisions of individuals regarding the magnitude of their cash holdings constitute the ultimate factor in the formation of purchasing power.
Changes in the quantity of money and in the demand for money for cash holding do not occur in the economic system as a whole if they do not occur in the households of individuals. These changes in the households of individuals never occur for all individuals at the same time and to the same degree and they therefore never affect their judgments of value to the same extent and at the same time. It is exactly the merit of Hume and Mill that they tried to construct a hypothetical case where the changes in the supply of money could affect all individuals in such a way that the prices of all commodities would rise or fall at the same time and in the same proportion. The failure of their attempts provided a negative proof, and modern economics has added to this the positive proof that the prices of different commodities are not influenced at the same time and to the same extent. The oversimple formula both of the old quantity theory and of contemporary mathematical economists according to which prices, that is all prices, rise or fall in the proportion of the increase or decrease in the quantity of money, is disproved.
To simplify and to shorten our analysis let us look at the case of inflation only. The additional quantity of money does not find its way at first into the pockets of all individuals; not every individual of those benefited first gets the same amount and not every individual reacts to the same additional quantity in the same way. Those first benefited — in the case of gold, the owners of the mines, in the case of government paper money, the treasury — now have greater cash holdings and they are now in a position to offer more money on the market for goods and services they wish to buy. The additional amount of money offered by them on the market makes prices and wages go up. But not all the prices and wages rise, and those which do rise do not rise to the same degree. If the additional money is spent for military purposes, the prices of some commodities only and the wages of only some kinds of labor rise, others remain unchanged or may even temporarily fall. They may fall because there are now on the market some groups of men whose incomes have not risen but who nevertheless are obliged to pay more for some commodities, namely for those asked by the men first benefited by the inflation. Thus, price changes which are the result of the inflation start with some commodities and services only, and are diffused more or less slowly from one group to the others. It takes time till the additional quantity of money has exhausted all its price changing possibilities. But even in the end the different commodities are not affected to the same extent. The process of progressive depreciation has changed the income and the wealth of the different social groups. As long as this depreciation is still going on, as long as the additional quantity of money has not yet exhausted all its possibilities of influencing prices, as long as there are still prices left unchanged at all or not yet changed to the extent that they will be, there are in the community some groups favored and some at a disadvantage. Those selling the commodities or services whose prices rise first are in a position to sell at the new higher prices and to buy what they want to buy at the old still unchanged prices. On the other hand, those who sell commodities or services whose prices remain for some time unchanged are selling at the old prices whereas they already have to buy at the new higher prices. The former are making a specific gain, they are profiteers, the latter are losing, they are the losers, out of whose pockets the extra-gains of the profiteers must come. As long as the inflation is in progress, there is a perpetual shift in income and wealth from some social group, to other social groups. When all price consequences of the inflation are consummated, a transfer of wealth between social groups has taken place. The result is that there is in the economic system a new dispersion of wealth and income and in this new social order the wants of individuals are satisfied to different relative degrees, than formerly. Prices in this new order cannot simply be a multiple of the previous prices.
The social consequences of a change in the purchasing power of money are twofold: first, as money is the standard of deferred payments, the relations between creditors and debtors is changed. Second, as the changes in purchasing power do not affect all prices and wages at the same moment and to the same extent, there is a shift of wealth and income between different social groups. It was one of the errors of all proposals to stabilize purchasing power that they did not take into account this second consequence. We may say that economic theory in general did not pay enough attention to this matter. As far as it did, it principally considered it only in reference to the reaction of a change in a country’s currency on its foreign trade. But this is only a special application of a problem which has a much wider scope.
What is fundamental for economic theory is that there is no constant relation between changes in the quantity of money and in prices. Changes in the supply of money affect individual prices and wages in different ways. The metaphorical use of the term price level is misleading.
The erroneous opinion to the contrary was based on a consideration which may be represented thus: let us think of two absolutely independent systems of static equilibrium A and B. Both are in every respect alike except that to the total quantity of money (M) in A and to every individual cash holding (m) in A there correspond in B a total quantity of Mn and individual cash holdings mn. On these assumptions of course all the prices and wages in B are n times those in A. But they are exactly thus because these are our hypothetical assumptions. But nobody can devise a way by which the system A can be transformed into the system B. Of course it is unpermissible to operate with static equilibrium if we wish to approach a dynamic problem.
Setting aside all qualms about the use of the terms dynamic and static, I wish to say: money is necessarily a dynamic agent and it was a mistake to deal with monetary problems in a static way.
Of course there is no room left for money in a concept of static equilibrium. In forming the concept of a static society we assume that no changes are taking place. Everything is going on in the same old manner. Today is like yesterday and tomorrow will be like today. But under these conditions nobody needs a cash holding. Cash holding is necessary only when the individual does not know what situation he will have to face in an uncertain future. If everybody knows when and what he will have to buy, he does not need a private cash holding and can entrust all his money to the central bank as time deposits due on the dates and in the amounts necessary for his future payments. As everybody would proceed in the same way, the central bank does not need any reserves to meet its obligations. Of course, the total amount which it has to pay out to the buyers every day exactly balances the amount which it receives as deposits from the sellers. If we assume that in this world of static equilibrium once, before the equilibrium was attained, there was metallic currency only, let us say gold, we have to assume that with the gradual approach towards conditions of equilibrium the citizens deposited more and more of their gold and that the bank, which had no need for it, sold the gold to jewelers and others for industrial consumption. With the advent of equilibrium there is no more metallic money, there is in fact no more money at all, but an unsubstantial and immaterial clearing system, which cannot be considered as money in the ordinary sense. It is rather an unrealizable and even unthinkable system of accounting, a numeraire as some economists believed ideal money ought to be. This, if it could be called money, would be neutral money. But we should never forget, that the state of equilibrium is purely hypothetical, that this concept is nothing but a tool for our mental work. Not being able to make experiments, the social sciences have to forge such tools. But we must be very careful in their use. We have to be aware that the state of static equilibrium can never be attained in real life. Still more important is the fact, that in this hypothetical state the individual does not make choices, does not act and does not have to decide between incompatible alternatives. Life in this hypothetical state is therefore robbed of its essential element. In constructing this hypothetical state we want merely to understand the incentives of action, which always implies change, by conceiving conditions, in which no action takes place. But a changeless world would be a dead world. We do not just have to deal with death, but with life, action, and change. In a living world there is no room for neutrality of money.
Money, of course, is a dynamic factor and as such cannot be discussed in terms of static equilibrium.
Let me now briefly point out some of the major conclusions derived from an insight into the non-neutrality of money.
First we have to realize that the abandonment of the fallacious concept of neutral money destroys the last stronghold of the advocates of quantitative economics. For a very long time eminent economists have believed that it will be possible one day to replace qualitative economics by quantitative economics. What renders these hopes vain, is the fact, that in economic quantities we never have any constant ratios among magnitudes. What the economist discovers when he studies relations between demand and prices is not comparable with the work of the natural scientist who determines by experiments in his laboratory constant relations, e.g., the specific gravity of different substances. What the economist determines is of historical value only; he is in his statistical work a historian, but not an experimenter. The work of the late lamented Henry Schultz was economic history; what we learn from his research is what happened with some commodities in a limited period of the past in the United States and Canada. It tells us nothing about what happened with the same commodities elsewhere or in another period or what will happen in the future.
But there still has remained the belief that it is different with money. I may cite, for example, Professor Fisher’s book on the Purchasing Power of Money, which is founded on the assumption that the purchasing power of the monetary unit changes in inverse proportion to the quantity of money. I think that this assumption is arbitrary and fallacious.
The second conclusion which we have to draw is the futility of all endeavors to make money stable in purchasing power. It is beyond the scope of my short address to explain the advantages of a sound money policy and the disadvantages of both inflation and deflation. But we should not confuse the political concept of sound money with the theoretical concept of stable money. I do not wish to discuss the inner contradictions of this stability concept. From the point of view of the present subject it is more important to emphasize that all proposals for stabilization, apart from other deficiencies, are based on the idea of money’s neutrality. They all suggest methods to undo changes in purchasing power already effected if there has been an inflation they wish to deflate to the same extent and vice versa. They do not realize that by this procedure they do not undo the social consequences of the first change, but simply add to it the social consequences of a new change. If a man has been hurt by being run over by an automobile, it is no remedy to let the car go back over him in the opposition direction.
The popularity of all schemes for stabilization invites us to a philosophical consideration. It is a general weakness of the human mind to regard the state of rest and absence of change as more perfect than the state of motion. The absolute, that old phantom of misguided philosophical speculation, is still with us; its modern name is stability. But stability, e.g., absence of change, is, we have to repeat, absence of life.
The third conclusion which we may draw is the futility of the distinction between statics and dynamics and between short-run and long-run economics. The way in which we have to study monetary changes provides us with the best evidence that every correct economic consideration has to be dynamic and that static concepts are only instrumental. And at the same time we have to realize that all correct economic theorizing is a gradual progress from short-run to long-run effects.
But the most important value of the theory of money’s dynamism is its use for the development of the monetary theory of the trade cycle. The old British Currency-Theory was already in a restricted sense a monetary explanation of the cycle. It studied the consequences of credit expansion on the assumption only that there is credit expansion in one country whereas in the rest of the world things are left unchanged. This seemed to be enough for the explanation of the business cycle in Great Britain in the first half of the nineteenth century. But the explanation of an external drain does not provide an answer to the question what may happen in a completely isolated country or in the case of a simultaneous credit expansion all over the world. But only the answer to this second question could be considered satisfactory under the conditions prevailing in the twentieth century. Only the answer to this second question is important, if we have to consider the proposals for eliminating the cyclical changes either by loosening the international ties of the national economy or by making credit expansion international in the way the Bretton Woods Agreements provide. It is the boast of the monetary theory of the trade cycle that it provides us with a satisfactory answer to these and to some other serious problems.
I do not wish to infringe more upon your time and so I wish only to add some remarks on the treatment of the problem by certain younger economists. I myself am not responsible for the term “neutral money.” I have developed a theory of the changes in purchasing power and its social consequences. I have demonstrated that money acts as a dynamic agent and that the assumption that the changes in purchasing power are inversely proportional to the changes in the relation of demand for to the supply of money is fallacious. The term “neutral money” was coined by later authors. I do not wish to consider the question of whether it was a happy choice. But in any case I must protest against the belief that it has to be a goal of monetary policy to make money neutral and that it is the duty of the economists to determine a method of doing so. I wish to emphasize that in a living and changing world, in a world of action, there is no room left for a neutral money. Money is non-neutral or it does not exist.
Economic Policy: Thoughts for Tomorrow and Today[Ludwig von Mises, Economic Policy: Thoughts for Tomorrow and Today (1979; Washington, D.C.: Regnery Gateway, 2006), Lecture 4, pp. 55–73.]“Inflation”If the supply of caviar were as plentiful as the supply of potatoes, the price of caviar — that is, the exchange ratio between caviar and money or caviar and other commodities — would change considerably. In that case, one could obtain caviar at a much smaller sacrifice than is required today. Likewise, if the quantity of money is increased, the purchasing power of the monetary unit decreases, and the quantity of goods that can be obtained for one unit of this money decreases also.
When, in the sixteenth century, American resources of gold and silver were discovered and exploited, enormous quantities of the precious metals were transported to Europe. The result of this increase in the quantity of money was a general tendency toward an upward movement of prices in Europe. In the same way, today, when a government increases the quantity of paper money, the result is that the purchasing power of the monetary unit begins to drop, and so prices rise. This is called inflation.
Unfortunately, in the United States, as well as in other countries, some people prefer to attribute the cause of inflation not to an increase in the quantity of money but, rather, to the rise in prices.
However, there has never been any serious argument against the economic interpretation of the relationship between prices and the quantity of money, or the exchange ratio between money and other goods, commodities, and services. Under present day technological conditions there is nothing easier than to manufacture pieces of paper upon which certain monetary amounts are printed. In the United States, where all the notes are of the same size, it does not cost the government more to print a bill of a thousand dollars than it does to print a bill of one dollar. It is purely a printing procedure that requires the same quantity of paper and ink.
In the eighteenth century, when the first attempts were made to issue bank notes and to give these bank notes the quality of legal tender — that is, the right to be honored in exchange transactions in the same way that gold and silver pieces were honored — the governments and nations believed that bankers had some secret knowledge enabling them to produce wealth out of nothing. When the governments of the eighteenth century were in financial difficulties, they thought all they needed was a clever banker at the head of their financial management in order to get rid of all their difficulties.
Some years before the French Revolution, when the royalty of France was in financial trouble, the king of France sought out such a clever banker, and appointed him to a high position. This man was, in every regard, the opposite of the people who, up to that time, had ruled France. First of all he was not a Frenchman, he was a foreigner — a Swiss from Geneva, Jacques Necker. Secondly, he was not a member of the aristocracy, he was a simple commoner. And what counted even more in eighteenth century France, he was not a Catholic, but a Protestant. And so Monsieur Necker, the father of the famous Madame de Staël, became the minister of finance, and everyone expected him to solve the financial problems of France. But in spite of the high degree of confidence Monsieur Necker enjoyed, the royal cashbox remained empty — Necker’s greatest mistake having been his attempt to finance aid to the American colonists in their war of independence against England without raising taxes. That was certainly the wrong way to go about solving France’s financial troubles.
There can be no secret way to the solution of the financial problems of a government; if it needs money, it has to obtain the money by taxing its citizens (or, under special conditions, by borrowing it from people who have the money). But many governments, we can even say most governments, think there is another method for getting the needed money; simply to print it.
If the government wants to do something beneficial — if, for example, it wants to build a hospital — the way to find the needed money for this project is to tax the citizens and build the hospital out of tax revenues. Then no special “price revolution” will occur, because when the government collects money for the construction of the hospital, the citizens — having paid the taxes — are forced to reduce their spending. The individual taxpayer is forced to restrict either his consumption, his investments or his savings. The government, appearing on the market as a buyer, replaces the individual citizen: the citizen buys less, but the government buys more. The government, of course, does not always buy the same goods which the citizens would have bought; but on the average there occurs no rise in prices due to the government’s construction of a hospital.
I choose this example of a hospital precisely because people sometimes say: “It makes a difference whether the government uses its money for good or for bad purposes.” I want to assume that the government always uses the money which it has printed for the best possible purposes-purposes with which we all agree. For it is not the way in which the money is spent, it is the way in which the government obtains this money that brings about those consequences we call inflation and which most people in the world today do not consider as beneficial.
For example, without inflating, the government could use the tax-collected money for hiring new employees or for raising the salaries of those who are already in government service. Then these people, whose salaries have been increased, are in a position to buy more. When the government taxes the citizens and uses this money to increase the salaries of government employees, the taxpayers have less to spend, but the government employees have more. Prices in general will not increase.
But if the government does not use tax money for this purpose, if it uses freshly printed money instead, it means that there will be people who now have more money while all other people still have as much as they had before. So those who received the newly-printed money will be competing with those people who were buyers before. And since there are no more commodities than there were previously, but there is more money on the market — and since there are now people who can buy more today than they could have bought yesterday — there will be an additional demand for that same quantity of goods. Therefore prices will tend to go up. This cannot be avoided, no matter what the use of this newly-issued money will be.
And more importantly, this tendency for prices to go up will develop step by step; it is not a general upward movement of what has been called the “price level.” The metaphorical expression “price level” must never be used.
When people talk of a “price level,” they have in mind the image of a level of a liquid which goes up or down according to the increase or decrease in its quantity, but which, like a liquid in a tank, always rises evenly. But with prices, there is no such thing as a “level.” Prices do not change to the same extent at the same time. There are always prices that are changing more rapidly, rising or falling more rapidly than other prices. There is a reason for this.
Consider the case of the government employee who received the new money added to the money supply. People do not buy today precisely the same commodities and in the same quantities as they did yesterday. The additional money which the government has printed and introduced into the market is not used for the purchase of all commodities and services. It is used for the purchase of certain commodities, the prices of which will rise, while other commodities will still remain at the prices that prevailed before the new money was put on the market. Therefore, when inflation starts, different groups within the population are affected by this inflation in different ways. Those groups who get the new money first gain a temporary benefit.
When the government inflates in order to wage a war, it has to buy munitions, and the first to get the additional money are the munitions industries and the workers within these industries. These groups are now in a very favorable position. They have higher profits and higher wages; their business is moving. Why? Because they were the first to receive the additional money. And having now more money at their disposal, they are buying. And they are buying from other people who are manufacturing and selling the commodities that these munitions makers want.
These other people form a second group. And this second group considers inflation to be very good for business. Why not? Isn’t it wonderful to sell more? For example, the owner of a restaurant in the neighborhood of a munitions factory says: “It is really marvelous! The munitions workers have more money; there are many more of them now than before; they are all patronizing my restaurant; I am very happy about it.” He does not see any reason to feel otherwise.
The situation is this: those people to whom the money comes first now have a higher income, and they can still buy many commodities and services at prices which correspond to the previous state of the market, to the condition that existed on the eve of inflation. Therefore, they are in a very favorable position. And thus inflation continues step by step, from one group of the population to another. And all those to whom the additional money comes at the early state of inflation are benefited because they are buying some things at prices still corresponding to the previous stage of the exchange ratio between money and commodities.
But there are other groups in the population to whom this additional money comes much, much later. These people are in an unfavorable position. Before the additional money comes to them they are forced to pay higher prices than they paid before for some — or for practically all — of the commodities they wanted to purchase, while their income has remained the same, or has not increased proportionately with prices.
Consider for instance a country like the United States during the Second World War; on the one hand, inflation at that time favored the munitions workers, the munitions industries, the manufacturers of guns, while on the other hand it worked against other groups of the population. And the ones who suffered the greatest disadvantages from inflation were the teachers and the ministers.
As you know, a minister is a very modest person who serves God and must not talk too much about money. Teachers, likewise, are dedicated persons who are supposed to think more about educating the young than about their salaries. Consequently, the teachers and ministers were among those who were most penalized by inflation, for the various schools and churches were the last to realize that they must raise salaries. When the church elders and the school corporations finally discovered that after all, one should also raise the salaries of those dedicated people, the earlier losses they had suffered still remained.
For a long time, they had to buy less than they did before, to cut down their consumption of better and more expensive foods, and to restrict their purchase of clothing — because prices had already adjusted upward, while their incomes, their salaries, had not yet been raised. (This situation has changed considerably today, at least for teachers.)
There are therefore always different groups in the population being affected differently by inflation. For some of them, inflation is not so bad; they even ask for a continuation of it because they are the first to profit from it. We will see, in the next lecture, how this unevenness in the consequences of inflation vitally affects the politics that lead toward inflation.
Under these changes brought about by inflation, we have groups who are favored and groups who are directly profiteering. I do not use the term “profiteering” as a reproach to these people, for if there is someone to blame, it is the government that established the inflation. And there are always people who favor inflation, because they realize what is going on sooner than other people do. Their special profits are due to the fact that there will necessarily be unevenness in the process of inflation.
The government may think that inflation — as a method of raising funds — is better than taxation, which is always unpopular and difficult. In many rich and great nations, legislators have often discussed, for months and months, the various forms of new taxes that were necessary because the parliament had decided to increase expenditures. Having discussed various methods of getting the money by taxation, they finally decided that perhaps it was better to do it by inflation.
But of course, the word “inflation” was not used. The politician in power who proceeds toward inflation does not announce: “I am proceeding toward inflation.” The technical methods employed to achieve the inflation are so complicated that the average citizen does not realize inflation has begun.
One of the biggest inflations in history was in the German Reich after the First World War. The inflation was not so momentous during the war; it was the inflation after the war that brought about the catastrophe. The government did not say: “We are proceeding toward inflation.” The government simply borrowed money very indirectly from the central bank. The government did not have to ask how the central bank would find and deliver the money. The central bank simply printed it.
Today the techniques for inflation are complicated by the fact that there is checkbook money. It involves another technique, but the result is the same. With the stroke of a pen, the government creates fiat money, thus increasing the quantity of money and credit. The government simply issues the order, and the fiat money is there.
The government does not care, at first, that some people will be losers, it does not care that prices will go up. The legislators say: “This is a wonderful system!” But this wonderful system has one fundamental weakness: it cannot last. If inflation could go on forever, there would be no point in telling governments they should not inflate. But the certain fact about inflation is that, sooner or later, it must come to an end. It is a policy that cannot last.
In the long run, inflation comes to an end with the breakdown of the currency; it comes to a catastrophe, to a situation like the one in Germany in 1923. On August 1, 1914, the value of the dollar was four marks and twenty pfennigs. Nine years and three months later, in November 1923, the dollar was pegged at 4.2 trillion marks. In other words, the mark was worth nothing. It no longer had any value.
Some years ago, a famous author, John Maynard Keynes, wrote: “In the long run we are all dead.” This is certainly true, I am sorry to say. But the question is, how short or long will the short run be? In the eighteenth century there was a famous lady, Madame de Pompadour, who is credited with the dictum: “Après nous le déluge” (“After us will come the flood”). Madame de Pompadour was happy enough to die in the short run. But her successor in office, Madame du Barry, outlived the short run and was beheaded in the long run. For many people the “long run” quickly becomes the “short run” — and the longer inflation goes on the sooner the “short run.”
How long can the short run last? How long can a central bank continue an inflation? Probably as long as people are convinced that the government, sooner or later, but certainly not too late, will stop printing money and thereby stop decreasing the value of each unit of money.
When people no longer believe this, when they realize that the government will go on and on without any intention of stopping, then they begin to understand that prices tomorrow will be higher than they are today. Then they begin buying at any price, causing prices to go up to such heights that the monetary system breaks down.
I refer to the case of Germany, which the whole world was watching. Many books have described the events of that time. (Although I am not a German, but an Austrian, I saw everything from the inside: in Austria, conditions were not very different from those in Germany; nor were they much different in many other European countries.) For several years, the German people believed that their inflation was just a temporary affair, that it would soon come to an end. They believed it for almost nine years, until the summer of 1923. Then, finally, they began to doubt. As the inflation continued, people thought it wiser to buy anything available, instead of keeping money in their pockets. Furthermore, they reasoned that one should not give loans of money, but on the contrary, that it was a very good idea to be a debtor. Thus inflation continued feeding on itself.
And it went on in Germany until exactly November 20, 1923. The masses had believed inflation money to be real money, but then they found out that conditions had changed. At the end of the German inflation, in the fall of 1923, the German factories paid their workers every morning in advance for the day. And the workingman who came to the factory with his wife, handed his wages — all the millions he got — over to her immediately. And the lady immediately went to a shop to buy something, no matter what. She realized what most people knew at that time-that overnight, from one day to another, the mark lost 50% of its purchasing power. Money, like chocolate in a hot oven, was melting in the pockets of the people. This last phase of German inflation did not last long; after a few days, the whole nightmare was over: the mark was valueless and a new currency had to be established.
Lord Keynes, the same man who said that in the long run we are all dead, was one of a long line of inflationist authors of the twentieth century. They all wrote against the gold standard. When Keynes attacked the gold standard, he called it a “barbarous relic.” And most people today consider it ridiculous to speak of a return to the gold standard. In the United States, for instance, you are considered to be more or less a dreamer if you say: “Sooner or later, the United States will have to return to the gold standard.”
Yet the gold standard has one tremendous virtue: the quantity of money under the gold standard is independent of the policies of governments and political parties. This is its advantage. It is a form of protection against spendthrift governments. If, under the gold standard, a government is asked to spend money for something new, the minister of finance can say: “And where do I get the money? Tell me, first, how I will find the money for this additional expenditure.”
Under an inflationary system, nothing is simpler for the politicians to do than to order the government printing office to provide as much money as they need for their projects. Under a gold standard, sound government has a much better chance; its leaders can say to the people and to the politicians: “We can’t do it unless we increase taxes.”
But under inflationary conditions, people acquire the habit of looking upon the government as an institution with limitless means at its disposal: the state, the government, can do anything. If, for instance, the nation wants a new highway system, the government is expected to build it. But where will the government get the money?
One could say that in the United States today — and even in the past, under McKinley — the Republican party was more or less in favor of sound money and of the gold standard, and the Democratic party was in favor of inflation, of course not a paper inflation, but a silver inflation.
It was, however, a Democratic president of the United States, President Cleveland, who at the end of the 1880s vetoed a decision of Congress, to give a small sum — about $10,000 — to help a community that had suffered some disaster. And President Cleveland justified his veto by writing: “While it is the duty of the citizens to support the government, it is not the duty of the government to support the citizens.” This is something which every statesman should write on the wall of his office to show to people who come asking for money.
I am rather embarrassed by the necessity to simplify these problems. There are so many complex problems in the monetary system, and I would not have written volumes about them if they were as simple as I am describing them here. But the fundamentals are precisely these: if you increase the quantity of money, you bring about the lowering of the purchasing power of the monetary unit. This is what people whose private affairs are unfavorably affected do not like. People who do not benefit from inflation are the ones who complain.
If inflation is bad and if people realize it, why has it become almost a way of life in all countries? Even some of the richest countries suffer from this disease. The United States today is certainly the richest country in the world, with the highest standard of living. But when you travel in the United States, you will discover that there is constant talk about inflation and about the necessity to stop it. But they only talk; they do not act.
To give you some facts: after the First World War, Great Britain returned to the prewar gold parity of the pound. That is, it revalued the pound upward. This increased the purchasing power of every worker’s wages. In an unhampered market the nominal money wage would have fallen to compensate for this and the workers’ real wage would not have suffered. We do not have time here to discuss the reasons for this. But the unions in Great Britain were unwilling to accept an adjustment of money wage rates downward as the purchasing power of the monetary unit rose. Therefore real wages were raised considerably by this monetary measure. This was a serious catastrophe for England, because Great Britain is a predominantly industrial country that has to import its raw materials, half-finished goods, and food stuffs in order to live, and has to export manufactured goods to pay for these imports. With the rise in the international value of the pound, the price of British goods rose on foreign markets and sales and exports declined. Great Britain had, in effect, priced itself out of the world market.
The unions could not be defeated. You know the power of a union today. It has the right, practically the privilege, to resort to violence. And a union order is, therefore, let us say, not less important than a government decree. The government decree is an order for the enforcement of which the enforcement apparatus of the government — the police — is ready. You must obey the government decree, otherwise you will have difficulties with the police.
Unfortunately, we have now, in almost all countries all over the world, a second power that is in a position to exercise force: the labor unions. The labor unions determine wages and then strike to enforce them in the same way in which the government might decree a minimum wage rate. I will not discuss the union question now; I shall deal with it later. I only want to establish that it is the union policy to raise wage rates above the level they would have on an unhampered market. As a result a considerable part of the potential labor force can be employed only by people or industries that are prepared to suffer losses. And, since businesses are not able to keep on suffering losses, they close their doors and people become unemployed. The setting of wage rates above the level they would have on the unhampered market always results in the unemployment of a considerable part of the potential labor force.
In Great Britain, the result of high wage rates enforced by the labor unions was lasting unemployment, prolonged year after year. Millions of workers were unemployed, production figures dropped. Even experts were perplexed. In this situation the British government made a move which it considered an indispensable, emergency measure: it devalued its currency.
The result was that the purchasing power of the money wages, upon which the unions had insisted, was no longer the same. The real wages, the commodity wages, were reduced. Now the worker could not buy as much as he had been able to buy before, even though the nominal wage rates remained the same. In this way, it was thought, real wage rates would return to free market levels and unemployment would disappear.
This measure — devaluation — was adopted by various other countries, by France, the Netherlands, and Belgium. One country even resorted twice to this measure within a period of one year and a half. That country was Czechoslovakia. It was a surreptitious method, let us say, to thwart the power of the unions. You could not call it a real success, however.
After a few years, the people, the workers, even the unions, began to understand what was going on. They came to realize that currency devaluation had reduced their real wages. The unions had the power to oppose this. In many countries they inserted a clause into wage contracts providing that money wages must go up automatically with an increase in prices. This is called indexing. The unions became index conscious. So, this method of reducing unemployment that the government of Great Britain started in 1931 — which was later adopted by almost all important governments — this method of “solving unemployment” no longer works today.
In 1936, in his General Theory of Employment, Interest and Money, Lord Keynes unfortunately elevated this method — the emergency measures of the period between 1929 and 1933 — to a principle, to a fundamental system of policy. And he justified it by saying, in effect: “Unemployment is bad. If you want unemployment to disappear you must inflate the currency.”
He realized very well that wage rates can be too high for the market, that is, too high to make it profitable for an employer to increase his work force, thus too high from the point of view of the total working population, for with wage rates imposed by unions above the market only a part of those anxious to earn wages can obtain jobs.
And Keynes said, in effect: “Certainly mass unemployment prolonged year after year, is a very unsatisfactory condition.” But instead of suggesting that wage rates could and should be adjusted to market conditions, he said, in effect: “If one devalues the currency and the workers are not clever enough to realize it, they will not offer resistance against a drop in real wage rates, as long as nominal wage rates remain the same.” In other words, Lord Keynes was saying that if a man gets the same amount of sterling today as he got before the currency was devalued, he will not realize that he is, in fact, now getting less.
In old fashioned language, Keynes proposed cheating the workers. Instead of declaring openly that wage rates must be adjusted to the conditions of the market — because, if they are not, a part of the labor force will inevitably remain unemployed — he said, in effect: “Full employment can be reached only if you have inflation. Cheat the workers.” The most interesting fact, however, is that when his General Theory was published, it was no longer possible to cheat, because people had already become index conscious. But the goal of full employment remained.
What does “full employment” mean? It has to do with the unhampered labor market, which is not manipulated by the unions or by the government. On this market, wage rates for every type of labor tend to reach a point at which everybody who wants a job can get one and every employer can hire as many workers as he needs. If there is an increase in the demand for labor, the wage rate will tend to be greater, and if fewer workers are needed, the wage rate will tend to fall.
The only method by which a “full employment” situation can be brought about is by the maintenance of an unhampered labor market. This is valid for every kind of labor and for every kind of commodity.
What does a businessman do who wants to sell a commodity for five dollars a unit? When he cannot sell it at that price, the technical business expression in the United States is, “the inventory does not move.” But it must move. He cannot retain things because he must buy something new; fashions are changing. So he sells at a lower price. If he cannot sell the merchandise at five dollars, he must sell it at four. If he cannot sell it at four, he must sell it at three. There is no other choice as long as he stays in business. He may suffer losses, but these losses are due to the fact that his anticipation of the market for his product was wrong.
It is the same with the thousands and thousands of young people who come every day from the agricultural districts into the city trying to earn money. It happens so in every industrial nation. In the United States they come to town with the idea that they should get, say, a hundred dollars a week. This may be impossible. So if a man cannot get a job for a hundred dollars a week, he must try to get a job for ninety or eighty dollars, and perhaps even less. But if he were to say — as the unions do — “one hundred dollars a week or nothing,” then he might have to remain unemployed. (Many do not mind being unemployed, because the government pays unemployment benefits — out of special taxes levied on the employers — which are sometimes nearly as high as the wages the man would receive if he were employed.)
Because a certain group of people believes that full employment can be attained only by inflation, inflation is accepted in the United States. But people are discussing the question: Should we have a sound currency with unemployment, or inflation with full employment? This is in fact a very vicious analysis.
To deal with this problem we must raise the question: How can one improve the condition of the workers and of all other groups of the population? The answer is: by maintaining an unhampered labor market and thus achieving full employment. Our dilemma is, shall the market determine wage rates or shall they be determined by union pressure and compulsion? The dilemma is not “shall we have inflation or unemployment?”
This mistaken analysis of the problem is argued in England, in European industrial countries and even in the United States. And some people say: “Now look, even the United States is inflating. Why should we not do it also.”
To these people one should answer first of all: “One of the privileges of a rich man is that he can afford to be foolish much longer than a poor man.” And this is the situation of the United States. The financial policy of the United States is very bad and is getting worse. Perhaps the United States can afford to be foolish a bit longer than some other countries.
The most important thing to remember is that inflation is not an act of God; inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy — a deliberate policy of people who resort to inflation because they consider it to be a lesser evil than unemployment. But the fact is that, in the not very long run, inflation does not cure unemployment.
Inflation is a policy. And a policy can be changed. Therefore, there is no reason to give in to inflation. If one regards inflation as an evil, then one has to stop inflating. One has to balance the budget of the government. Of course, public opinion must support this; the intellectuals must help the people to understand. Given the support of public opinion, it is certainly possible for the people’s elected representatives to abandon the policy of inflation.
We must remember that, in the long run, we may all be dead and certainly will be dead. But we should arrange our earthly affairs, for the short run in which we have to live, in the best possible way. And one of the measures necessary for this purpose is to abandon inflationary policies.
Economic Calculation in the Socialist Commonwealth[Ludwig von Mises, Economic Calculation in the Socialist Commonwealth (1920; Auburn, Ala.: Mises Institute, 1990), pp. 10–26.]2. The Nature of Economic CalculationEvery man who, in the course of economic life, takes a choice between the satisfaction of one need as against another, eo ipso makes a judgment of value. Such judgments of value at once include only the very satisfaction of the need itself; and from this they reflect back upon the goods of a lower, and then further upon goods of a higher order. As a rule, the man who knows his own mind is in a position to value goods of a lower order. Under simple conditions it is also possible for him without much ado to form some judgment of the significance to him of goods of a higher order. But where the state of affairs is more involved and their interconnections not so easily discernible, subtler means must be employed to accomplish a correctUsing that term, of course, in the sense only of the valuating subject, and not in an objective and universally applicable sense. valuation of the means of production. It would not be difficult for a farmer in economic isolation to come by a distinction between the expansion of pasture-farming and the development of activity in the hunting field. In such a case the processes of production involved are relatively short and the expense and income entailed can be easily gauged. But it is quite a different matter when the choice lies between the utilization of a water-course for the manufacture of electricity or the extension of a coal mine or the drawing up of plans for the better employment of the energies latent in raw coal. Here the roundabout processes of production are many and each is very lengthy; here the conditions necessary for the success of the enterprises which are to be initiated are diverse, so that one cannot apply merely vague valuations, but requires rather more exact estimates and some judgment of the economic issues actually involved.
Valuation can only take place in terms of units, yet it is impossible that there should ever be a unit of subjective use value for goods. Marginal utility does not posit any unit of value, since it is obvious that the value of two units of a given stock is necessarily greater than, but less than double, the value of a single unit. Judgments of value do not measure; they merely establish grades and scales.Franz Cuhel, Zur Lehre von den Bedürfnissen (Innsbruck: Wagner’sche Universität-Buchhandlung, 1907), pp. 198 f. Even Robinson Crusoe, when he has to make a decision where no ready judgment of value appears and where he has to construct one upon the basis of a more or less exact estimate, cannot operate solely with subjective use value, but must take into consideration the intersubstitutability of goods on the basis of which he can then form his estimates. In such circumstances it will be impossible for him to refer all things back to one unit. Rather will he, so far as he can, refer all the elements which have to be taken into account in forming his estimate to those economic goods which can be apprehended by an obvious judgment of value — that is to say, to goods of a lower order and to pain-cost. That this is only possible in very simple conditions is obvious. In the case of more complicated and more lengthy processes of production it will, plainly, not answer.
In an exchange economy the objective exchange value of commodities enters as the unit of economic calculation. This entails a threefold advantage. In the first place, it renders it possible to base the calculation upon the valuations of all participants in trade. The subjective use value of each is not immediately comparable as a purely individual phenomenon with the subjective use value of other men. It only becomes so in exchange value, which arises out of the interplay of the subjective valuations of all who take part in exchange. But in that case calculation by exchange value furnishes a control over the appropriate employment of goods. Anyone who wishes to make calculations in regard to a complicated process of production will immediately notice whether he has worked more economically than others or not; if he finds, from reference to the exchange relations obtaining in the market, that he will not be able to produce profitably, this shows that others understand how to make a better use of the goods of higher order in question. Lastly, calculation by exchange value makes it possible to refer values back to a unit. For this purpose, since goods are mutually substitutable in accordance with the exchange relations obtaining in the market, any possible good can be chosen. In a monetary economy it is money that is so chosen.
Monetary calculation has its limits. Money is no yardstick of value, nor yet of price. Value is not indeed measured in money, nor is price. They merely consist in money. Money as an economic good is not of stable value as has been naïvely, but wrongly, assumed in using it as a “standard of deferred payments.” The exchange-relationship which obtains between money and goods is subjected to constant, if (as a rule) not too violent, fluctuations originating not only from the side of other economic goods, but also from the side of money. However, these fluctuations disturb value calculations only in the slightest degree, since usually, in view of the ceaseless alternations in other economic data — these calculations will refer only to comparatively short periods of time — periods in which “good” money, at least normally, undergoes comparatively trivial fluctuations in regard to its exchange relations. The inadequacy of the monetary calculation of value does not have its mainspring in the fact that value is then calculated in terms of a universal medium of exchange, namely money, but rather in the fact that in this system it is exchange value and not subjective use value on which the calculation is based. It can never obtain as a measure for the calculation of those value determining elements which stand outside the domain of exchange transactions. If, for example, a man were to calculate the profitability of erecting a waterworks, he would not be able to include in his calculation the beauty of the waterfall which the scheme might impair, except that he may pay attention to the diminution of tourist traffic or similar changes, which may be valued in terms of money. Yet these considerations might well prove one of the factors in deciding whether or not the building is to go up at all.
It is customary to term such elements “extra-economic.” This perhaps is appropriate; we are not concerned with disputes over terminology; yet the considerations themselves can scarcely be termed irrational. In any place where men regard as significant the beauty of a neighborhood or of a building, the health, happiness and contentment of mankind, the honor of individuals or nations, they are just as much motive forces of rational conduct as are economic factors in the proper sense of the word, even where they are not substitutable against each other on the market and therefore do not enter into exchange relationships.
That monetary calculation cannot embrace these factors lies in its very nature; but for the purposes of our everyday economic life this does not detract from the significance of monetary calculation. For all those ideal goods are goods of a lower order, and can hence be embraced straightway within the ambit of our judgment of values. There is therefore no difficulty in taking them into account, even though they must remain outside the sphere of monetary value. That they do not admit of such computation renders their consideration in the affairs of life easier and not harder. Once we see clearly how highly we value beauty, health, honor and pride, surely nothing can prevent us from paying a corresponding regard to them. It may seem painful to any sensitive spirit to have to balance spiritual goods against material. But that is not the fault of monetary calculation; it lies in the very nature of things themselves. Even where judgments of value can be established directly without computation in value or in money, the necessity of choosing between material and spiritual satisfaction cannot be evaded. Robinson Crusoe and the socialist state have an equal obligation to make the choice.
Anyone with a genuine sense of moral values experiences no hardship in deciding between honor and livelihood. He knows his plain duty. If a man cannot make honor his bread, yet can he renounce his bread for honor’s sake. Only they who prefer to be relieved of the agony of this decision, because they cannot bring themselves to renounce material comfort for the sake of spiritual advantage, see in the choice a profanation of true values.
Monetary calculation only has meaning within the sphere of economic organization. It is a system whereby the rules of economics may be applied in the disposition of economic goods. Economic goods only have part in this system in proportion to the extent to which they may be exchanged for money. Any extension of the sphere of monetary calculation causes misunderstanding. It cannot be regarded as constituting a kind of yardstick for the valuation of goods, and cannot be so treated in historical investigations into the development of social relationships; it cannot be used as a criterion of national wealth and income, nor as a means of gauging the value of goods which stand outside the sphere of exchange, as who should seek to estimate the extent of human losses through emigrations or wars in terms of money?Cf. Friedrich von Wieser, Über den Ursprung und die Hauptgesetze des wirtschaftlichen Eertes (Vienna: A. Hölder, 1884), pp. 185 f. This is mere sciolistic tomfoolery, however much it may be indulged in by otherwise perspicacious economists.
Nevertheless within these limits, which in economic life it never oversteps, monetary calculation fulfils all the requirements of economic calculation. It affords us a guide through the oppressive plenitude of economic potentialities. It enables us to extend to all goods of a higher order the judgment of value, which is bound up with and clearly evident in, the case of goods ready for consumption, or at best of production goods of the lowest order. It renders their value capable of computation and thereby gives us the primary basis for all economic operations with goods of a higher order. Without it, all production involving processes stretching well back in time and all the longer roundabout processes of capitalistic production would be gropings in the dark.
There are two conditions governing the possibility of calculating value in terms of money. Firstly, not only must goods of a lower, but also those of a higher order, come within the ambit of exchange, if they are to be included. If they do not do so, exchange relationships would not arise. True enough, the considerations which must obtain in the case of Robinson Crusoe prepared, within the range of his own hearth, to exchange, by production, labor and flour for bread, are indistinguishable from those which obtain when he is prepared to exchange bread for clothes in the open market, and, therefore, it is to some extent true to say that every economic action, including Robinson Crusoe’s own production, can be termed exchange.Cf. [Ludwig von] Mises, Theorie des Geldes und der Umlaufsmittel (Munich and Leipzig: Duncker & Humblot, 1912), p. 16, with the references there given. [See the English translation by H.E. Batson, The Theory of Money and Credit (Indianapolis: Liberty Classics, 1980), p. 52.] Moreover, the mind of one man alone — be it ever so cunning, is too weak to grasp the importance of any single one among the countlessly many goods of a higher order. No single man can ever master all the possibilities of production, innumerable as they are, as to be in a position to make straightway evident judgments of value without the aid of some system of computation. The distribution among a number of individuals of administrative control over economic goods in a community of men who take part in the labor of producing them, and who are economically interested in them, entails a kind of intellectual division of labor, which would not be possible without some system of calculating production and without economy.
The second condition is that there exists in fact a universally employed medium of exchange — namely, money — which plays the same part as a medium in the exchange of production goods also. If this were not the case, it would not be possible to reduce all exchange-relationships to a common denominator.
Only under simple conditions can economics dispense with monetary calculation. Within the narrow confines of household economy, for instance, where the father can supervise the entire economic management, it is possible to determine the significance of changes in the processes of production, without such aids to the mind, and yet with more or less of accuracy. In such a case the process develops under a relatively limited use of capital. Few of the capitalistic roundabout processes of production are here introduced: what is manufactured is, as a rule, consumption goods or at least such goods of a higher order as stand very near to consumption-goods. The division of labor is in its rudimentary stages: one and the same laborer controls the labor of what is in effect, a complete process of production of goods ready for consumption, from beginning to end. All this is different, however, in developed communal production. The experiences of a remote and bygone period of simple production do not provide any sort of argument for establishing the possibility of an economic system without monetary calculation.
In the narrow confines of a closed household economy, it is possible throughout to review the process of production from beginning to end, and to judge all the time whether one or another mode of procedure yields more consumable goods. This, however, is no longer possible in the incomparably more involved circumstances of our own social economy. It will be evident, even in the socialist society, that 1,000 hectolitres of wine are better than 800, and it is not difficult to decide whether it desires 1,000 hectolitres of wine rather than 500 of oil. There is no need for any system of calculation to establish this fact: the deciding element is the will of the economic subjects involved. But once this decision has been taken, the real task of rational economic direction only commences, i.e., economically, to place the means at the service of the end. That can only be done with some kind of economic calculation. The human mind cannot orientate itself properly among the bewildering mass of intermediate products and potentialities of production without such aid. It would simply stand perplexed before the problems of management and location.Friedrich von Gottl-Ottlilienfeld, Wirtschaft und technik (Grundriss der Sozialökonomik, Section 2; Tübingen: J.C.B. Mohr, 1914), p. 216.
It is an illusion to imagine that in a socialist state calculation in natura can take the place of monetary calculation. Calculation in natura, in an economy without exchange, can embrace consumption goods only; it completely fails when it comes to dealing with goods of a higher order. And as soon as one gives up the conception of a freely established monetary price for goods of a higher order, rational production becomes completely impossible. Every step that takes us away from private ownership of the means of production and from the use of money also takes us away from rational economics.
It is easy to overlook this fact, considering that the extent to which socialism is in evidence among us constitutes only a socialistic oasis in a society with monetary exchange, which is still a free society to a certain degree. In one sense we may agree with the socialists’ assertion which is otherwise entirely untenable and advanced only as a demagogic point, to the effect that the nationalization and municipalization of enterprise is not really socialism, since these concerns in their business organizations are so much dependent upon the environing economic system with its free commerce that they cannot be said to partake today of the really essential nature of a socialist economy. In state and municipal undertakings technical improvements are introduced because their effect in similar private enterprises, domestic or foreign, can be noticed, and because those private industries which produce the materials for these improvements give the impulse for their introduction. In these concerns the advantages of reorganization can be established, because they operate within the sphere of a society based upon private ownership of the means of production and upon the system of monetary exchange, being thus capable of computation and account. This state of affairs, however, could not obtain in the case of socialist concerns operating in a purely socialistic environment.
Without economic calculation there can be no economy. Hence, in a socialist state wherein the pursuit of economic calculation is impossible, there can be — in our sense of the term — no economy whatsoever. In trivial and secondary matters rational conduct might still be possible, but in general it would be impossible to speak of rational production any more. There would be no means of determining what was rational, and hence it is obvious that production could never be directed by economic considerations. What this means is clear enough, apart from its effects on the supply of commodities. Rational conduct would be divorced from the very ground which is its proper domain. Would there, in fact, be any such thing as rational conduct at all, or, indeed, such a thing as rationality and logic in thought itself? Historically, human rationality is a development of economic life. Could it then obtain when divorced therefrom?
For a time the remembrance of the experiences gained in a competitive economy, which has obtained for some thousands of years, may provide a check to the complete collapse of the art of economy. The older methods of procedure might be retained not because of their rationality but because they appear to be hallowed by tradition. Actually, they would meanwhile have become irrational, as no longer comporting with the new conditions. Eventually, through the general reconstruction of economic thought, they will experience alterations which will render them in fact uneconomic. The supply of goods will no longer proceed anarchically of its own accord; that is true. All transactions which serve the purpose of meeting requirements will be subject to the control of a supreme authority. Yet in place of the economy of the “anarchic” method of production, recourse will be had to the senseless output of an absurd apparatus. The wheels will turn, but will run to no effect.
One may anticipate the nature of the future socialist society. There will be hundreds and thousands of factories in operation. Very few of these will be producing wares ready for use; in the majority of cases what will be manufactured will be unfinished goods and production goods. All these concerns will be interrelated. Every good will go through a whole series of stages before it is ready for use. In the ceaseless toil and moil of this process, however, the administration will be without any means of testing their bearings. It will never be able to determine whether a given good has not been kept for a superfluous length of time in the necessary processes of production, or whether work and material have not been wasted in its completion. How will it be able to decide whether this or that method of production is the more profitable? At best it will only be able to compare the quality and quantity of the consumable end product produced, but will in the rarest cases be in a position to compare the expenses entailed in production. It will know, or think it knows, the ends to be achieved by economic organization, and will have to regulate its activities accordingly, i.e., it will have to attain those ends with the least expense. It will have to make its computations with a view to finding the cheapest way. This computation will naturally have to be a value computation. It is eminently clear, and requires no further proof, that it cannot be of a technical character, and that it cannot be based upon the objective use value of goods and services.
Now, in the economic system of private ownership of the means of production, the system of computation by value is necessarily employed by each independent member of society. Everybody participates in its emergence in a double way: on the one hand as a consumer and on the other as a producer. As a consumer he establishes a scale of valuation for goods ready for use in consumption. As a producer he puts goods of a higher order into such use as produces the greatest return. In this way all goods of a higher order receive a position in the scale of valuations in accordance with the immediate state of social conditions of production and of social needs. Through the interplay of these two processes of valuation, means will be afforded for governing both consumption and production by the economic principle throughout. Every graded system of pricing proceeds from the fact that men always and ever harmonized their own requirements with their estimation of economic facts.
All this is necessarily absent from a socialist state. The administration may know exactly what goods are most urgently needed. But in so doing, it has only found what is, in fact, but one of the two necessary prerequisites for economic calculation. In the nature of the case it must, however, dispense with the other — the valuation of the means of production. It may establish the value attained by the totality of the means of production; this is obviously identical with that of all the needs thereby satisfied. It may also be able to calculate the value of any means of production by calculating the consequence of its withdrawal in relation to the satisfaction of needs. Yet it cannot reduce this value to the uniform expression of a money price, as can a competitive economy, wherein all prices can be referred back to a common expression in terms of money. In a socialist commonwealth which, whilst it need not of necessity dispense with money altogether, yet finds it impossible to use money as an expression of the price of the factors of production (including labor), money can play no role in economic calculation.This fact is also recognized by Otto Neurath (Durch die Kriegswirtschaft zur Naturalwirtschaft [Munich: G.D.W. Callwey, 1919], pp. 216 f.). He advances the view that every complete administrative economy is, in the final analysis, a natural economy. “Socialization,” he says, “is thus the pursuit of natural economy.” Neurath merely overlooks the insuperable difficulties that would have to develop with economic calculation in the socialist commonwealth.
Picture the building of a new railroad. Should it be built at all, and if so, which out of a number of conceivable roads should be built? In a competitive and monetary economy, this question would be answered by monetary calculation. The new road will render less expensive the transport of some goods, and it may be possible to calculate whether this reduction of expense transcends that involved in the building and upkeep of the next line. That can only be calculated in money. It is not possible to attain the desired end merely by counterbalancing the various physical expenses and physical savings. Where one cannot express hours of labor, iron, coal, all kinds of building material, machines and other things necessary for the construction and upkeep of the railroad in a common unit it is not possible to make calculations at all. The drawing up of bills on an economic basis is only possible where all the goods concerned can be referred back to money. Admittedly, monetary calculation has its inconveniences and serious defects, but we have certainly nothing better to put in its place, and for the practical purposes of life monetary calculation as it exists under a sound monetary system always suffices. Were we to dispense with it, any economic system of calculation would become absolutely impossible.
The socialist society would know how to look after itself. It would issue an edict and decide for or against the projected building. Yet this decision would depend at best upon vague estimates; it would never be based upon the foundation of an exact calculation of value.
The static state can dispense with economic calculation. For here the same events in economic life are ever recurring; and if we assume that the first disposition of the static socialist economy follows on the basis of the final state of the competitive economy, we might at all events conceive of a socialist production system which is rationally controlled from an economic point of view. But this is only conceptually possible. For the moment, we leave aside the fact that a static state is impossible in real life, as our economic data are forever changing, so that the static nature of economic activity is only a theoretical assumption corresponding to no real state of affairs, however necessary it may be for our thinking and for the perfection of our knowledge of economics. Even so, we must assume that the transition to socialism must, as a consequence of the levelling out of the differences in income and the resultant readjustments in consumption, and therefore production, change all economic data in such a way that a connecting link with the final state of affairs in the previously existing competitive economy becomes impossible. But then we have the spectacle of a socialist economic order floundering in the ocean of possible and conceivable economic combinations without the compass of economic calculation.
Thus in the socialist commonwealth every economic change becomes an undertaking whose success can be neither appraised in advance nor later retrospectively determined. There is only groping in the dark. Socialism is the abolition of rational economy.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 13: “Monetary Calculation as a Tool of Action,” pp. 230–32.]1. Monetary Calculation as a Method of ThinkingMonetary calculation is the guiding star of action under the social system of division of labor. It is the compass of the man embarking upon production. He calculates in order to distinguish the remunerative lines of production from the unprofitable ones, those of which the sovereign consumers are likely to approve from those of which they are likely to disapprove. Every single step of entrepreneurial activities is subject to scrutiny by monetary calculation. The premeditation of planned action becomes commercial precalculation of expected costs and expected proceeds. The retrospective establishment of the outcome of past action becomes accounting of profit and loss.
The system of economic calculation in monetary terms is conditioned by certain social institutions. It can operate only in an institutional setting of the division of labor and private ownership of the means of production in which goods and services of all orders are bought and sold against a generally used medium of exchange, i.e., money.
Monetary calculation is the method of calculating employed by people acting within the frame of society based on private control of the means of production. It is a device of acting individuals; it is a mode of computation designed for ascertaining private wealth and income and private profits and losses of individuals acting on their own behalf within a free enterprise society.In partnerships and corporations it is always individuals who act, although not only one individual. All its results refer to the actions of individuals only. When statisticians summarize these results, the outcome shows the sum of the autonomous actions of a plurality of self-directing individuals, but not the effect of the action of a collective body, of a whole, or of a totality. Monetary calculation is entirely inapplicable and useless for any consideration which does not look at things from the point of view of individuals. It involves calculating the individuals’ profits, not imaginary “social” values and “social” welfare.
Monetary calculation is the main vehicle of planning and acting in the social setting of a society of free enterprise directed and controlled by the market and its prices. It developed in this frame and was gradually perfected with the improvement of the market mechanism and with the expansion of the scope of things which are negotiated on markets against money. It was economic calculation that assigned to measurement, number, and reckoning the role they play in our quantitative and computing civilization. The measurements of physics and chemistry make sense for practical action only because there is economic calculation. It is monetary calculation that made arithmetic a tool in the struggle for a better life. It provides a mode of using the achievements of laboratory experiments for the most efficacious removal of uneasiness.
Monetary calculation reaches its full perfection in capital accounting. It establishes the money prices of the available means and confronts this total with the changes brought about by action and by the operation of other factors. This confrontation shows what changes occurred in the state of the acting men’s affairs, and the magnitude of those changes; it makes success and failure, profit and loss ascertainable. The system of free enterprise has been dubbed capitalism in order to deprecate and to smear it. However, this term can be considered very pertinent. It refers to the most characteristic feature of the system, its main eminence, viz. the role the notion of capital plays in its conduct.
There are people to whom monetary calculation is repulsive. They do not want to be roused from their daydreams by the voice of critical reason. Reality sickens them, they long for a realm of unlimited opportunity. They are disgusted by the meanness of a social order in which everything is nicely reckoned in dollars and pennies. They call their grumbling the noble deportment worthy of the friends of the spirit, of beauty, and virtue as opposed to the ignoble baseness and villainy of Babbittry. However, the cult of beauty and virtue, wisdom and the search for truth are not hindered by the rationality of the calculating and computing mind. It is only romantic reverie that cannot thrive in a milieu of sober criticism. The cool-headed reckoner is the stern chastiser of the ecstatic visionary.
Our civilization is inseparably linked with our methods of economic calculation. It would perish if we were to abandon this most precious intellectual tool of acting. Goethe was right in calling bookkeeping by double entry “one of the finest inventions of the human mind.”Cf. [Johann Wolfgang von] Goethe, Wilhelm Meister’s Apprenticeship (1795), Bk. 1, chap. 10.
- Economic Calculation and the Science of Human ActionThe evolution of capitalist economic calculation was the necessary condition for the establishment of a systematic and logically coherent science of human action. Praxeology and economics have a definite place in the evolution of human history and in the process of scientific research. They could only emerge when acting man had succeeded in creating methods of thinking that made it possible to calculate his actions. The science of human action was at the beginning merely a discipline dealing with those actions which can be tested by monetary calculation. It dealt exclusively with what we may call the orbit of economics in the narrower sense, that is, with those actions which within a market society are transacted by the intermediary of money. The first steps on the way to its elaboration were odd investigations concerning currency, moneylending, and the prices of various goods. The knowledge conveyed by Gresham’s Law, the first crude formulations of the quantity theory of money — such as those of Bodin and Davanzati — and the Law of Gregory King mark the first dawn of the cognition that regularity of phenomena and inevitable necessity prevail in the field of action. The first comprehensive system of economic theory, that brilliant achievement of the classical economists, was essentially a theory of calculated action. It drew implicitly the borderline between what is to be considered economic and what extra-economic along the line which separates action calculated in monetary terms from other action. Starting from this basis the economists were bound to widen step by step the field of their studies until they finally developed a system dealing with all human choices, a general theory of action.
Epistemological Problems of Economics[Ludwig von Mises, Epistemological Problems of Economics, 3rd ed. (1933; Auburn, Ala.: Mises Institute, 2003), chap. 1, sec. 2: “The Scope and Meaning of the System of A Priori Theorems,” pp. 24–27, 33–37.]1. The Basic Concept of Action and its Categorial ConditionsThe starting point of our reasoning is not behavior, but action, or, as it is redundantly designated, rational action. Human action is conscious behavior on the part of a human being. Conceptually it can be sharply and clearly distinguished from unconscious activity, even though in some cases it is perhaps not easy to determine whether given behavior is to be assigned to one or the other category.
As thinking and acting men, we grasp the concept of action. In grasping this concept we simultaneously grasp the closely correlated concepts of value, wealth, exchange, price, and cost. They are all necessarily implied in the concept of action, and together with them the concepts of valuing, scale of value and importance, scarcity and abundance, advantage and disadvantage, success, profit, and loss. The logical unfolding of all these concepts and categories in systematic derivation from the fundamental category of action and the demonstration of the necessary relations among them constitutes the first task of our science. The part that deals with the elementary theory of value and price serves as the starting point in its exposition. There can be no doubt whatever concerning the aprioristic character of these disciplines.
The most general prerequisite of action is a state of dissatisfaction, on the one hand, and, on the other, the possibility of removing or alleviating it by taking action. (Perfect satisfaction and its concomitant, the absence of any stimulus to change and action, belong properly to the concept of a perfect being. This, however, is beyond the power of the human mind to conceive. A perfect being would not act.) Only this most general condition is necessarily implied in the concept of action. The other categorial conditions of action are independent of the basic concept; they are not necessary prerequisites of concrete action. Whether or not they are present in a particular case can be shown by experience only. But where they are present, the action necessarily falls under definite laws that flow from the categorial determinacy of these further conditions.
It is an empirical fact that man grows old and dies and that therefore he cannot be indifferent to the passage of time. That this has been man’s experience thus far without exception, that we do not have the slightest evidence to the contrary, and that scarcely any other experience points more obviously to its foundation in a law of nature — all this in no way changes its empirical character. The fact that the passage of time is one of the conditions under which action takes place is established empirically and not a priori. We can without contradiction conceive of action on the part of immortal beings who would never age. But in so far as we take into consideration the action of men who are not indifferent to the passage of time and who therefore economize time because it is important to them whether they attain a desired end sooner or later, we must attribute to their action everything that necessarily follows from the categorial nature of time. The empirical character of our knowledge that the passage of time is a condition of any given action in no way affects the aprioristic character of the conclusions that necessarily follow from the introduction of the category of time. Whatever follows necessarily from empirical knowledge — e.g., the propositions of the agio theory of interest — lies outside the scope of empiricism.
Whether the exchange of economic goods (in the broadest sense, which also includes services) occurs directly, as in barter, or indirectly, through a medium of exchange, can be established only empirically. However, where and in so far as media of exchange are employed, all the propositions that are essentially valid with regard to indirect exchange must hold true. Everything asserted by the quantity theory of money, the theory of the relation between the quantity of money and interest, the theory of fiduciary media, and the circulation-credit theory of the business cycle, then becomes inseparably connected with action. All these theorems would still be meaningful even if there had never been any indirect exchange; only their practical significance for our action and for the science that explains it would then have to be appraised differently. However, the heuristic importance of experience for the analysis of action is not to be disregarded. Perhaps if there had never been indirect exchange, we would not have been able to conceive of it as a possible form of action and to study it in all its ramifications. But this in no way alters the aprioristic character of our science.
These considerations enable us to assess critically the thesis that all or most of the doctrines of economics hold only for a limited period of history and that, consequently, theorems whose validity is thus limited historically or geographically should replace, or at least supplement, those of the universally valid theory. All the propositions established by the universally valid theory hold to the extent that the conditions that they presuppose and precisely delimit are given. Where these conditions are present, the propositions hold without exception. This means that these propositions concern action as such; that is, that they presuppose only the existence of a state of dissatisfaction, on the one hand, and the recognized possibility, on the other, of relieving this dissatisfaction by conscious behavior, and that, therefore, the elementary laws of value are valid without exception for all human action. When an isolated person acts, his action occurs in accordance with the laws of value. Where, in addition, goods of higher order are introduced into action, all the laws of the theory of imputation are valid. Where indirect exchange takes place, all the laws of monetary theory are valid. Where fiduciary media are created, all the laws of the theory of fiduciary media (the theory of credit) are valid. There would be no point in expressing this fact by saying that the doctrines of the theory of money are true only in those periods of history in which indirect exchange takes place. ...
- The Distinction Between Means and Ends: The “Irrational”Most of the objections raised against the science of action stem from a misconception of the distinction between means and ends. In the strict sense, the end is always the removal of a dissatisfaction. However, we can doubtless also designate as an end the attainment of that condition of the external world which brings about our state of satisfaction either directly or indirectly, or which enables us to perform, without further difficulties, the act through which satisfaction is to be obtained. If the removal of the feeling of hunger is the end sought, the procuring of food and its preparation for eating can also be considered as ends; if one seeks the removal of the feeling of cold as an end, the heating of one’s quarters can just as well be called an end. If additional measures are needed for the removal of dissatisfaction, then the attainment of any particular step along the way toward the desired final condition is also designated as an end. In this sense the acquisition of money in the market economy and, proximately, the division of labor are designated as ends of action; in this sense too the attainment of all things that indirectly promote the end of want-satisfaction appear as proximate or intermediate ends.
In the course of attaining the primary end, secondary ends are attained. A man walks from A to B. He would choose the shortest route if other, secondary ends did not demand satisfaction. He makes a detour if he can walk in the shade a little longer; if he can include in his walk another place, C, which he wants to look for; if, by doing so, he can avoid dangers that may be lying in wait for him on the shortest route; or if he just happens to like the longer route. If he decides on a detour, we must infer that at the moment of decision the attainment of such secondary ends was of greater importance in his judgment than the saving of distance. Consequently, for him the “detour” was no detour at all, since his walk brought him greater satisfaction or — at least from the point of view that he took of his situation at the moment of decision — was expected to bring greater satisfaction than the attainment of his destination by the shorter route. Only one who does not have these secondary ends in mind can call the longer way a detour. As far as our stroller was concerned, it was the correct route, that is, the route that promised the greatest satisfactions.Cf. Lionel Robbins, An Essay on the Nature and Significance of Economic Science (London, 1932), p. 23.
Since satisfaction and dissatisfaction depend only on the subjective view of the individual, there is no room for argument on this question in a science that does not presume to establish a scale of values or to make judgments of value. Its conception of an end, in the strict sense, is more deductive than empirical: ends are determined by the wishes and the desires of the individual. Whenever reference is made to the greater or lesser appropriateness of means, this can only be from the point of view of the acting individual.
We must next deal with the objection of those who never weary of asserting that man does not act rationally at all. It has never been disputed that man does not always act correctly from the objective point of view; that is, that either from ignorance of causal relations or because of an erroneous judgment of the given situation, in order to realize his ends he acts differently from the way in which he would act if he had correct information. In 1833 the method of healing wounds was different from that used in 1933, and in 2033 still another way will presumably be thought suitable. Statesmen, field marshals, and stock-market speculators act differently at present from the way in which they would act if they knew exactly all the data needed for an accurate judgment of conditions. Only a perfect being, whose omniscience and omnipresence would enable him to survey all the data and every causal relationship, could know how each erring human being would have to act at every moment if he wanted to possess the divine attribute of omniscience. If we were to attempt to distinguish rational action from irrational action, we should not only be setting ourselves up as a judge over the scales of value of our fellow men, but we should also be declaring our own knowledge to be the only correct, objective standard of knowledge. We should be arrogating to ourselves the position that only an all-knowing being has the power to occupy.
The assertion that there is irrational action is always rooted in an evaluation of a scale of values different from our own. Whoever says that irrationality plays a role in human action is merely saying, that his fellow men behave in a way that he does not consider correct. If we do not wish to pass judgment on the ends and the scales of value of other people and to claim omniscience for ourselves, the statement, “He acts irrationally,” is meaningless, because it is not compatible with the concept of action. The “seeking to attain an end” and the “striving after a goal” cannot be eliminated from the concept of action. Whatever does not strive after goals or seek the attainment of ends reacts with absolute passivity to an external stimulus and is without a will of its own, like an automaton or a stone. To be sure, man too is as far outside the effective range of his action as a reed in the wind. But in so far as he is able to do anything, he always acts: even negligence and passivity are action if another course of conduct could have been chosen. And the conduct that is determined by the unconscious, in the Freudian sense, or by the subconscious, is also action in so far as conscious behavior could prevent it but neglects to do so. Even in the unconscious and apparently senseless behavior of the neurotic and the psychopath there is meaning, i.e., there is striving after ends and goals.Cf. Sigmund Freud, Lectures on the Introduction to Psychoanalysis, 17th lecture.
Everything that we say about action is independent of the motives that cause it and of the goals toward which it strives in the individual case. It makes no difference whether action springs from altruistic or from egoistic motives, from a noble or from a base disposition; whether it is directed toward the attainment of materialistic or idealistic ends; whether it arises from exhaustive and painstaking deliberation or follows fleeting impulses and passions. The laws of catallactics that economics expounds are valid for every exchange regardless of whether those involved in it have acted wisely or unwisely or whether they were actuated by economic or noneconomic motives. The causes of action and the goals toward which it strives are data for the theory of action: upon their concrete configuration depends the course of action taken in the individual case, but the nature of action as such is not thereby affected.
These considerations have an evident bearing on the widespread tendency of the present age to appeal to the irrational. The concepts rational and irrational are not applicable to ends at all. Whoever wishes to pass judgment on ends may praise or condemn them as good or evil, fine or vulgar, etc. When the expressions “rational” and “irrational” are applied to the means employed for the attainment of an end, such a usage has significance only from the standpoint of a definite technology. However, the use of means other than those prescribed as “rational” by this technology can be accounted for in only two possible ways: either the “rational” means were not known to the actor, or he did not employ them because he wished to attain still other ends — perhaps very foolish ones from the point of view of the observer. In neither of these two cases is one justified in speaking of “irrational” action.
Action is, by definition, always rational. One is unwarranted in calling goals of action irrational simply because they are not worth striving for from the point of view of one’s own valuations. Such a mode of expressions leads to gross misunderstandings. Instead of saying that irrationality plays a role in action, one should accustom oneself to saying merely: There are people who aim at different ends from those that I aim at, and people who employ different means from those I would employ in their situation.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 1: “Acting Man,” pp. 11–16.]1. Purposeful Action and Animal ReactionHuman 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. Such paraphrases may clarify the definition given and prevent possible misinterpretations. But the definition itself is adequate and does not need complement or commentary.
Conscious or purposeful behavior is in sharp contrast to unconscious behavior, i.e., the reflexes and the involuntary responses of the body’s cells and nerves to stimuli. People are sometimes prepared to believe that the boundaries between conscious behavior and the involuntary reaction of the forces operating within man’s body are more or less indefinite. This is correct only as far as it is sometimes not easy to establish whether concrete behavior is to be considered voluntary or involuntary. But the distinction between consciousness and unconsciousness is nonetheless sharp and can be clearly determined.
The unconscious behavior of the bodily organs and cells is for the acting ego no less a datum than any other fact of the external world. Acting man must take into account all that goes on within his own body as well as other data, e.g., the weather or the attitudes of his neighbors. There is, of course, a margin within which purposeful behavior has the power to neutralize the working of bodily factors. It is feasible within certain limits to get the body under control. Man can sometimes succeed through the power of his will in overcoming sickness, in compensating for the innate or acquired insufficiency of his physical constitution, or in suppressing reflexes. As far as this is possible, the field of purposeful action is extended. If a man abstains from controlling the involuntary reaction of cells and nerve centers, although he would be in a position to do so, his behavior is from our point of view purposeful.
The field of our science is human action, not the psychological events which result in an action. It is precisely this which distinguishes the general theory of human action, praxeology, from psychology. The theme of psychology is the internal events that result or can result in a definite action. The theme of praxeology is action as such. This also settles the relation of praxeology to the psychoanalytical concept of the subconscious. Psychoanalysis too is psychology and does not investigate action but the forces and factors that impel a man toward a definite action. The psychoanalytical subconscious is a psychological and not a praxeological category. Whether an action stems from clear deliberation, or from forgotten memories and suppressed desires which from submerged regions, as it were, direct the will, does not influence the nature of the action. The murderer whom a subconscious urge (the Id) drives toward his crime and the neurotic whose aberrant behavior seems to be simply meaningless to an untrained observer both act; they like anybody else are aiming at certain ends. It is the merit of psychoanalysis that it has demonstrated that even the behavior of neurotics and psychopaths is meaningful, that they too act and aim at ends, although we who consider ourselves normal and sane call the reasoning determining their choice of ends nonsensical and the means they choose for the attainment of these ends contrary to purpose.
The term “unconscious” as used by praxeology and the term “subconscious” as applied by psychoanalysis belong to two different systems of thought and research. Praxeology no less than other branches of knowledge owes much to psychoanalysis. The more necessary is it then to become aware of the line which separates praxeology from psychoanalysis.
Action is not simply giving preference. Man also shows preference in situations in which things and events are unavoidable or are believed to be so. Thus a man may prefer sunshine to rain and may wish that the sun would dispel the clouds. He who only wishes and hopes does not interfere actively with the course of events and with the shaping of his own destiny. But acting man chooses, determines, and tries to reach an end. Of two things both of which he cannot have together he selects one and gives up the other. Action therefore always involves both taking and renunciation.
To express wishes and hopes and to announce planned action may be forms of action in so far as they aim in themselves at the realization of a certain purpose. But they must not be confused with the actions to which they refer. They are not identical with the actions they announce, recommend, or reject. Action is a real thing. What counts is a man’s total behavior, and not his talk about planned but not realized acts. On the other hand action must be clearly distinguished from the application of labor. Action means the employment of means for the attainment of ends. As a rule one of the means employed is the acting man’s labor. But this is not always the case. Under special conditions a word is all that is needed. He who gives orders or interdictions may act without any expenditure of labor. To talk or not to talk, to smile or to remain serious, may be action. To consume and to enjoy are no less action than to abstain from accessible consumption and enjoyment.
Praxeology consequently does not distinguish between “active” or energetic and “passive” or indolent man. The vigorous man industriously striving for the improvement of his condition acts neither more nor less than the lethargic man who sluggishly takes things as they come. For to do nothing and to be idle are also action, they too determine the course of events. Wherever the conditions for human interference are present, man acts no matter whether he interferes or refrains from interfering. He who endures what he could change acts no less than he who interferes in order to attain another result. A man who abstains from influencing the operation of physiological and instinctive factors which he could influence also acts. Action is not only doing but no less omitting to do what possibly could be done.
We may say that action is the manifestation of a man’s will. But this would not add anything to our knowledge. For the term will means nothing else than man’s faculty to choose between different states of affairs, to prefer one, to set aside the other, and to behave according to the decision made in aiming at the chosen state and forsaking the other.
- The Prerequisites of Human ActionWe call contentment or satisfaction that state of a human being which does not and cannot result in any action. Acting man is eager to substitute a more satisfactory state of affairs for a less satisfactory. His mind imagines conditions which suit him better, and his action aims at bringing about this desired state. The incentive that impels a man to act is always some uneasiness.Cf. [John] Lock, An Essay Concerning Human Understanding, ed. Fraser (Oxford, 1894), vol. I, pp. 331–333; [Gottfried Wilhelm] Leibniz, Nouveaux essais sur l’entendement humain, ed. Flammarion, p. 119. A man perfectly content with the state of his affairs would have no incentive to change things. He would have neither wishes nor desires; he would be perfectly happy. He would not act; he would simply live free from care.
But to make a man act, uneasiness and the image of a more satisfactory state alone are not sufficient. A third condition is required: the expectation that purposeful behavior has the power to remove or at least to alleviate the felt uneasiness. In the absence of this condition no action is feasible. Man must yield to the inevitable. He must submit to destiny.
These are the general conditions of human action. Man is the being that lives under these conditions. He is not only homo sapiens, but no less homo agens. Beings of human descent who either from birth or from acquired defects are unchangeably unfit for any action (in the strict sense of the term and not merely in the legal sense) are practically not human. Although the statutes and biology consider them to be men, they lack the essential feature of humanity. The newborn child too is not an acting being. It has not yet gone the whole way from conception to the full development of its human qualities. But at the end of this evolution it becomes an acting being.
On HappinessIn colloquial speech we call a man “happy” who has succeeded in attaining his ends. A more adequate description of his state would be that he is happier than he was before. There is however no valid objection to a usage that defines human action as the striving for happiness.
But we must avoid current misunderstandings. The ultimate goal of human action is always the satisfaction of the acting man’s desire. There is no standard of greater or lesser satisfaction other than individual judgments of value, different for various people and for the same people at various times. What makes a man feel uneasy and less uneasy is established by him from the standard of his own will and judgment, from his personal and subjective valuation. Nobody is in a position to decree what should make a fellow man happier.
To establish this fact does not refer in any way to the antitheses of egoism and altruism, of materialism and idealism, of individualism and collectivism, of atheism and religion. There are people whose only aim is to improve the condition of their own ego. There are other people with whom awareness of the troubles of their fellow men causes as much uneasiness as or even more uneasiness than their own wants. There are people who desire nothing else than the satisfaction of their appetites for sexual intercourse, food, drinks, fine homes, and other material things. But other men care more for the satisfactions commonly called “higher” and “ideal.” There are individuals eager to adjust their actions to the requirements of social cooperation; there are, on the other hand, refractory people who defy the rules of social life. There are people for whom the ultimate goal of the earthly pilgrimage is the preparation for a life of bliss. There are other people who do not believe in the teachings of any religion and do not allow their actions to be influenced by them.
Praxeology is indifferent to the ultimate goals of action. Its findings are valid for all kinds of action irrespective of the ends aimed at. It is a science of means, not of ends. It applies the term happiness in a purely formal sense. In the praxeological terminology the proposition: man’s unique aim is to attain happiness, is tautological. It does not imply any statement about the state of affairs from which man expects happiness.
The idea that the incentive of human activity is always some uneasiness and its aim always to remove such uneasiness as far as possible, that is, to make the acting men feel happier, is the essence of the teachings of Eudaemonism and Hedonism. Epicurean
is that state of perfect happiness and contentment at which all human activity aims without ever wholly attaining it. In the face of the grandeur of this cognition it is of little avail only that many representatives of this philosophy failed to recognize the purely formal character of the notions pain and pleasure and gave them a material and carnal meaning. The theological, mystical, and other schools of a heteronomous ethic did not shake the core of Epicureanism because they could not raise any other objection than its neglect of the “higher” and “nobler” pleasures. It is true that the writings of many earlier champions of Eudaemonism, Hedonism, and Utilitarianism are in some points open to misinterpretation. But the language of modern philosophers and still more that of the modern economists is so precise and straightforward that no misinterpretation can possibly occur.
On Instincts and ImpulsesOne does not further the comprehension of the fundamental problem of human action by the methods of instinct-sociology. This school classifies the various concrete goals of human action and assigns to each class a special instinct as its motive. Man appears as a being driven by various innate instincts and dispositions. It is assumed that this explanation demolishes once for all the odious teachings of economics and utilitarian ethics. However, Feuerbach has already justly observed that every instinct is an instinct to happiness.Cf. [Ludwig] Feuerbach, Sämmtliche Werke, ed. Bolin and Jodl (Stuttgart, 1907), vol. 10, p. 231. The method of instinct-psychology and instinct-sociology consists in an arbitrary classification of the immediate goals of action and in a hypostasis of each. Whereas praxeology says that the goal of an action is to remove a certain uneasiness, instinct-psychology says it is the satisfaction of an instinctive urge.
Many champions of the instinct school are convinced that they have proved that action is not determined by reason, but stems from the profound depths of innate forces, impulses, instincts, and dispositions which are not open to any rational elucidation. They are certain they have succeeded in exposing the shallowness of rationalism and disparage economics as “a tissue of false conclusions drawn from false psychological assumptions.”Cf. William McDougall, An Introduction to Social Psychology, 14th ed. (Boston, 1921), p. 11. Yet rationalism, praxeology, and economics do not deal with the ultimate springs and goals of action, but with the means applied for the attainment of an end sought. However unfathomable the depths may be from which an impulse or instinct emerges, the means which man chooses for its satisfaction are determined by a rational consideration of expense and success.
He who acts under an emotional impulse also acts. What distinguishes an emotional action from other actions is the valuation of input and output. Emotions disarrange valuations. Inflamed with passion, man sees the goal as more desirable and the price he has to pay for it as less burdensome than he would in cool deliberation. Men have never doubted that even in the state of emotion means and ends are pondered and that it is possible to influence the outcome of this deliberation by rendering more costly the yielding to the passionate impulse. To punish criminal offenses committed in a state of emotional excitement or intoxication more mildly than other offenses is tantamount to encouraging such excesses. The threat of severe retaliation does not fail to deter even people driven by seemingly irresistible passion.
We interpret animal behavior on the assumption that the animal yields to the impulse which prevails at the moment. As we observe that the animal feeds, cohabits, and attacks other animals or men, we speak of its instincts of nourishment, of reproduction, and of aggression. We assume that such instincts are innate and peremptorily ask for satisfaction.
But is it different with man. Man is not a being who cannot help yielding to the impulse that most urgently asks for satisfaction. Man is a being capable of subduing his instincts, emotions, and impulses; he can rationalize his behavior. He renounces the satisfaction of a burning impulse in order to satisfy other desires. He is not a puppet of his appetites. A man does not ravish every female that stirs his senses; he does not devour every piece of food that entices him; he does not knock down every fellow he would like to kill. He arranges his wishes and desires into a scale, he chooses; in short, he acts. What distinguishes man from beasts is precisely that he adjusts his behavior deliberatively. Man is the being that has inhibitions, that can master his impulses and desires, that has the power to suppress instinctive desires and impulses.
It may happen that an impulse emerges with such vehemence that no disadvantage which its satisfaction may cause appears great enough to prevent the individual from satisfying it. In this case too there is choosing. Man decides in favor of yielding to the desire concerned.In such cases a great role is played by the circumstances that the two satisfactions concerned — that expected from yielding to the impulse and that expected from the avoidance of its undesirable consequences — are not simultaneous.
Interventionism: An Economic Analysis[Ludwig von Mises, Interventionism: An Economic Analysis, ed. Bettina Bien Greaves (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1998), Introduction, pp. 2–5.]2. Capitalism or Market EconomyIn the capitalistic economy the means of production are owned by individuals or associations of individuals, such as corporations. The owners use the means of production directly to produce, or they lend them, for a compensation, to others who want to use them in production. The individuals or associations of individuals who produce with their own or with borrowed money are called entrepreneurs.
Superficially, it seems that the entrepreneurs decide what should be produced, and how it should be produced. However, as they do not produce for their own needs but for those of all members of the community, they have to sell the products on the market to consumers, that is, those individuals who want to use and consume them. Only that entrepreneur is successful and realizes a profit who knows how to produce in the best and cheapest way, that is with a minimum expenditure of material and labor, the articles most urgently wanted by the consumers. Therefore, in actuality the consumers, not the entrepreneurs, determine the direction and scope of production. In the market economy the consumers are sovereign. They are the masters, and the entrepreneurs have to strive, in their own interest, to serve the wishes of the consumers to the best of their ability.
The market economy has been called a democracy of consumers, because it brings about a daily recurring ballot of consumer preferences. The casting of votes at an election and the spending of dollars in the market are both methods of expressing public opinion. The consumers decide, by buying or by refraining from buying, the success or failure of the entrepreneurs. They make poor entrepreneurs rich and rich entrepreneurs poor. They take away the means of production from those entrepreneurs who do not know how to use them best in the service of the consumers and transfer them to those who know how to make better use of them. It is true that only the entrepreneurs producing consumers’ goods have direct contact with the consumers; only they are immediately dependent on the consumers; only they receive directly the consumers’ orders. But they transmit those orders and their dependence to the entrepreneurs who bring producers’ goods to the market. The producers of consumers’ goods have to purchase where they can, at lowest cost, the producers’ goods which are required for the ultimate satisfaction of the wants of the consumers. Should they fail to use the cheapest supplies, should they fail to make the most efficient use of the producers’ goods in production, they would be unable to satisfy the wants of the consumers at lowest prices; more efficient entrepreneurs who know better how to buy and how to produce would crowd them out of the market. The consumer as buyer may follow his own liking and his own fancy. The entrepreneur must do the buying for his enterprise as the most efficient satisfaction of the wants of the consumers’ dictates. Deviations from this line prescribed by the consumers affect the entrepreneur’s returns, thus causing losses and endangering his position as entrepreneur.
Such is the oft-decried harshness of the entrepreneur who figures everything in dollars and cents. He is forced to take this attitude by order of the consumers, who are unwilling to reimburse the entrepreneurs for unnecessary expenditures. What in everyday language is called economy is simply law prescribed by the consumers for the actions of the entrepreneurs and their helpers. The consumers, by their behavior in the market, are the ones who indirectly determine prices and wages and, thus, the distribution of wealth among the members of society. Their choices in the market determine who shall be entrepreneur and owner of the means of production. By every dollar spent, the consumers influence the direction, size, and kind of production and marketing.
The entrepreneurs do not form a closed class or order. Any individual may become an entrepreneur if he has the ability to foresee the future development of the market better than his fellow-citizens, if he can inspire the confidence of capitalists, and if his attempts to act on his own risk and responsibility prove successful. One becomes an entrepreneur, literally, by pushing forward and exposing oneself to the impartial test to which the market puts everyone who wants to become or remain an entrepreneur. Everyone has the privilege of choosing whether he wants to submit himself to this rigorous examination or not. He doesn’t have to wait to be asked to do so — he must step forward on his own initiative, and he has to worry where and how he can secure the means for his entrepreneurial activity.
For decades it was repeatedly asserted that the rise of poor people into entrepreneurial positions was no longer possible in the stage of “late capitalism.” The proof for this assertion was never given. Since this thesis was first voiced, the composition of the entrepreneurial class has basically changed; a considerable part of the former entrepreneurs and their heirs have disappeared, and the most outstanding entrepreneurs of today are again what we usually call self-made men. This constant recomposition of the entrepreneurial elite is as old as the capitalist economy itself and forms an integral part of it.
What is true of the entrepreneurs holds true for the capitalists as well. Only the capitalist who knows how to use his capital properly (from the consumer’s point of view), that is, to invest it so that the means of production will be employed most efficiently in the service of consumers, is able to keep and augment his property. If he does not want to suffer losses the capitalist has to place his means at the disposal of successful enterprises. In the market economy the capitalist, just like the entrepreneurs and the workers, serves the consumers. It seems superfluous to point out specifically in this connection that the consumers are not merely consumers but that the totality of the consumers is identical with the totality of the workers, entrepreneurs, and capitalists.
In a world of unchanging economic conditions the exact amounts which the entrepreneurs would expend for the means of production as wages, interest, and rent, would later be received by them in the prices of their products. Production costs would thus equal the prices of the products and the entrepreneurs would neither make profits nor suffer losses. But the world of reality is constantly changing, and therefore all industrial activity is essentially uncertain and speculative in character. Goods are produced to meet a future demand, about which we have little positive knowledge in the present. It is from this uncertainty that profits and losses arise; the profits and losses of the entrepreneurs depend upon how successfully they can forecast the state of future demand. Only that entrepreneur realizes a profit who anticipates the future wants of the consumers better than his competitors.
It is irrelevant to the entrepreneur, as the servant of the consumers, whether the wishes and wants of the consumers are wise or unwise, moral or immoral. He produces what the consumers want. In this sense he is amoral. He manufactures whiskey and guns just as he produces food and clothing. It is not his task to teach reason to the sovereign consumers. Should one entrepreneur, for ethical reasons of his own, refuse to manufacture whiskey, other entrepreneurs would do so as long as whiskey is wanted and bought. It is not because we have distilleries that people drink whiskey; it is because people like to drink whiskey that we have distilleries. One may deplore this. But it is not up to the entrepreneurs to improve mankind morally. And they are not to be blamed if those whose duty this is have failed to do so.
Thus the market in the capitalist economy is the process regulating production and consumption. It is the nerve-center of the capitalist system. Through it the orders of the consumers are transmitted to the producers, and the smooth functioning of the economic system is secured thereby. The market prices establish themselves at the level which equates demand and supply. When, other things being equal, more goods are brought to the market, prices fall; when, other things being equal, demand increases, prices rise.
One thing more must be noted. If within a society based on private ownership of the means of production some of these means are publicly owned and operated, this still does not make for a mixed system which would combine socialism and private property. As long as only certain individual enterprises are publicly owned, the remaining being privately owned, the characteristics of the market economy which determine economic activity remain essentially unimpaired. The publicly owned enterprises, too, as buyers of raw materials, semi-finished goods, and labor, and as sellers of goods and services, must fit into the mechanism of the market economy; they are subject to the same laws of the market. In order to maintain their position they, too, have to strive after profits or at least to avoid losses. When it is attempted to mitigate or eliminate this dependence by covering the losses of such enterprises by subsidies out of public funds, the only accomplishment is a shifting of this dependence somewhere else. This is because the means for the subsidies have to be raised somewhere. They may be raised by collecting taxes; the burden of such taxes has its effects on the market, not on the government collecting the tax; it is the market and not the revenue department which decides upon whom the tax falls and how it affects production and consumption. In these facts the domination of the market and the inescapable force of its laws is evidenced.
Economic Policy: Thoughts for Tomorrow and Today[Ludwig von Mises, Economic Policy: Thoughts for Tomorrow and Today (1979; Washington, D.C.: Regnery Gateway, 2006), Lecture 1, pp. 1–15.]“Capitalism”Descriptive terms which people use are often quite misleading. In talking about modern captains of industry and leaders of big business, for instance, they call a man a “chocolate king” or a “cotton king” or an “automobile king.” Their use of such terminology implies that they see practically no difference between the modern heads of industry and those feudal kings, dukes or lords of earlier days. But the difference is in fact very great, for a chocolate king does not rule at all, he serves. He does not reign over conquered territory, independent of the market, independent of his customers. The chocolate king — or the steel king or the automobile king or any other king of modern industry — depends on the industry he operates and on the customers he serves. This “king” must stay in the good graces of his subjects, the consumers; he loses his “kingdom” as soon as he is no longer in a position to give his customers better service and provide it at lower cost than others with whom he must compete.
Two hundred years ago, before the advent of capitalism, a man’s social status was fixed from the beginning to the end of his life; he inherited it from his ancestors, and it never changed. If he was born poor, he always remained poor, and if he was born rich — a lord or a duke — he kept his dukedom and the property that went with it for the rest of his life.
As for manufacturing, the primitive processing industries of those days existed almost exclusively for the benefit of the wealthy. Most of the people (ninety percent or more of the European population) worked the land and did not come in contact with the city-oriented processing industries. This rigid system of feudal society prevailed in the most developed areas of Europe for many hundreds of years.
However, as the rural population expanded, there developed a surplus of people on the land. For this surplus of population without inherited land or estates, there was not enough to do, nor was it possible for them to work in the processing industries; the kings of the cities denied them access. The numbers of these “outcasts” continued to grow, and still no one knew what to do with them. They were, in the full sense of the word, “proletarians,” outcasts whom the government could only put into the workhouse or the poorhouse. In some sections of Europe, especially in the Netherlands and in England, they became so numerous that, by the eighteenth century, they were a real menace to the preservation of the prevailing social system.
Today, in discussing similar conditions in places like India or other developing countries, we must not forget that, in eighteenth-century England, conditions were much worse. At that time, England had a population of six or seven million people, but of those six or seven million people, more than one million, probably two million, were simply poor outcasts for whom the existing social system made no provision. What to do with these outcasts was one of the great problems of eighteenth-century England.
Another great problem was the lack of raw materials. The British, very seriously, had to ask themselves this question: what are we going to do in the future, when our forests will no longer give us the wood we need for our industries and for heating our houses? For the ruling classes it was a desperate situation. The statesmen did not know what to do, and the ruling gentry were absolutely without any ideas on how to improve conditions.
Out of this serious social situation emerged the beginnings of modern capitalism. There were some persons among those outcasts, among those poor people, who tried to organize others to set up small shops which could produce something. This was an innovation. These innovators did not produce expensive goods suitable only for the upper classes; they produced cheaper products for everyone’s needs. And this was the origin of capitalism as it operates today. It was the beginning of mass production, the fundamental principle of capitalistic industry. Whereas the old processing industries serving the rich people in the cities had existed almost exclusively for the demands of the upper classes, the new capitalist industries began to produce things that could be purchased by the general population. It was mass production to satisfy the needs of the masses.
This is the fundamental principle of capitalism as it exists today in all of those countries in which there is a highly developed system of mass production: Big business, the target of the most fanatic attacks by the so-called leftists, produces almost exclusively to satisfy the wants of the masses. Enterprises producing luxury goods solely for the well-to-do can never attain the magnitude of big businesses. And today, it is the people who work in large factories who are the main consumers of the products made in those factories. This is the fundamental difference between the capitalistic principles of production and the feudalistic principles of the preceding ages.
When people assume, or claim, that there is a difference between the producers and the consumers of the products of big businesses, they are badly mistaken. In American department stores you hear the slogan, “the customer is always right.” And this customer is the same man who produces in the factory those things which are sold in the department stores. The people who think that the power of big business is enormous are mistaken also, since big business depends entirely on the patronage of those who buy its products: the biggest enterprise loses its power and its influence when it loses its customers.
Fifty or sixty years ago it was said in almost all capitalist countries that the railroad companies were too big and too powerful; they had a monopoly; it was impossible to compete with them. It was alleged that, in the field of transportation, capitalism had already reached a stage at which it had destroyed itself, for it had eliminated competition. What people overlooked was the fact that the power of the railroads depended on their ability to serve people better than any other method of transportation. Of course it would have been ridiculous to compete with one of these big railroad companies by building another railroad parallel to the old line, since the old line was sufficient to serve existing needs. But very soon there came other competitors. Freedom of competition does not mean that you can succeed simply by imitating or copying precisely what someone else has done. Freedom of the press does not mean that you have the right to copy what another man has written and thus to acquire the success which this other man has duly merited on account of his achievements. It means that you have the right to write something different. Freedom of competition concerning railroads, for example, means that you are free to invent something, to do something, which will challenge the railroads and place them in a very precarious competitive situation.
In the United States the competition to the railroads — in the form of buses, automobiles, trucks, and airplanes — has caused the railroads to suffer and to be almost completely defeated, as far as passenger transportation is concerned.
The development of capitalism consists in everyone’s having the right to serve the customer better and/or more cheaply. And this method, this principle, has, within a comparatively short time, transformed the whole world. It has made possible an unprecedented increase in world population.In eighteenth-century England, the land could support only six million people at a very low standard of living. Today more than fifty million people enjoy a much higher standard of living than even the rich enjoyed during the eighteenth-century. And today’s standard of living in England would probably be still higher, had not a great deal of the energy of the British been wasted in what were, from various points of view, avoidable political and military “adventures.”
These are the facts about capitalism. Thus, if an Englishman — or, for that matter, any other man in any country of the world — says today to his friends that he is opposed to capitalism, there is a wonderful way to answer him: “You know that the population of this planet is now ten times greater than it was in the ages preceding capitalism; you know that all men today enjoy a higher standard of living than your ancestors did before the age of capitalism. But how do you know that you are the one out of ten who would have lived in the absence of capitalism? The mere fact that you are living today is proof that capitalism has succeeded, whether or not you consider your own life very valuable.”
In spite of all its benefits, capitalism has been furiously attacked and criticized. It is necessary that we understand the origin of this antipathy. It is a fact that the hatred of capitalism originated not with the masses, not among the workers themselves, but among the landed aristocracy — the gentry, the nobility, of England and the European continent. They blamed capitalism for something that was not very pleasant for them: at the beginning of the nineteenth century, the higher wages paid by industry to its workers forced the landed gentry to pay equally higher wages to their agricultural workers. The aristocracy attacked the industries by criticising the standard of living of the masses of the workers.
Of course — from our viewpoint, the workers’ standard of living was extremely low; conditions under early capitalism were absolutely shocking, but not because the newly developed capitalistic industries had harmed the workers. The people hired to work in factories had already been existing at a virtually subhuman level.
The famous old story, repeated hundreds of times, that the factories employed women and children and that these women and children, before they were working in factories, had lived under satisfactory conditions, is one of the greatest falsehoods of history. The mothers who worked in the factories had nothing to cook with; they did not leave their homes and their kitchens to go into the factories, they went into factories because they had no kitchens, and if they had a kitchen they had no food to cook in those kitchens. And the children did not come from comfortable nurseries. They were starving and dying. And all the talk about the so-called unspeakable horror of early capitalism can be refuted by a single statistic: precisely in these years in which British capitalism developed, precisely in the age called the Industrial Revolution in England, in the years from 1760 to 1830, precisely in those years the population of England doubled, which means that hundreds or thousands of children — who would have died in preceding times — survived and grew to become men and women.
There is no doubt that the conditions of the preceding times were very unsatisfactory. It was capitalist business that improved them. It was precisely those early factories that provided for the needs of their workers, either directly or indirectly by exporting products and importing food and raw materials from other countries. Again and again, the early historians of capitalism have — one can hardly use a milder word — falsified history.
One anecdote they used to tell, quite possibly invented, involved Benjamin Franklin. According to the story, Ben Franklin visited a cotton mill in England, and the owner of the mill told him, full of pride: “Look, here are cotton goods for Hungary.” Benjamin Franklin, looking around, seeing that the workers were shabbily dressed, said: “Why don’t you produce also for your own workers?”
But those exports of which the owner of the mill spoke really meant that he did produce for his own workers, because England had to import all its raw materials. There was no cotton either in England or in continental Europe. There was a shortage of food in England, and food had to be imported from Poland, from Russia, from Hungary. These exports were the payment for the imports of the food which made the survival of the British population possible. Many examples from the history of those ages will show the attitude of the gentry and aristocracy toward the workers. I want to cite only two examples. One is the famous British “Speenhamland” system. By this system, the British government paid all workers who did not get the minimum wage (determined by the government) the difference between the wages they received and this minimum wage. This saved the landed aristocracy the trouble of paying higher wages. The gentry would pay the traditionally low agricultural wage, and the government would supplement it, thus keeping workers from leaving rural occupations to seek urban factory employment.
Eighty years later, after capitalism’s expansion from England to continental Europe, the landed aristocracy again reacted against the new production system. In Germany the Prussian Junkers, having lost many workers to the higher-paying capitalistic industries, invented a special term for the problem: “flight from the countryside” — Landflucht. And in the German Parliament, they discussed what might be done against this evil, as it was seen from the point of view of the landed aristocracy.
Prince Bismarck, the famous chancellor of the German Reich, in a speech one day said, “I met a man in Berlin who once had worked on my estate, and I asked this man, ‘Why did you leave the estate; why did you go away from the country; why are you now living in Berlin?’ ” And according to Bismarck, this man answered, “You don’t have such a nice Biergarten in the village as we have here in Berlin, where you can sit, drink beer, and listen to music.” This is, of course, a story told from the point of view of Prince Bismarck, the employer. It was not the point of view of all his employees. They went into industry because industry paid them higher wages and raised their standard of living to an unprecedented degree.
Today, in the capitalist countries, there is relatively little difference between the basic life of the so-called higher and lower classes; both have food, clothing, and shelter. But in the eighteenth century and earlier, the difference between the man of the middle class and the man of the lower class was that the man of the middle class had shoes and the man of the lower class did not have shoes. In the United States today the difference between a rich man and a poor man means very often only the difference between a Cadillac and a Chevrolet. The Chevrolet may be bought secondhand, but basically it renders the same services to its owner: he, too, can drive from one point to another. More than fifty percent of the people in the United States are living in houses and apartments they own themselves.
The attacks against capitalism — especially with respect to the higher wage rates — start from the false assumption that wages are ultimately paid by people who are different from those who are employed in the factories. Now it is all right for economists and for students of economic theories to distinguish between the worker and the consumer and to make a distinction between them. But the fact is that every consumer must, in some way or the other, earn the money he spends, and the immense majority of the consumers are precisely the same people who work as employees in the enterprises that produce the things which they consume. Wage rates under capitalism are not set by a class of people different from the class of people who earn the wages; they are the same people. It is not the Hollywood film corporation that pays the wages of a movie star; it is the people who pay admission to the movies. And it is not the entrepreneur of a boxing match who pays the enormous demands of the prize fighters; it is the people who pay admission to the fight. Through the distinction between the employer and the employee, a distinction is drawn in economic theory, but it is not a distinction in real life; here, the employer and the employee ultimately are one and the same person.
There are people in many countries who consider it very unjust that a man who has to support a family with several children will receive the same salary as a man who has only himself to take care of. But the question is not whether the employer should bear greater responsibility for the size of a worker’s family.
The question we must ask in this case is: Are you, as an individual, prepared to pay more for something, let us say, a loaf of bread, if you are told that the man who produced this loaf of bread has six children? The honest man will certainly answer in the negative and say, “In principle I would, but in fact if it costs less I would rather buy the bread produced by a man without any children.” The fact is that, if the buyers do not pay the employer enough to enable him to pay his workers, it becomes impossible for the employer to remain in business.
The capitalist system was termed “capitalism” not by a friend of the system, but by an individual who considered it to be the worst of all historical systems, the greatest evil that had ever befallen mankind. That man was Karl Marx. Nevertheless, there is no reason to reject Marx’s term, because it describes clearly the source of the great social improvements brought about by capitalism. Those improvements are the result of capital accumulation; they are based on the fact that people, as a rule, do not consume everything they have produced, that they save — and invest — a part of it. There is a great deal of misunderstanding about this problem and — in the course of these lectures — I will have the opportunity to deal with the most fundamental misapprehensions which people have concerning the accumulation of capital, the use of capital, and the universal advantages to be gained from such use. I will deal with capitalism particularly in my lectures about foreign investment and about that most critical problem of present-day politics, inflation. You know, of course, that inflation exists not only in this country. It is a problem all over the world today.
An often unrealized fact about capitalism is this: savings mean benefits for all those who are anxious to produce or to earn wages. When a man has accrued a certain amount of money — let us say, one thousand dollars — and, instead of spending it, entrusts these dollars to a savings bank or an insurance company, the money goes into the hands of an entrepreneur, a businessman, enabling him to go out and embark on a project which could not have been embarked on yesterday, because the required capital was unavailable.
What will the businessman do now with the additional capital? The first thing he must do, the first use he will make of this additional capital, is to go out and hire workers and buy raw materials — in turn causing a further demand for workers and raw materials to develop, as well as a tendency toward higher wages and higher prices for raw materials. Long before the saver or the entrepreneur obtains any profit from all of this, the unemployed worker, the producer of raw materials, the farmer, and the wage-earner are all sharing in the benefits of the additional savings.
When the entrepreneur will get something out of the project depends on the future state of the market and on his ability to anticipate correctly the future state of the market. But the workers as well as the producers of raw materials get the benefits immediately. Much was said, thirty or forty years ago, about the “wage policy,” as they called it, of Henry Ford. One of Mr. Ford’s great accomplishments was that he paid higher wages than did other industrialists or factories. His wage policy was described as an “invention,” yet it is not enough to say that this new “invented” policy was the result of the liberality of Mr. Ford. A new branch of business, or a new factory in an already existing branch of business, has to attract workers from other employments, from other parts of the country, even from other countries. And the only way to do this is to offer the workers higher wages for their work. This is what took place in the early days of capitalism, and it is still taking place today.
When the manufacturers in Great Britain first began to produce cotton goods, they paid their workers more than they had earned before. Of course, a great percentage of these new workers had earned nothing at all before that and were prepared to take anything they were offered. But after a short time — when more and more capital was accumulated and more and more new enterprises were developed — wage rates went up, and the result was the unprecedented increase in British population which I spoke of earlier.
The scornful depiction of capitalism by some people as a system designed to make the rich become richer and the poor become poorer is wrong from beginning to end. Marx’s thesis regarding the coming of socialism was based on the assumption that workers were getting poorer, that the masses were becoming more destitute, and that finally all the wealth of a country would be concentrated in a few hands or in the hands of one man only. And then the masses of impoverished workers would finally rebel and expropriate the riches of the wealthy proprietors. According to this doctrine of Karl Marx, there can be no opportunity, no possibility within the capitalistic system for any improvement of the conditions of the workers.
In 1864, speaking before the International Workingmen’s Association in England, Marx said the belief that labor unions could improve conditions for the working population was “absolutely in error.” The union policy of asking for higher wage rates and shorter work hours he called conservative — conservatism being, of course, the most condemnatory term which Karl Marx could use. He suggested that the unions set themselves a new, revolutionary goal: that they “do away with the wage system altogether,” that they substitute “socialism” — government ownership of the means of production — for the system of private ownership.
If we look upon the history of the world, and especially upon the history of England since 1865, we realize that Marx was wrong in every respect. There is no western, capitalistic country in which the conditions of the masses have not improved in an unprecedented way. All these improvements of the last eighty or ninety years were made in spite of the prognostications of Karl Marx. For the Marxian socialists believed that the conditions of the workers could never be ameliorated. They followed a false theory, the famous “iron law of wages” — the law which stated that a worker’s wages, under capitalism, would not exceed the amount he needed to sustain his life for service to the enterprise.
The Marxians formulated their theory in this way: if the workers’ wage rates go up, raising wages above the subsistence level, they will have more children; and these children, when they enter the labor force, will increase the number of workers to the point where the wage rates will drop, bringing the workers once more down to the subsistence level — to that minimal sustenance level which will just barely prevent the working population from dying out. But this idea of Marx, and of many other socialists, is a concept of the working man precisely like that which biologists use — and rightly so — in studying the life of animals. Of mice, for instance.
If you increase the quantity of food available for animal organisms or for microbes, then more of them will survive. And if you restrict their food, then you will restrict their numbers. But man is different. Even the worker — in spite of the fact that Marxists do not acknowledge it — has human wants other than food and reproduction of his species. An increase in real wages results not only in an increase in population, it results also, and first of all, in an improvement in the average standard of living. That is why today we have a higher standard of living in Western Europe and in the United States than in the developing nations of, say, Africa.
We must realize, however, that this higher standard of living depends on the supply of capital. This explains the difference between conditions in the United States and conditions in India; modern methods of fighting contagious diseases have been introduced in India — at least, to some extent — and the effect has been an unprecedented increase in population but, since this increase in population has not been accompanied by a corresponding increase in the amount of capital invested, the result has been an increase in poverty. A country becomes more prosperous in proportion to the rise in the invested capital per unit of its population.
I hope that in my other lectures I will have the opportunity to deal in greater detail with these problems and will be able to clarify them, because some terms — such as “the capital invested per capita” — require a rather detailed explanation.
But you have to remember that, in economic policies, there are no miracles. You have read in many newspapers and speeches, about the so-called German economic miracle — the recovery of Germany after its defeat and destruction in the Second World War. But this was no miracle. It was the application of the principles of the free market economy, of the methods of capitalism, even though they were not applied completely in all respects. Every country can experience the same “miracle” of economic recovery, although I must insist that economic recovery does not come from a miracle; it comes from the adoption of — and is the result of — sound economic policies.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 5: “Time,” pp. 99–104.]1. The Temporal Character of PraxeologyThe notion of change implies the notion of temporal sequence. A rigid, eternally immutable universe would be out of time, but it would be dead. The concepts of change and of time are inseparably linked together. Action aims at change and is therefore in the temporal order. Human reason is even incapable of conceiving the ideas of timeless existence and of timeless action.
He who acts distinguishes between the time before the action, the time absorbed by the action, and the time after the action has been finished. He cannot be neutral with regard to the lapse of time.
Logic and mathematics deal with an ideal system of thought. The relations and implications of their system are coexistent and interdependent. We may say as well that they are synchronous or that they are out of time. A perfect mind could grasp them all in one thought. Man’s inability to accomplish this makes thinking itself an action, proceeding step by step from the less satisfactory state of insufficient cognition to the more satisfactory state of better insight. But the temporal order in which knowledge is acquired must not be confused with the logical simultaneity of all parts of this aprioristic deductive system. Within this system the notions of anteriority and consequence are metaphorical only. They do not refer to the system, but to our action in grasping it. The system itself implies neither the category of time nor that of causality. There is functional correspondence between elements, but there is neither cause nor effect.
What distinguishes epistemologically the praxeological system from the logical system epistemologically is precisely that it implies the categories both of time and of causality. The praxeological system too is aprioristic and deductive. As a system it is out of time. But change is one of its elements. The notions of sooner and later and of cause and effect are among its constituents. Anteriority and consequence are essential concepts of praxeological reasoning. So is the irreversibility of events. In the frame of the praxeological system any reference to functional correspondence is no less metaphorical and misleading than is the reference to anteriority and consequence in the frame of the logical system.In a treatise on economics there is no need to enter into a discussion of the endeavors to construct mechanics as an axiomatic system in which the concept of function is substituted for that of cause and effect. It will be shown later that axiomatic mechanics cannot serve as a model for the treatment of the economic system.
- Past, Present, and FutureIt is acting that provides man with the notion of time and makes him aware of the flux of time. The idea of time is a praxeological category.Action is always directed toward the future; it is essentially and necessarily always a planning and acting for a better future. Its aim is always to render future conditions more satisfactory than they would be without the interference of action. The uneasiness that impels a man to act is caused by a dissatisfaction with expected future conditions as they would probably develop if nothing were done to alter them. In any case action can influence only the future, never the present that with every infinitesimal fraction of a second sinks down into the past. Man becomes conscious of time when he plans to convert a less satisfactory present state into a more satisfactory future state.
For contemplative meditation time is merely duration, “la durée pure, dont l’écoulement est continu, et où l’on passe, par gradations insensibles, d’un état à l’autre: Continuité réellement vécue.”Henri Bergson, Matière et mémoire (7th ed. Paris, 1911), p. 205. The “now” of the present is continually shifted to the past and is retained in the memory only. Reflecting about the past, say the philosophers, man becomes aware of time.Edmund Husserl, “Vorlesungen zur Phänomenologie des inneren Zeitbewusstseins,” Jahrbuch für Philosophie und Phänomenologische Forschung (1928), vol. 9, pp. 391ff.; Alfred Schütz, Der sinnhafte Aufbau der sozialen Welt (Vienna, 1932), pp. 45 ff. However, it is not recollection that conveys to man the categories of change and of time, but the will to improve the conditions of his life.
Time as we measure it by various mechanical devices is always past, and time as the philosophers use this concept is always either past or future. The present is, from these aspects, nothing but an ideal boundary line separating the past from the future. But from the praxeological aspect there is between the past and the future a real extended present. Action is as such in the real present because it utilizes the instant and thus embodies its reality.“Ce que j’appelle mon présent, c’est mon attitude vis-à-vis de l’avenir immédiat, c’est nom action imminente.” Bergson, Matière et mémoire, p. 152. Later retrospective reflection discerns in the instant passed away first of all the action and the conditions which it offered to action. That which can no longer be done or consumed because the opportunity for it has passed away, contrasts the past with the present. That which cannot yet be done or consumed, because the conditions for undertaking it or the time for its ripening have not yet come, contrasts the future with the past. The present offers to acting opportunities and tasks for which it was hitherto too early and for which it will be hereafter too late.
The present qua duration is the continuation of the conditions and opportunities given for acting. Every kind of action requires special conditions to which it must be adjusted with regard to the aims sought. The concept of the present is therefore different for various fields of action. It has no reference whatever to the various methods of measuring the passing of time by spatial movements. The present encloses as much of the time passed away as still is actual, i.e., of importance for acting. The present contrasts itself, according to the various actions one has in view, with the Middle Ages, with the nineteenth century, with the past year, month, or day, but no less with the hour, minute, or second just passed away. If a man says: Nowadays Zeus is no longer worshiped, he has a present in mind other than that the motorcar driver who thinks: Now it is still too early to turn.
As the future is uncertain it always remains undecided and vague how much of it we can consider as now and present. If a man had said in 1913: At present — now — in Europe freedom of thought is undisputed, he would have not foreseen that this present would very soon be a past.
- The Economization of TimeMan is subject to the passing of time. He comes into existence, grows, becomes old, and passes away. His time is scarce. He must economize it as he does other scarce factors.
The economization of time has a peculiar character because of the uniqueness and irreversibility of the temporal order. The importance of these facts manifests itself in every part of the theory of action.
Only one fact must be stressed at this point. The economization of time is independent of the economization of economic goods and services. Even in the land of Cockaigne man would be forced to economize time, provided he were not immortal and not endowed with eternal youth and indestructible health and vigor. Although all his appetites could be satisfied immediately without any expenditure of labor, he would have to arrange his time schedule, as there are states of satisfaction which are incompatible and cannot be consummated at the same time. For this man, too, time would be scarce and subject to the aspect of sooner and later.
- The Temporal Relation Between ActionsTwo actions of an individual are never synchronous; their temporal relation is that of sooner and later. Actions of various individuals can be considered as synchronous only in the light of the physical methods for the measurement of time. Synchronism is a praxeological notion only with regard to the concerted efforts of various acting men.In order to avoid any possible misunderstanding it may well be expedient to emphasize that this theorem has nothing at all to do with Einstein’s theorem concerning the temporal relation of spatially distant events.
A man’s individual actions succeed one another. They can never be effected at the same instant; they can only follow one another in more or less rapid succession. There are actions which serve several purposes at one blow. It would be misleading to refer to them as a coincidence of various actions.
People have often failed to recognize the meaning of the term “scale of value” and have disregarded the obstacles preventing the assumption of synchronism in the various actions of an individual. They have interpreted a man’s various acts as the outcome of a scale of value, independent of these acts and preceding them, and of a previously devised plan whose realization they aim at. The scale of value and the plan to which duration and immutability for a certain period of time were attributed, were hypostasized into the cause and motive of the various individual actions. Synchronism which could not be asserted with regard to various acts was then easily discovered in the scale of value and in the plan. But this overlooks the fact that the scale of value is nothing but a constructed tool of thought. The scale of value manifests itself only in real acting; it can be discerned only from the observation of real acting. It is therefore impermissible to contrast it with real acting and to use it as a yardstick for the appraisal of real actions.
It is no less impermissible to differentiate between rational and allegedly irrational acting on the basis of a comparison of real acting with earlier drafts and plans for future actions. It may be very interesting that yesterday goals were set for today’s acting other than those really aimed at today. But yesterday’s plans do not provide us with any more objective and nonarbitrary standard for the appraisal of today’s real acting than any other ideas and norms.
The attempt has been made to attain the notion of a nonrational action by this reasoning: If a is preferred to b and b to c, logically a should be preferred to c. But if actually c is preferred to a, we are faced with a mode of acting to which we cannot ascribe consistency and rationality.Cf. Felix Kaufmann, “On the Subject-Matter of Economic Science,” Economica 13: 390. This reasoning disregards the fact that two acts of an individual can never be synchronous. If in one action a is preferred to b and in another action b to c, it is, however short the interval between the two actions may be, not permissible to construct a uniform scale of value in which a precedes b and b precedes c. Nor is it permissible to consider a later third action as coincident with the two previous actions. All that the example proves is that value judgments are not immutable and that therefore a scale of value, which is abstracted from various, necessarily nonsynchronous actions of an individual, may be self-contradictory.Cf. [Philip H.] Wicksteed, The Common Sense of Political Economy, ed. Robbins (London, 1933), vol. 1, pp. 32 ff.; [Lionel] Robbins, An Essay on the Nature and Significance of Economic Science, 2d ed. (London, 1935), pp. 91 ff.
One must not confuse the logical concept of consistency (viz., absence of contradiction) and the praxeological concept of consistency (viz., constancy or clinging to the same principles). Logical consistency has its place only in thinking, constancy has its place only in acting.
Constancy and rationality are entirely different notions. If one’s valuations have changed, unremitting faithfulness to the once espoused principles of action merely for the sake of constancy would not be rational but simply stubborn. Only in one respect can acting be constant: in preferring the more valuable to the less valuable. If the valuations change, acting must change also. Faithfulness, under changed conditions, to an old plan would be nonsensical. A logical system must be consistent and free of contradictions because it implies the coexistence of all its parts and theorems. In acting, which is necessarily in the temporal order, there cannot be any question of such consistency. Acting must be suited to purpose, and purposefulness requires adjustment to changing conditions.
Presence of mind is considered a virtue in acting man. A man has presence of mind if he has the ability to think and to adjust his acting so quickly that the interval between the emergence of new conditions and the adaptation of his actions to them becomes as short as possible. If constancy is viewed as faithfulness to a plan once designed without regard to changes in conditions, then presence of mind and quick reaction are the very opposite of constancy.
When the speculator goes to the stock exchange, he may sketch a definite plan for his operations. Whether or not he clings to this plan, his actions are rational also in the sense which those eager to distinguish rational acting from irrational attribute to the term “rational.” This speculator in the course of the day may embark upon transactions which an observer, not taking into account the changes occurring in market conditions, will not be able to interpret as the outcome of constant behavior. But the speculator is firm in his intention to make profits and to avoid losses. Accordingly he must adjust his conduct to the change in market conditions and in his own judgment concerning the future development of prices.Plans too, of course, may be self-contradictory. Sometimes their contradictions may be the effect of mistaken judgment. But sometimes such contradictions may be intentional and serve a definite purpose. If, for instance, a publicized program of a government or a political party promises high prices to the producers and at the same time low prices to the consumers, the purpose of such an espousal of incompatible goals may be demagogic. Then the program, the publicized plan, is self-contradictory; but the plan of its authors who wanted to attain a definite end through the endorsement of incompatible aims and their public announcement is free of any contradiction.
However one twists things, one will never succeed in formulating the notion of “irrational” action whose “irrationality” is not founded upon an arbitrary judgment of value. Let us suppose that somebody has chosen to act inconstantly for no other purpose than for the sake of refuting the praxeological assertion that there is no irrational action. What happens here is that a man aims at a peculiar goal, viz., the refutation of a praxeological theorem, and that he accordingly acts differently from what he would have done otherwise. He has chosen an unsuitable means for the refutation of praxeology, that is all. ...
- Uncertainty and Acting[Mises, Human Action, chap. 6: “Uncertainty,” pp. 105–15.]The uncertainty of the future is already implied in the very notion of action. That man acts and that the future is uncertain are by no means two independent matters. They are only two different modes of establishing one thing.
We may assume that the outcome of all events and changes is uniquely determined by eternal unchangeable laws governing becoming and development in the whole universe. We may consider the necessary connection and interdependence of all phenomena, i.e., their causal concatenation, as the fundamental and ultimate fact. We may entirely discard the notion of undetermined chance. But however that may be, or appear to the mind of a perfect intelligence, the fact remains that to acting man the future is hidden. If man knew the future, he would not have to choose and would not act. He would be like an automaton, reacting to stimuli without any will of his own.
Some philosophers are prepared to explode the notion of man’s will as an illusion and self-deception because man must unwittingly behave according to the inevitable laws of causality. They may be right or wrong from the point of view of the prime mover or the cause of itself. However, from the human point of view action is the ultimate thing. We do not assert that man is “free” in choosing and acting. We merely establish the fact that he chooses and acts and that we are at a loss to use the methods of the natural sciences for answering the question why he acts this way and not otherwise.
Natural science does not render the future predictable. It makes it possible to foretell the results to be obtained by definite actions. But it leaves impredictable two spheres: that of insufficiently known natural phenomena and that of human acts of choice. Our ignorance with regard to these two spheres taints all human actions with uncertainty. Apodictic certainty is only within the orbit of the deductive system of aprioristic theory. The most that can be attained with regard to reality is probability.
It is not the task of praxeology to investigate whether or not it is permissible to consider as certain some of the theorems of the empirical natural sciences. This problem is without practical importance for praxeological considerations. At any rate, the theorems of physics and chemistry have such a high degree of probability that we are entitled to call them certain for all practical purposes. We can practically forecast the working of a machine constructed according to the rules of scientific technology. But the construction of a machine is only a part in a broader program that aims at supplying the consumers with the machine’s products. Whether this was or was not the most appropriate plan depends on the development of future conditions which at the time of the plan’s execution cannot be forecast with certainty. Thus the degree of certainty with regard to the technological outcome of the machine’s construction, whatever it may be, does not remove the uncertainty inherent in the whole action. Future needs and valuations, the reaction of men to changes in conditions, future scientific and technological knowledge, future ideologies and policies can never be foretold with more than a greater or smaller degree of probability. Every action refers to an unknown future. It is in this sense always a risky speculation.
The problems of truth and certainty concern the general theory of human knowledge. The problem of probability, on the other hand, is a primary concern of praxeology.
- The Meaning of ProbabilityThe treatment of probability has been confused by the mathematicians. From the beginning there was an ambiguity in dealing with the calculus of probability. When the Chevalier de Méré consulted Pascal on the problems involved in the games of dice, the great mathematician should have frankly told his friend the truth, namely, that mathematics cannot be of any use to the gambler in a game of pure chance. Instead he wrapped his answer in the symbolic language of mathematics. What could easily be explained in a few sentences of mundane speech was expressed in a terminology which is unfamiliar to the immense majority and therefore regarded with reverential awe. People suspected that the puzzling formulas contain some important revelations, hidden to the uninitiated; they got the impression that a scientific method of gambling exists and that the esoteric teachings of mathematics provide a key for winning. The heavenly mystic Pascal unintentionally became the patron saint of gambling. The textbooks of the calculus of probability gratuitously propagandize for the gambling casinos precisely because they are sealed books to the layman.
No less havoc was spread by the equivocations of the calculus of probability in the field of scientific research. The history of every branch of knowledge records instances of the misapplication of the calculus of probability which, as John Stuart Mill observed, made it “the real opprobrium of mathematics.”John Stuart Mill, A System of Logic Ratiocinative and Inductive (new impression; London, 1936), p. 353. Some of the worst errors have arisen in our day in the interpretation of the methods of physics.
The problem of probable inference is much bigger than those problems which constitute the field of the calculus of probability. Only preoccupation with the mathematical treatment could result in the prejudice that probability always means frequency.
A further error confused the problem of probability with the problem of inductive reasoning as applied by the natural sciences. The attempt to substitute a universal theory of probability for the category of causality characterizes an abortive mode of philosophizing, very fashionable only a few years ago.
A statement is probable if our knowledge concerning its content is deficient. We do not know everything which would be required for a definite decision between true and not true. But, on the other hand, we do know something about it; we are in a position to say more than simply non liquet or ignoramus.
There are two entirely different instances of probability; we may call them class probability (or frequency probability) and case probability (or the specific understanding of the sciences of human action). The field for the application of the former is the field of the natural sciences, entirely ruled by causality; the field for the application of the latter is the field of the sciences of human action, entirely ruled by teleology.
- Class ProbabilityClass probability means: 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.
We know, for instance, that there are ninety tickets in a lottery and that five of them will be drawn. Thus we know all about the behavior of the whole class of tickets. But with regard to the singular tickets we do not know anything but that they are elements of this class of tickets.
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.
For this defective knowledge the calculus of probability provides a presentation in symbols of the mathematical terminology. It neither expands nor deepens nor complements our knowledge. It translates it into mathematical language. Its calculations repeat in algebraic formulas what we knew beforehand. They do not lead to results that would tell us anything about the actual singular events. And, of course, they do not add anything to our knowledge concerning the behavior of the whole class, as this knowledge was already perfect — or was considered perfect — at the very outset of our consideration of the matter.
It is a serious mistake to believe that the calculus of probability provides the gambler with any information which could remove or lessen the risk of gambling. It is, contrary to popular fallacies, quite useless for the gambler, as is any other mode of logical or mathematical reasoning. It is the characteristic mark of gambling that it deals with the unknown, with pure chance. The gambler’s hopes for success are not based on substantial considerations. The nonsuperstitious gambler thinks: “There is a slight chance [or, in other words: ‘it is not impossible’] that I may win; I am ready to put up the stake required. I know very well that in putting it up I am behaving like a fool. But the biggest fools have the most luck. Anyway!”
Cool reasoning must show the gambler that he does not improve his chances by buying two tickets instead of one of a lottery in which the total amount of the winnings is smaller than the proceeds from the sale of all tickets. If he were to buy all the tickets, he would certainly lose a part of his outlay. Yet every lottery customer is firmly convinced that it is better to buy more tickets than less. The habitués of the casinos and slot machines never stop. They do not give a thought to the fact that, because the ruling odds favor the banker over the player, the outcome will the more certainly result in a loss for them the longer they continue to play. The lure of gambling consists precisely in its unpredictability and its adventurous vicissitudes.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. He would substitute himself for the insured. He would collect ten dollars and would get the chance either of keeping it or of losing that ten dollars and ninety dollars more.
If a man promises to pay at the death of another man a definite sum and charges for this promise the amount adequate to the life expectancy as determined by the calculus of probability, he is not an insurer but a gambler. Insurance, whether conducted according to business principles or according to the principle of mutuality, requires the insurance of a whole class or what can reasonably be considered as such. Its basic idea is pooling and distribution of risks, not the calculus of probability. The mathematical operations that it requires are the four elementary operations of arithmetic. The calculus of probability is mere by-play.
This is clearly evidenced by the fact that the elimination of hazardous risk by pooling can also be effected without any recourse to actuarial methods. Everybody practices it in his daily life. Every businessman includes in his normal cost accounting the compensation for losses which regularly occur in the conduct of affairs. “Regularly” means in this context: The amount of these losses is known as far as the whole class of the various items is concerned. The fruit dealer may know, for instance, that one of every fifty apples will rot in this stock; but he does not know to which individual apple this will happen. He deals with such losses as with any other item in the bill of costs.
The definition of the essence of class probability as given above is the only logically satisfactory one. It avoids the crude circularity implied in all definitions referring to the equiprobability of possible events. In stating that we know nothing about actual singular events except that they are elements of a class the behavior of which is fully known, this vicious circle is disposed of. Moreover, it is superfluous to add a further condition called the absence of any regularity in the sequence of the singular events.
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.
- Case ProbabilityCase probability means: We know, with regard to a particular event, some of the factors which determine its outcome; but there are other determining factors about which we know nothing.
Case probability has nothing in common with class probability but the incompleteness of our knowledge. In every other regard the two are entirely different.
There are, of course, many instances in which men try to forecast a particular future event on the basis of their knowledge about the behavior of the class. A doctor may determine the chances for the full recovery of his patient if he knows that 70 per cent of those afflicted with the same disease recover. If he expresses his judgment correctly, he will not say more than that the probability of recovery is 0.7, that is, that out of ten patients not more than three on the average die. All such predictions about external events, i.e., events in the field of the natural sciences, are of this character. They are in fact not forecasts about the issue of the case in question, but statements about the frequency of the various possible outcomes. They are based either on statistical information or simply on the rough estimate of the frequency derived from nonstatistical experience.
So far as such types of probable statements are concerned, we are not faced with case probability. In fact we do not know anything about the case in question except that it is an instance of a class the behavior of which we know or think we know.
A surgeon tells a patient who considers submitting himself to an operation that thirty out of every hundred undergoing such an operation die. If the patient asks whether this number of deaths is already full, he has misunderstood the sense of the doctor’s statement. He has fallen prey to the error known as the “gambler’s fallacy.” Like the roulette player who concludes from a run of ten red in succession that the probability of the next turn being black is now greater than it was before the run, he confuses case probability with class probability.
All medical prognoses, when based only on physiological knowledge, deal with class probability. A doctor who hears that a man he does not know has been seized by a definite illness will, on the basis of his general medical experience, say: His chances for recovery are 7 to 3. If the doctor himself treats the patient, he may have a different opinion. The patient is a young, vigorous man; he was in good health before he was taken with the illness. In such cases, the doctor may think, the mortality figures are lower; the chances for this patient are not 7:3, but 9:1. The logical approach remains the same, although it may be based not on a collection of statistical data, but simply on a more or less exact résumé of the doctor’s own experience with previous cases. What the doctor knows is always only the behavior of classes. In our instance the class is the class of young, vigorous men seized by the illness in question.
Case probability is a particular feature of our dealing with problems of human action. Here any reference to frequency is inappropriate, as our statements always deal with unique events which as such — i.e., with regard to the problem in question — are not members of any class. We can form a class “American presidential elections.” This class concept may prove useful or even necessary for various kinds of reasoning, as, for instance, for a treatment of the matter from the viewpoint of constitutional law. But if we are dealing with the election of 1944 — either, before the election, with its future outcome or, after the election, with an analysis of the factors which determined the outcome — we are grappling with an individual, unique, and nonrepeatable case. The case is characterized by its unique merits, it is a class by itself. All the marks which make it permissible to subsume it under any class are irrelevant for the problem in question.
Two football teams, the Blues and the Yellows, will play tomorrow. In the past the Blues have always defeated the Yellows. This knowledge is not knowledge about a class of events. If we were to consider it as such, we would have to conclude that the Blues are always victorious and that the Yellows are always defeated. We would not be uncertain with regard to the outcome of the game. We would know for certain that the Blues will win again. The mere fact that we consider our forecast about tomorrow’s game as only probable shows that we do not argue this way.
On the other hand, we believe that the fact that the Blues were victorious in the past is not immaterial with regard to the outcome of tomorrow’s game. We consider it as a favorable prognosis for the repeated success of the Blues. If we were to argue correctly according to the reasoning appropriate to class probability, we would not attach any importance to this fact. If we were not to resist the erroneous conclusion of the “gambler’s fallacy,” we would, on the contrary, argue that tomorrow’s game will result in the success of the Yellows.
If we risk some money on the chance of one team’s victory, the lawyers would qualify our action as a bet. They would call it gambling if class probability were involved.
Everything that outside the field of class probability is commonly implied in the term probability refers to the peculiar mode of reasoning involved in dealing with historical uniqueness or individuality, the specific understanding of the historical sciences.
Understanding is always based on incomplete knowledge. We may know the motives of the acting men, the ends they are aiming at, and the means they plan to apply for the attainment of these ends. We have a definite opinion with regard to the effects to be expected from the operation of these factors. But this knowledge is defective. We cannot exclude beforehand the possibility that we have erred in the appraisal of their influence or have failed to take into consideration some factors whose interference we did not foresee at all, or not in a correct way.
Gambling, engineering, and speculating are three different modes of dealing with the future.
The gambler knows nothing about the event on which the outcome of his gambling depends. All that he knows is the frequency of a favorable outcome of a series of such events, knowledge which is useless for his undertaking. He trusts to good luck, that is his only plan.
Life itself is exposed to many risks. At any moment it is endangered by disastrous accidents which cannot be controlled, or at least not sufficiently. Every man banks on good luck. He counts upon not being struck by lightning and not being bitten by a viper. There is an element of gambling in human life. Man can remove some of the chrematistic consequences of such disasters and accidents by taking out insurance policies. In doing so he banks upon the opposite chances. On the part of the insured the insurance is gambling. His premiums were spent in vain if the disaster does not occur.In life insurance the insured’s stake spent in vain consists only in the difference between the amount collected and the amount he could have accumulated by saving. With regard to noncontrollable natural events man is always in the position of a gambler.
The engineer, on the other hand, knows everything that is needed for a technologically satisfactory solution of his problem, the construction of a machine. As far as some fringes of uncertainty are left in his power to control, he tries to eliminate them by taking safety margins. The engineer knows only soluble problems and problems which cannot be solved under the present state of knowledge. He may sometimes discover from adverse experience that his knowledge was less complete than he had assumed and that he failed to recognize the indeterminateness of some issues which he thought he was able to control. Then he will try to render his knowledge more complete. Of course he can never eliminate altogether the element of gambling present in human life. But it is his principle to operate only within an orbit of certainty. He aims at full control of the elements of his action.
It is customary nowadays to speak of “social engineering.” Like planning, this term is a synonym for dictatorship and totalitarian tyranny. The idea is to treat human beings in the same way in which the engineer treats the stuff out of which he builds his bridges, roads, and machines. The social engineer’s will is to be substituted for the will of the various people he plans to use for the construction of his utopia. Mankind is to be divided into two classes: the almighty dictator, on the one hand, and the underlings who are to be reduced to the status of mere pawns in his plans and cogs in his machinery, on the other. If this were feasible, then of course the social engineer would not have to bother about understanding other people’s actions. He would be free to deal with them as technology deals with lumber and iron.
In the real world acting man is faced with the fact that there are fellow men acting on their own behalf as he himself acts. The necessity to adjust his actions to other people’s actions makes him a speculator for whom success and failure depend on his greater or lesser ability to understand the future. Every investment is a form of speculation. There is in the course of human events no stability and consequently no safety.
- Numerical Evaluation of Case ProbabilityCase probability is not open to any kind of numerical evaluation. What is commonly considered as such exhibits, when more closely scrutinized, a different character.
On the eve of the 1944 presidential election people could have said:
(a) I am ready to bet three dollars against one that Roosevelt will be elected.
(b) I guess that out of the total amount of electors 45 million will exercise their franchise, 25 millions of whom will vote for Roosevelt.
(c) I estimate Roosevelt’s chances as 9 to 1.
(d) I am certain that Roosevelt will be elected.
Statement (d) is obviously inexact. If asked under oath on the witness stand whether he is as certain about Roosevelt’s future victory as about the fact that a block of ice will melt when exposed to a temperature of 150 degrees, our man would have answered no. He would have rectified his statement and would have declared: I am personally fully convinced that Roosevelt will carry on. That is my opinion. But, of course, this is not certainty, only the way I understand the conditions involved.
The case of statement (a) is similar. This man believed that he risked very little when laying such a wager. The relation 3:1 is the outcome of the interplay of two factors: the opinion that Roosevelt will be elected and the man’s propensity for betting.
Statement (b) is an evaluation of the outcome of the impending event. Its figures refer not to a greater or smaller degree of probability, but to the expected result of the voting. Such a statement may be based on a systematic investigation like the Gallup poll or simply on estimates.
It is different with statement (c). This is a proposition about the expected outcome couched in arithmetical terms. It certainly does not mean that out of ten cases of the same type nine are favorable for Roosevelt and one unfavorable. It cannot have any reference to class probability. But what else can it mean?
It is a metaphorical expression. Most of the metaphors used in daily speech imaginatively identify an abstract object with another object that can be apprehended directly by the senses. Yet this is not a necessary feature of metaphorical language, but merely a consequence of the fact that the concrete is as a rule more familiar to us than the abstract. As metaphors aim at an explanation of something which is less well known by comparing it with something better known, they consist for the most part in identifying something abstract with a better-known concrete. The specific mark of our case is that it is an attempt to elucidate a complicated state of affairs by resorting to an analogy borrowed from a branch of higher mathematics, the calculus of probability. As it happens, this mathematical discipline is more popular than the analysis of the epistemological nature of understanding.
There is no use in applying the yardstick of logic to a critique of metaphorical language. Analogies and metaphors are always defective and logically unsatisfactory. It is usual to search for the underlying tertium comparationis. But even this is not permissible with regard to the metaphor we are dealing with. For the comparison is based on a conception which is in itself faulty in the very frame of the calculus of probability, namely the gambler’s fallacy. In asserting that Roosevelt’s chances are 9:1, the idea is that Roosevelt is in regard to the impending election in the position of a man who owns 90 per cent of all tickets of a lottery in regard to the first prize. It is implied that this ratio 9:1 tells us something substantial about the outcome of the unique case in which we are interested. There is no need to repeat that this is a mistaken idea.
No less impermissible is the recourse to the calculus of probability in dealing with hypotheses in the field of the natural sciences. Hypotheses are tentative explanations consciously based on logically insufficient arguments. With regard to them all that can be asserted is: The hypothesis does or does not contradict either logical principles or the facts as experimentally established and considered as true. In the first case it is untenable, in the second case it is — under the present state of our experimental knowledge — not untenable. (The intensity of personal conviction is purely subjective.) Neither frequency probability nor historical understanding enters into the matter.
The term hypothesis, applied to definite modes of understanding historical events, is a misnomer. If a historian asserts that in the fall of the Romanoff dynasty the fact that this house was of German background played a relevant role, he does not advance a hypothesis. The facts on which his understanding is founded are beyond question. There was a widespread animosity against Germans in Russia, and the ruling line of the Romanoffs, having for 200 years intermarried exclusively with scions of families of German descent, was viewed by many Russians as a Germanized family, even by those who assumed that Tsar Paul was not the son of Peter III. But the question remains what the relevance of these facts was in the chain of events which brought about the dethronement of this dynasty. Such problems are not open to any elucidation other than that provided by understanding.
The Mises Reader can be found here.
From the Introduction by Shawn Ritenour ...
During my time in college, while I was still working through Human Action, I sought out other more accessible books by Mises. This was years before the advent of the internet and mises.org. I had to turn to that ancient institution called the library and I discovered that our college library had a collection of shorter essays by Mises published by Libertarian Press in a collection entitled Planning for Freedom and Sixteen Other Essays. This book proved to be a more accessible introduction to Mises’s thought. I began reading it during my free time and did not stop until I had come to the end. Planning for Freedom turned out to be the first book by Mises that I read completely. As I read, I began to put together an economic and political philosophy that revolved around private property. It was the writings of Mises that provided me the intellectual foundation to evaluate and integrate what I was being taught in school. Looking back on those years, I have grown to appreciate the wisdom expressed in the sentiment by Mark Thornton that one of the best ways to become introduced to the work of Ludwig von Mises is through some of his shorter, more popular works. While sacrificing nothing in the way of sound economic theory, they are more accessible and in any event are not as intimidating as Mises’s 881-page magnum opus.
In The Mises Reader, I have sought to bring you the best of both worlds. An attempt has been made to acquaint the reader with the broad spectrum of Mises’s ideas and analyses in a way that is more accessible and less daunting. The selections include, therefore, several shorter, more popular works side-by-side with excerpts from longer, more scholarly and technically difficult works. It is my hope that this book will provide a user-friendly gateway into the brilliance of Mises, because we desperately need his wisdom as much now as in any other time in our history.
The work of Ludwig von Mises is an important guide for thoughtful citizens because he strongly, yet matter-of-factly sets forth economics as the pursuit of truth. Not the truth of the passing fancy, nor the so-called “small t-truth” that is always in danger of being refuted by the latest bit of empirical data; but economic truth that will stand for all ages. Misesian economic theory is a triumphant response to the epistemological relativism of today because it is economics developed in light of reality.
Upon reading the works of Mises, one is immediately set forth on the right road, because Mises begins where economics must begin — human action. All of his economic theorems and corollaries are deduced from the non-controversial axiom that people engage in purposeful behavior. This immediately sets his theories on intellectual bedrock. ...
Ludwig von Mises truly was an intellectual giant among men and, as Murray Rothbard saw, his thought and causal-realist framework is the best alternative to the economic paradigm of our age. In the contemporary fog of the modern academy, Mises serves as a lighthouse, warning unsuspecting students of the perils of bad economics and statist economic policies, while illuminating students to the principles of the free society.
The book in your hands is intended to give a taste of the many facets of Mises’s thought in a way that accessibly communicates most of his key contributions to the social sciences. It therefore includes excerpts from his larger and more technically demanding works side-by-side with shorter, more introductory articles and lectures. The finished product is sort of an intelligent person’s guide to the work of Ludwig von Mises. It is especially suitable for those with an interest in Mises, but find jumping right into Human Action, Socialism, or The Theory of Money and Credit rather daunting. The hope is to give the reader a survey of Mises’s insights in a format that nourishes his intellectual soul, while also whetting the appetite for his larger corpus of work. Those not quite ready to dive deeply into Misesian waters may wish to pick up The Mises Reader, an abridged version of this volume. It is hoped that together these two volumes will foster a rising generation of citizens more thoroughly acquainted with sound economics and the principles of the free society. ...
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 1: “Acting Man,” chap. 17: “Indirect Exchange,” pp. 402–04.]The Epistemological Import of Carl Menger’s Theory of the Origin of MoneyCarl Menger has not only provided an irrefutable praxeological theory of the origin of money. He has also recognized the import of his theory for the elucidation of fundamental principles of praxeology and its methods of research.Cf. Carl Menger’s books Grundsätze der Volkswirtschaftslehre (Vienna, 1871), pp. 250 ff.; ibid. (2d ed. Vienna, 1923), pp. 241 ff.; Untersuchungen über die Methode der Sozialwissenschaften (Leipzig, 1883), pp. 171 ff.
There were authors who tried to explain the origin of money by decree or covenant. The authority, the state, or a compact between citizens has purposively and consciously established indirect exchange and money. The main deficiency of this doctrine is not to be seen in the assumption that people of an age unfamiliar with indirect exchange and money could design a plan of a new economic order, entirely different from the real conditions of their own age, and could comprehend the importance of such a plan. Neither is it to be seen in the fact that history does not afford a clue for the support of such statements. There are more substantial reasons for rejecting it.
If it is assumed that the conditions of the parties concerned are improved by every step that leads from direct exchange to indirect exchange and subsequently to giving preference for use as a medium of exchange to certain goods distinguished by their especially high marketability, it is difficult to conceive why one should, in dealing with the origin of indirect exchange, resort in addition to authoritarian decree or an explicit compact between citizens. A man who finds it hard to obtain in direct barter what he wants to acquire renders better his chances to acquire what he is asking for in later acts of exchange by the procurement of a more marketable good. Under these circumstances there was no need of government interference or of a compact between the citizens. The happy idea of proceeding in this way could strike the shrewdest individuals, and the less resourceful could imitate the former’s method. It is certainly more plausible to take for granted that the immediate advantages conferred by indirect exchange were recognized by the acting parties than to assume that the whole image of a society trading by means of money was conceived by a genius and, if we adopt the covenant doctrine, made obvious to the rest of the people by persuasion.
If, however, we do not assume that individuals discovered the fact that they fare better through indirect exchange than through waiting for an opportunity for direct exchange, and, for the sake of argument, admit that the authorities or a compact introduced money, further questions are raised. We must ask what kind of measures were applied in order to induce people to adopt a procedure the utility of which they did not comprehend and which was technically more complicated than direct exchange. We may assume that compulsion was practiced. But then we must ask, further, at what time and by what occurrences indirect exchange and the use of money later ceased to be procedures troublesome or at least indifferent to the individuals concerned and became advantageous to them.
The praxeological method traces all phenomena back to the actions of individuals. If conditions of interpersonal exchange are such that indirect exchange facilitates the transactions, and if and as far as people realize these advantages, indirect exchange and money come into being. Historical experience shows that these conditions were and are present. How, in the absence of these conditions, people could have adopted indirect exchange and money and clung to these modes of exchanging is inconceivable.
The historical question concerning the origin of indirect exchange and money is after all of no concern to praxeology. The only relevant thing is that indirect exchange and money exist because the conditions for their existence were and are present. If this is so, praxeology does not need to resort to the hypothesis that authoritarian decree or a covenant invented these modes of exchanging. The étatists may if they like continue to ascribe the “invention” of money to the state, however unlikely this may be. What matters is that a man acquires a good not in order to consume it or to use it in production, but in order to give it away in a further act of exchange. Such conduct on the part of people makes a good a medium of exchange and, if such conduct becomes common with regard to a certain good, makes it money. All theorems of the catallactic theory of media of exchange and of money refer to the services which a good renders in its capacity as a medium of exchange. Even if it were true that the impulse for the introduction of indirect exchange and money was provided by the authorities or by an agreement between the members of society, the statement remains unshaken that only the conduct of exchanging people can create indirect exchange and money.
History may tell us where and when for the first time media of exchange came into use and how, subsequently, the range of goods employed for this purpose was more and more restricted. As the differentiation between the broader notion of a medium of exchange and the narrower notion of money is not sharp, but gradual, no agreement can be reached about the historical transition from simple media of exchange to money. This is a matter of historical understanding. But, as has been mentioned, the distinction between direct exchange and indirect exchange is sharp and everything that catallactics establishes with regard to media of exchange refers categorially to all goods which are demanded and acquired as such media.
As far as the statement that indirect exchange and money were established by decree or by covenant is meant to be an account of historical events, it is the task of historians to expose its falsity. As far as it is advanced merely as a historical statement, it can in no way affect the catallactic theory of money and its explanation of the evolution of indirect exchange. But if it is designed as a statement about human action and social events, it is useless because it states nothing about action. It is not a statement about human action to declare that one day rulers of citizens assembled in convention were suddenly struck by the inspiration that it would be a good idea to exchange indirectly and through the intermediary of a commonly used medium of exchange. It is merely pushing back the problem involved.
It is necessary to comprehend that one does not contribute anything to the scientific conception of human actions and social phenomena if one declares that the state or a charismatic leader or an inspiration which descended upon all the people have created them. Neither do such statements refute the teachings of a theory showing how such phenomena can be acknowledged as “the unintentional outcome, the resultant not deliberately designed and aimed at by specifically individual endeavors of the members of society.”
Economic Freedom and Interventionism[“Man, Economy, and State: A New Treatise on Economics,” in Economic Freedom and Interventionism: An Anthology of Articles and Essays, ed. Bettina Bien Greaves (1962; Indianapolis, Ind.: Liberty Fund, 1990), chap. 36.]“Man, Economy, and State”Most of what goes today under the label of the social sciences is poorly disguised apologetics for the policies of governments. What the philosopher George Santayana (1863–1952) once said about a teacher of philosophy of the, then Royal Prussian, University of Berlin, that it seemed to this man “that a professor’s business was to trudge along a governmental towpath with a legal cargo,” is today everywhere true for the majority of those appointed to teach economics. As these doctors see it, all the evils that plague mankind are caused by the acquisitiveness of greedy exploiters, speculators and monopolists, who are supreme in the conduct of affairs in the market economy. The foremost task of good government is to curb these scoundrels by suppressing their “economic freedom” and subjecting all affairs to the decisions of the central authority. Full government control of everybody’s activities — whether called planning, socialism, communism, or any other name — is praised as the panacea.
To make these ideas plausible one had to proscribe as orthodox, classical, neoclassical, and reactionary all that economics had brought forward before the emergence of the New Deal, the Fair Deal, and the New Frontier. Any acquaintance with pre-Keynesian economics is considered as rather unsuitable and unseemly for an up-to-date economist. It could easily raise in his mind some critical thoughts. It could encourage him to reflect, instead of meekly endorsing the empty slogans of governments and powerful pressure groups. There is, in fact, in the writings and teaching of those who nowadays call themselves “economists,” no longer any comprehension of the operation of the economic system as such. Their books and articles do not describe, analyze, or explain the economic phenomena. They do not pay attention to the interdependence and mutuality of the various individuals’ and groups’ activities. In their view, there exist different economic spheres that have to be treated by and large as isolated domains. They dissolve economics into a number of special fields, such as economics of labor, agriculture, insurance, foreign trade, domestic trade, and so on. These books and articles deal with the height of wage rates, for example, as if it were possible to treat this subject independently of the problems of commodity prices, interest, profit and loss, and all the other issues of economics. They assemble, without any idea for what purpose they are doing it, a vast array of statistical and other historical data about the recent past, which they choose to style the “present.” They entirely fail to comprehend the interconnectedness and mutual determination of the actions of the various individuals whose behavior results in the emergence of the market economy.
The economic writings of the last decades provide a pitiful story of progressing deterioration and degradation. Even a comparison of the recent publications of many older authors with their previous writings, shows an advancing decline. The few, very few, good contributions that came out in our age were smeared as old-fashioned and reactionary by the government economists, boycotted by the universities, the academic magazines and the newspapers, and ignored by the public.
Let us hope that the fate of Murray N. Rothbard’s book Man, Economy and State (Princeton: D. Van Nostrand, 1962) will be different. Dr. Rothbard is already well known as the author of several excellent monographs. Now, as the result of many years of sagacious and discerning meditation, he joins the ranks of eminent economists by publishing a voluminous work, a systematic treatise on economics.
The main virtue of this book is that it is a comprehensive and methodical analysis of all activities commonly called economic. It looks upon these activities as human action, i.e., as conscious striving after chosen ends by resorting to appropriate means. This cognition exposes the fateful efforts of the mathematical treatment of economic problems. The mathematical economist attempts to ignore the difference between physical phenomena, on the one hand, the emergence and consummation of which man is unable to see the operation of any final causes and which can be studied scientifically only because there prevails a perceptible regularity in their concatenation and succession, and praxeological phenomena, on the other hand, that lack such a regularity but are conceivable to the human mind as the outcomes of purposeful aiming at definite ends chosen. Mathematical equations, says Rothbard, are appropriate and useful where there are constant quantitative relations among unmotivated variables; they are inappropriate in the field of conscious behavior. In a few brilliant lines he demolishes the main device of mathematical economists, viz., the fallacious idea of substituting the concepts of mutual determination and equilibrium for the allegedly outdated concept of cause and effect. And he shows that the concepts of equilibrium and the evenly rotating economy do not refer to reality; although indispensable for any economic inquiry, they are merely auxiliary mental tools to aid us in the analysis of real action.
The equations of physics describe a process through time, while those of economics do not describe a process at all, but merely the final equilibrium point, a hypothetical situation that is outside of time and will never be reached in reality. Furthermore, they cannot say anything about the path by which the economy moves in the direction of the final equilibrium position. As there are no constant relations between any of the elements which the science of action studies, there is no measurement possible and all numerical data available have merely an historical character; they belong to economic history and not to economics as such. The positivist slogan, “science is measurement,” in no way refers to the sciences of human action; the claims of “econometrics” are vain.
In every chapter of his treatise, Dr. Rothbard, adopting the best of the teachings of his predecessors, and adding to them highly important observations, not only develops the correct theory but is no less anxious to refute all objections ever raised against these doctrines. He exposes the fallacies and contradictions of the popular interpretation of economic affairs. Thus, for instance, in dealing with the problem of unemployment he points out: in the whole modern and Keynesian discussion of this subject the missing link is precisely the wage rate. It is meaningless to talk of unemployment or employment without reference to a wage rate. Whatever supply of labor service is brought to market can be sold, but only if wages are set at whatever rate will clear the market. If a man wishes to be employed, he will be, provided the wage rate is adjusted according to what Rothbard calls his discounted marginal value product, i.e., the present height of the value which the consumers — at the time of the final sale of the product — will ascribe to his contribution to its production. Whenever the job-seeker insists on a higher wage, he will remain unemployed. If people refuse to be employed except at places, in occupations, or at wage rates they would like, then they are likely to be choosing unemployment for substantial periods. The full import of this state of affairs becomes manifest if one gives attention to the fact that, under present conditions, those offering their services on the labor market themselves represent the immense majority of the consumers whose buying or abstention from buying ultimately determines the height of wage rates.
Less successful than his investigations in the fields of general praxeology and economics are the author’s occasional observations concerning the philosophy of law and some problems of the penal code. But disagreement with his opinions concerning these matters cannot prevent me from qualifying Rothbard’s work as an epochal contribution to the general science of human action, praxeology, and its practically most important and up-to-now best elaborated part, economics. Henceforth all essential studies in these branches of knowledge will have to take full account of the theories and criticisms expounded by Dr. Rothbard.
The publication of a standard book on economics raises again an important question, viz., for whom are essays of this consequence written: only for specialists, the students of economics, or for all of the people?
To answer this question we have to keep in mind that the citizens in their capacity as voters are called upon to determine ultimately all issues of economic policies. The fact that the masses are ignorant of physics and do not know anything substantial about electricity does not obstruct the endeavors of experts who utilize the teachings of science for the satisfaction of the wants of the consumers. From various points of view one may deplore the intellectual insufficiency and indolence of the multitude. But their ignorance regarding the achievements of the natural sciences does not endanger our spiritual and material welfare.
It is quite different in the field of economics. The fact that the majority of our contemporaries, the masses of semi-barbarians led by self-styled intellectuals, entirely ignore everything that economics has brought forward, is the main political problem of our age. There is no use in deceiving ourselves. American public opinion rejects the market economy, the capitalistic free enterprise system that provided the nation with the highest standard of living ever attained. Full government control of all activities of the individual is virtually the goal of both national parties. The individual is to be deprived of his moral, political and economic responsibility and autonomy and to be converted into a pawn in the schemes of a supreme authority aiming at a “national” purpose. His “affluence” is to be cut down for the benefit of what is called the “public sector,” i.e., the machine operated by the party in power. Hosts of authors, writers, and professors are busy denouncing alleged shortcomings of capitalism and exalting the virtues of “planning.” Full of a quasi-religious ardor, the immense majority is advocating measures that step by step lead to the methods of administration practiced in Moscow and in Peking.
If we want to avoid the destruction of Western civilization and the relapse into primitive wretchedness, we must change the mentality of our fellow citizens. We must make them realize what they owe to the much vilified “economic freedom,” the system of free enterprise and capitalism. The intellectuals and those who call themselves educated must use their superior cognitive faculties and power of reasoning for the refutation of erroneous ideas about social, political, and economic problems and for the dissemination of a correct grasp of the operation of the market economy. They must start by familiarizing themselves with all the issues involved in order to teach those who are blinded by ignorance and emotions. They must learn in order to acquire the ability to enlighten the misguided many.
It is a fateful error on the part of our most valuable contemporaries to believe that economics can be left to specialists in the same way in which various fields of technology can be safely left to those who have chosen to make any one of them their vocation. The issues of society’s economic organization are every citizen’s business. To master them to the best of one’s ability is the duty of everyone.
Now such a book as Man, Economy, and State offers to every intelligent man an opportunity to obtain reliable information concerning the great controversies and conflicts of our age. It is certainly not easy reading and asks for the utmost exertion of one’s attention. But there are no shortcuts to wisdom.
“The Economist Eugen v. Böhm-Bawerk: on the Occasion of the Tenth Anniversary of His Death”[A transcript of the German language original under the title “Der Economist Eugen v. Böhm-Bawerk — Zu seinem 10. Todestage” was found in one of Bettina Bien Greaves’s books at the Mises Institute. The text was originally published in the Neue Freie Presse (New Free Press), a Viennese newspaper which was founded by Adolf Werthner, Max Friedländer, and Michael Etienne. It existed from 1864 until 1938. Böhm-Bawerk’s last publication Unsere passive Handelsbilanz (Our passive balance of trade), from which Mises quotes, was also published in this newspaper, and has, to our knowledge, never been translated into English. Translated from German by Karl-Friedrich Israel.]Eugen v. Böhm-Bawerk will remain unforgotten for all those who have known him. The students, who enjoyed the fortune of attending his seminars, will never lose what the acquaintance with such a strong mind has given them. For the politicians, who have met him as a statesman, the integrity of his ethos and his altruistic commitment to duty will continue to be exemplary. And no citizen of this country shall forget the minister of finance, the last Austrian minister of finance, who, in spite of all obstacles, earnestly aimed at balancing the public budget and preventing the upcoming financial catastrophe. But even when the lives of all those, who had known him personally, have come to an end, his scientific oeuvre shall live on and bear fruit.
In his scientific work Böhm-Bawerk focused from the outset on the central problem of theoretical economics, the interest problem. At the age of twenty-five, in the spring of 1876, he gave a lecture on the interest on capital in the Knies seminar in Heidelberg, which already contained the main features of what would later become his famous agio theory of interest. Before he could however publish his work, there were difficult preliminary questions to answer. It was to these questions that he dedicated his work. Always keeping the ultimate object in mind, he published Rechte und Verhältnisse vom Standpunkte der volkswirtschaftlichen Güterlehre in 1881, Die Geschichte und Kritik der Kapitalzinstheorien in 1884, Grundzüge der Theorie des wirtschaftlichen Güterwertes in 1886, and finally his Positive Theorie des Kapitals in 1889. His work was thereby brought to completion. As Senior Legal Secretary and Head of Division in the ministry of finance, as k. u. k. minister of finance and President of the Senate of the Higher Administrative Court, he had very little leisure in the following years to perform any scientific work. Only since 1904 when he retired from office for the third and last time could he devote himself again undisturbed to his research. A series of excellent works is the fruit of the tireless effort during the last decade that he was allowed to live. He died on August 27 in 1914, when the Austrian armies were about to fight the first battles of the Great War in Poland and Eastern Galicia.
Böhm-Bawerk’s scientific work has quickly found the recognition it richly deserves. His magnum opus [The Positive Theory of Capital] was translated into English by William Smart as early as 1890; shortly afterward a French edition followed. In England, the United States, France, Italy, the Netherlands, Sweden, and Denmark his doctrine became the starting point for further in-depth analyses and studies. Sure enough, in Germany an understanding of Böhm’s achievements was long missing. The prevailing doctrine at the universities ignored him. It took decades until the accomplishments of the “Austrian school” were recognized in the Reich. Today, however, it is considered a grave mischief that only Böhm-Bawerk’s magnum opus, which is already in its fourth German language edition, is easily accessible. His shorter writings, which are indispensable for any friend of economic enquiry, are rather difficult to access. It is therefore a thankworthy enterprise to republish them in a collected edition. A student of Böhm-Bawerk, well known for several scientific works, has addressed himself to this task.Gesammelte Schriften von Eugen von Böhm-Bawerk, edited by Franz X. Weiss and published by Hölder-Pichler-Tempsky A.G., Vienna and Leipzig, 1924. The well-endowed volume, which is graced with a felicitous portrait of Böhm, contains the above mentioned work Rechte und Verhältnisse, along with a tract on general theory and methodology, essays on the theory of value, and finally an essay that has been published on January 6, 8, and 9, 1924 in the Neue Freie Presse, entitled Unsere passive Handelsbilanz. It starts with a short biographical introduction by the editor, Dr. Franz X. Weiss. The essays on capital and interest, which are not contained in this collection, shall be republished in a separate volume.
To praise the tremendous value of the theoretical works collected in this volume would be like bringing owls to Athens. For the experts and numerous intellectuals who are concerned with economic questions, this would hardly constitute anything new. Let us however quote some sentences from the above mentioned essay on the passive balance of trade, merely to emphasize the sharpness with which Böhm has early on pointed to the fundamental problem underlying our state finances. It reads: “thrift is never popular. … If parliaments have historically been the guardians of — thrift, they now have turned much rather into its sworn enemies. Nowadays, the political and national parties — maybe not exclusively in our own country, but certainly also here tend to develop a certain covetousness, almost considered to be dutiful, for all kinds of benefits for their own electorate at the expense of the general public. And when the political situation is relatively convenient, that is to say, if it is relatively inconvenient for the government, one’s ends can be achieved through political pressure.” Our population suffers from economical megalomania. This is among other things shown by the “investments from the public purse.” One is often mistaken when using the famous slogan of “indirect productivity” of public spending, even if at times the indirect advantages of public enterprises, which are unprofitable by themselves, may exceed the amount that has to be paid from public funds for their passive operations. The “blind eulogists of frivolous investment policies” will feel the mistakes of their approach “only when, like these days, the capital stock has been exhausted by the public sector over many years to a degree that capital is lacking for the most important and vital private businesses in all spheres, only when many enterprises begin to stumble, many projects have to remain undone, and all suffer severely from the increased rate of interest.”
These were the last words that Böhm-Bawerk has addressed to Austria’s financial authorities. Today they will be valued more highly than at the time when they were first published in this newspaper.
The Theory of Money and Credit[Ludwig von Mises, The Theory of Money and Credit (1934; Indianapolis, Ind.: LibertyClassics, 1980), chap. 1: “The Function of Money,” pp. 29–37.]1. The General Economic Conditions for the Use of MoneyWhere the free exchange of goods and services is unknown, money is not wanted. In a state of society in which the division of labor was a purely domestic matter and production and consumption were consummated within the single household it would be just as useless as it would be for an isolated man. But even in an economic order based on division of labor, money would still be unnecessary if the means of production were socialized, the control of production and the distribution of the finished product were in the hands of a central body, and individuals were not allowed to exchange the consumption goods allotted to them for the consumption goods allotted to others.
The phenomenon of money presupposes an economic order in which production is based on division of labor and in which private property consists not only in goods of the first order (consumption goods), but also in goods of higher orders (production goods). In such a society, there is no systematic centralized control of production, for this is inconceivable without centralized disposal over the means of production. Production is “anarchistic.” What is to be produced, and how it is to be produced, is decided in the first place by the owners of the means of production, who produce, however, not only for their own needs, but also for the needs of others, and in their valuations take into account, not only the use-value that they themselves attach to their products, but also the use-value that these possess in the estimation of the other members of the community. The balancing of production and consumption takes place in the market, where the different producers meet to exchange goods and services by bargaining together. The function of money is to facilitate the business of the market by acting as a common medium of exchange.
- The Origin of MoneyIndirect exchange is distinguished from direct exchange according as a medium is involved or not.
Suppose that A and B exchange with each other a number of units of the commodities m and n. A acquires the commodity n because of the use-value that it has for him. He intends to consume it. The same is true of B, who acquires the commodity m for his immediate use. This is a case of direct exchange.
If there are more than two individuals and more than two kinds of commodity in the market, indirect exchange also is possible. A may then acquire a commodity p, not because he desires to consume it, but in order to exchange it for a second commodity q which he does desire to consume. Let us suppose that A brings to the market two units of the commodity m, B two units of the commodity n, and C two units of the commodity o, and that A wishes to acquire one unit of each of the commodities n and o, B one unit of each of the commodities o and m, and C one unit of each of the commodities m and n. Even in this case a direct exchange is possible if the subjective valuations of the three commodities permit the exchange of each unit of m, n, and o for a unit of one of the others. But if this or a similar hypothesis does not hold good, and in by far the greater number of all exchange transactions it does not hold good, then indirect exchange becomes necessary, and the demand for goods for immediate wants is supplemented by a demand for goods to be exchanged for others.See [Knut] Wicksell, Über Wert, Kapital und Rente (Jena, 1893; London, 1933), pp. 50 f.
Let us take, for example, the simple case in which the commodity p is desired only by the holders of the commodity q, while the commodity q is not desired by the holders of the commodity p but by those, say, of a third commodity r, which in its turn is desired only by the possessors of p. No direct exchange between these persons can possibly take place. If exchanges occur at all, they must be indirect; as, for instance, if the possessors of the commodity p exchange it for the commodity q and then exchange this for the commodity r which is the one they desire for their own consumption. The case is not essentially different when supply and demand do not coincide quantitatively; for example, when one indivisible good has to be exchanged for various goods in the possession of several persons.
Indirect exchange becomes more necessary as division of labor increases and wants become more refined. In the present stage of economic development, the occasions when direct exchange is both possible and actually effected have already become very exceptional. Nevertheless, even nowadays, they sometimes arise. Take, for instance, the payment of wages in kind, which is a case of direct exchange so long on the one hand as the employer uses the labor for the immediate satisfaction of his own needs and does not have to procure through exchange the goods in which the wages are paid, and so long on the other hand as the employee consumes the goods he receives and does not sell them. Such payment of wages in kind is still widely prevalent in agriculture, although even in this sphere its importance is being continually diminished by the extension of capitalistic methods of management and the development of division of labor.The conclusion that indirect exchange is necessary in the majority of cases is extremely obvious. As we should expect, it is among the earliest discoveries of economics. We find it clearly expressed in the famous fragment of the Pandects of Paulus: “Quia non semper nec facile concurrebat, ut, cum tu haberas, quod ego desiderarem, invicem haberem, quod tu accipere velles” (Paulus, lib. 33 ad edictum 1.I pr. D. de contr. empt. 18, I). Schumpeter is surely mistaken in thinking that the necessity for money can be proved solely from the assumption of indirect exchange (see his Wesen und Hauptinhalt der theoretischen Nationalökonomie [Leipzig, 1908], pp. 273 ff.). On this point, cf. Weiss, Die moderne Tendenz in der Lehre vom Geldwert, Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung, vol. 19, pp. 518 ff.
Thus along with the demand in a market for goods for direct consumption there is a demand for goods that the purchaser does not wish to consume but to dispose of by further exchange. It is clear that not all goods are subject to this sort of demand. An individual obviously has no motive for an indirect exchange if he does not expect that it will bring him nearer to his ultimate objective, the acquisition of goods for his own use. The mere fact that there would be no exchanging unless it was indirect could not induce individuals to engage in indirect exchange if they secured no immediate personal advantage from it. Direct exchange being impossible, and indirect exchange being purposeless from the individual point of view, no exchange would take place at all. Individuals have recourse to indirect exchange only when they profit by it; that is, only when the goods they acquire are more marketable than those which they surrender.
Now all goods are not equally marketable. While there is only a limited and occasional demand for certain goods, that for others is more general and constant. Consequently, those who bring goods of the first kind to market in order to exchange them for goods that they need themselves have as a rule a smaller prospect of success than those who offer goods of the second kind. If, however, they exchange their relatively unmarketable goods for such as are more marketable, they will get a step nearer to their goal and may hope to reach it more surely and economically than if they had restricted themselves to direct exchange.
It was in this way that those goods that were originally the most marketable became common media of exchange; that is, goods into which all sellers of other goods first converted their wares and which it paid every would-be buyer of any other commodity to acquire first. And as soon as those commodities that were relatively most marketable had become common media of exchange, there was an increase in the difference between their marketability and that of all other commodities, and this in its turn further strengthened and broadened their position as media of exchange.See [Carl] Menger, Untersuchungen über die Methode der Sozialwissenschaften und der politischen Okonomie insbesondere (Leipzig, 1883), pp. 172 ff.; Grundsätze der Volkswirtschaftslehre, 2d ed. (Vienna, 1923), pp. 247 ff.
Thus the requirements of the market have gradually led to the selection of certain commodities as common media of exchange. The group of commodities from which these were drawn was originally large, and differed from country to country; but it has more and more contracted. Whenever a direct exchange seemed out of the question, each of the parties to a transaction would naturally endeavor to exchange his superfluous commodities, not merely for more marketable commodities in general, but for the most marketable commodities; and among these again he would naturally prefer whichever particular commodity was the most marketable of all. The greater the marketability of the goods first acquired in indirect exchange, the greater would be the prospect of being able to reach the ultimate objective without further maneuvering. Thus there would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.
This stage of development in the use of media of exchange, the exclusive employment of a single economic good, is not yet completely attained. In quite early times, sooner in some places than in others, the extension of indirect exchange led to the employment of the two precious metals gold and silver as common media of exchange. But then there was a long interruption in the steady contraction of the group of goods employed for that purpose. For hundreds, even thousands, of years the choice of mankind has wavered undecided between gold and silver. The chief cause of this remarkable phenomenon is to be found in the natural qualities of the two metals. Being physically and chemically very similar, they are almost equally serviceable for the satisfaction of human wants. For the manufacture of ornaments and jewelry of all kinds the one has proved as good as the other. (It is only in recent times that technological discoveries have been made which have considerably extended the range of uses of the precious metals and may have differentiated their utility more sharply.) In isolated communities, the employment of one or the other metal as sole common medium of exchange has occasionally been achieved, but this short-lived unity has always been lost again as soon as the isolation of the community has succumbed to participation in international trade.
Economic history is the story of the gradual extension of the economic community beyond its original limits of the single household to embrace the nation and then the world. But every increase in its size has led to a fresh duality of the medium of exchange whenever the two amalgamating communities have not had the same sort of money. It would not be possible for the final verdict to be pronounced until all the chief parts of the inhabited earth formed a single commercial area, for not until then would it be impossible for other nations with different monetary systems to join in and modify the international organization.
Of course, if two or more economic goods had exactly the same marketability, so that none of them was superior to the others as a medium of exchange, this would limit the development toward a unified monetary system. We shall not attempt to decide whether this assumption holds good of the two precious metals gold and silver. The question, about which a bitter controversy has raged for decades, has no very important bearings upon the theory of the nature of money. For it is quite certain that even if a motive had not been provided by the unequal marketability of the goods used as media of exchange, unification would still have seemed a desirable aim for monetary policy. The simultaneous use of several kinds of money involves so many disadvantages and so complicates the technique of exchange that the endeavor to unify the monetary system would certainly have been made in any case.
The theory of money must take into consideration all that is implied in the functioning of several kinds of money side by side. Only where its conclusions are unlikely to be affected one way or the other, may it proceed from the assumption that a single good is employed as common medium of exchange. Elsewhere, it must take account of the simultaneous use of several media of exchange. To neglect this would be to shirk one of its most difficult tasks.
- The “Secondary” Functions of MoneyThe simple statement, that money is a commodity whose economic function is to facilitate the interchange of goods and services, does not satisfy those writers who are interested rather in the accumulation of material than in the increase of knowledge. Many investigators imagine that insufficient attention is devoted to the remarkable part played by money in economic life if it is merely credited with the function of being a medium of exchange; they do not think that due regard has been paid to the significance of money until they have enumerated half a dozen further “functions” — as if, in an economic order founded on the exchange of goods, there could be a more important function than that of the common medium of exchange.
After Menger’s review of the question, further discussion of the connection between the secondary functions of money and its basic function should be unnecessary.See Menger, Grundsätze, pp. 278 ff. Nevertheless, certain tendencies in recent literature on money make it appear advisable to examine briefly these secondary functions — some of them are coordinated with the basic function by many writers — and to show once more that all of them can be deduced from the function of money as a common medium of exchange.
This applies in the first place to the function fulfilled by money in facilitating credit transactions. It is simplest to regard this as part of its function as medium of exchange. Credit transactions are in fact nothing but the exchange of present goods against future goods. Frequent reference is made in English and American writings to a function of money as a standard of deferred payments.See [J. Shield] Nicholson, A Treatise on Money and Essays on Present Monetary Problems (Edinburgh, 1888), pp. 22 ff.; [Laurence] Laughlin, The Principles of Money (London, 1903), pp. 22 f. But the original purpose of this expression was not to contrast a particular function of money with its ordinary economic function, but merely to simplify discussions about the influence of changes in the value of money upon the real amount of money debts. It serves this purpose admirably. But it should be pointed out that its use has led many writers to deal with the problems connected with the general economic consequences of changes in the value of money merely from the point of view of modifications in existing debt relations and to overlook their significance in all other connections.
The functions of money as a transmitter of value through time and space may also be directly traced back to its function as medium of exchange. Menger has pointed out that the special suitability of goods for hoarding, and their consequent widespread employment for this purpose, has been one of the most important causes of their increased marketability and therefore of their qualification as media of exchange.Cf. Menger, Grundsätze, pp. 284 ff. As soon as the practice of employing a certain economic good as a medium of exchange becomes general, people begin to store up this good in preference to others. In fact, hoarding as a form of investment plays no great part in our present stage of economic development, its place having been taken by the purchase of interest-bearing property.That is, apart from the exceptional propensity to hoard gold, silver, and foreign bills, encouraged by inflation and the laws enacted to further it. On the other hand, money still functions today as a means for transporting value through space.[Karl] Knies in particular (Geld und Kredit, 2d ed. [Berlin, 1885], vol. 1, pp. 233 ff.) has laid stress upon the function of money as interlocal transmitter of value.
This function again is nothing but a matter of facilitating the exchange of goods. The European farmer who emigrates to America and wishes to exchange his property in Europe for a property in America, sells the former, goes to America with the money (or a bill payable in money), and there purchases his new homestead. Here we have an absolute textbook example of an exchange facilitated by money.
Particular attention has been devoted, especially in recent times, to the function of money as a general medium of payment. Indirect exchange divides a single transaction into two separate parts which are connected merely by the ultimate intention of the exchangers to acquire consumption goods. Sale and purchase thus apparently become independent of each other Furthermore, if the two parties to a sale-and-purchase transaction perform their respective parts of the bargain at different times, that of the seller preceding that of the buyer (purchase on credit), then the settlement of the bargain, or the fulfillment of the seller’s part of it (which need not be the same thing), has no obvious connection with the fulfillment of the buyer’s part. The same is true of all other credit transactions, especially of the most important sort of credit transaction — lending. The apparent lack of a connection between the two parts of the single transaction has been taken as a reason for regarding them as independent proceedings, for speaking of the payment as an independent legal act, and consequently for attributing to money the function of being a common medium of payment. This is obviously incorrect. “If the function of money as an object which facilitates dealings in commodities and capital is kept in mind, a function that includes the payment of money prices and repayment of loans ... there remains neither necessity nor justification for further discussion of a special employment, or even function of money, as a medium of payment.”
The root of this error (as of many other errors in economics) must be sought in the uncritical acceptance of juristical conceptions and habits of thought. From the point of view of the law, outstanding debt is a subject which can and must be considered in isolation and entirely (or at least to some extent) without reference to the origin of the obligation to pay. Of course, in law as well as in economics, money is only the common medium of exchange. But the principal, although not exclusive, motive of the law for concerning itself with money is the problem of payment. When it seeks to answer the question, What is money? it is in order to determine how monetary liabilities can be discharged. For the jurist, money is a medium of payment. The economist to whom the problem of money presents a different aspect, may not adopt this point of view if he does not wish at the very outset to prejudice his prospects of contributing to the advancement of economic theory.
Money, Method, and the Market Process[Ludwig von Mises, Money, Method, and the Market Process: Essays by Ludwig von Mises, ed. Richard M. Ebeling (1933; Norwell, Mass. and Auburn, Ala.: Kluwer Academic Publishers and Mises Institute, 1990), chap. 8, pp. 106–09.]“Senior’s Lectures on Monetary Problems”When people today generally assert that things have so radically changed since the time in which the classical theory of money and foreign exchanges was expounded, that one cannot apply their results to modern conditions, they unfortunately do not give any proof. It is totally wrong to pretend that raising the rate of discount would not have any effect today on the flow of gold and on the exchange rate, or an insufficient effect. There is no proof that discount policy of the old type is inapplicable to the present situation. The fact is that the ruling parties prefer the consequences of a depreciation of the national currency to the consequences resulting from non-interference in the market’s money rate.
Let us consider separately the different recent cases of departure from the old gold parity. There was the case of England in 1931. Britain had to choose between a policy of defending the gold standard by raising the rate of discount, as has been done over and over again, and a policy of depreciation. She decided for the second because it made it possible to maintain unchanged the British level of prices and wages in the midst of a world of falling gold prices. Opinions differ on the soundness of this policy, and there is no doubt that it was very unsound from the point of view of [Nassau William] Senior’s ideas. But there was nothing in the situation which could not be explained from the point of view of Senior’s theoretical teaching. It is true that his decision would have been very different from that of Great Britain’s rulers in 1931. He would have believed that nominal wages had to fall pari passu with prices, and that there was nothing alarming in a situation where the prices of raw materials which England buys fall more rapidly than the prices of the manufactures which England exports. But Senior in discussing these problems with Mr. Norman and Mr. Keynes would at the end of the conversation have said: “I see, gentlemen, that you follow other aims.” But he would have had no reason to say: “You have to cope with a situation which my theory does not cover.”
Yet in another respect a radical change in the financial situation has been accomplished. In the modern banking system the short-term debts play a dominating role. The banks of the lending countries have lent enormous sums to the banks of the borrowing countries. Literally they had the right to withdraw this money at short notice. But in fact such withdrawals could not be affected at once, as the borrowing banks had lent this money to business which could not pay it back at all or at least only after some delay. The international credit relations were based on a fallacious assumption of liquidity. The moment the lenders tried to exert their right of withdrawal there were only two alternatives: open declaration of bankruptcy by the debtor banks or intervention of the government which suspended payments to foreign countries. The introduction of foreign exchange control in some continental countries in the summer of 1931 was a makeshift for a formal moratorium.
Banking today is not sounder when considered from the point of view of the home situation. Deposits subject to cheques and saving deposits are two entirely different things. The saver wishes to entrust his money for a longer period; he wishes to get interest. The bank which receives his money has to lend it to business. A withdrawal of the money entrusted to it by the saver can only take place in the same measure as the bank is able to get back the money it has lent. As the total amount of the saving deposits is working in the country’s business, a total withdrawal is not possible. The individual saver can get back his money from the bank, but not all savers at the same time. That does not mean that banking is unsound. It does not become unsound until the banks explicitly or tacitly promise what they cannot perform: to pay back the savings at call or at short notice.
The deposits subject to cheques have a different purpose. They are the business man’s cash like coins and bank notes. The depositor intends to dispose of them day by day. He does not demand interest, or at least he would entrust the money to the bank even without interest. The bank, to be sure, could not earn anything if it were to hold the whole amount of these deposits available. It has to lend the money at short notice to business. If all depositors simultaneously were to ask their deposits back, it could not meet the demand. This fact that a bank which issues notes or receives deposits subject to cheque cannot hold the total amount corresponding to the notes in circulation and to the deposits in its vaults, and therefore can never redeem at once the total amount of its liabilities of this kind, is the knotty problem of banking policy. It is the consideration of this difficulty which has to govern the credit policy of the banks which issue notes or receive deposits subject to cheque. It is this consideration that led to the legislation which limits the issue of bank notes and imposes on the central banks the retention of a reserve fund of a certain magnitude.
But the case of the saving deposits is different. Since the saver does not need the deposited sum at call or short notice it is not necessary that the saving banks and the other banks which take over such deposits should promise repayment at call or at short notice. Nevertheless, this is what they did. And so they became exposed to the dangers of a panic. They would not have run this danger, if they had accepted the saving deposits only on condition that withdrawal must be notified some months ahead.
Public opinion assumes that the real danger to maintenance of monetary stability lies in the flight of capital. This assumption is not correct. Capital invested in real estate or in industrial plants or in shares of companies holding property of this nature cannot fly. You can sell such property and leave the country with the proceeds. But — unless there is no expansion of credit — the buyer simply replaces you. If he is a foreigner, then the capital flight of the native is compensated by the immigration of capital from abroad. If the buyer is another native, then he can provide the means — when additional credit is not granted by credit expansion — merely by selling his property, and so the case with him is the same. One person or another can withdraw his capital from a country, but this can never be a mass movement. There is only one apparent exception, i.e., the saving deposit which can be withdrawn from the bank at once or at short notice. When the saving deposits are subject to instant withdrawal and the bank of issue renders the immediate withdrawal possible by advancing credits for these savings to be withdrawn, then credit expansion and inflation cause the exchange ratio to rise. It is obvious that not the flight of capital but the credit expansion in favor of the saving banks is the root of the evil.
The pith of the problem lies in the deposit policy. Banks which promise no more than they can fulfill without extraordinary assistance from the central bank, never jeopardize the stability of the country’s currency. And even the other banks who have been imprudent enough to assume liabilities which they cannot meet are only a danger when the central bank tries to assist them. If the Central Bank were to leave them to their fate, their peculiar embarrassment would not have any effect on foreign exchanges. That the additional issue of great amounts of bank notes for the sake of the repayment of the total amount or of a great portion of the country’s saving deposits makes the foreign exchange go up is easy to understand. It is not simply the wish of the capitalists to fly with their capital, but the expansion of the circulation, that imperils monetary stability.
Had the central banks not believed that it was their duty to cover up the consequences of the deposit banks’ wrong policy they would have not only maintained without artificial and, at the same time, ineffective measures of the stability of the exchange ratio, but would have forced the deposit banks to make agreements with their clients concerning the payments due. By such agreements they would have adjusted the payments due to the payments receivable. The Standstill Agreements would have been made definitively and for all debts, foreign, and domestic.
To sum up, we are not entitled to say that Senior in his writings on money and monetary subjects had to deal with problems other than those which we have today. The task of monetary and banking theory is in principle not different today from Senior’s time. Different, of course, are the conditions of our banking organization, the institutions, and the considerations which politicians keep in mind. Different are the data, but not the mechanism of exchange and social cooperation. All the questions of principles which Senior had to face are identical with those which our theory has to answer. We may differ from Senior in regard to the treatment of the fundamental items of value and exchange, but we have still the same problems to solve. And notwithstanding all changes in economic thought and reasoning, in social conditions and political aspects, in banking organization and in business life generally, no one can read these old pamphlets without profit.
“The Position of Money among Economic Goods”[Mises, Money, Method, and the Market Process (1932), chap. 4, pp. 55–64.]Karl Knies has recommended to replace the traditional division of economic goods into consumer goods and producer goods with a threefold classification: producer goods, consumer goods, and means of exchange.Karl Knies, Geld und Kredit, 2d. (Berlin: Weidmann, 1885), pp. 20 ff. Terminological questions of this kind, however, should be decided solely on the basis of their usefulness for furthering scientific work; definitions, concepts, and the taxonomy of phenomena have to prove their usefulness in the results of the research which makes use of them. When these criteria are applied to the classification and terminology suggested by Knies, it becomes apparent that they are extremely appropriate. Indeed, there is no theory of catallactics which does not make use of them. The theory of the value of money is always reserved for special treatment and separated for the explanation of the price formation of producer goods as well as consumer goods, although it is obviously part of a uniform theory of value and price. Even if we do not use the Kniesian terminology and classification consciously, in all significant discussions we act as if we had adopted them completely.
But it is also necessary to note that the special role of money among economic goods has, if anything, been over-emphasized. The problems of the determination of the purchasing power of money have mostly been treated as if they had nothing or very little in common with the problems of non-monetary exchange. This led to a special status of monetary theory and has been detrimental to the development of economic understanding. Even today, we continually encounter attempts to defend certain unjustified peculiarities of monetary theory.
Roscher’s often quoted remark, “[that] the wrong definitions of money can be divided into two main groups: Those which think of it as more and those which think of it as less than the most saleable good,”Wilhelm Roscher, Gundlagen der Nationalökonomie, 25th ed. (Stuttgart and Berlin: J.G. Cotta’sche Buchhandlung Nachtfolger, 1918), p. 340. applies not only to the question of the definition of money. Even a number of those who consider the theory of money a part of catallactics go too far in emphasizing its special position. This branch of our science offers plenty of difficulties and it is not necessary to construct artificial problems; the existing ones provide enough challenge.
- Monetary Services and the Value of MoneyIt is clear that the naive conception of the layman that things have value in themselves, i.e., intrinsic value, necessarily leads to a position which draws the dividing line between money and money substitutes differently from the position according to which the value of a thing is derived from its usefulness. Those who conceive of value as the result of properties inherent in things must necessarily make a distinction between physically valuable money and means of exchange which provide monetary services but are without material value. This approach inescapably leads to a contrasting of normal money with bad and abnormal money, which, in reality, is not money at all.
Today there is no need to deal with this theory. For the modern subjective theory of value, the question has long been decided. No one would still openly defend a concept according to which the whole or a portion of value and price theory was based upon intrinsic exchange value, i.e., independent of the valuations of acting men. Once this is admitted, one has already adopted the fundamental principle of subjective value theory, i.e., the theory of marginal utility.
For prescientific economists — the predecessors of the Physiocrats and the Classical Economists — it was a significant problem to integrate the theory of the value of money with that of the value of other goods. Holding a crudely materialistic bias, they saw the source of value in the “objective” usefulness of goods. From this point of view, it is obvious why bread, which can still hunger, and cloth, which can protect from the cold, will have value. But from where does money, which can neither nourish people nor keep them warm, derive its value? Some responded that it arose “from convention” and others maintained that the value of money was “imaginary.”
The error in this view was discovered early. John Law had put it most succinctly. If all value is derived from usefulness, then it must be true that the adoption of the precious metals as means of exchange must generate a value for it. If one wishes to call the value of the metal used as money, insofar as it is derived from its monetary services, imaginary, one has to regard all value as imaginary,
Car aucune chose n’a de valeur que par l’usage auquel on l’applique, et a raison des demandes qu’on en fait, proportionellement a sa quantite.John Law, Considerations sur le Numeraire et le Commerce (Paris: Buisson, 1851), pp. 447 ff. The passage translates as: The value of a thing is only in the use we make of it and the expectations we put into it, proportional to its quantity.
With these words, Law anticipated the subjective theory of value; he should not be denied the place he deserves in the history of our science. The importance of his accomplishment is not reduced by his inability to develop all the implications from his fundamental idea or that he got lost in the impenetrable thicket of error or, perhaps, even of guilt.
Researchers who came after him were also unable to make full use of the content of the clearly developed fundamental idea advanced by Law. In three respects we still encounter misconceptions.
First, some writers categorically deny that the service provided by money can generate value. Unfortunately, they do not provide a justification why monetary services should be different from the services provided by food and clothing. The difficulty posed by “paper money” is circumvented by viewing “paper money” as a claim on genuine, i.e., “materially” valuable, metallic money. Fluctuations in the rate of exchange of “paper money” are explained by changes in the probability of payment in species. In view of the development of monetary theory during the last decades, I consider it superfluous to challenge this theory. I have attempted an empirical refutation and have not encountered adequate opposition.See [Ludwig von] Mises, The Theory of Money and Credit, pp. 146–53.
In a way, the second error is connected with the first: the denial of the possibility of there being a money whose “substance” only produces monetary services and nothing else. It is usually granted that monetary services can generate value, just as every other service, in general. Without reservation, we have to agree with Knies when he argues, “[that] gold and silver would have been as unsuitable for the purpose of performing the functions of money as any other commodity, if they had not previously — before their adoption for monetary services — served as economic goods for the satisfaction of human wants, a ‘general’ economic need, a need that was widely felt and persistent.”Knies, Geld und Kredit, p. 322. But Knies is in error when he continues, “it is not sufficient that this primary use of the precious metals has preceded their use for monetary services; it is necessary that this use continues, lest the pieces of precious metal lose their usefulness as money. ... If people ceased to use gold and silver to satisfy their desire for jewelry or ornamentation, etc., then the other use of the precious metals, their use as a means of exchange, would be eliminated, also.”Ibid., pp. 322 ff. Knies did not succeed in proving the validity of this assertion. It is by no means evident why an economic good, which performs the services of a commonly used means of exchange, should lose its ability to serve as money simply because its use for other purposes are gradually discontinued.
That the adoption of a good as a medium of exchange requires the goods’ previous use or consumption for other purposes results from the fact that the specific demand for its services as a means of exchange presupposes an already existing objective exchange value. This objective exchange value, which subsequently will be modified by the demand for the good as a medium of exchange in addition to the demand for it in its “other” use, will be based exclusively upon its “other” use when it begins to be used as a means of exchange. But once an economic good has become money, then the specific demand for money can tie into an already existing exchange relationship between money and goods in the market, even if the demand for the money-good, as motivated by the other use, disappears.
Only very slowly and with difficulty has the human spirit freed itself from the crude materialistic mode of thought that has resulted in a prolonged resistance to the idea that the use of a good as a medium of exchange, like any other possible use for the good, generates a demand that establishes a price and is capable of changing that price. If the ability of a thing to satisfy a human need, as well as the recognition of this ability, are made the prerequisites for establishing the goods-quality of a thing,This is even done by [Carl] Menger; see, his Principles of Economics (1871) (New York: New York University Press, 1981), pp. 52–53. then one comes close to distinguishing between “real” and “unreal” goods among the objects of economic action. As soon as the economist steps upon this ground, he loses his footing and slides unintentionally out of the domain of scientific objectivity; he enters the realm of ethical valuations, morality, and policy. There, he will compare the “objectively useful” things to those which are merely “thought to be useful.” He will examine whether and to what extent the things which are thought to be useful (and therefore are treated accordingly) are indeed so in an “objective” sense. As soon as one has come this far, it is only logical to ask whether the usefulness provided by a good satisfies a genuine need or merely a fictitious one. This way of thinking may subsequently lead to the view that the value of precious metals (which serve “only” the desire for jewelry and do not satisfy a physiological need as, e.g., food and clothing undeniably do from a crude materialistic point-of-view) is entirely imaginary, a result of inappropriate social institutions and human vanity. On the other hand, the result can be that the value of precious metals is admitted as legitimate since even the desire for jewelry is “genuine” and “justified.” The objective utility of the precious metals is not denied; rather, the general validity of the requirement for the services of money is questioned since society had once existed without money and, in any case, such a society is imaginable. It is an untenable assumption that the “goods-quality” requires a “natural” utility not limited to the particular requirements of any presupposed social order.
But an even cruder materialism was the view which wanted to deny monetary services their value-creating power because money in its performance of this service did not lose its ability to serve other purposes; in other words, because its “substance” was not used up in its services as money.
All of those who denied the ability of the services of money to determine its exchange value failed to recognize that the only decisive element is demand. The fact that there exists a demand for money — the most marketable (most saleable) good, for which the owners of other goods are prepared to exchange — means that the monetary function is capable of creating value.
- Money Supply and Money Demand: The “Velocity of Circulation” of MoneyThe most disastrous of the unjustified deviations of monetary theory from the theory of direct exchange was the failure to base the analysis of the fundamental problem of the theory of the value of money on the relation between the stock of money and the demand for it by the individual economic units, or between the demand for money and the supply of money on the market. Rather, the analysis began with the objective usefulness of the monetary unit for the aggregate economy, which was expressed as the velocity of money relative to the money stock and which was then compared to the sum of transactions.
The old tendency, taken over from the Cameralists, to base the analysis of economic problems of the “national economy,” on the “totality” and not on the acting human subjects, seems hard to eradicate. In spite of all the warnings of the subjective economists, we continue to observe relapses. It is one of the lesser evils that ethical judgments regarding phenomena are presented under the guise of scientific objectivity. For example, productive activity (i.e., activity carried out in an imagined socialist community led by the critic) is contrasted with profit-seeking activity (i.e., the activity of individuals in a society based on private property in the means of production). The former will be viewed as the “just” and the latter as the “unjust” mode of production. Much more important is the fact that if one thinks in terms of the totality of a society’s economy, one can never understand the operation of a society based on private property in the means of production. It is erroneous to maintain that the necessity for the collectivist method can be proved by showing that actions of the individuals can only be understood within the framework of that individual’s environment. This is so because economic analysis does not depend on the psychological understanding of the motives of action, but only an understanding of action itself. It is unimportant for catallactics why bread, clothes, books, cannons or religious items are desired on the market; it is only important that a certain demand does exist. The mechanism of the market and, therefore, the laws of the capitalistic economy can only be grasped if one begins with the forces operating on the market. But on the market there are only individuals acting as buyers and sellers, never the “totality.” In economic theory, the totality can be taken only in the sense of an economic collective where the means of production are entirely outside the orbit of exchange and, therefore, cannot be sold for money. Here there is neither room for price theory nor a theory of money. But if we wish to grasp the value problems of a collective economy, we can — ironically — only use that method of analysis which has come to be known as the “individualistic method.”
The attempts to solve the problem of the value of money with reference to the aggregate economy, rather than through market factors, culminated in a tautological equation without any epistemological value. Only a theory which shows how subjective value judgments of buyers and sellers are influenced by changes in the different elements of the equation of exchange can legitimately be called a theory of the value of money.
Buyers and sellers on the market never concern themselves with the elements in the equation of exchange, of which two — velocity of circulation and the price level — do not even exist before market parties act and the other two — the quantity of money (in the whole economy) and the sum of transactions — could not possibly be known to the parties in the market. Only the importance which the various actors in the market attach, on the one hand, to the maintenance of a cash balance of a certain magnitude and, on the other hand, to the ownership of the various goods in question determines the formation of the exchange relationship between money and goods.
Connected with the concept of the velocity of circulation of money is the mental image that money generates its usefulness only at the instant of transaction, but is “idle” and useless at other times. A distinction between active and idle money is also made when one speaks of money hoarding and proceeds to a comparison between the “hoarded” quantity of money and the quantity of money that would be necessary to perform the monetary services; what distinguishes this from the previous case is the way in which the boundary between active and idle money is drawn. Both distinctions must be rejected.
The service of money is not confined to transactions. It fulfills its task not only at the moment it passes from one hand to the next. It also performs services when it rests in the till, as the most marketable good, in anticipation of its future use in trade as a generally used means of exchange. The demand for money of individuals, as well as the entire economy, is determined by the desire to maintain a cash balance and not by the aggregate of transactions to be carried out during a certain time period.Also see, Edwin Cannan, Money, 4th ed. (Westminster: P.S. King and Son, 1932), pp. 72 ff.
It is an arbitrary procedure to divide the money stock into two parts: that which is designated to perform money services proper and that which serves as a money hoard. Of course, no damage will be done if, on the one hand, the demand for money is separated into a demand for hoarding and a demand to perform the monetary service proper. But a formula which portrays and solves only an arbitrarily delineated part of the problem must be rejected if we are able to show another one which will deal with and solve the whole problem in a uniform fashion.
- Fluctuations in the Value of MoneyOne of the most peculiar phenomena in the history of monetary theory is the stubborn resistance encountered by the quantity theory. The imperfect formulation given to it by many of its advocates inevitably ran into opposition, with many — as, for example, Benjamin AndersonBenjamin Anderson, The Value of Money (New York: Macmillan, 1917). — ascribing to the concept a meaning quite different from that commonly accepted. As a result, what they call the quantity theory, and oppose as such, is not the theory itself but only a variation of it. This is not particularly astonishing. But what is quite surprising is that an attempt was made and sometimes is still made today to deny that changes in the relation between money supply and money demand will modify the purchasing power of the monetary unit. It is not sufficient to base an explanation on the special interests of inflationists, statists and socialists, of civil servants and politicians who would be harmed by a spreading of knowledge concerning monetary policy. We will never arrive at an answer by following the path of the Historical-Realistic School, which (following the Marxian example) explains all ideas by ideologies. It had never been a problem to explain why a particular ideology is developed and advocated by certain classes who believe they can benefit from it directly (even if this direct advantage is more than outweighed by indirect disadvantages). What has to be explained, however, is rather how incorrect theories come about and find followers. How does it come about that many people, without justification, come to assume that a certain policy benefits either the entire society or many groups in that society?
However, the theory of money as such is not interested in these psychological aspects which explain the reasons for the unpopularity of the quantity theory and the tendency to adopt other explanations for the value of money. Rather, it is interested in the question: which elements of the doctrines opposing the quantity theory could be useful? Since it was equally inadmissible to deny the importance of changes in supply for the formation of exchange relations in the area of indirect exchange as it was in the area of direct exchange, one could oppose the quantity theory only by admitting its correctness in principle, but arguing that notwithstanding its general validity another principle would regularly eliminate its effectiveness. This attempt was made by the Banking School with its famous theory of hoarding, and its offshoot, the theory of the automatic adjustment of the circulation of money substitutes to the demand for money in the broader sense. Today, both theories are overthrown.
As is the case with so many theories, the advocates of the quantity theory have harmed it more than its enemies. We have already mentioned the inadequacy of those theories based on the concept of the velocity of circulation of money. It was not any less erroneous to interpret the quantity theory as saying that the changes in the quantity of money resulted in proportional changes in the prices of goods. It was overlooked that every change in the relationship between the supply of money and the demand for money would necessarily bring about a shift in the distribution of wealth and income and that, therefore, the prices of the different goods and services could not be effected proportionally and simultaneously.
Nowhere has the practice of working with formulas modeled after mechanics, instead of paying attention to the problem of the influence of market factors, taken a greater toll than in this case. Economists wanted to operate with the equation of exchange without noticing that the changes in the volume of money and the demand for money can come about in only one way: at first, the evaluations and with them the actions of only a few economic subjects will be influenced, with the resulting changes in the purchasing power of the monetary unit only spreading through the economy in a step-by-step pattern. In other words, the problem of changes in the value of money have been treated with the method of “statics,” although there should never have been any doubt concerning the dynamic character of the problem.
- Money SubstitutesThe most difficult and most important special problem of monetary theory is that of money substitutes. The fact that money services can also be rendered by secure money claims redeemable on demand, presents considerable difficulties to the monetary theorists’ attempt to define the supply of money and the demand for money. This difficulty could not be overcome as long as money substitutes were not clearly defined and separated into money certificates and fiduciary media, in order to treat the granting of credit through the issue of fiduciary media separately from all other types of credit.
Loans which do not involve the issuing of fiduciary media (i.e., bank notes or deposits which are not backed by money) is of no consequence for the volume of money. The demand for money can be influenced by lending as much as by any other institution of the economic order. Without knowledge of the data of the specific case, we cannot say in which direction this influence will operate. The widely-held opinion that an expansion of credit will always lead to a reduction in the demand for money is not correct. If many of the loan contracts provide for large repayments on certain days (for example, at the end of the month or quarter), the result will be an increase and not a reduction in the demand for money. The consequences of this increase in the demand for money will be expressed in prices, if it were not for clearing arrangements, on the one hand, and the practice of banks to increase the volume of fiduciary media on critical days, on the other hand.
Everything depends on the clear separation of money from money substitutes and within the category of money substitutes a distinction between money certificates (a money substitute fully backed by money) and the fiduciary medium (the money substitute not backed by money). But this is above all a question of terminological appropriateness. However, this question gains in importance in view of the difficulty and complexity of the problems. It is not — as so often is still maintained — the “granting of credit” but the issuing of fiduciary media which causes those effects on prices, wages, and interest rates, which banking theory has to deal with. It is, therefore, not inappropriate to refer to banking theory as the theory of fiduciary media.
Knowledge of the principles of the free society is not something that everyone is born with or something that we just catch like the common cold. The principles of liberty must be carefully passed on from one generation to the next if they are to survive, let alone flourish. Each generation must learn anew from their predecessors the virtues of private property and the consequences of statism. It is even more crucial today, in our contemporary intellectual environment, to have something to offer besides empty platitudes about how we can all “just get along.” Today’s citizen who is interested in things economic, can do no better than to turn to Ludwig von Mises. In his life and work Mises provides the intelligent person a vision for the importance of truth, economics, liberty, and scholarship that continually inspires to greatness.For a good and accessible overview of Mises’s thought see The Essential von Mises and Ludwig von Mises: Scholar, Creator, Hero (Auburn, Ala.: Mises Institute, 2009), both by Murray N. Rothbard. They are combined in one volume in Rothbard (2009). A more extensive biography of Mises can be found in Israel Kirzner’s Ludwig von Mises: The Man and His Economics (Wilmington, Del.: ISI Book, 2001). Jörg Guido Hülsmann’s massive Mises: The Last Knight of Liberalism (Auburn, Ala.: Mises Institute, 2007) is the most extensive biography and the standard-bearer on Mises’s life and work.
The reason Mises is so important can be understood by looking at our halls of learning. It is no secret that state-run elementary and secondary schools are failing their charges. Year after year we hear the all-too-familiar reports telling us again and again how test scores are falling. Such dismal performance sows the seeds for a meager harvest reaped by these same students as they enter college. Fewer and fewer of them graduate high school with a basic knowledge about history, literature, science, and math. It should not surprise us that 20 percent of all college freshmen in the United States need remedial classes.A. Lu, States Reform Remedial College Education (2013). Available at: http://www.pewstates.org/projects/stateline/headlines/states-reform-college-remedial-education-85899492704 It is particularly disheartening to observe the decayed condition of modern American higher education. Not so very long ago, the college was seen as a most important institution charged with transmitting Western civilization from one generation to the next. It was here that students had the luxury of critically examining what different voices throughout time have answered when considering the big questions regarding man, life, death, and God. The goal was not an endless pursuit for pursuit’s sake, but was indeed pursuit for true answers to these questions.
Most people, I am sure, recognize that this is no longer the case. Most college faculties are now dominated, especially in the humanities, by one manifestation or another of deconstructionism. Everything is up for grabs and, at worst, the intellectual sees his chief end as the destruction of the foundations of Western civilization so that we can all dance on its ruins.
On the economic front, things are not much better. Several years ago a college near mine was having a political debate of sorts and evidently could not find anyone on their campus to defend the free market position, so they asked some of my students if they would participate. The report back from my students was by turns outrageous and depressing. From their opponents, there were numerous serious calls for stronger anti-trust regulation, energy regulation, increased state funding of education, subsidization of business, increased welfare, socialized health care, state urban planning, increased environmental regulation, an $11/hour living wage, regulations forcing insurance companies to cover abortions, and increased gun ownership restrictions.
This is what happens when intellectuals, teachers, and college professors see themselves as destroyers instead of cultivators. If we want to preserve our noble cultural inheritance, we cannot think that it will happen automatically. It is always easier to destroy than to maintain and build up. If civilization is not to descend into barbarism, we must teach each generation the importance of truth, liberty, and private property. It is not called culture for nothing. We must cultivate civilization. A former colleague of mine reminds me from time to time that as professors we are indeed the thin tweed line separating civilization from barbarism. Recently, however, the barbarians have been winning because the troops charged with manning the thin tweed line have been either absent without leave or actually fighting for the enemy.
What makes the fight more difficult is that to preserve society, it is not enough merely to oppose destructive philosophies, although oppose them we must. We also must offer a positive and real alternative. As Mises warns us at the end of his book, The Anti-capitalist Mentality,
An “anti-something” movement displays a purely negative attitude. It has no chance whatever to succeed. Its passionate diatribes virtually advertise the program they attack. People must fight for something they want to achieve, not simply reject an evil, no matter how bad it may be. They must, without any reservations, endorse the program of the market economy.Ludwig von Mises, The Anti-capitalist Mentality (New York: D. Van Nostrand, 1956), p. 112.
In this, Mises was, perhaps unwittingly, in agreement with the Apostle Paul who told us many years ago to hate indeed that which is evil, but also to cling to that which is good. In order to maintain our cultural inheritance, we must not only oppose statism but also teach our students to cultivate and nurture the roots of civilization: the free society of voluntary exchange built on private property.
In today’s intellectual vacuum, students need someone to whom they can look for an example of sound scholarship that provides true answers to the important economic and political questions of the day. They could do no better than to turn to the writings of Ludwig von Mises. The life and work of Mises provides students with a magnificent example of what an economist, a scholar, and, in many ways, what a person should be.
This is certainly true in my own experience. As a freshman at a Christian liberal arts college in Northwest Iowa, I was instinctively conservative. I thought, for instance, that low taxes were better than high taxes, low inflation was better than high inflation, and communism was a bad economic and political system. However, I could not satisfactorily explain why.
That same year I joined the Conservative Book Club. As a member I agreed to buy four books from the Club over the course of three years. One month the Club was offering this book Human Action by some Austrian economist I had never heard of as its featured alternative. Because of its price, it was allowed to count for two of my required purchases. I thought, “hey, pretty economical,” and upon encouragement from my economics professor, I went ahead and bought it. The book changed my life. In Mises’s own memoirs, he recounts how near Christmas in 1903 he read Carl Menger’s Principles of Economics and that book made him an economist.Ludwig von Mises, Memoirs (Auburn, Ala.: Mises Institute, 2009), p. 25. Well, Human Action did the same for me.
I found the book at once inspiring and intimidating. I plowed into it with an eager mind and immediately was impressed with Mises’s intellect and his rigorous logic. What also impressed me was the density of Mises’s arguments. He did not waste words that did not advance his theories. As such, Human Action can be rather daunting for readers relatively new to economics. On the one hand, I had several eureka! moments as Mises unpacked the logic demonstrating another economic truth. A number of times I also found some of it rather slow-going. Many times I read and re-read pages to gain a sense of understanding. I would start at the top of a page and by the time I had worked my way down to the bottom, I forgot what the main point was, so I had to start again. Some of it is quite technical, so I had to slow way down to grasp material. I would read passages, sections, and chapters and need to set the book aside for a bit while I thought about, puzzled over, evaluated, and, finally, achieved understanding. It took me five years of off-and-on reading in the midst of my other studies and then work to complete reading it the first time through. Now all of this work was definitely worth it. The benefit from reading and re-reading Human Action is incalculable. Still, I began to look for a less taxing way of becoming acquainted with Mises’s ideas.
During my time in college, while I was still working through Human Action, I sought out other more accessible books by Mises. This was years before the advent of the internet and mises.org. I had to turn to that ancient institution called the library and I discovered that our college library had a collection of shorter essays by Mises published by Libertarian Press in a collection entitled Planning for Freedom and Sixteen Other Essays. This book proved to be a more accessible introduction to Mises’s thought. I began reading it during my free time and did not stop until I had come to the end. Planning for Freedom turned out to be the first book by Mises that I read completely. As I read, I began to put together an economic and political philosophy that revolved around private property. It was the writings of Mises that provided me the intellectual foundation to evaluate and integrate what I was being taught in school. Looking back on those years, I have grown to appreciate the wisdom expressed in the sentiment by Mark Thornton that one of the best ways to become introduced to the work of Ludwig von Mises is through some of his shorter, more popular works.Mark Thornton, from a Mises Wire post “How to Read Mises,” October 8, 2013. https://mises.org/blog/how-read-mises While sacrificing nothing in the way of sound economic theory, they are more accessible and in any event are not as intimidating as Mises’s 881-page magnum opus.
In this anthology, I have sought to bring you the best of both worlds. An attempt has been made to acquaint the reader with the broad spectrum of Mises’s ideas and analyses in a way that is more accessible and less daunting. The selections include, therefore, several shorter, more popular works side-by-side with excerpts from longer, more scholarly and technically difficult works. A special feature of this collection is the inclusion of an appreciation of Eugen von Böhm-Bawerk, available for the first time in English, translated from the French by Karl-Friederich Israel. It is my hope that this book will provide a user-friendly gateway into the brilliance of Mises, because we desperately need his wisdom as much now as in any other time in our history.
The work of Ludwig von Mises is an important guide for thoughtful citizens because he strongly, yet matter-of-factly sets forth economics as the pursuit of truth. Not the truth of the passing fancy, nor the so-called “small t-truth” that is always in danger of being refuted by the latest bit of empirical data; but economic truth that will stand for all ages. Misesian economic theory is a triumphant response to the epistemological relativism of today because it is economics developed in light of reality.
Upon reading the works of Mises, one is immediately set forth on the right road, because Mises begins where economics must begin — human action. All of his economic theorems and corollaries are deduced from the non-controversial axiom that people engage in purposeful behavior. This immediately sets his theories on intellectual bedrock.
As I read the opening chapters of Human Action during my sophomore year, I had a sort of epiphany as all of the conclusions I had learned in my economics classes began to fall into logical place. The law of demand was not merely a plausible sounding notion that is true only in an unrealizable ideal world. It was not the necessary implication of arbitrary assumptions that must be tested again and again. Mises showed that economics is logically whole and that demand is rooted in the law of marginal utility which itself is deduced from the premise that human beings act purposefully. Readers of Mises are not left walking on the shifting sand of empiricism, but on the solid ground of true axioms and sound logic.
A former student of mine who received his J.D. at Harvard Law School had a similar reaction. He once told me that while he appreciated the insights that economics in general gives him in the field of law and economics, what sets Mises above all others in his mind is Mises’s focus on individual human action. The modern focus on bell curves and treating people as rats in mazes, he said, makes it difficult to imagine the practical implication of economic theory relating to a contract case between Joe and Bob. Mises’s framework starts with people like Joe and Bob.
In arguing for economic truth, Mises explicitly rejects relativism. A much-too-large segment of our intellectual culture is under the spell of post-modernism. One root of such thinking is what Mises termed polylogism, the idea that different groups of people have different mental categories and systems of logic. Marxists, for instance, argue that there is an inseparable gulf between the proletariat mind and the bourgeois mind. Not that they have different opinions on things, but that they have entirely different laws of logic and ways of thinking. The same notions are found in feminist academic circles and in all brands of multiculturalism. These theories attempt to shield their subscribers from criticism made by those outside of their particular cults. Mises refutes such illogic by stressing that truth is truth no matter who says it. He writes,
A theory is either correct or incorrect. ... But a theory can never be valid for a bourgeois or an American if it is invalid for a proletarian or a Chinese.Ludwig von Mises, Human Action (Auburn, Ala.:Mises Institute [1949] 1998), p. 91.
Mises’s demolition of polylogism provides students a basis from which they can reply to the Marxist, feminist, and racist theories of criticism that have been running amok within the humanities for some time.
The work of Mises is also important for today because Mises provides a clear understanding of why economics is important by asking the right and important questions and providing correct answers. His books and essays are not consumed with inquiries regarding what the stock market will do in the next six months, or will a federal funds rate of 0.25 percent achieve full employment or should it be 0.5 percent.
While Mises does help us speak to such questions, he focuses on the larger, more fundamental issues. A key theme that runs throughout the work of Mises, for instance, is the consideration of the survival of civilization. Mises warns that social progress is not automatic. In Human Action he explains that our
civilization was able to spring into existence because the peoples were dominated by ideas which were the application of the teachings of economics to the problems of economic policy. It will and must perish if the nations continue to pursue the course which they entered upon under the spell of doctrines rejecting economic thinking.Mises, Human Action, p. 10.
The work of Mises is important to the survival of civilization because it helps pass along knowledge to a new generation of students. And this knowledge helps answer one of the most pressing dilemmas of our human existence — a dilemma that has been with us since the beginning of time. How do we deal with the fundamental condition of scarcity? As we are reminded by that eminent modern philosopher and former student of the London School of Economics Mick Jagger, “You can’t always get what you want.” We are presented with the question: How do we go about our business in this world of scarcity without descending into a barbaric struggle for survival?
Because of the relative material comfort we possess in the West, it is natural for this question to never have occurred to most people. The brilliance of Mises, however, lies in the fact that he invites us to ponder this very real question and then sets out the right answer. He explains that in order to escape starvation and a barbaric struggle for survival, it is crucial that we take advantage of social cooperation through the division of labor. Without the division of labor, everyone would have to produce all that he or she consumes. Each person would have to produce his own food, plus his own house, plus his own clothes, plus all the other goods that make his life better. Without the division of labor, no one would be able to specialize in that thing he does relatively better than everyone else. Our total wealth would be greatly reduced and we would be left living largely from hand to mouth.
By reading Mises, however, students clearly see that as the result of our ability to exchange goods with one another, we can specialize in producing only those things at which we are most efficient and then trade the surplus we don’t need for other things we want. As we specialize, our productivity goes up individually and the total wealth of our community increases. The division of labor through voluntary exchange allows us to rise above a barbaric struggle for existence in which we hope that we are one of the fittest that will survive. The division of labor allows us to build civilization.
However the expansion of the division of labor has challenges of its own. And it is here that Mises is really in his element. An economy that has taken advantage of an extensive division of labor is very complex and yet, decentralized. Such an economy features a multitude of different markets in which the participants must coordinate their activities if we want to avoid recessions and depressions. The biggest problem for this decentralized economy to work is that all of the various producers have to know what to produce, how much to produce, and how to produce it.
This can only be done if some method of calculation exists. No other economist of his day stressed this point more than Mises. Indeed in the 1920s Mises demonstrated that the lack of economic calculation is the Achilles heel of socialism. Alternatives must be compared to one another if producers are to know how best to fulfill the desires of consumers for goods and services. Even if they know what consumers want they must be able to compare alternative ways to produce it. Should we build this house with wooden studs or metal? Blown or rolled insulation? Air or coil heating? This can be known only if there is a common denominator we can use to assess the relative value of each alternative. We cannot simply use physical units of goods for the comparison. Saying that ten two-by-fours are worth less than fifty nails because ten is less than fifty is like saying I’m taller than you because I’m 5 foot 8 and you are 98.6 degrees Fahrenheit.
Mises recognizes that what makes such comparisons even harder is that we all value goods subjectively, according to our personal preferences. We cannot, therefore, measure value because there are no objective units of value measurement.
Again it was Mises who demonstrated that voluntary exchange in a monetary economy opens the door to a solution. In a monetary economy, every good is exchanged against money, so every price is expressed in terms of the monetary unit — in our case dollars and cents. Even though value is subjective, in a free market, people manifest their values by voluntarily deciding what they will pay for particular products and services. These objective prices, therefore, are reflections of subjective values. Entrepreneurs are able to use these objective prices to calculate expected profit and loss and act accordingly. In a free market, Mises shows, entrepreneurs are able to plan for the future and consumers will receive what they most want.
Socialism, on the other hand, is doomed because there is no way for the central planner to efficiently allocate factors of production because there is no way to calculate profit and loss. In a completely socialistic economy all of the means of production are owned by the state. There is, therefore, no actual exchange of goods, and hence no actual prices that reflect the actual subjective values of human beings. Producers, then, have no way to calculate whether their actions are productive or wasteful from the point of view of society. What is called a planned economy is, instead, as Mises so eloquently put it, “groping about in the dark.”
I once had a student from China who cited Human Action as the book that finally turned him away from socialism. He had read all of Human Action, praising it for its readability. He told me that reading Human Action helped him realize that Communism was an impossible utopia. Mises’s explanation of the devastating economic consequences of war also attracted this student to read further works by Mises.
The moral of the story is that voluntary exchange in a monetary economy allows us to have the civilization we enjoy. In order to engage in voluntary exchange using money, however, Mises stresses that it is necessary for people to own private property. You cannot exchange what you do not own. If there is no ownership of private property, there is no actual exchange. If there is no exchange, there is no division of labor and there is no money so there are neither money prices, nor economic calculation. We would be left with chaos, not civilization. For civilization to survive, consequently, Mises teaches us that society must be a private property order. If people are able to own and trade their property as they see fit, wealth increases and civilization prospers.
The insights of Mises do not stop with his critique of socialism, however. From his 1929 collection of essays A Critique of Interventionism through the rest of his career, he continually explained to whomever would listen that even if the state does not fully socialize the economy, but intervenes only here and there, this too hinders the workings of the price system. To the extent that the state intervenes and curbs the free actions of individuals through price controls, monetary inflation, product restrictions, taxation, and subsidization, to that extent will prices for goods not accurately reflect the values of the people in that society. Such intervention will make it that much harder for entrepreneurs to do their job and one should expect to see shortages in some industries and surpluses in another.
You can see, then, that Mises builds his economic theory into a massive, logically integrated edifice of truth. More than any other economist of his day, Mises demonstrates that laws of economics are indeed laws every bit as universal and irrevocable as the laws of chemistry and physics, and we violate them at our peril. It is this fact that enables the study of economics to be a noble endeavor for everyone. In Human Action, Mises comments on the role of the economist by likening him to a chemist warning people against poisoning themselves. He writes,
A man who chooses between drinking a glass of milk and a glass of a solution of potassium cyanide does not choose between two beverages; he chooses between life and death. A society that chooses between capitalism and socialism does not choose between two social systems; it chooses between social cooperation and the disintegration of society. Socialism is not an alternative to capitalism; it is an alternative to any system under which men can live as human beings. To stress this point is the task of economics as it is the task of biology and chemistry to teach that potassium cyanide is not a nutriment but a deadly poison.Mises, Human Action, p. 676.
Indeed, one of the most important benefits received from reading Mises is the ability to critically evaluate public policy.
When assigned in a college class long ago to research the viability of the social security system, the first place I turned to was Human Action. The passage I read then I have never forgotten. It is a passage that is as timely as today’s headlines. Mises writes,
One may try to justify [social security] by declaring that the wage earners lack the insight and the moral strength to provide spontaneously for their own future. But then it is not easy to silence the voices of those who ask whether it is not paradoxical to entrust the nation’s welfare to the decisions of voters whom the law itself considers incapable of managing their own affairs.Ibid., p. 613.
This is dynamite for the intelligent person who wants to truly understand the nature of hydra-headed interventionism that pushes a myriad of statist policies including inflationism, the welfare-warfare state, Keynesian fiscal management, socialized medicine, and countless business regulations that serve only to hamper mutually beneficial exchange.
Today people are increasingly urged to support this or that political program advertised as solving a vexing social problem with no understanding of economics and hence no frame of reference from which to evaluate different policies. All that is mustered in justification for interventionism are feelings that make people want to “do something.” The economics of Mises is the crucial antidote for the current interventionist ideology supporting the progressive march to economic fascism. Citizens acquainted with Mises quickly understand that any sort of middle-of-the-road economic policy does indeed lead to socialism.
Ludwig von Mises does not only provide us a vision of economic truth, however. He also inspires us to greatness by presenting the student an example of what an outstanding scholar should be. It does not take the reader of Mises’s work very long to see what a breadth of knowledge Mises had. Murray Rothbard once recounted how, when someone first recommended Human Action to him, he asked, “What is it about?” The response to Rothbard was “Everything.” A student in one of my managerial economics courses was impressed with the same observation. I had assigned from Human Action a brief section about the distinction between the manager and the entrepreneur. He liked what was assigned, so he began to read through the first part of the book. He was greatly impressed and told me, “He doesn’t write just about economics. It’s all there, of course, but he also writes about everything else.” This student now has a standard for real scholarship.
Throughout Mises’s works are insightful discussions about history, philosophy, political science, sociology, and even aesthetics. He makes not only references to, but thoughtful comments on the likes of Aristotle, Bentham, Bismark, Comte, Locke, Kant, Marx, Mill, Napoleon, Tacitus, Saint Francis of Assisi, and Spinoza. As he once explained in his New York University Seminar,
One of the indispensable prerequisites of a master of economics is a perfect knowledge of history, the history of ideas and of civilization, and of social, economic, and political history. To know one field well, one must also know other fields.John Chamberlain, “My Years with Ludwig von Mises,” The Freeman 27, no. 2 (February 1977): 126–27.
In another instance Mises cited a number of authors in French and German. One student spoke up, asking, “Why are you giving these citations, Professor? I can’t read French and German.” Mises replied simply, “Learn it. You are engaged in scholarly activities.”Margit von Mises, My Years with Ludwig von Mises (New Rochelle, New York: Arlington Press, 1976), pp. 135–36. He also encouraged his students not only to read authors with which they agreed, but to read about an issue from all sides. A student who reads Mises is inspired to be such a scholar.
Looking at Mises the scholar, the contemporary student learns a valuable lesson in integrity. His life was a never-ending fight for economic truth, liberty, scholarly excellence, and the principles of the free market. As he notes in his autobiography, at a particularly depressing time in his life when it appeared that he had become merely “an historian of decline,” he remembered his personal motto adopted from a line out of Virgil: “Do not give in to the evil, but proceed ever the more against it.” Throughout his life, he did just that.
His research and logical analysis convinced him of the negative consequences of socialism and interventionism. He never wavered from those convictions and his steadfastness cost him plenty. He did without a salaried academic appointment because he was not willing to be a court intellectual. However, he never grew bitter about this. In his autobiography he writes,
I was sometimes accused of representing my viewpoint in a manner too abrupt and intransigent. It was also claimed that I could have accomplished more had I displayed a greater willingness to compromise. ... When I look back at my work … my only regret is my willingness to compromise, and not my intransigence.Mises, Memoirs, p. 60.
The reason for his uncompromising attitude is that he took his work as a scholar seriously. Mises thought, “In science, compromise is a betrayal of truth.”Ibid., p. 61. Would that more contemporary economists had the same convictions.
Ludwig von Mises truly was an intellectual giant among men and, as Murray RothbardMurray N. Rothbard, “Ludwig von Mises and the Paradigm for our Age,” Modern Age (Fall 1971): 370–79. saw, his thought and causal-realist framework is the best alternative to the economic paradigm of our age. In the contemporary fog of the modern academy, Mises serves as a lighthouse, warning unsuspecting students of the perils of bad economics and statist economic policies, while illuminating students to the principles of the free society.
The book in your hands is intended to give a taste of the many facets of Mises’s thought in a way that accessibly communicates most of his key contributions to the social sciences. It therefore includes excerpts from his larger and more technically demanding works side-by-side with shorter, more introductory articles and lectures. The finished product is sort of an intelligent person’s guide to the work of Ludwig von Mises. It is especially suitable for those with an interest in Mises, but find jumping right into Human Action, Socialism, or The Theory of Money and Credit rather daunting. The hope is to give the reader a survey of Mises’s insights in a format that nourishes his intellectual soul, while also whetting the appetite for his larger corpus of work. Those ready to dive into deeper Misesian waters are encouraged to pick up The Mises Reader Unabridged which contains all of the material in The Mises Reader plus over 125 pages of additional material, primarily from his more scholarly works. It is hoped that together these two volumes will foster a rising generation of citizens more thoroughly acquainted with sound economics and the principles of the free society.
If we want to preserve our civilization from the cultural destroyers, post-modern relativists, and enemies of freedom, we must provide our generation of inquisitive minds with a sound alternative. We must direct our fellow sojourners to a literature that defends truth and property and inspires us to greatness. Fortunately we have such a literature to turn to — a literature of freedom. Those desiring to beat back the barbarians at the gate, would do well to begin with the works of Ludwig von Mises. In him, the reader will find, as Murray Rothbard found, a scholar, creator, and hero.
Shawn RitenourGrove City College
Planning for Freedom and Other Essays and Addresses[Ludwig von Mises, Planning for Freedom and Sixteen Other Essays and Addresses (1952; South Holland, Ill.: Libertarian Press, 1980), chap. 9: “Profit and Loss,” section A: “The Economic Nature of Profit and Loss,” pp. 108–28.]“Profit and Loss”
- The Emergence of Profit and LossIn the capitalist system of society’s economic organization the entrepreneurs determine the course of production. In the performance of this function they are unconditionally and totally subject to the sovereignty of the buying public, the consumers. If they fail to produce in the cheapest and best possible way those commodities which the consumers are asking for most urgently, they suffer losses and are finally eliminated from their entrepreneurial position. Other men who know better how to serve the consumers replace them.
If all people were to anticipate correctly the future state of the market, the entrepreneurs would neither earn any profits nor suffer any losses. They would have to buy the complementary factors of production at prices which would, already at the instant of the purchase, fully reflect the future prices of the products. No room would be left either for profit or for loss. What makes profit emerge is the fact that the entrepreneur who judges the future prices of the products more correctly than other people do buys some or all of the factors of production at prices which, seen from the point of view of the future state of the market, are too low. Thus the total costs of production — including interest on the capital invested — lag behind the prices which the entrepreneur receives for the product. This difference is entrepreneurial profit.
On the other hand, the entrepreneur who misjudges the future prices of the products allows for the factors of production prices which, seen from the point of view of the future state of the market, are too high. His total costs of production exceed the prices at which he can sell the product. This difference is entrepreneurial loss.
Thus profit and loss are generated by success or failure in adjusting the course of production activities to the most urgent demand of the consumers. Once this adjustment is achieved, they disappear. The prices of the complementary factors of production reach a height at which total costs of production coincide with the price of the product. Profit and loss are ever-present features only on account of the fact that ceaseless change in the economic data makes again and again new discrepancies, and consequently the need for new adjustments originate.
- The Distinction Between Profits and Other ProceedsMany errors concerning the nature of profit and loss were caused by the practice of applying the term profit to the totality of the residual proceeds of an entrepreneur.
Interest on the capital employed is not a component part of profit. The dividends of a corporation are not profit. They are interest on the capital invested plus profit or minus loss.
The market equivalent of work performed by the entrepreneur in the conduct of the enterprise’s affairs is entrepreneurial quasi-wages but not profit.
If the enterprise owns a factor on which it can earn monopoly prices, it makes a monopoly gain. If this enterprise is a corporation, such gains increase the dividend. Yet they are not profit proper.
Still more serious are the errors due to the confusion of entrepreneurial activity and technological innovation and improvement.
The maladjustment, the removal of which is the essential function of entrepreneurship, may often consist in the fact that new technological methods have not yet been utilized to the full extent to which they should be in order to bring about the best possible satisfaction of consumers’ demand. But this is not necessarily always the case. Changes in the data, especially in consumers’ demand, may require adjustments which have no reference at all to technological innovations and improvements. The entrepreneur who simply increases the production of an article by adding to the existing production facilities a new outfit without any change in the technological method of production is no less an entrepreneur than the man who inaugurates a new way of producing. The business of the entrepreneur is not merely to experiment with new technological methods, but to select from the multitude of technologically feasible methods those which are best fit to supply the public in the cheapest way with the things they are asking for most urgently. Whether a new technological procedure is or is not fit for this purpose is to be provisionally decided by the entrepreneur and will be finally decided by the conduct of the buying public. The question is not whether a new method is to be considered as a more “elegant” solution of a technological problem. It is whether, under the given state of economic data, it is the best possible method of supplying the consumers in the cheapest way.
The activities of the entrepreneur consist in making decisions. He determines for what purpose the factors of production should be employed. Any other acts which an entrepreneur may perform are merely accidental to his entrepreneurial function. It is this that laymen often fail to realize. They confuse the entrepreneurial activities with the conduct of the technological and administrative affairs of a plant. In their eyes not the stockholders, the promoters and speculators, but hired employees are the real entrepreneurs. The former are merely idle parasites who pocket the dividends.
Now nobody ever contended that one could produce without working. But neither is it possible to produce without capital goods, the previously produced factors of further production. These capital goods are scarce, i.e., they do not suffice for the production of all things which one would like to have produced. Hence the economic problem arises: to employ them in such a way that only those goods should be produced which are fit to satisfy the most urgent demands of the consumers. No good should remain unproduced on account of the fact that the factors required for its production were used — wasted — for the production of another good for which the demand of the public is less intense. To achieve this is, under capitalism, the function of entrepreneurship that determines the allocation of capital to the various branches of production. Under socialism it would be a function of the state, the social apparatus of coercion and oppression. The problem whether a socialist directorate, lacking any method of economic calculation, could fulfill this function is not to be dealt with in this essay.
There is a simple rule of thumb to tell entrepreneurs from non-entrepreneurs. The entrepreneurs are those on whom the incidence of losses on the capital employed falls. Amateur-economists may confuse profits with other kinds of intakes. But it is impossible to fail to recognize losses on the capital employed.
- Non-Profit Conduct of AffairsWhat has been called the democracy of the market manifests itself in the fact that profit-seeking business is unconditionally subject to the supremacy of the buying public.
Non-profit organizations are sovereign unto themselves. They are, within the limits drawn by the amount of capital at their disposal, in a position to defy the wishes of the public.
A special case is that of the conduct of government affairs, the administration of the social apparatus of coercion and oppression, viz., the police power. The objectives of government, the protection of the inviolability of the individuals’ lives and health and of their efforts to improve the material conditions of their existence, are indispensable. They benefit all and are the necessary prerequisite of social cooperation and civilization. But they cannot be sold and bought in the way merchandise is sold and bought; they have therefore no price on the market. With regard to them there cannot be any economic calculation. The costs expended for their conduct cannot be confronted with a price received for the product. This state of affairs would make the officers entrusted with the administration of governmental activities irresponsible despots if they were not curbed by the budget system. Under this system the administrators are forced to comply with detailed instructions enjoined upon them by the sovereign, be it a self-appointed autocrat or the whole people acting through elected representatives. To the officers limited funds are assigned which they are bound to spend only for those purposes which the sovereign has ordered. Thus the management of public administration becomes bureaucratic, i.e., dependent on definite detailed rules and regulations.
Bureaucratic management is the only alternative available where there is no profit and loss management.
- The Ballot of the MarketThe consumers by their buying and abstention from buying elect the entrepreneurs in a daily repeated plebiscite as it were. They determine who should own and who not, and how much each owner should own.
As is the case with all acts of choosing a person — choosing holders of public office, employees, friends or a consort — the decision of the consumers is made on the ground of experience and thus necessarily always refers to the past. There is no experience of the future. The ballot of the market elevates those who in the immediate past have best served the consumers. However, the choice is not unalterable and can daily be corrected. The elected who disappoints the electorate is speedily reduced to the ranks.
Each ballot of the consumers adds only a little to the elected man’s sphere of action. To reach the upper levels of entrepreneurship he needs a great number of votes, repeated again and again over a long period of time, a protracted series of successful strokes. He must stand every day a new trial, must submit anew to reelection as it were.
It is the same with his heirs. They can retain their eminent position only by receiving again and again confirmation on the part of the public. Their office is revocable. If they retain it, it is not on account of the deserts of their predecessor, but on account of their own ability to employ the capital for the best possible satisfaction of the consumers.
The entrepreneurs are neither perfect nor good in any metaphysical sense. They owe their position exclusively to the fact that they are better fit for the performance of the functions incumbent upon them than other people are. They earn profit not because they are clever in performing their tasks, but because they are more clever or less clumsy than other people are. They are not infallible and often blunder. But they are less liable to error and blunder less than other people do. Nobody has the right to take offense at the errors made by the entrepreneurs in the conduct of affairs and to stress the point that people would have been better supplied if the entrepreneurs had been more skillful and prescient. If the grumbler knew better, why did he not himself fill the gap and seize the opportunity to earn profits? It is easy indeed to display foresight after the event. In retrospect all fools become wise.
A popular chain of reasoning runs this way: The entrepreneur earns profit not only on account of the fact that other people were less successful than he in anticipating correctly the future state of the market. He himself contributed to the emergence of profit by not producing more of the article concerned; but for intentional restriction of output on his part, the supply of this article would have been so ample that the price would have dropped to a point at which no surplus of proceeds over costs of production expended would have emerged. This reasoning is at the bottom of the spurious doctrines of imperfect and monopolistic competition. It was resorted to a short time ago by the American Administration when it blamed the enterprises of the steel industry for the fact that the steel production capacity of the United States was not greater than it really was.
Certainly those engaged in the production of steel are not responsible for the fact that other people did not likewise enter this field of production. The reproach on the part of the authorities would have been sensible if they had conferred on the existing steel corporations the monopoly of steel production. But in the absence of such a privilege, the reprimand given to the operating mills is not more justified than it would be to censure the nation’s poets and musicians for the fact that there are not more and better poets and musicians. If somebody is to blame for the fact that the number of people who joined the voluntary civilian defense organization is not larger, then it is not those who have already joined but only those who have not.
That the production of a commodity p is not larger than it really is, is due to the fact that the complementary factors of production required for an expansion were employed for the production of other commodities. To speak of an insufficiency of the supply of p is empty rhetoric if it does not indicate the various products m which were produced in too large quantities with the effect that their production appears now, i.e., after the event, as a waste of scarce factors of production. We may assume that the entrepreneurs who instead of producing additional quantities of p turned to the production of excessive amounts of m and consequently suffered losses did not intentionally make their mistake.
Neither did the producers of p intentionally restrict the production of p. Every entrepreneur’s capital is limited; he employs it for those projects which, he expects, will, by filling the most urgent demand of the public, yield the highest profit.
An entrepreneur at whose disposal are 100 units of capital employs, for instance, 50 units for the production of p and 50 units for the production of q. If both lines are profitable, it is odd to blame him for not having employed more, e.g., 75 units, for the production of p. He could increase the production of p only by curtailing correspondingly the production of q. But with regard to q the same fault could be found by the grumblers. If one blames the entrepreneur for not having produced more p, one must blame him also for not having produced more q. This means: one blames the entrepreneur for the facts that there is a scarcity of the factors of production and that the earth is not a land of Cockaigne.
Perhaps the grumbler will object on the ground that he considers p a vital commodity, much more important than q, and that therefore the production of p should be expanded and that of q restricted. If this is really the meaning of his criticism, he is at variance with the valuations of the consumers. He throws off his mask and shows his dictatorial aspirations. Production should not be directed by the wishes of the public but by his own despotic discretion.
But if our entrepreneur’s production of q involves a loss, it is obvious that his fault was poor foresight and not intentional.
Entrance into the ranks of the entrepreneurs in a market society, not sabotaged by the interference of government or other agencies resorting to violence, is open to everybody. Those who know how to take advantage of any business opportunity cropping up will always find the capital required. For the market is always full of capitalists anxious to find the most promising employment for their funds and in search of the ingenious newcomers, in partnership with whom they could execute the most remunerative projects.
People often failed to realize this inherent feature of capitalism because they did not grasp the meaning and the effects of capital scarcity. The task of the entrepreneur is to select from the multitude of technologically feasible projects those which will satisfy the most urgent of the not yet satisfied needs of the public. Those projects for the execution of which the capital supply does not suffice must not be carried out. The market is always crammed with visionaries who want to float such impracticable and unworkable schemes. It is these dreamers who always complain about the blindness of the capitalists who are too stupid to look after their own interests. Of course, the investors often err in the choice of their investments. But these faults consist precisely in the fact that they preferred an unsuitable project to another that would have satisfied more urgent needs of the buying public.
People often err very lamentably in estimating the work of the creative genius. Only a minority of men are appreciative enough to attach the right value to the achievement of poets, artists and thinkers. It may happen that the indifference of his contemporaries makes it impossible for a genius to accomplish what he would have accomplished if his fellow-men had displayed better judgment. The way in which the poet laureate and the philosopher à la mode are selected is certainly questionable.
But it is impermissible to question the free market’s choice of the entrepreneurs. The consumers’ preference for definite articles may be open to condemnation from the point of view of a philosopher’s judgment. But judgments of value are necessarily always personal and subjective. The consumer chooses what, as he thinks, satisfies him best. Nobody is called upon to determine what could make another man happier or less unhappy. The popularity of motor cars, television sets and nylon stockings may be criticized from a “higher” point of view. But these are the things that people are asking for. They cast their ballots for those entrepreneurs who offer them this merchandise of the best quality at the cheapest price.
In choosing between various political parties and programs for the commonwealth’s social and economic organization most people are uninformed and groping in the dark. The average voter lacks the insight to distinguish between policies suitable to attain the ends he is aiming at and those unsuitable. He is at a loss to examine the long chains of aprioristic reasoning which constitute the philosophy of a comprehensive social program. He may at best form some opinion about the short-run effects of the policies concerned. He is helpless in dealing with the long-run effects. The socialists and communists in principle often assert the infallibility of majority decisions. However, they belie their own words in criticizing parliamentary majorities rejecting their creed, and in denying to the people, under the one-party system, the opportunity to choose between different parties.
But in buying a commodity or abstaining from its purchase there is nothing else involved than the consumer’s longing for the best possible satisfaction of his instantaneous wishes. The consumer does not — like the voter in political voting — choose between different means whose effects appear only later. He chooses between things which immediately provide satisfaction. His decision is final.
An entrepreneur earns profit by serving the consumers, the people, as they are and not as they should be according to the fancies of some grumbler or potential dictator.
- The Social Function of Profit and LossProfits are never normal. They appear only where there is a maladjustment, a divergence between actual production and production as it should be in order to utilize the available material and mental resources for the best possible satisfaction of the wishes of the public. They are the prize of those who remove this maladjustment; they disappear as soon as the maladjustment is entirely removed. In the imaginary construction of an evenly rotating economy there are no profits. There the sum of the prices of the complementary factors of production, due allowance being made for time preference, coincides with the price of the product.
The greater the preceding maladjustments, the greater the profit earned by their removal. Maladjustments may sometimes be called excessive. But it is inappropriate to apply the epithet “excessive” to profits.
People arrive at the idea of excessive profits by confronting the profit earned with the capital employed in the enterprise and measuring the profit as a percentage of the capital. This method is suggested by the customary procedure applied in partnerships and corporations for the assignment of quotas of the total profit to the individual partners and shareholders. These men have contributed to a different extent to the realization of the project and share in the profits and losses according to the extent of their contribution.
But it is not the capital employed that creates profits and losses. Capital does not “beget profit” as Marx thought. The capital goods as such are dead things that in themselves do not accomplish anything. If they are utilized according to a good idea, profit results. If they are utilized according to a mistaken idea, no profit or losses result. It is the entrepreneurial decision that creates either profit or loss. It is mental acts, the mind of the entrepreneur, from which profits ultimately originate. Profit is a product of the mind, of success in anticipating the future state of the market. It is a spiritual and intellectual phenomenon.
The absurdity of condemning any profits as excessive can easily be shown. An enterprise with a capital of the amount c produced a definite quantity of p which it sold at prices that brought a surplus of proceeds over costs of s and consequently a profit of n per cent. If the entrepreneur had been less capable, he would have needed a capital of 2c for the production of the same quantity of p. For the sake of argument we may even neglect the fact that this would have necessarily increased costs of production as it would have doubled the interest on the capital employed, and we may assume that s would have remained unchanged. But at any rate s would have been confronted with 2c instead of c and thus the profit would have been only n/2 per cent of the capital employed. The “excessive” profit would have been reduced to a “fair” level. Why? Because the entrepreneur was less efficient and because his lack of efficiency deprived his fellow-men of all the advantages they could have got if an amount c of capital goods had been left available for the production of other merchandise.
In branding profits as excessive and penalizing the efficient entrepreneurs by discriminatory taxation, people are injuring themselves. Taxing profits is tantamount to taxing success in best serving the public. 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. But the better an entrepreneur succeeds in this regard, the more is he vilified and the more is he soaked by taxation. Increasing costs per unit of output, that is, waste, is praised as a virtue.
The most amazing manifestation of this complete failure to grasp the task of production and the nature and functions of profit and loss is shown in the popular superstition that profit is an addendum to the costs of production, the height of which depends uniquely on the discretion of the seller. It is this belief that guides governments in controlling prices. It is the same belief that has prompted many governments to make arrangements with their contractors according to which the price to be paid for an article delivered is to equal costs of production expended by the seller increased by a definite percentage. The effect was that the purveyor got a surplus the higher, the less he succeeded in avoiding superfluous costs. Contracts of this type enhanced considerably the sums the United States had to expend in the two world wars. But the bureaucrats, first of all the professors of economics who served in the various war agencies, boasted of their clever handling of the matter.
All people, entrepreneurs as well as non-entrepreneurs, look askance upon any profits earned by other people. Envy is a common weakness of men. People are loath to acknowledge the fact that they themselves could have earned profits if they had displayed the same foresight and judgment the successful businessman did. Their resentment is the more violent the more they are subconsciously aware of this fact.
There would not be any profits but for the eagerness of the public to acquire the merchandise offered for sale by the successful entrepreneur. But the same people who scramble for these articles vilify the businessman and call his profit ill got.
The semantic expression of this enviousness is the distinction between earned and unearned income. It permeates the textbooks, the language of the laws and administrative procedure. Thus, for instance, the official Form 201 for the New York state income tax return calls “earnings” only the compensation received by employees and, by implication, all other income, also that resulting from the exercise of a profession, unearned income. Such is the terminology of a state whose governor is a Republican and whose state assembly has a Republican majority.
Public opinion condones profits only as far as they do not exceed the salary paid to an employee. All surplus is rejected as unfair. The objective of taxation is, under the ability-to-pay principle, to confiscate this surplus.
Now one of the main functions of profits is to shift the control of capital to those who know how to employ it in the best possible way for the satisfaction of the public. The more profits a man earns, the greater his wealth consequently becomes, the more influential does he become in the conduct of business affairs. Profit and loss are the instruments by means of which the consumers pass the direction of production activities into the hands of those who are best fit to serve them. Whatever is undertaken to curtail or to confiscate profits impairs this function. The result of such measures is to loosen the grip the consumers hold over the course of production. The economic machine becomes, from the point of view of the people, less efficient and less responsive.
The jealousy of the common man looks upon the profits of the entrepreneurs as if they were totally used for consumption. A part of them is, of course, consumed. But only those entrepreneurs attain wealth and influence in the realm of business who consume merely a fraction of their proceeds and plough back the much greater part into their enterprises. What makes small business develop into big business is not spending, but saving and capital accumulation.
- Profit and Loss in the Progressing and in the Retrogressing EconomyWe call a stationary economy an economy in which the per head quota of the income and wealth of the individuals remains unchanged. In such an economy what the consumers spend more for the purchase of some articles must be equal to what they spend less for other articles. The total amount of the profits earned by one part of the entrepreneurs equals the total amount of losses suffered by other entrepreneurs.
A surplus of the sum of all profits earned in the whole economy above the sum of all losses suffered emerges only in a progressing economy, that is, in an economy in which the per head quota of capital increases. This increment is an effect of saving that adds new capital goods to the quantity already previously available. The increase of capital available creates maladjustments insofar as it brings about a discrepancy between the actual state of production and that state which the additional capital makes possible. Thanks to the emergence of additional capital, certain projects which hitherto could not be executed become feasible. In directing the new capital into those channels in which it satisfies the most urgent among the previously not satisfied wants of the consumers, the entrepreneurs earn profits which are not counterbalanced by the losses of other entrepreneurs.
The enrichment which the additional capital generates goes only in part to those who have created it by saving. The rest goes, by raising the marginal productivity of labor and thereby wage rates, to the earners of wages and salaries and, by raising the prices of definite raw materials and foodstuffs, to the owners of land, and, finally, to the entrepreneurs who integrate this new capital into the most economical production processes. But while the gain of the wage earners and of the landowners is permanent, the profits of the entrepreneurs disappear once this integration is accomplished. Profits of the entrepreneurs are, as has been mentioned already, a permanent phenomenon only on account of the fact that maladjustments appear daily anew by the elimination of which profits are earned.
Let us for the sake of argument resort to the concept of national income as employed in popular economics. Then it is obvious that in a stationary economy no part of the national income goes into profits. Only in a progressing economy is there a surplus of total profits over total losses. The popular belief that profits are a deduction from the income of workers and consumers is entirely fallacious. If we want to apply the term deduction to the issue, we have to say that this surplus of profits over losses as well as the increments of the wage earners and the landowners is deducted from the gains of those whose saving brought about the additional capital. It is their saving that is the vehicle of economic improvement, that makes the employment of technological innovations possible and raises productivity and the standard of living. It is the entrepreneurs whose activity takes care of the most economical employment of the additional capital. As far as they themselves do not save, neither the workers nor the landowners contribute anything to the emergence of the circumstances which generate what is called economic progress and improvement. They are benefited by other peoples’ saving that creates additional capital on the one hand and by the entrepreneurial action that directs this additional capital toward the satisfaction of the most urgent wants on the other hand.
A retrogressing economy is an economy in which the per head quota of capital invested is decreasing. In such an economy the total amount of losses incurred by entrepreneurs exceeds the total amount of profits earned by other entrepreneurs.
- The Competition of Profit and LossThe originary praxeological categories of profit and loss are psychic qualities and not reducible to any interpersonal description in quantitative terms. They are intensive magnitudes. The difference between the value of the end attained and that of the means applied for its attainment is profit if it is positive and loss if it is negative.
Where there are social division of efforts and cooperation as well as private ownership of the means of production, economic calculation in terms of monetary units becomes feasible and necessary. Profit and loss are computable as social phenomena. The psychic phenomena of profit and loss, from which they are ultimately derived, remain, of course, incalculable intensive magnitudes.
The fact that in the frame of the market economy entrepreneurial profit and loss are determined by arithmetical operations has misled many people. They fail to see that essential items that enter into this calculation are estimates emanating from the entrepreneur’s specific understanding of the future state of the market. They think that these computations are open to examination and verification or alteration on the part of a disinterested expert. They ignore the fact that such computations are as a rule an inherent part of the entrepreneur’s speculative anticipation of uncertain future conditions.
For the task of this essay it suffices to refer to one of the problems of cost accounting. One of the items of a bill of costs is the establishment of the difference between the price paid for the acquisition of what is commonly called durable production equipment and its present value. This present value is the money equivalent of the contribution this equipment will make to future earnings. There is no certainty about the future state of the market and about the height of these earnings. They can only be determined by a speculative anticipation on the part of the entrepreneur. It is preposterous to call in an expert and to substitute his arbitrary judgment for that of the entrepreneur. The expert is objective insofar as he is not affected by an error made. But the entrepreneur exposes his own material well-being.
Of course, the law determines magnitudes which it calls profit and loss. But these magnitudes are not identical with the economic concepts of profit and loss and must not be confused with them. If a tax law calls a magnitude profit, it in effect determines the height of taxes due. It calls this magnitude profit because it wants to justify its tax policy in the eyes of the public. It would be more correct for the legislator to omit the term profit and simply to speak of the basis for the computation of the tax due.
The tendency of the tax laws is to compute what they call profit as high as possible in order to increase immediate public revenue. But there are other laws which are committed to the tendency to restrict the magnitude they call profit. The commercial codes of many nations were and are guided by the endeavor to protect the rights of creditors. They aimed at restricting what they called profit in order to prevent the entrepreneur from withdrawing to the prejudice of creditors too much from the firm or corporation for his own benefit. It was these tendencies which were operative in the evolution of the commercial usages concerning the customary height of depreciation quotas.
There is no need today to dwell upon the problem of the falsification of economic calculation under inflationary conditions. All people begin to comprehend the phenomenon of illusory profits, the offshoot of the great inflations of our age.
Failure to grasp the effects of inflation upon the customary methods of computing profits originated the modern concept of profiteering. An entrepreneur is dubbed a profiteer if his profit and loss statement, calculated in terms of a currency subject to a rapidly progressing inflation, shows profits which other people deem “excessive.” It has happened very often in many countries that the profit and loss statement of such a profiteer, when calculated in terms of a non-inflated or less inflated currency, showed not only no profit at all but considerable losses.
Even if we neglect for the sake of argument any reference to the phenomenon of merely inflation-induced illusory profits, it is obvious that the epithet profiteer is the expression of an arbitrary judgment of value. There is no other standard available for the distinction between profiteering and earning fair profits than that provided by the censor’s personal envy and resentment. ...
- The Consequences of the Abolition of Profit[Ibid., section B: “The Condemnation of Profit,” pp. 132–43.]The idea to abolish profit for the advantage of the consumers involves that the entrepreneur should be forced to sell the products at prices not exceeding the costs of production expended. As such prices are, for all articles the sale of which would have brought profit, below the potential market price, the available supply is not sufficient to make it possible for all those who want to buy at these prices to acquire the articles. The market is paralyzed by the maximum price decree. It can no longer allocate the products to the consumers. A system of rationing must be adopted.
The suggestion to abolish the entrepreneur’s profit for the benefit of the employees aims not at the abolition of profit. It aims at wresting it from the hands of the entrepreneur and handing it over to his employees.
Under such a scheme the incidence of losses incurred falls upon the entrepreneur, while profits go to the employees. It is probable that the effect of this arrangement would consist in making losses increase and profits dwindle. At any rate, a greater part of the profits would be consumed and less would be saved and ploughed back into the enterprise. No capital would be available for the establishment of new branches of production and for the transfer of capital from branches which — in compliance with the demand of the customers — should shrink into branches which should expand. For it would harm the interests of those employed in a definite enterprise or branch to restrict the capital employed in it and to transfer it into another enterprise or branch. If such a scheme had been adopted half a century ago, all the innovations accomplished in this period would have been rendered impossible. If, for the sake of argument, we were prepared to neglect any reference to the problem of capital accumulation, we would still have to realize that giving profit to the employees must result in rigidity of the once attained state of production and preclude any adjustment, improvement and progress.
In fact, the scheme would transfer ownership of the capital invested into the hands of the employees. It would be tantamount to the establishment of syndicalism and would generate all the effects of syndicalism, a system which no author or reformer ever had the courage to advocate openly.
A third solution of the problem would be to confiscate all the profits earned by the entrepreneurs for the benefit of the state. A one hundred per cent tax on profits would accomplish this task. It would transform the entrepreneurs into irresponsible administrators of all plants and workshops. They would no longer be subject to the supremacy of the buying public. They would just be people who have the power to deal with production as it pleases them.
The policies of all contemporary governments which have not adopted outright socialism apply all these three schemes jointly. They confiscate by various measures of price control a part of the potential profits for the alleged benefit of the consumers. They support the labor unions in their endeavors to wrest, under the ability-to-pay principle of wage determination, a part of the profits from the entrepreneurs. And, last but not least, they are intent upon confiscating, by progressive income taxes, special taxes on corporation income, and “excess profits” taxes, an ever-increasing part of profits for public revenue. It can easily be seen that these policies if continued will very soon succeed in abolishing entrepreneurial profit altogether.
The joint effect of the application of these policies is already today rising chaos. The final effect will be the full realization of socialism by smoking out the entrepreneurs. Capitalism cannot survive the abolition of profit. It is profit and loss that force the capitalists to employ their capital for the best possible service to the consumers. It is profit and loss that make those people supreme in the conduct of business who are best fit to satisfy the public. If profit is abolished, chaos results.
- The Anti-Profit ArgumentsAll the reasons advanced in favor of an anti-profit policy are the outcome of an erroneous interpretation of the operation of the market economy.
The tycoons are too powerful, too rich and too big. They abuse their power for their own enrichment. They are irresponsible tyrants. Bigness of an enterprise is in itself an evil. There is no reason why some men should own millions while others are poor. The wealth of the few is the cause of the poverty of the masses.
Each word of these passionate denunciations is false. The businessmen are not irresponsible tyrants. It is precisely the necessity of making profits and avoiding losses that gives to the consumers a firm hold over the entrepreneurs and forces them to comply with the wishes of the people. What makes a firm big is its success in best filling the demands of the buyers. If the bigger enterprise did not better serve the people than a smaller one, it would long since have been reduced to smallness. There is no harm in a businessman’s endeavors to enrich himself by increasing his profits. The businessman has in his capacity as a businessman only one task: to strive after the highest possible profit. Huge profits are the proof of good service rendered in supplying the consumers. Losses are the proof of blunders committed, of failure to perform satisfactorily the tasks incumbent upon an entrepreneur. The riches of successful entrepreneurs are not the cause of anybody’s poverty; they are consequences of the fact that the consumers are better supplied than they would have been in the absence of the entrepreneur’s effort. The penury of millions in the backward countries is not caused by anybody’s opulence; it is the correlative of the fact that their country lacks entrepreneurs who have acquired riches. The standard of living of the common man is highest in those countries which have the greatest number of wealthy entrepreneurs. It is to the foremost material interest of everybody that control of the factors of production should be concentrated in the hands of those who know how to utilize them in the most efficient way.
It is the avowed objective of the policies of all present-day governments and political parties to prevent the emergence of new millionaires. If this policy had been adopted in the United States fifty years ago, the growth of the industries producing new articles would have been stunted. Motorcars, refrigerators, radio sets and a hundred other less spectacular but even more useful innovations would not have become standard equipment of most of the American family households.
The average wage earner thinks that nothing else is needed to keep the social apparatus of production running and to improve and to increase output than the comparatively simple routine work assigned to him. He does not realize that the mere toil and trouble of the routinist is not sufficient. Sedulousness and skill are spent in vain if they are not directed toward the most important goal by the entrepreneur’s foresight and are not aided by the capital accumulated by capitalists. The American worker is badly mistaken when he believes that his high standard of living is due to his own excellence. He is neither more industrious nor more skillful than the workers of Western Europe. He owes his superior income to the fact that his country clung to “rugged individualism” much longer than Europe. It was his luck that the United States turned to an anti-capitalistic policy as much as forty or fifty years later than Germany. His wages are higher than those of the workers of the rest of the world because the capital equipment per head of the employee is highest in America and because the American entrepreneur was not so much restricted by crippling regimentation as his colleagues in other areas. The comparatively greater prosperity of the United States is an outcome of the fact that the New Deal did not come in 1900 or 1910, but only in 1933.
If one wants to study the reasons for Europe’s backwardness, it would be necessary to examine the manifold laws and regulations that prevented in Europe the establishment of an equivalent of the American drugstore and crippled the evolution of chain stores, department stores, supermarkets and kindred outfits. It would be important to investigate the German Reich’s effort to protect the inefficient methods of traditional Handwerk (handicraft) against the competition of capitalist business. Still more revealing would be an examination of the Austrian Gewerbepolitik, a policy that from the early eighties on aimed at preserving the economic structure of the ages preceding the Industrial Revolution.
The worst menace to prosperity and civilization and to the material well-being of the wage earners is the inability of union bosses, of “union economists” and of the less intelligent strata of the workers themselves to appreciate the role entrepreneurs play in production. This lack of insight has found a classical expression in the writings of Lenin. As Lenin saw it all that production requires besides the manual work of the laborer and the designing of the engineers is “control of production and distribution,” a task that can easily be accomplished “by the armed workers.” For this accounting and control “have been simplified by capitalism to the utmost, till they have become the extraordinarily simple operations of watching, recording and issuing receipts, within the reach of everybody who can read and write and knows the first four rules of arithmetic.”Lenin, State and Revolution (Edition by International Publishers, New York, 1917), pp. 83–84. The italics are Lenin’s (or the communist translator’s). No further comment is needed.
- The Equality ArgumentIn the eyes of the parties who style themselves progressive and leftist the main vice of capitalism is the inequality of incomes and wealth. The ultimate end of their policies is to establish equality. The moderates want to attain this goal step by step; the radicals plan to attain it at one stroke, by a revolutionary overthrow of the capitalist mode of production.
However, in talking about equality and asking vehemently for its realization, nobody advocates a curtailment of his own present income. The term equality as employed in contemporary political language always means upward levelling of one’s income, never downward levelling. It means getting more, not sharing one’s own affluence with people who have less.
If the American automobile worker, railroadman or compositor says equality, he means expropriating the holders of shares and bonds for his own benefit. He does not consider sharing with the unskilled workers who earn less. At best, he thinks of equality of all American citizens. It never occurs to him that the peoples of Latin America, Asia and Africa may interpret the postulate of equality as world equality and not as national equality.
The political labor movement as well as the labor union movement flamboyantly advertise their internationalism. But this internationalism is a mere rhetorical gesture without any substantial meaning. In every country in which average wage rates are higher than in any other area, the unions advocate insurmountable immigration barriers in order to prevent foreign “comrades” and “brothers” from competing with their own members. Compared with the anti-immigration laws of the European nations, the immigration legislation of the American republics is mild indeed because it permits the immigration of a limited number of people. No such normal quotas are provided in most of the European laws.
All the arguments advanced in favor of income equalization within a country can with the same justification or lack of justification also be advanced in favor of world equalization. An American worker has no better title to claim the savings of the American capitalist than has any foreigner. That a man has earned profits by serving the consumers and has not entirely consumed his funds but ploughed back the greater part of them into industrial equipment does not give anybody a valid title to expropriate this capital for his own benefit. But if one maintains the opinion to the contrary, there is certainly no reason to ascribe to anybody a better right to expropriate than to anybody else. There is no reason to assert that only Americans have the right to expropriate other Americans. The big shots of American business are the scions of people who immigrated to the United States from England, Scotland, Ireland, France, Germany and other European countries. The people of their country of origin contend that they have the same title to seize the property acquired by these men as the American people have. The American radicals are badly mistaken in believing that their social program is identical or at least compatible with the objectives of the radicals of other countries. It is not. The foreign radicals will not acquiesce in leaving to the Americans, a minority of less than seven per cent of the world’s total population, what they think is a privileged position. A world government of the kind the American radicals are asking for would try to confiscate by a world income tax all the surplus an average American earns above the average income of a Chinese or Indian worker. Those who question the correctness of this statement would drop their doubts after a conversation with any of the intellectual leaders of Asia.
There is hardly any Iranian who would qualify the objections raised by the British Labor government against the confiscation of the oil wells as anything else but a manifestation of the most reactionary spirit of capitalist exploitation. Today governments abstain from virtually expropriating — by foreign exchange control, discriminatory taxation and similar devices — foreign investments only if they expect to get in the next years more foreign capital and thus to be able in the future to expropriate a greater amount.
The disintegration of the international capital market is one of the most important effects of the anti-profit mentality of our age. But no less disastrous is the fact that the greater part of the world’s population looks upon the United States — not only upon the American capitalists but also upon the American workers — with the same feelings of envy, hatred and hostility with which, stimulated by the socialist and communist doctrines, the masses everywhere look upon the capitalists of their own nation.
- Communism and PovertyA customary method of dealing with political programs and movements is to explain and to justify their popularity by referring to the conditions which people found unsatisfactory and to the goals they wanted to attain by the realization of these programs.
However, the only thing that matters is whether or not the program concerned is fit to attain the ends sought. A bad program and a bad policy can never be explained, still less justified by pointing to the unsatisfactory conditions of its originators and supporters. The sole question that counts is whether or not these policies can remove or alleviate the evils which they are designed to remedy.
Yet almost all our contemporaries declare again and again: If you want to succeed in fighting communism, socialism and interventionism, you must first of all improve peoples’ material conditions. The policy of laissez faire aims precisely at making people more prosperous. But it cannot succeed as long as want is worsened more and more by socialist and interventionist measures.
In the very short run the conditions of a part of the people can be improved by expropriating entrepreneurs and capitalists and by distributing the booty. But such predatory inroads, which even the Communist Manifesto described as “despotic” and as “economically insufficient and untenable,” sabotage the operation of the market economy, impair very soon the conditions of all the people, and frustrate the endeavors of entrepreneurs and capitalists to make the masses more prosperous. What is good for a quickly vanishing instant, (i.e., in the shortest run) may very soon (i.e., in the long run) result in most detrimental consequences.
Historians are mistaken in explaining the rise of Nazism by referring to real or imaginary adversities and hardships of the German people. What made the Germans support almost unanimously the twenty-five points of the “unalterable” Hitler program was not some conditions which they deemed unsatisfactory, but their expectation that the execution of this program would remove their complaints and render them happier. They turned to Nazism because they lacked common sense and intelligence. They were not judicious enough to recognize in time the disasters that Nazism was bound to bring upon them.
The immense majority of the world’s population is extremely poor when compared with the average standard of living of the capitalist nations. But this poverty does not explain their propensity to adopt the communist program. They are anti-capitalistic because they are blinded by envy, ignorant and too dull to appreciate correctly the causes of their distress. There is but one means to improve their material conditions, namely, to convince them that only capitalism can render them more prosperous.
The worst method to fight communism is that of the Marshall Plan. It gives to the recipients the impression that the United States alone is interested in the preservation of the profit system while their own concerns require a communist regime. The United States, they think, is aiding them because its people have a bad conscience. They themselves pocket this bribe but their sympathies go to the socialist system. The American subsidies make it possible for their governments to conceal partially the disastrous effects of the various socialist measures they have adopted.
Not poverty is the source of socialism, but spurious ideological pre-possessions. Most of our contemporaries reject beforehand, without having ever studied them, all the teachings of economics as aprioristic nonsense. Only experience, they maintain, is to be relied upon. But is there any experience that would speak in favor of socialism?
Retorts the socialist: But capitalism creates poverty; look at India and China. The objection is vain. Neither India nor China has ever established capitalism. Their poverty is the result of the absence of capitalism.
What happened in these and other underdeveloped countries was that they were benefited from abroad by some of the fruits of capitalism without having adopted the capitalist mode of production. European, and in more recent years also American, capitalists invested capital in their areas and thereby increased the marginal productivity of labor and wage rates. At the same time these peoples received from abroad the means to fight contagious diseases, medications developed in the capitalist countries. Consequently mortality rates, especially infant mortality, dropped considerably. In the capitalist countries this prolongation of the average length of life was partially compensated by a drop in the birth rate. As capital accumulation increased more quickly than population, the per head quota of capital invested grew continuously. The result was progressing prosperity. It was different in the countries which enjoyed some of the effects of capitalism without turning to capitalism. There the birth rate did not decline at all or not to the extent required to make the per head quota of capital invested rise. These nations prevent by their policies both the importation of foreign capital and the accumulation of domestic capital. The joint effect of the high birth rate and the absence of an increase in capital is, of course, increasing poverty.
There is but one means to improve the material well-being of men, viz., to accelerate the increase in capital accumulated as against population. No psychological lucubrations, however sophisticated, can alter this fact. There is no excuse whatever for the pursuit of policies which not only fail to attain the ends sought, but even seriously impair conditions.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 15: “The Market,” pp. 286–91.]8. Entrepreneurial Profit and LossProfit, in a broader sense, is the gain derived from action; it is the increase in satisfaction (decrease in uneasiness) brought about; it is the difference between the higher value attached to the result attained and the lower value attached to the sacrifices made for its attainment; it is, in other words, yield minus costs. To make profit is invariably the aim sought by any action. If an action fails to attain the ends sought, yield either does not exceed costs or lags behind costs. In the latter case the outcome means a loss, a decrease in satisfaction.
Profit and loss in this original sense are psychic phenomena and as such not open to measurement and a mode of expression which could convey to other people precise information concerning their intensity. A man can tell a fellow man that a suits him better than b; but he cannot communicate to another man, except in vague and indistinct terms, how much the satisfaction derived from a exceeds that derived from b.
In the market economy all those things that are bought and sold against money are marked with money prices. In the monetary calculus profit appears as a surplus of money received over money expended and loss as a surplus of money expended over money received. Profit and loss can be expressed in definite amounts of money. It is possible to ascertain in terms of money how much an individual has profited or lost. However, this is not a statement about this individual’s psychic profit or loss. It is a statement about a social phenomenon, about the individual’s contribution to the societal effort as it is appraised by the other members of society. It does not tell us anything about the individual’s increase or decrease in satisfaction or happiness. It merely reflects his fellow men’s evaluation of his contribution to social cooperation. This evaluation is ultimately determined by the efforts of every member of society to attain the highest possible psychic profit. It is the resultant of the composite effect of all these people’s subjective and personal value judgments as manifested in their conduct on the market. But it must not be confused with these value judgments as such.
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.If an action neither improves nor impairs the state of satisfaction, it still involves a psychic loss because of the uselessness of the expended psychic effort. The individual concerned would have been better off if he had inertly enjoyed life. In the imaginary construction of an evenly rotating economy there are neither money profits nor money losses. But every individual derives a psychic profit from his actions, or else he would not act at all. The farmer feeds and milks his cows and sells the milk because he values the things he can buy against the money thus earned more highly than the costs expended. The absence of money profits or losses in such an evenly rotating system is due to the fact that, if we disregard the differences brought about by the higher valuation of present goods as compared with future goods, the sum of the prices of all complementary factors needed for production precisely equals the price of the product.
In the changing world of reality differences between the sum of the prices of the complementary factors of production and the prices of the products emerge again and again. It is these differences that bring about money profits and money losses. As far as such changes affect the sellers of labor and those of the original nature-given factors of production and of the capitalists as moneylenders, we will deal with them later. At this point we are dealing with entrepreneurial profit and loss. It is this problem that people have in mind when employing the terms profit and loss in mundane speech.
Like every acting man, the entrepreneur is always a speculator. He deals with the uncertain conditions of the future. His success or failure depends on the correctness of his anticipation of uncertain events. If he fails in his understanding of things to come, he is doomed. The only source from which an entrepreneur’s profits stem is his ability to anticipate better than other people the future demand of the consumers. If everybody is correct in anticipating the future state of the market of a certain commodity, its price and the prices of the complementary factors of production concerned would already today be adjusted to this future state. Neither profit nor loss can emerge for those embarking upon this line of business.
The specific entrepreneurial function consists in determining the employment of the factors of production. The entrepreneur is the man who dedicates them to special purposes. In doing so he is driven solely by the selfish interest in making profits and in acquiring wealth. But he cannot evade the law of the market. He can succeed only by best serving the consumers. His profit depends on the approval of his conduct by the consumers.
One must not confuse entrepreneurial profit and loss with other factors affecting the entrepreneur’s proceeds.
The entrepreneur’s technological ability does not affect the specific entrepreneurial profit or loss. As far as his own technological activities contribute to the returns earned and increase his net income, we are confronted with a compensation for work rendered. It is wages paid to the entrepreneur for his labor. Neither does the fact that not every process of production succeeds technologically in bringing about the product expected, influence the specific entrepreneurial profit or loss. Such failures are either avoidable or unavoidable. In the first case they are due to the technologically inefficient conduct of affairs. Then the losses resulting are to be debited to the entrepreneur’s personal insufficiency, i.e., either to his lack of technological ability or to his lack of the ability to hire adequate helpers. In the second case the failures are due to the fact that the present state of technological knowledge prevents us from fully controlling the conditions on which success depends. This deficiency may be caused either by incomplete knowledge concerning the conditions of success or by ignorance of methods for controlling fully some of the known conditions. The price of the factors of production takes into account this unsatisfactory state of our knowledge and technological power. The price of arable land, for instance, takes into full account the fact that there are bad harvests, as it is determined by the anticipated average yield. The fact that the bursting of bottles reduces the output of champagne does not affect entrepreneurial profit and loss. It is merely one of the factors determining the cost of production and the price of champagne.Cf. [Hans von] Mangoldt, Die Lehre vom Unternehmergewinn (Leipzig, 1855), p. 82. The fact that out of 100 liters of plain wine one cannot produce 100 liters of champagne, but a smaller quantity, has the same significance as the fact that 100 kilograms of sugar beet do not yield 100 kilograms of sugar but a smaller quantity.
Accidents affecting the process of production, the means of production, or the products while they are still in the hands of the entrepreneur are an item in the bill of production costs. Experience, which conveys to the businessman all other technological knowledge, provides him also with information about the average reduction in the quantity of physical output which such accidents are likely to bring about. By opening contingency reserves, he converts their effects into regular costs of production. With regard to contingencies the expected incidence of which is too rare and too irregular to be dealt with in this way by individual firms of normal size, concerted action on the part of sufficiently large groups of firms takes care of the matter. The individual firms cooperate under the principle of insurance against damage caused by fire, flood, or other similar contingencies. Then an insurance premium is substituted for an appropriation to a contingency reserve. At any rate, the risks incurred by accidents do not introduce uncertainty into the conduct of the technological processes. If an entrepreneur neglects to deal with them duly, he gives proof of his technical insufficiency. The losses thus incurred are to be debited to bad techniques applied, not to his entrepreneurial function.
The elimination of those entrepreneurs who fail to give to their enterprises the adequate degree of technological efficiency or whose technological ignorance vitiates their cost calculation is effected on the market in the same way in which those deficient in the performance of the specific entrepreneurial functions are eliminated. It may happen that an entrepreneur is so successful in his specific entrepreneurial function that he can compensate losses caused by his technological failure. It may also happen that an entrepreneur can counterbalance losses due to failure in his entrepreneurial function by the advantages derived from his technological superiority or from the differential rent yielded by the higher productivity of the factors of production he employs. But one must not confuse the various functions which are combined in the conduct of a business unit. The technologically more efficient entrepreneur earns higher wage rates or quasi-wage rates than the less efficient in the same way in which the more efficient worker earns more than the less efficient. The more efficient machine and the more fertile soil produce higher physical returns per unit of costs expended; they yield a differential rent when compared with the less efficient machine and the less fertile soil. The higher wage rates and the higher rent are, ceteris paribus, the corollary of higher physical output. But the specific entrepreneurial profits and loses are not produced by the quantity of physical output. They depend on the adjustment of output to the most urgent wants of the consumers. What produces them is the extent to which the entrepreneur has succeeded or failed in anticipating the future — necessarily uncertain — state of the market.
The entrepreneur is also jeopardized by political dangers. Government policies, revolutions, and wars can damage or annihilate his enterprise. Such events do not affect him alone; they affect the market economy as such and all individuals, although not all of them to the same extent. For the individual entrepreneur they are data which he cannot alter. If he is efficient, he will anticipate them in time. But it is not always possible for him to adjust his operations in such a way as to avoid damage. If the dangers expected concern only a part of the territory which is accessible to his entrepreneurial activities, he can avoid operating in the menaced areas and can prefer countries in which the danger is less imminent. But if he cannot emigrate, he must stay where he is. If all entrepreneurs were fully convinced that the total victory of Bolshevism was impending, they would nevertheless not abandon their entrepreneurial activities. The expectation of imminent expropriation will impel the capitalists to consume their funds. The entrepreneurs will be forced to adjust their plans to the market situation created by such capital consumption and the threatened nationalization of their shops and plants. But they will not stop operating. If some entrepreneurs go out of business, others will take their place — newcomers or old entrepreneurs expanding the size of their enterprises. In the market economy there will always be entrepreneurs. Policies hostile to capitalism may deprive the consumers of the greater part of the benefits they would have reaped from unhampered entrepreneurial activities. But they cannot eliminate the entrepreneurs as such if they do not entirely destroy the market economy.
The ultimate source from which entrepreneurial profit and loss are derived is the uncertainty of the future constellation of demand and supply.
If all entrepreneurs were to anticipate correctly the future state of the market, there would be neither profits nor losses. The prices of all the factors of production would already today be fully adjusted to tomorrow’s prices of the products. In buying the factors of production the entrepreneur would have to expend (with due allowance for the difference between the prices of present goods and future goods) no less an amount than the buyers will pay him later for the product. An entrepreneur can make a profit only if he anticipates future conditions more correctly than other entrepreneurs. Then he buys the complementary factors of production at prices the sum of which, including allowance for the time difference, is smaller than the price at which he sells the product.
If we want to construct the image of changing economic conditions in which there are neither profits nor losses, we must resort to an unrealizable assumption: perfect foresight of all future events on the part of all individuals. If those primitive hunters and fishermen to whom it is customary to ascribe the first accumulation of produced factors of production had known in advance all the future vicissitudes of human affairs, and if they and all their descendants until the last day of judgment, equipped with the same omniscience, had appraised all factors of production accordingly, entrepreneurial profits and losses would never have emerged. Entrepreneurial profits and losses are created through the discrepancy between the expected prices and the prices later really fixed on the markets. It is possible to confiscate profits and to transfer them from the individuals to whom they have accrued to other people. But neither profits nor losses can ever disappear from a changing world not populated solely with omniscient people.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 18: “Action in the Passing of Time,” pp. 476–85, 496–99.]1. Perspective in the Valuation of Time PeriodsActing man distinguishes the time before satisfaction of a want is attained and the time for which the satisfaction continues.
Action always aims at the removal of future uneasiness, be it only the future of the impending instant. Between the setting in of action and the attainment of the end sought there always elapses a fraction of time, viz., the maturing time in which the seed sown by the action grows to maturity. The most obvious example is provided by agriculture. Between the tilling of the soil and the ripening of the fruit there passes a considerable period of time. Another example is the improvement of the quality of wine by aging. In some cases, however, the maturing time is so short that ordinary speech may assert that the success appears instantly.
As far as action requires the employment of labor, it is concerned with the working time. The performance of every kind of labor absorbs time. In some cases the working time is so short that people say the performance requires no time at all.
Only in rare cases does a simple, indivisible and nonrepeated act suffice to attain the end aimed at. As a rule what separates the actor from the goal of his endeavors is more than one step only. He must make many steps. And every further step to be added to those previously made raises anew the question whether or not he should continue marching toward the goal once chosen. Most goals are so far away that only determined persistence leads to them. Persevering action, unflinchingly directed to the end sought, is needed in order to succeed. The total expenditure of time required, i.e., working time plus maturing time, may be called the period of production. The period of production is long in some cases and short in other cases. It is sometimes so short that it can be entirely neglected in practice.
The increment in want-satisfaction which the attainment of the end brings about is temporally limited. The result produced extends services only over a period of time which we may call the duration of serviceableness. The duration of serviceableness is shorter with some products and longer with other goods which are commonly called durable goods. Hence acting man must always take into account the period of production and the duration of serviceableness of the product. In estimating the disutility of a project considered he is not only concerned with the expenditure of material factors and labor required, but also with the period of production. In estimating the utility of the expected product he is concerned with the duration of its serviceableness. Of course, the more durable a product is, the greater is the amount of services it renders. But if these services are not cumulatively available on the same date, but extended piecemeal over a certain period of time, the time element, as will be shown, plays a particular role in their evaluation. It makes a difference whether n units of service are rendered on the same date or whether they are stretched over a period of n days in such a way that only one unit is available daily.
It is important to realize that the period of production as well as the duration of serviceableness are categories of human action and not concepts constructed by philosophers, economists, and historians as mental tools for their interpretation of events. They are essential elements present in every act of reasoning that precedes and directs action. It is necessary to stress this point because Böhm-Bawerk, to whom economics owes the discovery of the role played by the period of production, failed to comprehend the difference.
Acting man does not look at his condition with the eyes of a historian. He is not concerned with how the present situation originated. His only concern is to make the best use of the means available today for the best possible removal of future uneasiness. The past does not count for him. He has at his disposal a definite quantity of material factors of production. He does not ask whether these factors are nature-given or the product of production processes accomplished in the past. It does not matter for him how great a quantity of nature-given, i.e., original material factors of production and labor, was expended in their production and how much time these processes of production have absorbed. He values the available means exclusively from the aspect of the services they can render him in his endeavors to make future conditions more satisfactory. The period of production and the duration of serviceableness are for him categories in planning future action, not concepts of academic retrospection and historical research. They play a role in so far as the actor has to choose between periods of production of different length and between the production of more durable and less durable goods.
Action is not concerned with the future in general, but always with a definite and limited fraction of the future. This fraction is limited, on the one side, by the instant in which the action must take place. Where its other end lies depends on the actor’s decision and choice. There are people who are concerned with only the impending instant. There are other people whose provident care stretches far beyond the prospective length of their own life. We may call the fraction of future time for which the actor in a definite action wants to provide in some way and to some extent, the period of provision. In the same way in which acting man chooses among various kinds of want-satisfaction within the same fraction of future time, he chooses also between want-satisfaction in the nearer and in the remoter future. Every choice implies also a choice of a period of provision. In making up his mind how to employ the various means available for the removal of uneasiness, man also determines implicitly the period of provision. In the market economy the demand of the consumers also determines the length of the period of provision.
There are various methods available for a lengthening of the period of provision:
- The accumulation of larger stocks of consumers’ goods destined for later consumption.2. The production of goods which are more durable.3. The production of goods requiring a longer period of production.4. The choice of methods of production consuming more time for the production of goods which could also be produced within a shorter period of production.
The first two methods do not require any further comment. The third and the fourth methods must be scrutinized more closely.
It is one of the fundamental data of human life and action that the shortest processes of production, i.e., those with the shortest period of production, do not remove felt uneasiness entirely. If all those goods which these shortest processes can provide are produced, unsatisfied wants remain and incentive to further action is still present. As acting man prefers those processes which, other things being equal, produce the products in the shortest time,Why man proceeds in this way, will be shown on the following pages. only such processes are left for further action which consume more time. People embark upon these more time-consuming processes because they value the increment in satisfaction expected more highly than the disadvantage of waiting longer for their fruits. Böhm-Bawerk speaks of the higher productivity of roundabout ways of production requiring more time. It is more appropriate to speak of the higher physical productivity of production processes requiring more time. The higher productivity of these processes does not always consist in the fact that they produce — with the same quantity of factors of production expended — a greater quantity of products. More often it consists in the fact that they produce products which could not be produced at all in shorter periods of production. These processes are not roundabout processes. They are the shortest and quickest way to the goal chosen. If one wants to catch more fish, there is no other method available than the substitution of fishing with the aid of nets and canoes for fishing without the aid of this equipment. There is no better, shorter, and cheaper method for the production of aspirin known than that adopted by the chemical plants. If one disregards error and ignorance, there cannot be any doubt about the highest productivity and expediency of the processes chosen. If people had not considered them the most direct processes, viz., those leading by the shortest way to the end sought, they would not have adopted them.
The lengthening of the period of provision through the mere accumulation of stocks of consumers’ goods is the outcome of the desire to provide in advance for a longer period of time. The same is valid for the production of goods the durability of which is greater in proportion to the greater expenditure of factors of production required.If the lengthening of durability were not at least proportionate to the increment in expenditure needed, it would be more advantageous to increase the quantity of units of a shorter durability. But if temporally remoter goals are aimed at, lengthening of the period of production is a necessary corollary of the venture. The end sought cannot be attained in a shorter period of production.
The postponement of an act of consumption means that the individual prefers the satisfaction which later consumption will provide to the satisfaction which immediate consumption could provide. The choice of a longer period of production means that the actor values the product of the process bearing fruit only at a later date more highly than the products which a process consuming less time could provide. In such deliberations and the resulting choices the period of production appears as waiting time. It was the great contribution of Jevons and Böhm-Bawerk to have shown the role played by taking account of waiting time.
If acting men were not to pay heed to the length of the waiting time, they would never say that a goal is temporally so distant that one cannot consider aiming at it. Faced with the alternative of choosing between two processes of production which render different output with the same input, they would always prefer that process which renders the greater quantity of the same products or better products in the same quantity, even if this result could be attained only by lengthening the period of production. Increments in input which result in a more than proportionate increase in the products’ duration of serviceableness would unconditionally be deemed advantageous. The fact that men do not act in this way evidences that they value fractions of time of the same length in a different way according as they are nearer or remoter from the instant of the actor’s decision. Other things being equal, satisfaction in a nearer period of the future is preferred to satisfaction in a more distant period; disutility is seen in waiting.
This fact is already implied in the statement stressed in the opening of this chapter that man distinguishes the time before satisfaction is attained and the time for the duration of which there is satisfaction. If any role at all is played by the time element in human life, there cannot be any question of equal valuation of nearer and remoter periods of the same length. Such an equal valuation would mean that people do not care whether success is attained sooner or later. It would be tantamount to a complete elimination of the time element from the process of valuation.
The mere fact that goods with a longer duration of serviceableness are valued more highly than those with a shorter duration does not yet in itself imply a consideration of time. A roof that can protect a house against the weather during a period of ten years is more valuable than a roof which renders this service only for a period of five years. The quantity of service rendered is different in both cases. But the question which we have to deal with is whether or not an actor in making his choices attaches to a service to be available in a later period of the future the same value he attaches to a service available at an earlier period.
- Time Preference as an Essential Requisite of ActionThe answer to this question is that acting man does not appraise time periods merely with regard to their dimension. His choices regarding the removal of future uneasiness are directed by the categories sooner and later. Time for man is not a homogeneous substance of which only length counts. It is not a more or a less in dimension. It is an irreversible flux the fractions of which appear in different perspective according to whether they are nearer to or remoter from the instant of valuation and decision. Satisfaction of a want in the nearer future is, other things being equal, preferred to that in the farther distant future. Present goods are more valuable than future goods.
Time preference is a categorial requisite of human action. No mode of action can be thought of in which satisfaction within a nearer period of the future is not — other things being equal — preferred to that in a later period. The very act of gratifying a desire implies that gratification at the present instant is preferred to that at a later instant. He who consumes a nonperishable good instead of postponing consumption for an indefinite later moment thereby reveals a higher valuation of present satisfaction as compared with later satisfaction. If he were not to prefer satisfaction in a nearer period of the future to that in a remoter period, he would never consume and so satisfy wants. He would always accumulate, he would never consume and enjoy. He would not consume today, but he would not consume tomorrow either, as the morrow would confront him with the same alternative.
Not only the first step toward want-satisfaction, but also any further step is guided by time preference. Once the desire a to which the scale of values assigns the rank 1 is satisfied, one must choose between the desire b to which the rank 2 is assigned and c that desire of tomorrow to which — in the absence of time preference — the rank 1 would have been assigned. If b is preferred to c, the choice clearly involves time preference. Purposive striving after want-satisfaction must needs be guided by a preference for satisfaction in the nearer future over that in a remoter future.
The conditions under which modern man of the capitalist West must act are different from those under which his primitive ancestors lived and acted. As a result of the providential care of our forebears we have at our disposal an ample stock of intermediate products (capital goods or produced factors of production) and of consumers’ goods. Our activities are designed for a longer period of provision because we are the lucky heirs of a past which has lengthened, step by step, the period of provision and has bequeathed to us the means to expand the waiting period. In acting we are concerned with longer periods and are aiming at an even satisfaction in all parts of the period chosen as the period of provision. We are in a position to rely upon a continuing influx of consumers’ goods and have at our disposal not only stocks of goods ready for consumption but also stocks of producers’ goods out of which our continuous efforts again and again make new consumers’ goods mature. In our dealing with this increasing “stream of income,” says the superficial observer, there is no heed paid to any considerations related to a different valuation of present and of future goods. We synchronize, he asserts, and thus the time element loses any importance for the conduct of affairs. It is, therefore, pointless, he continues, in the interpretation of modern conditions to resort to time preference.
The fundamental error involved in this popular objection is caused, like so many other errors, by a lamentable misapprehension of the imaginary construction of the evenly rotating economy. In the frame of this imaginary construction no change occurs; there prevails an unvarying course of all affairs. In the evenly rotating economy consequently nothing is altered in the allocation of goods for the satisfaction of wants in nearer and in remoter periods of the future. No one plans any change because — according to our assumptions — the prevailing allocation best serves him and because he does not believe that any possible rearrangement could improve his condition. No one wants to increase his consumption in a nearer period of the future at the expense of his consumption in a more distant period or vice versa because the existing mode of allocation pleases him better than any other thinkable and feasible mode.
The praxeological distinction between capital and income is a category of thought based on a different valuation of want-satisfaction in various periods of the future. In the imaginary construction of the evenly rotating economy it is implied that the whole income but not more than the income is consumed and that therefore the capital remains unchanged. An equilibrium is reached in the allocation of goods for want-satisfaction in different periods of the future. It is permissible to describe this state of affairs by asserting that nobody wants to consume tomorrow’s income today. We have precisely designed the imaginary construction of the evenly rotating economy in such a way as to make it fit just this condition. But it is necessary to realize that we can assert with the same apodictic assurance that, in the evenly rotating economy, nobody wants to have more of any commodity than he really has. These statements are true with regard to the evenly rotating economy because they are implied in our definition of this imaginary construction. They are nonsensical when asserted with regard to a changing economy which alone is real. As soon as a change in the data occurs, the individuals are faced anew with the necessity of choosing both between various modes of want-satisfaction in the same period and between want-satisfaction in different periods. An increment can be either employed for immediate consumption or invested for further production. No matter how the actors employ it, their choice must needs be the result of a weighing of the advantages expected from want-satisfaction in different periods of the future. In the world of reality, in the living and changing universe, each individual in each of his actions is forced to choose between satisfaction in various periods of time. Some people consume all that they earn, others consume a part of their capital, others save a part of their income.
Those contesting the universal validity of time preference fail to explain why a man does not always invest a sum of 100 dollars available today, although these 100 dollars would increase to 104 dollars within a year’s time. It is obvious that this man in consuming this sum today is determined by a judgment of value which values 100 present dollars higher than 104 dollars available a year later. But even in case he chooses to invest these 100 dollars, the meaning is not that he prefers satisfaction in a later period to that of today. It means that he values 100 dollars today less than 104 dollars a year later. Every penny spent today is, precisely under the conditions of a capitalist economy in which institutions make it possible to invest even the smallest sums, a proof of the higher valuation of present satisfaction as compared with later satisfaction.
The theorem of time preference must be demonstrated in a double way. First for the case of plain saving in which people must choose between the immediate consumption of a quantity of goods and the later consumption of the same quantity. Second for the case of capitalist saving in which the choice is to be made between the immediate consumption of a quantity of goods and the later consumption either of a greater quantity or of goods which are fit to provide a satisfaction which — except for the difference in time — is valued more highly. The proof has been given for both cases. No other case is thinkable.
It is possible to search for a psychological understanding of the problem of time preference. Impatience and the pains caused by waiting are certainly psychological phenomena. One may approach their elucidation by referring to the temporal limitations of human life, to the individual’s coming into existence, his growth and maturing, and his inevitable decay and passing away. There is in the course of man’s life a right moment for everything as well as a too early and a too late. However, the praxeological problem is in no way related to psychological issues. We must conceive, not merely understand. We must conceive that a man who does not prefer satisfaction within a nearer period of the future to that in a remoter period would never achieve consumption and enjoyment at all.
Neither must the praxeological problem be confused with the physiological. He who wants to live to see the later day, must first of all care for the preservation of his life in the intermediate period. Survival and appeasement of vital needs are thus requirements for the satisfaction of any wants in the remoter future. This makes us understand why in all those situations in which bare life in the strict sense of the term is at stake satisfaction in the nearer future is preferred to that in later periods. But we are dealing with action as such, not with the motives directing its course. In the same way in which as economists we do not ask why albumin, carbohydrates, and fat are demanded by man, we do not inquire why the satisfaction of vital needs appears imperative and does not brook any delay. We must conceive that consumption and enjoyment of any kind presuppose a preference for present satisfaction to later satisfaction. The knowledge provided by this insight far exceeds the orbit for which the physiological facts concerned provide explanation. It refers to every kind of want-satisfaction, not only to the satisfaction of the vital necessities of mere survival.
It is important to stress this point because the term “supply of subsistence, available for advances of subsistence,” as used by Böhm-Bawerk, can easily be misinterpreted. It is certainly one of the tasks of this stock to provide the means for a satisfaction of the bare necessities of life and thus to secure survival. But besides it must be large enough to satisfy, beyond the requirements of necessary maintenance for the waiting time, all those wants and desires which — apart from mere survival — are considered more urgent than the harvesting of the physically more abundant fruits of production processes consuming more time.
Böhm-Bawerk declared that every lengthening of the period of production depends on the condition that “a sufficient quantity of present goods is available to make it possible to overbridge the lengthened average interval between the starting of preparatory work and the harvesting of its product.”Cf. [Eugen von] Böhm-Bawerk, Kleinere Abhandlungen über Kapital und Zins, vol. 2 in Gesammelte Schriften, ed. F.X. Weiss (Vienna, 1926), p. 169. The expression “sufficient quantity” needs elucidation. It does not mean a quantity sufficient for necessary sustenance. The quantity in question must be large enough to secure the satisfaction of all those wants the satisfaction of which during the waiting time is considered more urgent than the advantages which a still greater lengthening of the period of production would provide. If the quantity in question were smaller, a shortening of the period of production would appear advantageous; the increase in the quantity of products or the improvement of their quality to be expected from the preservation of the longer period of production would no longer be considered a sufficient remuneration for the restriction of consumption enjoined during the waiting time. Whether or not the supply of subsistence is sufficient, does not depend on any physiological or other facts open to objective determination by the methods of technology and physiology. The metaphorical term “overbridge,” suggesting a body of water the breadth of which poses to the bridge builder an objectively determined task, is misleading. The quantity in question is valued by men, and their subjective judgments decide whether or not it is sufficient.
Even in a hypothetical world in which nature provides every man with the means for the preservation of biological survival (in the strict sense of the term), in which the most important foodstuffs are not scarce and action is not concerned with the provision for bare life, the phenomenon of time preference would be present and direct all actions.Time preference is not specifically human. It is an inherent feature of the behavior of all living beings. The distinction of man consists in preference is not inexorable and the lengthening of the period of provision not merely instinctive as with certain animals that store food, but the result of a process of valuation. ...
Some Applications of the Time-Preference TheoryEvery part of economics is open to intentional misrepresentation and misinterpretation on the part of people eager to excuse or to justify fallacious doctrines underlying their party programs. To prevent such misuse as far as possible it seems expedient to add some explanatory remarks to the exposition of the time-preference theory.
There are schools of thought which flatly deny that men differ with regard to innate characteristics inherited from their ancestors.About the Marxian attack against genetics, cf. T.D. Lysenko, Heredity and Variability (New York, 1945). A critical appraisal of this controversy is provided by J.R. Baker, Science and the Planned State (New York, 1945), pp. 71–76. In the opinion of these authors the only difference between the white men of Western civilization and Eskimos is that the latter are in arrears in their progress toward modern industrial civilization. This merely temporal difference of a few thousand years is insignificant when compared with the many hundreds of thousands of years which were absorbed by man’s evolution from the simian state of his apelike forebears to the conditions of present-day homo sapiens. It does not support the assumption that racial differences prevail between the various specimens of mankind.
Praxeology and economics are foreign to the issues raised by this controversy. But they must take precautionary measures lest they become implicated by partisan spirit in this clash of antagonistic ideas. If those fanatically rejecting the teachings of modern genetics were not entirely ignorant of economics, they would certainly try to turn the time-preference theory to their advantage. They would refer to the circumstance that the superiority of the Western nations consists merely in their having started earlier in endeavors to save and to accumulate capital goods. They would explain this temporal difference by accidental factors, the better opportunity offered by environment.
Against such possible misinterpretations one must emphasize the fact that the temporal head start gained by the Western nations was conditioned by ideological factors which cannot be reduced simply to the operation of environment. What is called human civilization has up to now been a progress from cooperation by virtue of hegemonic bonds to cooperation by virtue of contractual bonds. But while many races and peoples were arrested at an early stage of this movement, others kept on advancing. The eminence of the Western nations consisted in the fact that they succeeded better in checking the spirit of predatory militarism than the rest of mankind and that they thus brought forth the social institutions required for saving and investment on a broader scale. Even Marx did not contest the fact that private initiative and private ownership of the means of production were indispensable stages in the progress from primitive man’s penury to the more satisfactory conditions of nineteenth-century Western Europe and North America. What the East Indies, China, Japan, and the Mohammedan countries lacked were institutions for safeguarding the individual’s rights. The arbitrary administration of pashas, kadis, rajahs, mandarins, and daimios was not conducive to large-scale accumulation of capital. The legal guarantees effectively protecting the individual against expropriation and confiscation were the foundations upon which the unprecedented economic progress of the West came into flower. These laws were not an outgrowth of chance, historical accidents, and geographical environment. They were the product of reason.
We do not know what course the history of Asia and Africa would have taken if these peoples had been left alone. What happened was that some of these peoples were subject to European rule and others — like China and Japan — were forced by the display of naval power to open their frontiers. The achievements of Western industrialism came to them from abroad. They were ready to take advantage of the foreign capital lent to them and invested in their territories. But they were rather slow in the reception of the ideologies from which modern industrialism had sprung. Their assimilation to Western ways of life is superficial.
We are in the midst of a revolutionary process which will very soon do away with all varieties of colonialism. This revolution is not limited to those countries which were subject to the rule of the British, the French and the Dutch. Even nations which without any infringement of their political sovereignty had profited from foreign capital are intent upon throwing off what they call the yoke of foreign capitalists. They are expropriating the foreigners by various devices — discriminatory taxation, repudiation of debts, undisguised confiscation, foreign exchange restrictions. We are on the eve of the complete disintegration of the international capital market. The economic consequences of this event are obvious; its political repercussions are unpredictable.
In order to appreciate the political consequences of the disintegration of the international capital market it is necessary to remember what effects were brought about by the internationalization of the capital market. Under the conditions of the later nineteenth century it did not matter whether or not a nation was prepared and equipped with the required capital in order to utilize adequately the natural resources of its territory. There was practically free access for everybody to every area’s natural wealth. In searching for the most advantageous opportunities for investment capitalists and promoters were not stopped by national borderlines. As far as investment for the best possible utilization of the known natural resources was concerned, the greater part of the earth’s surface could be considered as integrated into a uniform world-embracing market system. It is true that this result was attained in some areas, like the British and the Dutch East Indies and Malaya, only by colonial regimes and that autochthonous governments of these territories would probably not have created the institutional setting indispensable for the importation of capital. But Eastern and Southern Europe and the Western Hemisphere had of their own accord joined the community of the international capital market.
The Marxians were intent upon indicting foreign loans and investments for the lust for war, conquest, and colonial expansion. In fact the internationalization of the capital market, together with free trade and the freedom of migration, was instrumental in removing the economic incentives to war and conquest. It no longer mattered for a man where the political boundaries of his country were drawn. The entrepreneur and the investor were not checked by them. Precisely those nations which in the age preceding the first World War were paramount in foreign lending and investment were committed to the ideas of peace-loving “decadent” liberalism. Of the foremost aggressor nations Russia, Italy, and Japan were not capital exporters; they themselves needed foreign capital for the development of their own natural resources. Germany’s imperialist adventures were not supported by its big business and finance.Cf. [Ludwig von] Mises, Omnipotent Government (New Haven, 1944), p. 99 and the books quoted there.
The disappearance of the international capital market alters conditions entirely. It abolishes the freedom of access to natural resources. If one of the socialist governments of the economically backward nations lacks the capital needed for the utilization of its natural resources, there will be no means to remedy this situation. If this system had been adopted a hundred years ago, it would have been impossible to exploit the oil fields of Mexico, Venezuela, and Iran, to establish the rubber plantations in Malaya or to develop the banana production of Central America. It is illusory to assume that the advanced nations will acquiesce forever in such a state of affairs. They will resort to the only method which gives them access to badly needed raw materials; they will resort to conquest. War is the alternative to freedom of foreign investment as realized by the international capital market.
The inflow of foreign capital did not harm the receiving nations. It was European capital that accelerated considerably the marvelous economic evolution of the United States and the British Dominions. Thanks to foreign capital the countries of Latin America and Asia are today equipped with facilities for production and transportation which they would have had to forego for a very long time if they had not received this aid. Real wage rates and farm yields are higher today in those areas than they would have been in the absence of foreign capital. The mere fact that almost all nations are vehemently asking today for “foreign aid” explodes the fables of the Marxians and the nationalists.
However, the mere lust for imported capital goods does not resuscitate the international capital market. Investment and lending abroad are only possible if the receiving nations are unconditionally and sincerely committed to the principle of private property and do not plan to expropriate the foreign capitalists at a later date. It was such expropriations that destroyed the international capital market.
Intergovernmental loans are no substitute for the functioning of an international capital market. If they are granted on business terms, they presuppose no less than private loans the full acknowledgment of property rights. If they are granted, as is usually the case, as virtual subsidies without any regard for payment of principal and interest, they impose restrictions upon the debtor nation’s sovereignty. In fact such “loans” are for the most part the price paid for military assistance in coming wars. Such military considerations already played an important role in the years in which the European powers prepared the great wars of our age. The outstanding example was provided by the huge sums which the French capitalists, pressed hard by the Government of the Third Republic, lent to Imperial Russia. The Tsars used the capital borrowed for armaments, not for an improvement of the Russian apparatus of production.
Planning for Freedom and Sixteen Other Essays and Addresses[Ludwig von Mises, Planning for Freedom and Sixteen Other Essays and Addresses (1950; South Holland, Ill.: Libertarian Press, 1980), chap. 5, pp. 64–71.]“Lord Keynes and Say’s Law”
ILord Keynes’s main contribution did not lie in the development of new ideas but “in escaping from the old ones,” as he himself declared at the end of the preface to his General Theory. The Keynesians tell us that his immortal achievement consists in the entire refutation of what has come to be known as Say’s Law of Markets. The rejection of this law, they declare, is the gist of all Keynes’s teachings; all other propositions of his doctrine follow with logical necessity from this fundamental insight and must collapse if the futility of his attack on Say’s Law can be demonstrated.P. M. Sweezy in The New Economics, ed. by S. E. Harris, New York, 1947, p. 105.
Now it is important to realize that what is called Say’s Law was in the first instance designed as a refutation of doctrines popularly held in the ages preceding the development of economics as a branch of human knowledge. It was not an integral part of the new science of economics as taught by the Classical economists. It was rather a preliminary — the exposure and removal of garbled and untenable ideas which dimmed people’s minds and were a serious obstacle to a reasonable analysis of conditions.
Whenever business turned bad, the average merchant had two explanations at hand: the evil was caused by a scarcity of money and by general overproduction. Adam Smith, in a famous passage in The Wealth of Nations, exploded the first of these myths. Say devoted himself predominantly to a thorough refutation of the second.
As long as a definite thing is still an economic good and not a “free good,” its supply is not, of course, absolutely abundant. There are still unsatisfied needs which a larger supply of the good concerned could satisfy. There are still people who would be glad to get more of this good than they are really getting. With regard to economic goods there can never be absolute overproduction. (And economics deals only with economic goods, not with free goods such as air which are no object of purposive human action, are therefore not produced, and with regard to which the employment of terms like underproduction and overproduction is simply nonsensical.)
With regard to economic goods there can be only relative overproduction. While the consumers are asking for definite quantities of shirts and of shoes, business has produced, say, a larger quantity of shoes and a smaller quantity of shirts. This is not general overproduction of all commodities. To the overproduction of shoes corresponds an underproduction of shirts. Consequently the result cannot be a general depression of all branches of business. The outcome is a change in the exchange ratio between shoes and shirts. If, for instance, previously one pair of shoes could buy four shirts, it now buys only three shirts. While business is bad for the shoemakers, it is good for the shirtmakers. The attempts to explain the general depression of trade by referring to an allegedly general overproduction are therefore fallacious.
Commodities, says Say, are ultimately paid for not by money, but by other commodities. Money is merely the commonly used medium of exchange; it plays only an intermediary role. What the seller wants ultimately to receive in exchange for the commodities sold is other commodities. Every commodity produced is therefore a price, as it were, for other commodities produced. The situation of the producer of any commodity is improved by any increase in the production of other commodities. What may hurt the interests of the producer of a definite commodity is his failure to anticipate correctly the state of the market. He has overrated the public’s demand for his commodity and underrated its demand for other commodities. Consumers have no use for such a bungling entrepreneur; they buy his products only at prices which make him incur losses, and they force him, if he does not in time correct his mistakes, to go out of business. On the other hand, those entrepreneurs who have better succeeded in anticipating the public demand earn profits and are in a position to expand their business activities. This, says Say, is the truth behind the confused assertions of businessmen that the main difficulty is not in producing but in selling. It would be more appropriate to declare that the first and main problem of business is to produce in the best and cheapest way those commodities which will satisfy the most urgent of the not yet satisfied needs of the public.
Thus Smith and Say demolished the oldest and most naïve explanation of the trade cycle as provided by the popular effusions of inefficient traders. True, their achievement was merely negative. They exploded the belief that the recurrence of periods of bad business was caused by a scarcity of money and by a general overproduction. But they did not give us an elaborated theory of the trade cycle. The first explanation of this phenomenon was provided much later by the British Currency School.
The important contributions of Smith and Say were not entirely new and original. The history of economic thought can trace back some essential points of their reasoning to older authors. This in no way detracts from the merits of Smith and Say. They were the first to deal with the issue in a systematic way and to apply their conclusions to the problem of economic depressions. They were therefore also the first against whom the supporters of the spurious popular doctrine directed their violent attacks. Sismondi and Malthus chose Say as the target of passionate volleys when they tried — in vain — to salvage the discredited popular prejudices.
IISay emerged victoriously from his polemics with Malthus and Sismondi. He proved his case, while his adversaries could not prove theirs. Henceforth, during the whole rest of the nineteenth century, the acknowledgment of the truth contained in Say’s Law was the distinctive mark of an economist. Those authors and politicians who made the alleged scarcity of money responsible for all ills and advocated inflation as the panacea were no longer considered economists but “monetary cranks.”
The struggle between the champions of sound money and the inflationists went on for many decades. But it was no longer considered a controversy between various schools of economists. It was viewed as a conflict between economists and anti-economists, between reasonable men and ignorant zealots. When all civilized countries had adopted the gold standard or the gold-exchange standard, the cause of inflation seemed to be lost forever.
Economics did not content itself with what Smith and Say had taught about the problems involved. It developed an integrated system of theorems which cogently demonstrated the absurdity of the inflationist sophisms. It depicted in detail the inevitable consequences of an increase in the quantity of money in circulation and of credit expansion. It elaborated the monetary or circulation credit theory of the business cycle which clearly showed how the recurrence of depressions of trade is caused by the repeated attempts to “stimulate” business through credit expansion. Thus it conclusively proved that the slump, whose appearance the inflationists attributed to an insufficiency of the supply of money, is on the contrary the necessary outcome of attempts to remove such an alleged scarcity of money through credit expansion.
The economists did not contest the fact that a credit expansion in its initial stage makes business boom. But they pointed out how such a contrived boom must inevitably collapse after a while and produce a general depression. This demonstration could appeal to statesmen intent on promoting the enduring well-being of their nation. It could not influence demagogues who care for nothing but success in the impending election campaign and are not in the least troubled about what will happen the day after tomorrow. But it is precisely such people who have become supreme in the political life of this age of wars and revolutions. In defiance of all the teachings of the economists, inflation and credit expansion have been elevated to the dignity of the first principle of economic policy. Nearly all governments are now committed to reckless spending and finance their deficits by issuing additional quantities of unredeemable paper money and by boundless credit expansion.
The great economists were harbingers of new ideas. The economic policies they recommended were at variance with the policies practiced by contemporary governments and political parties. As a rule many years, even decades, passed before public opinion accepted the new ideas as propagated by the economists and before the required corresponding changes in policies were effected.
It was different with the “new economics” of Lord Keynes. The policies he advocated were precisely those which almost all governments, including the British, had already adopted many years before his “General Theory” was published. Keynes was not an innovator and champion of new methods of managing economic affairs. His contribution consisted rather in providing an apparent justification for the policies which were popular with those in power in spite of the fact that all economists viewed them as disastrous. His achievement was a rationalization of the policies already practiced. He was not a “revolutionary,” as some of his adepts called him. The “Keynesian revolution” took place long before Keynes approved of it and fabricated a pseudo-scientific justification for it. What he really did was to write an apology for the prevailing policies of governments.
This explains the quick success of his book. It was greeted enthusiastically by the governments and the ruling political parties. Especially enraptured were a new type of intellectuals, the “government economists.” They had had a bad conscience. They were aware of the fact that they were carrying out policies which all economists condemned as contrary to purpose and disastrous. Now they felt relieved. The “new economics” reestablished their moral equilibrium. Today they are no longer ashamed of being the handymen of bad policies. They glorify themselves. They are the prophets of the new creed.
IIIThe exuberant epithets which these admirers have bestowed upon his work cannot obscure the fact that Keynes did not refute Say’s Law. He rejected it emotionally, but he did not advance a single tenable argument to invalidate its rationale.
Neither did Keynes try to refute by discursive reasoning the teachings of modern economics. He chose to ignore them, that was all. He never found any word of serious criticism against the theorem that increasing the quantity of money cannot effect anything else than, on the one hand, to favor some groups at the expense of other groups, and, on the other hand, to foster capital malinvestment and capital decumulation. He was at a complete loss when it came to advancing any sound argument to demolish the monetary theory of the trade cycle. All he did was to revive the self-contradictory dogmas of the various sects of inflationism. He did not add anything to the empty presumptions of his predecessors, from the old Birmingham School of Little Shilling Men down to Silvio Gesell. He merely translated their sophisms — a hundred times refuted — into the questionable language of mathematical economics. He passed over in silence all the objections which such men as Jevons, Walras and Wicksell — to name only a few — opposed to the effusions of the inflationists.
It is the same with his disciples. They think that calling “those who fail to be moved to admiration of Keynes’s genius” such names as “dullard” or “narrow-minded fanatic”Professor [Gofftried] Haberler, op. cit., p. 161. is a substitute for sound economic reasoning. They believe that they have proved their case by dismissing their adversaries as “orthodox” or “neo-classical.” They reveal the utmost ignorance in thinking that their doctrine is correct because it is new.
In fact, inflationism is the oldest of all fallacies. It was very popular long before the days of Smith, Say and Ricardo, against whose teachings the Keynesians cannot advance any other objection than that they are old.
IVThe unprecedented success of Keynesianism is due to the fact that it provides an apparent justification for the “deficit spending” policies of contemporary governments. It is the pseudo-philosophy of those who can think of nothing else than to dissipate the capital accumulated by previous generations.
Yet no effusions of authors however brilliant and sophisticated can alter the perennial economic laws. They are and work and take care of themselves. Notwithstanding all the passionate fulminations of the spokesmen of governments, the inevitable consequences of inflationism and expansionism as depicted by the “orthodox” economists are coming to pass. And then, very late indeed, even simple people will discover that Keynes did not teach us how to perform the “miracle ... of turning a stone into bread,”[John Maynard] Keynes [The General Theory of Employment, Interest and Money (London: Macmillan, 1936)], p. 332. but the not at all miraculous procedure of eating the seed corn.
“Stones into Bread, The Keynesian Miracle”[Mises, Planning for Freedom, chap. 6, pp. 50–63.]
IThe stock-in-trade of all Socialist authors is the idea that there is potential plenty and that the substitution of socialism for capitalism would make it possible to give to everybody “according to his needs.” Other authors want to bring about this paradise by a reform of the monetary and credit system. As they see it, all that is lacking is more money and credit. They consider that the rate of interest is a phenomenon artificially created by the man-made scarcity of the “means of payment.” In hundreds, even thousands, of books and pamphlets they passionately blame the “orthodox” economists for their reluctance to admit that inflationist and expansionist doctrines are sound. All evils, they repeat again and again, are caused by the erroneous teachings of the “dismal science” of economics and the “credit monopoly” of the bankers and usurers. To unchain money from the fetters of “restrictionism,” to create free money (Freigeld, in the terminology of Silvio Gesell) and to grant cheap or even gratuitous credit, is the main plank in their political platform.
Such ideas appeal to the uninformed masses. And they are very popular with governments committed to a policy of increasing the quantity both of money in circulation and of deposits subject to check. However, the inflationist governments and parties have not been ready to admit openly their endorsement of the tenets of the inflationists. While most countries embarked upon inflation and on a policy of easy money, the literary champions of inflationism were still spurned as “monetary cranks.” Their doctrines were not taught at the universities.
John Maynard Keynes, late economic adviser to the British government, is the new prophet of inflationism. The “Keynesian Revolution” consisted in the fact that he openly espoused the doctrines of Silvio Gesell. As the foremost of the British Gesellians, Lord Keynes adopted also the peculiar messianic jargon of inflationist literature and introduced it into official documents. Credit expansion, says the Paper of the British Experts of April 8, 1943, performs the “miracle ... of turning a stone into bread.” The author of this document was, of course, Keynes. Great Britain has indeed traveled a long way to this statement from Hume’s and Mill’s views on miracles.
IIKeynes entered the political scene in 1920 with his book, The Economic Consequences of the Peace. He tried to prove that the sums demanded for reparations were far in excess of what Germany could afford to pay and to “transfer.” The success of the book was overwhelming. The propaganda machine of the German nationalists, well entrenched in every country, was busily representing Keynes as the world’s most eminent economist and Great Britain’s wisest statesman.
Yet it would be a mistake to blame Keynes for the suicidal foreign policy that Great Britain followed in the interwar period. Other forces, especially the adoption of the Marxian doctrine of imperialism and “capitalist warmongering,” were of incomparably greater importance in the rise of appeasement. With the exception of a small number of keen-sighted men, all Britons supported the policy which finally made it possible for the Nazis to start the Second World War.
A highly gifted French economist, Étienne Mantoux, has analyzed Keynes’s famous book point for point. The result of his very careful and conscientious study is devastating for Keynes the economist and statistician, as well as Keynes the statesman. The friends of Keynes are at a loss to find any substantial rejoinder. The only argument that his friend and biographer, Professor E.A.G. Robinson, could advance is that this powerful indictment of Keynes’s position came “as might have been expected, from a Frenchman.”Economic Journal, vol. 57, p. 23. As if the disastrous effects of appeasement and defeatism had not affected Great Britain also!
Étienne Mantoux, son of the famous historian Paul Mantoux, was the most distinguished of the younger French economists. He had already made valuable contributions to economic theory — among them a keen critique of Keynes’s General Theory, published in 1937 in the Revue d’Économie Politique — before he began his The Carthaginian Peace or the Economic Consequences of Mr. Keynes.Oxford University Press, 1946. He did not live to see his book published. As an officer in the French forces he was killed on active service during the last days of the war. His premature death was a heavy blow to France, which is today badly in need of sound and courageous economists.
IIIIt would be a mistake, also, to blame Keynes for the faults and failures of contemporary British economic and financial policies. When he began to write, Britain had long since abandoned the principle of laissez-faire. That was the achievement of such men as Thomas Carlyle and John Ruskin and, especially, of the Fabians. Those born in the eighties of the nineteenth century and later were merely epigones of the university and parlor Socialists of the late Victorian period. They were no critics of the ruling system, as their predecessors had been, but apologists of government and pressure group policies whose inadequacy, futility and perniciousness became more and more evident.
Professor Seymour E. Harris has just published a stout volume of collected essays by various academic and bureaucratic authors dealing with Keynes’s doctrines as developed in his General Theory of Employment, Interest and Money, published in 1936. The title of the volume is The New Economics, Keynes’ Influence on Theory and Public Policy.Alfred A. Knopf, New York, 1947. Whether Keynesianism has a fair claim to the appellation “new economics” or whether it is not, rather, a rehash of often-refuted Mercantilist fallacies and of the syllogisms of the innumerable authors who wanted to make everybody prosperous by fiat money, is unimportant. What matters is not whether a doctrine is new, but whether it is sound.
The remarkable thing about this symposium is that it does not even attempt to refute the substantiated objections raised against Keynes by serious economists. The editor seems to be unable to conceive that any honest and uncorrupted man could disagree with Keynes. As he sees it, opposition to Keynes comes from “the vested interests of scholars in the older theory” and “the preponderant influence of press, radio, finance and subsidized research.” In his eyes, non-Keynesians are just a bunch of bribed sycophants, unworthy of attention. Professor Harris thus adopts the methods of the Marxians and the Nazis, who preferred to smear their critics and to question their motives instead of refuting their theses.
A few of the contributions are written in dignified language and are reserved, even critical, in their appraisal of Keynes’s achievements. Others are simply dithyrambic outbursts. Thus Professor Paul A. Samuelson tells us: “To have been born as an economist before 1936 was a boon — yes. But not to have been born too long before!” And he proceeds to quote Wordsworth:
Bliss was it in that dawn to be alive,But to be young was very heaven!
Descending from the lofty heights of Parnassus into the prosaic valleys of quantitative science, Professor Samuelson provides us with exact information about the susceptibility of economists to the Keynesian gospel of 1936. Those under the age of 35 fully grasped its meaning after some time; those beyond 50 turned out to be quite immune, while economists in-between were divided. After thus serving us a warmed-over version of Mussolini’s giovanezza theme, he offers more of the outworn slogans of fascism, e.g., the “wave of the future.” However, on this point another contributor, Mr. Paul M. Sweezy, disagrees. In his eyes Keynes, tainted by “the shortcomings of bourgeois thought” as he was, is not the savior of mankind, but only the forerunner whose historical mission it is to prepare the British mind for the acceptance of pure Marxism and to make Great Britain ideologically ripe for full socialism.
IVIn resorting to the method of innuendo and trying to make their adversaries suspect by referring to them in ambiguous terms allowing of various interpretations, the camp-followers of Lord Keynes are imitating their idol’s own procedures. For what many people have admiringly called Keynes’s “brilliance of style” and “mastery of language” were, in fact, cheap rhetorical tricks.
Ricardo, says Keynes, “conquered England as completely as the Holy Inquisition conquered Spain.” This is as vicious as any comparison could be. The Inquisition, aided by armed constables and executioners, beat the Spanish people into submission. Ricardo’s theories were accepted as correct by British intellectuals without any pressure or compulsion being exercised in their favor. But in comparing the two entirely different things, Keynes obliquely hints that there was something shameful in the success of Ricardo’s teachings and that those who disapprove of them are as heroic, noble and fearless champions of freedom as were those who fought the horrors of the Inquisition.
The most famous of Keynes’s aperçus is: “Two pyramids, two masses for the dead, are twice as good as one; but not so two railways from London to York.” It is obvious that this sally, worthy of a character in a play by Oscar Wilde or Bernard Shaw, does not in any way prove the thesis that digging holes in the ground and paying for them out of savings “will increase the real national dividend of useful goods and services.” But it puts the adversary in the awkward position of either leaving an apparent argument unanswered or of employing the tools of logic and discursive reasoning against sparkling wit.
Another instance of Keynes’s technique is provided by his malicious description of the Paris Peace Conference. Keynes disagreed with Clemenceau’s ideas. Thus, he tried to ridicule his adversary by broadly expatiating upon his clothing and appearance which, it seems, did not meet with the standard set by London outfitters. It is hard to discover any connection with the German reparations problem in the fact that Clemenceau’s boots “were of thick black leather, very good, but of a country style, and sometimes fastened in front, curiously, by a buckle instead of laces.” After 15 million human beings had perished in the war, the foremost statesmen of the world were assembled to give mankind a new international order and lasting peace — and the British Empire’s financial expert was amused by the rustic style of the French prime minister’s footwear.
Fourteen years later there was another international conference. This time Keynes was not a subordinate adviser, as in 1919, but one of the main figures. Concerning this London World Economic Conference of 1933, Professor Robinson observes: “Many economists the world over will remember ... the performance in 1933 at Covent Garden in honour of the Delegates of the World Economic Conference, which owed its conception and organization very much to Maynard Keynes.”
Those economists who were not in the service of one of the lamentably inept governments of 1933 and therefore were not delegates and did not attend the delightful ballet evening will remember the London Conference for other reasons. It marked the most spectacular failure in the history of international affairs of those policies of neo-Mercantilism which Keynes backed. Compared with this fiasco of 1933, the Paris Conference of 1919 appears to have been a highly successful affair. But Keynes did not publish any sarcastic comments on the coats, boots and gloves of the delegates of 1933.
VAlthough Keynes looked upon “the strange, unduly neglected prophet Silvio Gesell” as a forerunner, his own teachings differ considerably from those of Gesell. What Keynes borrowed from Gesell as well as from the host of other pro-inflation propagandists was not the content of their doctrine, but their practical conclusions and the tactics they applied to undermine their opponents’ prestige. These stratagems are:
(a) All adversaries, that is, all those who do not consider credit expansion as the panacea, are lumped together and called orthodox. It is implied that there are no differences between them.
(b) It is assumed that the evolution of economic science culminated in Alfred Marshall and ended with him. The findings of modern subjective economics are disregarded.
(c) All that economists from David Hume on down to our time have done to clarify the results of changes in the quantity of money and money substitutes is simply ignored. Keynes never embarked upon the hopeless task of refuting these teachings by ratiocination.
In all these respects the contributors to the symposium adopt their master’s technique. Their critique aims at a body of doctrine created by their own illusions, which has no resemblance to the theories expounded by serious economists. They pass over in silence all that economists have said about the inevitable outcome of credit expansion. It seems as if they have never heard anything about the monetary theory of the trade cycle.
For a correct appraisal of the success which Keynes’s General Theory found in academic circles, one must consider the conditions prevailing in university economics during the period between the two world wars.
Among the men who occupied chairs of economics in the last few decades, there have been only a few genuine economists, i.e., men fully conversant with the theories developed by modern subjective economics. The ideas of the old classical economists, as well as those of the modern economists, were caricatured in the textbooks and in the classrooms; they were called such names as old-fashioned, orthodox, reactionary, bourgeois or Wall Street economics. The teachers prided themselves on having refuted for all time the abstract doctrines of Manchesterism and laissez-faire.
The antagonism between the two schools of thought had its practical focus in the treatment of the labor union problem. Those economists disparaged as orthodox taught that a permanent rise in wage rates for all people eager to earn wages is possible only to the extent that the per capita quota of capital invested and the productivity of labor increases. If — whether by government decree or by labor union pressure — minimum wage rates are fixed at a higher level than that at which the unhampered market would have fixed them, unemployment results as a permanent mass phenomenon.
Almost all professors of the fashionable universities sharply attacked this theory. As these self-styled “unorthodox” doctrinaires interpreted the economic history of the last two hundred years, the unprecedented rise in real wage rates and standards of living was caused by labor unionism and government pro-labor legislation. Labor unionism was, in their opinion, highly beneficial to the true interests of all wage-earners and of the whole nation. Only dishonest apologists of the manifestly unfair interests of callous exploiters could find fault with the violent acts of the unions, they maintained. The foremost concern of popular government, they said, should be to encourage the unions as much as possible and to give them all the assistance they needed to combat the intrigues of the employers and to fix wage rates higher and higher.
But as soon as the governments and legislatures had vested the unions with all the powers they needed to enforce their minimum wage rates, the consequences appeared which the “orthodox” economists had predicted; unemployment of a considerable part of the potential labor force was prolonged year after year.
The “unorthodox” doctrinaires were perplexed. The only argument they had advanced against the “orthodox” theory was the appeal to their own fallacious interpretation of experience. But now events developed precisely as the “abstract school” had predicted. There was confusion among the “unorthodox.”
It was at this moment that Keynes published his General Theory. What a comfort for the embarrassed “progressives”! Here, at last, they had something to oppose to the “orthodox” view. The cause of unemployment was not the inappropriate labor policies, but the shortcomings of the monetary and credit system. No need to worry any longer about the insufficiency of savings and capital accumulation and about deficits in the public household. On the contrary. The only method to do away with unemployment was to increase “effective demand” through public spending financed by credit expansion and inflation.
The policies which the General Theory recommended were precisely those which the “monetary cranks” had advanced long before and which most governments had espoused in the depression of 1929 and the following years. Some people believe that Keynes’s earlier writings played an important part in the process which converted the world’s most powerful governments to the doctrines of reckless spending, credit expansion and inflation. We may leave this minor issue undecided. At any rate it cannot be denied that the governments and peoples did not wait for the General Theory to embark upon these “Keynesian” — or more correctly, Gesellian policies.
VIKeynes’s General Theory of 1936 did not inaugurate a new age of economic policies; rather, it marked the end of a period. The policies which Keynes recommended were already then very close to the time when their inevitable consequences would be apparent and their continuation would be impossible. Even the most fanatical Keynesians do not dare to say that present-day England’s distress is an effect of too much saving and insufficient spending. The essence of the much glorified “progressive” economic policies of the last decades was to expropriate ever-increasing parts of the higher incomes and to employ the funds thus raised for financing public waste and for subsidizing the members of the most powerful pressure groups. In the eyes of the “unorthodox,” every kind of policy, however manifest its inadequacy may have been, was justified as a means of bringing about more equality. Now this process has reached its end. With the present tax rates and the methods applied in the control of prices, profits and interest rates, the system has liquidated itself. Even the confiscation of every penny earned above 1,000 pounds a year will not provide any perceptible increase to Great Britain’s public revenue. The most bigoted Fabians cannot fail to realize that henceforth funds for public spending must be taken from the same people who are supposed to profit from it. Great Britain has reached the limit both of monetary expansionism and of spending.
Conditions in this country are not essentially different. The Keynesian recipe to make wage rates soar no longer works. Credit expansion, on an unprecedented scale engineered by the New Deal, for a short time delayed the consequences of inappropriate labor policies. During this interval the Administration and the union bosses could boast of the “social gains” they had secured for the “common man.” But now the inevitable consequences of the increase in the quantity of money and deposits has become visible; prices are rising higher and higher. What is going on today in the United States is the final failure of Keynesianism.
There is no doubt that the American public is moving away from the Keynesian notions and slogans. Their prestige is dwindling. Only a few years ago politicians were naively discussing the extent of national income in dollars without taking into account the changes which government-made inflation had brought about in the dollar’s purchasing power. Demagogues specified the level to which they wanted to bring the national (dollar) income. Today this form of reasoning is no longer popular. At last the “common man” has learned that increasing the quantity of dollars does not make America richer. Professor Harris still praises the Roosevelt Administration for having raised dollar incomes. But such Keynesian consistency is found today only in classrooms.
There are still teachers who tell their students that “an economy can lift itself by its own bootstraps” and that “we can spend our way into prosperity.”Cf. Lorie Tarshis, The Elements of Economics (New York 1947), p. 565. But the Keynesian miracle fails to materialize; the stones do not turn into bread. The panegyrics of the learned authors who cooperated in the production of the present volume merely confirm the editor’s introductory statement that “Keynes could awaken in his disciples an almost religious fervor for his economics, which could be effectively harnessed for the dissemination of the new economics.” And Professor Harris goes on to say, “Keynes indeed had the Revelation.”
There is no use in arguing with people who are driven by “an almost religious fervor” and believe that their master “had the Revelation.” It is one of the tasks of economics to analyze carefully each of the inflationist plans, those of Keynes and Gesell no less than those of their innumerable predecessors from John Law down to Major Douglas. Yet no one should expect that any logical argument or any experience could ever shake the almost religious fervor of those who believe in salvation through spending and credit expansion.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 31: “Currency and Credit Manipulation,” pp. 792–94.]The Chimera of Contracyclical PoliciesAn essential element of the “unorthodox” doctrines, advanced both by all socialists and by all interventionists, is that the recurrence of depressions is a phenomenon inherent in the very operation, of the market economy. But while the socialists contend that only the substitution of socialism for capitalism can eradicate the evil, the interventionists ascribe to the government the power to correct the operation of the market economy in such a way as to bring about what they call “economic stability.” These interventionists would be right if their antidepression plans were to aim at a radical abandonment of credit expansion policies. However, they reject this idea in advance. What they want is to expand credit more and more and to prevent depressions by the adoption of special “contracyclical” measures.
In the context of these plans the government appears as a deity that stands and works outside the orbit of human affairs, that is independent of the actions of its subjects, and has the power to interfere with these actions from without. It has at its disposal means and funds that are not provided by the people and can be freely used for whatever purposes the rulers are prepared to employ them for. What is needed to make the most beneficent use of this power is merely to follow the advice given by the experts.
The most advertised among these suggested remedies is contracyclical timing of public works and expenditure on public enterprises. The idea is not so new as its champions would have us believe. When depression came, in the past, public opinion always asked the government to embark upon public works in order to create jobs and to stop the drop in prices. But the problem is how to finance these public works. If the government taxes the citizens or borrows from them, it does not add anything to what the Keynesians call the aggregate amount of spending. It restricts the private citizen’s power to consume or to invest to the same extent that it increases its own. If, however, the government resorts to the cherished inflationary methods of financing, it makes things worse, not better. It may thus delay for a short time the outbreak of the slump. But when the unavoidable payoff does come, the crisis is the heavier the longer the government has postponed it.
The interventionist experts are at a loss to grasp the real problems involved. As they see it, the main thing is “to plan public capital expenditure well in advance and to accumulate a shelf of fully worked out capital projects which can be put into operation at short notice.” This, they say, “is the right policy and one which we recommend all countries should adopt.”Cf. League of Nations, Economic Stability in the Post-War World, Report of the Delegation on Economic Depressions (Geneva, 1945), Part 2, p. 173. However, the problem is not to elaborate projects, but to provide the material means for their execution. The interventionists believe that this could be easily achieved by holding back government expenditure in the boom and increasing it when the depression comes.
Now, restriction of government expenditure may certainly be a good thing. But it does not provide the funds a government needs for a later expansion of its expenditure. An individual may conduct his affairs in this way. He may accumulate savings when his income is high and spend them later when his income drops. But it is different with a nation or all nations together. The treasury may hoard a considerable part of the lavish revenue from taxes which flows into the public exchequer as a result of the boom. As far and as long as it withholds these funds from circulation, its policy is really deflationary and contracyclical and may to this extent weaken the boom created by credit expansion. But when these funds are spent again, they alter the money relation and create a cash-induced tendency toward a drop in the monetary unit’s purchasing power. By no means can these funds provide the capital goods required for the execution of the shelved public works.
The fundamental error of the interventionists consists in the fact that they ignore the shortage of capital goods. In their eyes the depression is merely caused by a mysterious lack of the people’s propensity both to consume and to invest. While the only real problem is to produce more and to consume less in order to increase the stock of capital goods available, the interventionists want to increase both consumption and investment. They want the government to embark upon projects which are unprofitable precisely because the factors of production needed for their execution must be withdrawn from other lines of employment in which they would fulfill wants the satisfaction of which the consumers consider more urgent. They do not realize that such public works must considerably intensify the real evil, the shortage of capital goods.
One could, of course, think of another mode for the employment of the savings the government makes in the boom period. The treasury could invest its surplus in buying large stocks of all those materials which it will later, when the depression comes, need for the execution of the public works planned and of the consumers’ goods which those occupied in these public works will ask for. But if the authorities were to act in this way, they would considerably intensify the boom, accelerate the outbreak of the crisis, and make its consequences more serious.In dealing with the contracyclical policies the interventionists always refer to the alleged success of these policies in Sweden. It is true that public capital expenditure in Sweden was actually doubled between 1932 and 1939. But this was not the cause, but an effect, of Sweden’s prosperity in the thirties. This prosperity was entirely due to the rearmament of Germany. This Nazi policy increased the German demand for Swedish products on the one hand and restricted, on the other hand, German competition on the world market for those products which Sweden could supply. Thus Swedish exports increased from 1932 to 1938 (in thousands of tons): iron ore from 2,219 to 12,485; pig iron from 31,047 to 92,980; ferro-alloys from 15,453 to 28,605; other kinds of iron and steel from 134,237 to 256,146; machinery from 46,230 to 70,605. The number of unemployed applying for relief was 114,000 in 1932 and 165,000 in 1933. It dropped, as soon as German rearmament came into full swing, to 115,000 in 1934, to 62,000 in 1935, and was 16,000 in 1938. The author of this “miracle” was not Keynes, but Hitler.
All this talk about contracyclical government activities aims at one goal only, namely, to divert the public’s attention from cognizance of the real cause of the cyclical fluctuations of business. All governments are firmly committed to the policy of low interest rates, credit expansion, and inflation. When the unavoidable aftermath of these short-term policies appears, they know only of one remedy — to go on in inflationary ventures.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 19: “Interest,” pp. 521–29.]1. The Phenomenon of InterestIt has been shown that time preference is a category inherent in every human action. Time preference manifests itself in the phenomenon of originary interest, i.e., the discount of future goods as against present goods.
Interest is not merely interest on capital. Interest is not the specific income derived from the utilization of capital goods. The correspondence between three factors of production — labor, capital, and land — and three classes of income — wages, profit, and rent — as taught by the classical economists is untenable. Rent is not the specific revenue from land. Rent is a general catallactic phenomenon; it plays in the yield of labor and capital goods the same role it plays in the yield of land. Furthermore there is no homogeneous source of income that could be called profit in the sense in which the classical economists applied this term. Profit (in the sense of entrepreneurial profit) and interest are no more characteristic of capital than they are of land.
The prices of consumers’ goods are by the interplay of the forces operating on the market apportioned to the various complementary factors cooperating in their production. As the consumers’ goods are present goods, while the factors of production are means for the production of future goods, and as present goods are valued higher than future goods of the same kind and quantity, the sum thus apportioned, even in the imaginary construction of the evenly rotating economy, falls behind the present price of the consumers’ goods concerned. This difference is the originary interest. It is not specifically connected with any of the three classes of factors of production which the classical economists distinguished. Entrepreneurial profit and loss are produced by changes in the data and the resulting price changes which occur in the passing of the period of production.
Naïve reasoning does not see any problem in the current revenue derived from hunting, fishing, cattle breeding, forestry, and agriculture. Nature generates deer, fish, and cattle and makes them grow, causes the cows to give milk and the chickens to lay eggs, the trees to put on wood and to bear fruit, and the seeds to shoot into ears. He who has a title to appropriate for himself this recurring wealth enjoys a steady income. Like a stream which continually carries new water, the “stream of income” flows continually and conveys again and again new wealth. The whole process appears as a natural phenomenon. But for the economist a problem is presented in the determination of prices for land, cattle, and all the rest. If future goods were not bought and sold at a discount as against present goods, the buyer of land would have to pay a price which equals the sum of all future net revenues and which would leave nothing for a current reiterated income.
The yearly recurring proceeds of the owners of land and cattle are not marked by any characteristic which would catallactically distinguish them from the proceeds stemming from produced factors of production which are used up sooner or later in the processes of production. The power of disposal over a piece of land is the control of this field’s cooperation in the production of all the fruit which can ever be grown on it, and the power of disposal over a mine is the control of its cooperation in the extraction of all the minerals which can ever be brought to the surface from it. In the same way the ownership of a machine or a bale of cotton is the control of its cooperation in the manufacture of all goods which are produced with its cooperation. The fundamental fallacy implied in all the productivity and use approaches to the problem of interest was that they traced back the phenomenon of interest to these productive services rendered by the factors of production. However, the serviceableness of the factors of production determines the prices paid for them, not interest. These prices exhaust the whole difference between the productivity of a process aided by a definite factor’s cooperation and that of a process lacking this cooperation. The difference between the sum of the prices of the complementary factors of production and the products which emerges even in the absence of changes in the market data concerned, is an outcome of the higher valuation of present goods as compared with future goods. As production goes on, the factors of production are transformed or ripen into present goods of a higher value. This increment is the source of specific proceeds flowing into the hands of the owners of the factors of production, of originary interest.
The owners of the material factors of production — as distinct from the pure entrepreneurs of the imaginary construction of an integration of catallactic functions — harvest two catallactically different items: the prices paid for the productive cooperation of the factors they control on the one hand and interest on the other hand. These two things must not be confused. It is not permissible to refer, in the explanation of interest, to the services rendered by the factors of production in the turning out of products.
Interest is a homogeneous phenomenon. There are no different sources of interest. Interest on durable goods and interest on consumption-credit are like other kinds of interest an outgrowth of the higher valuation of present goods as against future goods.
- Originary InterestOriginary interest is the ratio of the value assigned to want-satisfaction in the immediate future and the value assigned to want-satisfaction in remoter periods of the future. It manifests itself in the market economy in the discount of future goods as against present goods. It is a ratio of commodity prices, not a price in itself. There prevails a tendency toward the equalization of this ratio for all commodities. In the imaginary construction of the evenly rotating economy the rate of originary interest is the same for all commodities.
Originary interest is not “the price paid for the services of capital.”This is the popular definition of interest as, for instance, given by [Richard T.] Ely, [Thomas] Adams, [Max]Lorenz, and [Allyn] Young, Outlines of Economics (3d ed. New York, 1920), p. 493. The higher productivity of more time-consuming roundabout methods of production which is referred to by Böhm-Bawerk and by some later economists in the explanation of interest, does not explain the phenomenon. It is, on the contrary, the phenomenon of originary interest that explains why less time-consuming methods of production are resorted to in spite of the fact that more time-consuming methods would render a higher output per unit of input. Moreover, the phenomenon of originary interest explains why pieces of usable land can be sold and bought at finite prices. If the future services which a piece of land can render were to be valued in the same way in which its present services are valued, no finite price would be high enough to impel its owner to sell it. Land could neither be bought nor sold against definite amounts of money, nor bartered against goods which can render only a finite number of services. Pieces of land would be bartered only against other pieces of land. A superstructure that can yield during a period of ten years an annual revenue of one hundred dollars would be priced (apart from the soil on which it is built) at the beginning of this period at one thousand dollars, at the beginning of the second year at nine hundred dollars, and so on.
Originary interest is not a price determined on the market by the interplay of the demand for and the supply of capital or capital goods. Its height does not depend on the extent of this demand and supply. It is rather the rate of originary interest that determines both the demand for and the supply of capital and capital goods. It determines how much of the available supply of goods is to be devoted to consumption in the immediate future and how much to provision for remoter periods of the future.
People do not save and accumulate capital because there is interest. Interest is neither the impetus to saving nor the reward or the compensation granted for abstaining from immediate consumption. It is the ratio in the mutual valuation of present goods as against future goods.
The loan market does not determine the rate of interest. It adjusts the rate of interest on loans to the rate of originary interest as manifested in the discount of future goods.
Originary interest is a category of human action. It is operative in any valuation of external things and can never disappear. If one day the state of affairs were to return which was actual at the close of the first millennium of the Christian era when people believed that the ultimate end of all earthly things was impending, men would stop providing for future secular wants. The factors of production would in their eyes become useless and worthless. The discount of future goods as against present goods would not vanish. It would, on the contrary, increase beyond all measure. On the other hand, the fading away of originary interest would mean that people do not care at all for want-satisfaction in nearer periods of the future. It would mean that they prefer to an apple available today, tomorrow, in one year or in ten years, two apples available in a thousand or ten thousand years.
We cannot even think of a world in which originary interest would not exist as an inexorable element in every kind of action. Whether there is or is not division of labor and social cooperation and whether society is organized on the basis of private or of public control of the means of production, originary interest is always present. In a socialist commonwealth its role would not differ from that in the market economy.
Böhm-Bawerk has once for all unmasked the fallacies of the naïve productivity explanations of interest, i.e., of the idea that interest is the expression of the physical productivity of factors of production. However, Böhm-Bawerk has himself based his own theory to some extent on the productivity approach. In referring in his explanation to the technological superiority of more time-consuming, roundabout processes of production, he avoids the crudity of the naïve productivity fallacies. But in fact he returns, although in a subtler form, to the productivity approach. Those later economists who, neglecting the time-preference idea, have stressed exclusively the productivity idea contained in Böhm-Bawerk’s theory cannot help concluding that originary interest must disappear if men were one day to reach a state of affairs in which no further lengthening of the period of production could bring about a further increase in productivity.Cf. [Friedrich A.] Hayek, “The Mythology of Capital,” The Quarterly Journal of Economics 50 (1936): 223 ff. However Professor Hayek has since partly changed his point of view. (Cf. his article “Time-Preference and Productivity, a Reconsideration,” Economica 12 [1945]: 22–25.) But the idea criticized in the text is still widely held by economists. This is, however, utterly wrong. Originary interest cannot disappear as long as there is scarcity and therefore action.
As long as the world is not transformed into a land of Cockaigne, men are faced with scarcity and must act and economize; they are forced to choose between satisfaction in nearer and in remoter periods of the future because neither for the former nor for the latter can full contentment be attained. Then a change in the employment of factors of production which withdraws such factors from their employment for want-satisfaction in the nearer future and devotes them to want-satisfaction in the remoter future must necessarily impair the state of satisfaction in the nearer future and improve it in the remoter future. If we were to assume that this is not the case, we should become embroiled in insoluble contradictions. We may at best think of a state of affairs in which technological knowledge and skill have reached a point beyond which no further progress is possible for mortal men. No new processes increasing the output per unit of input can henceforth be invented. But if we suppose that some factors of production are scarce, we must not assume that all processes which — apart from the time they absorb — are the most productive ones are fully utilized, and that no process rendering a smaller output per unit of input is resorted to merely because of the fact that it produces its final result sooner than other, physically more productive processes. Scarcity of factors of production means that we are in a position to draft plans for the improvement of our well-being the realization of which is unfeasible because of the insufficient quantity of the means available. It is precisely the unfeasibility of such desirable improvements that constitutes the element of scarcity. The reasoning of the modern supporters of the productivity approach is misled by the connotations of Böhm-Bawerk’s term roundabout methods of production and the idea of technological improvement which it suggests. However, if there is scarcity, there must always be an unused technological opportunity to improve the state of well-being by a lengthening of the period of production in some branches of industry, regardless of whether or not the state of technological knowledge has changed. If the means are scarce, if the praxeological correlation of ends and means still exists, there are by logical necessity unsatisfied wants with regard both to nearer and to remoter periods of the future. There are always goods the procurement of which we must forego because the way that leads to their production is too long and would prevent us from satisfying more urgent needs. The fact that we do not provide more amply for the future is the outcome of a weighing of satisfaction in nearer periods of the future against satisfaction in remoter periods of the future. The ratio which is the outcome of this valuation is originary interest.
In such a world of perfect technological knowledge a promoter drafts a plan A according to which a hotel in picturesque, but not easily accessible, mountain districts and the roads leading to it should be built. In examining the practicability of this plan he discovers that the means available are not sufficient for its execution. Calculating the prospects of the profitability of the investment, he comes to the conclusion that the expected proceeds are not great enough to cover the costs of material and labor to be expended and interest on the capital to be invested. He renounces the execution of project A and embarks instead upon the realization of another plan, B. According to plan B the hotel is to be erected in a more easily accessible location which does not offer all the advantages of the picturesque landscape which plan A had selected, but in which it can be built either with lower costs of construction or finished in a shorter time. If no interest on the capital invested were to enter into the calculation, the illusion could arise that the state of the market data — supply of capital goods and the valuations of the public — allows for the execution of plan A. However, the realization of plan A would withdraw scarce factors of production from employments in which they could satisfy wants considered more urgent by the consumers. It would mean a manifest malinvestment, a squandering of the means available.
A lengthening of the period of production can increase the quantity of output per unit of input or produce goods which cannot be produced at all within a shorter period of production. But it is not true that the imputation of the value of this additional wealth to the capital goods required for the lengthening of the period of production generates interest. If one were to assume this, one would relapse into the crassest errors of the productivity approach, irrefutably exploded by Böhm-Bawerk. The contribution of the complementary factors of production to the result of the process is the reason for their being considered as valuable; it explains the prices paid for them and is fully taken into account in the determination of these prices. No residuum is left that is not accounted for and could explain interest.
It has been asserted that in the imaginary construction of the evenly rotating economy no interest would appear.Cf. [Joseph] Schumpeter, The Theory of Economic Development, trans. by R. Opie (Cambridge, 1934), pp. 34–46, 54. However, it can be shown that this assertion is incompatible with the assumptions on which the construction of the evenly rotating economy is based.
We begin with the distinction between two classes of saving: plain saving and capitalist saving. Plain saving is merely the piling up of consumers’ goods for later consumption. Capitalist saving is the accumulation of goods which are designed for an improvement of production processes. The aim of plain saving is later consumption; it is merely postponement of consumption. Sooner or later the goods accumulated will be consumed and nothing will be left. The aim of capitalist saving is first an improvement in the productivity of effort. It accumulates capital goods which are employed for further production and are not merely reserves for later consumption. The boon derived from plain saving is later consumption of the stock not instantly consumed but accumulated for later use. The boon derived from capitalist saving is the increase of the quantity of goods produced or the production of goods which could not be produced at all without its aid. In constructing the image of an evenly rotating (static) economy, economists disregard the process of capital accumulation; the capital goods are given and remain, as, according to the underlying assumptions, no changes occur in the data. There is neither accumulation of new capital through saving, nor consumption of capital available through a surplus of consumption over income, i.e., current production minus the funds required for the maintenance of capital. It is now our task to demonstrate that these assumptions are incompatible with the idea that there is no interest.
There is no need to dwell, in this reasoning, upon plain saving. The objective of plain saving is to provide for a future in which the saver could possibly be less amply supplied than in the present. Yet, one of the fundamental assumptions characterizing the imaginary construction of the evenly rotating economy is that the future does not differ at all from the present, that the actors are fully aware of this fact and act accordingly. Hence, in the frame of this construction, no room is left for the phenomenon of plain saving.
It is different with the fruit of capitalist saving, the accumulated stock of capital goods. There is in the evenly rotating economy neither saving and accumulation of additional capital goods nor eating up of already existing capital goods. Both phenomena would amount to a change in the data and would thus disturb the even rotation of the imaginary system. Now, the magnitude of saving and capital accumulation in the past — i.e., in the period preceding the establishment of the evenly rotating economy — was adjusted to the height of the rate of interest. If — with the establishment of the conditions of the evenly rotating economy — the owners of the capital goods were no longer to receive any interest, the conditions which were operative in the allocation of the available stocks of goods to the satisfaction of wants in the various periods of the future would be upset. The altered state of affairs requires a new allocation. Also in the evenly rotating economy the difference in the valuation of want-satisfaction in various periods of the future cannot disappear. Also in the frame of this imaginary construction, people will assign a higher value to an apple available today as against an apple available in ten or a hundred years. If the capitalist no longer receives interest, the balance between satisfaction in nearer and remoter periods of the future is disarranged. The fact that a capitalist has maintained his capital at just 100,000 dollars was conditioned by the fact that 100,000 present dollars were equal to 105,000 dollars available twelve months later. These 5,000 dollars were in his eyes sufficient to outweigh the advantages to be expected from an instantaneous consumption of a part of this sum. If interest payments are eliminated, capital consumption ensues.
This is the essential deficiency of the static system as Schumpeter depicts it. It is not sufficient to assume that the capital equipment of such a system has been accumulated in the past, that it is now available to the extent of this previous accumulation and is henceforth unalterably maintained at this level. We must also assign in the frame of this imaginary system a role to the operation of forces which bring about such a maintenance. If one eliminates the capitalist’s role as receiver of interest, one replaces it by the capitalist’s role as consumer of capital. There is no longer any reason why the owner of capital goods should abstain from employing them for consumption. Under the assumptions implied in the imaginary construction of static conditions (the evenly rotating economy) there is no need to keep them in reserve for rainy days. But even if, inconsistently enough, we were to assume that a part of them is devoted to this purpose and therefore withheld from current consumption, at least that part of capital will be consumed which corresponds to the amount that capitalist saving exceeds plain saving.Cf. [Lionel] Robbins, “On a Certain Ambiguity in the Conception of Stationary Equilibrium,” The Economic Journal 40 (1930): 211 ff.
If there were no originary interest, capital goods would not be devoted to immediate consumption and capital would not be consumed. On the contrary, under such an unthinkable and unimaginable state of affairs there would be no consumption at all, but only saving, accumulation of capital, and investment. Not the impossible disappearance of originary interest, but the abolition of payment of interest to the owners of capital, would result in capital consumption. The capitalists would consume their capital goods and their capital precisely because there is originary interest and present want-satisfaction is preferred to later satisfaction.
Therefore there cannot be any question of abolishing interest by any institutions, laws, and devices of bank manipulation. He who wants to “abolish” interest will have to induce people to value an apple available in a hundred years no less than a present apple. What can be abolished by laws and decrees is merely the right of the capitalists to receive interest. But such laws would bring about capital consumption and would very soon throw mankind back into the original state of natural poverty.
Planning for Freedom and Sixteen Other Essays and Addresses[Ludwig von Mises, Planning for Freedom and Sixteen Other Essays and Addresses (1952; South Holland, Ill.: Libertarian Press, 1980), chap. 2, pp. 18–35.]“Middle-of-the-Road Policy Leads to Socialism”
The fundamental dogma of all brands of socialism and communism is that the market economy or capitalism is a system that hurts the vital interests of the immense majority of people for the sole benefit of a small minority of rugged individualists. It condemns the masses to progressing impoverishment. It brings about misery, slavery, oppression, degradation and exploitation of the working men, while it enriches a class of idle and useless parasites.
This doctrine was not the work of Karl Marx. It had been developed long before Marx entered the scene. Its most successful propagators were not the Marxian authors, but such men as Carlyle and Ruskin, the British Fabians, the German professors and the American Institutionalists. And it is a very significant fact that the correctness of this dogma was contested only by a few economists who were very soon silenced and barred from access to the universities, the press, the leadership of political parties and, first of all, public office. Public opinion by and large accepted the condemnation of capitalism without any reservation.
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SocialismBut, of course, the practical political conclusions which people drew from this dogma were not uniform. One group declared that there is but one way to wipe out these evils, namely to abolish capitalism entirely. They advocate the substitution of public control of the means of production for private control. They aim at the establishment of what is called socialism, communism, planning, or state capitalism. All these terms signify the same thing. No longer should the consumers, by their buying and abstention from buying, determine what should be produced, in what quantity and of what quality. Henceforth a central authority alone should direct all production activities.
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Interventionism, Allegedly a Middle-of-the-Road PolicyA second group seems to be less radical. They reject socialism no less than capitalism. They recommend a third system, which, as they say, is as far from capitalism as it is from socialism, which as a third system of society’s economic organization, stands midway between the two other systems, and while retaining the advantages of both, avoids the disadvantages inherent in each. This third system is known as the system of interventionism. In the terminology of American politics it is often referred to as the middle-of-the-road policy.
What makes this third system popular with many people is the particular way they choose to look upon the problems involved. As they see it, two classes, the capitalists and entrepreneurs on the one hand and the wage earners on the other hand, are arguing about the distribution of the yield of capital and entrepreneurial activities. Both parties are claiming the whole cake for themselves. Now, suggest these mediators, let us make peace by splitting the disputed value equally between the two classes. The State as an impartial arbiter should interfere, and should curb the greed of the capitalists and assign a part of the profits to the working classes. Thus it will be possible to dethrone the moloch capitalism without enthroning the moloch of totalitarian socialism.
Yet this mode of judging the issue is entirely fallacious. The antagonism between capitalism and socialism is not a dispute about the distribution of booty. It is a controversy about which two schemes for society’s economic organization, capitalism or socialism, is conducive to the better attainment of those ends which all people consider as the ultimate aim of activities commonly called economic, viz., the best possible supply of useful commodities and services. Capitalism wants to attain these ends by private enterprise and initiative, subject to the supremacy of the public’s buying and abstention from buying on the market. The socialists want to substitute the unique plan of a central authority for the plans of the various individuals. They want to put in place of what Marx called the “anarchy of production” the exclusive monopoly of the government. The antagonism does not refer to the mode of distributing a fixed amount of amenities. It refers to the mode of producing all those goods which people want to enjoy.
The conflict of the two principles is irreconcilable and does not allow for any compromise. Control is indivisible. Either the consumers’ demand as manifested on the market decides for what purposes and how the factors of production should be employed, or the government takes care of these matters. There is nothing that could mitigate the opposition between these two contradictory principles. They preclude each other. Interventionism is not a golden mean between capitalism and socialism. It is the design of a third system of society’s economic organization and must be appreciated as such.
- How Interventionism WorksIt is not the task of today’s discussion to raise any questions about the merits either of capitalism or of socialism. I am dealing today with interventionism alone. And I do not intend to enter into an arbitrary evaluation of interventionism from any preconceived point of view. My only concern is to show how interventionism works and whether or not it can be considered as a pattern of a permanent system for society’s economic organization.
The interventionists emphasize that they plan to retain private ownership of the means of production, entrepreneurship and market exchange. But, they go on to say, it is peremptory to prevent these capitalist institutions from spreading havoc and unfairly exploiting the majority of people. It is the duty of government to restrain, by orders and prohibitions, the greed of the propertied classes lest their acquisitiveness harm the poorer classes. Unhampered or laissez-faire capitalism is an evil. But in order to eliminate its evils, there is no need to abolish capitalism entirely. It is possible to improve the capitalist system by government interference with the actions of the capitalists and entrepreneurs. Such government regulation and regimentation of business is the only method to keep off totalitarian socialism and to salvage those features of capitalism which are worth preserving. On the ground of this philosophy, the interventionists advocate a galaxy of various measures. Let us pick out one of them, the very popular scheme of price control.
- How Price Control Leads to SocialismThe government believes that the price of a definite commodity, e.g., milk, is too high. It wants to make it possible for the poor to give their children more milk. Thus it resorts to a price ceiling and fixes the price of milk at a lower rate than that prevailing on the free market. The result is that the marginal producers of milk, those producing at the highest cost, now incur losses. As no individual farmer or businessman can go on producing at a loss, these marginal producers stop producing and selling milk on the market. They will use their cows and their skill for other more profitable purposes. They will, for example, produce butter, cheese or meat. There will be less milk available for the consumers, not more. This, or course, is contrary to the intentions of the government. It wanted to make it easier for some people to buy more milk. But, as an outcome of its interference, the supply available drops. The measure proves abortive from the very point of view of the government and the groups it was eager to favor. It brings about a state of affairs, which — again from the point of view of the government — is even less desirable than the previous state of affairs which it was designed to improve.
Now, the government is faced with an alternative. It can abrogate its decree and refrain from any further endeavors to control the price of milk. But if it insists upon its intention to keep the price of milk below the rate the unhampered market would have determined and wants nonetheless to avoid a drop in the supply of milk, it must try to eliminate the causes that render the marginal producers’ business unremunerative. It must add to the first decree concerning only the price of milk a second decree fixing the prices of the factors of production necessary for the production of milk at such a low rate that the marginal producers of milk will no longer suffer losses and will therefore abstain from restricting output. But then the same story repeats itself on a remoter plane. The supply of the factors of production required for the production of milk drops, and again the government is back where it started. If it does not want to admit defeat and to abstain from any meddling with prices, it must push further and fix the prices of those factors of production which are needed for the production of the factors necessary for the production of milk. Thus the government is forced to go further and further, fixing step by step the prices of all consumers’ goods and of all factors of production — both human, i.e., labor, and material — and to order every entrepreneur and every worker to continue work at these prices and wages. No branch of industry can be omitted from this all-around fixing of prices and wages and from this obligation to produce those quantities which the government wants to see produced. If some branches were to be left free out of regard for the fact that they produce only goods qualified as non-vital or even as luxuries, capital and labor would tend to flow into them and the result would be a drop in the supply of those goods, the prices of which government has fixed precisely because it considers them as indispensable for the satisfaction of the needs of the masses.
But when this state of all-around control of business is attained, there can no longer be any question of a market economy. No longer do the citizens by their buying and abstention from buying determine what should be produced and how. The power to decide these matters has devolved upon the government. This is no longer capitalism; it is all-around planning by the government, it is socialism.
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The Zwangswirtschaft Type of SocialismIt is, of course, true that this type of socialism preserves some of the labels and the outward appearance of capitalism. It maintains, seemingly and nominally, private ownership of the means of production, prices, wages, interest rates and profits. In fact, however, nothing counts but the government’s unrestricted autocracy. The government tells the entrepreneurs and capitalists what to produce and in what quantity and quality, at what prices to buy and from whom, at what prices to sell and to whom. It decrees at what wages and where the workers must work. Market exchange is but a sham. All the prices, wages, and interest rates are determined by the authority. They are prices, wages, and interest rates in appearance only; in fact they are merely quantity relations in the government’s orders. The government, not the consumers, directs production. The government determines each citizen’s income, it assigns to everybody the position in which he has to work. This is socialism in the outward guise of capitalism. It is the Zwangswirtschaft of Hitler’s German Reich and the planned economy of Great Britain.
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German and British ExperienceFor the scheme of social transformation which I have depicted is not merely a theoretical construction. It is a realistic portrayal of the succession of events that brought about socialism in Germany, in Great Britain and in some other countries.
The Germans, in the first World War, began with price ceilings for a small group of consumers’ goods considered as vital necessities. It was the inevitable failure of these measures that impelled them to go further and further until, in the second period of the war, they designed the Hindenburg plan. In the context of the Hindenburg plan no room whatever was left for a free choice on the part of the consumers and for initiative action on the part of business. All economic activities were unconditionally subordinated to the exclusive jurisdiction of the authorities. The total defeat of the Kaiser swept the whole imperial apparatus of administration away and with it went also the grandiose plan. But when in 1931 Chancellor Brüning embarked anew on a policy of price control and his successors, first of all Hitler, obstinately clung to it, the same story repeated itself.
Great Britain and all the other countries which in the first World War adopted measures of price control, had to experience the same failure. They too were pushed further and further in their attempts to make the initial decrees work. But they were still at a rudimentary stage of this development when the victory and the opposition of the public brushed away all schemes for controlling prices.
It was different in the second World War. Then Great Britain again resorted to price ceilings for a few vital commodities and had to run the whole gamut proceeding further and further until it had substituted all-around planning of the country’s whole economy for economic freedom. When the war came to an end, Great Britain was a socialist commonwealth.
It is noteworthy to remember that British socialism was not an achievement of Mr. Attlee’s Labor Government, but of the war cabinet of Mr. Winston Churchill. What the Labor Party did was not the establishment of socialism in a free country, but retaining socialism as it had developed during the war and in the post-war period. The fact has been obscured by the great sensation made about the nationalization of the Bank of England, the coal mines and other branches of business. However, Great Britain is to be called a socialist country not because certain enterprises have been formally expropriated and nationalized, but because all the economic activities of all citizens are subject to full control of the government and its agencies. The authorities direct the allocation of capital and of manpower to the various branches of business. They determine what should be produced. Supremacy in all business activities is exclusively vested in the government. The people are reduced to the status of wards, unconditionally bound to obey orders. To the businessmen, the former entrepreneurs, merely ancillary functions are left. All that they are free to do is to carry into effect, within a nearly circumscribed narrow field, the decisions of the government departments.
What we have to realize is that price ceilings affecting only a few commodities fail to attain the ends sought. On the contrary. They produce effects which from the point of view of the government are even worse than the previous state of affairs which the government wanted to alter. If the government, in order to eliminate these inevitable but unwelcome consequences, pursues its course further and further, it finally transforms the system of capitalism and free enterprise into socialism of the Hindenburg pattern.
- Crises and UnemploymentThe same is true of all other types of meddling with the market phenomena. Minimum wage rates, whether decreed and enforced by the government or by labor union pressure and violence, result in mass unemployment prolonged year after year as soon as they try to raise wage rates above the height of the unhampered market. The attempts to lower interest rates by credit expansion generate, it is true, a period of booming business. But the prosperity thus created is only an artificial hot-house product and must inexorably lead to the slump and to the depression. People must pay heavily for the easy-money orgy of a few years of credit expansion and inflation.
The recurrence of periods of depression and mass unemployment has discredited capitalism in the opinion of injudicious people. Yet these events are not the outcome of the operation of the free market. They are on the contrary the result of well-intentioned but ill-advised government interference with the market. There are no means by which the height of wage rates and the general standard of living can be raised other than by accelerating the increase of capital as compared with population. The only means to raise wage rates permanently for all those seeking jobs and eager to earn wages is to raise the productivity of the industrial effort by increasing the per-head quota of capital invested. What makes American wage rates by far exceed the wage rates of Europe and Asia is the fact that the American worker’s toil and trouble is aided by more and better tools. All that good government can do to improve the material well-being of the people is to establish and to preserve an institutional order in which there are no obstacles to the progressing accumulation of new capital required for the improvement of technological methods of production. This is what capitalism did achieve in the past and will achieve in the future too if not sabotaged by a bad policy.
- Two Roads to SocialismInterventionism 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. It is as such different from the endeavors of the communists to bring about socialism at one stroke. The difference does not refer to the ultimate end of the political movement; it refers mainly to the tactics to be resorted to for the attainment of an end that both groups are aiming at.
Karl Marx and Friedrich Engels recommended successively each of these two ways for the realization of socialism. In 1848, in the Communist Manifesto, they outlined a plan for the step-by-step transformation of capitalism into socialism. The proletariat should be raised to the position of the ruling class and use its political supremacy “to wrest, by degrees, all capital from the bourgeoisie.” This, they declare, “cannot be effected except by means of despotic inroads on the rights of property and on the conditions of bourgeois production; by means of measures, therefore, which appear economically insufficient and untenable, but which in the course of the movement outstrip themselves, necessitate further inroads upon the old social order, and are unavoidable as a means of entirely revolutionizing the mode of production.” In this vein they enumerate by way of example ten measures.
In later years Marx and Engels changed their minds. In his main treatise, Das Capital, first published in 1867, Marx saw things in a different way. Socialism is bound to come “with the inexorability of a law of nature.” But it cannot appear before capitalism has reached its full maturity. There is but one road to the collapse of capitalism, namely the progressive evolution of capitalism itself. Then only will the great final revolt of the working class give it the finishing stroke and inaugurate the everlasting age of abundance.
From the point of view of this later doctrine Marx and the school of orthodox Marxism reject all policies that pretend to restrain, to regulate and to improve capitalism. Such policies, they declare, are not only futile, but outright harmful. For they rather delay the coming of age of capitalism, its maturity, and thereby also its collapse. They are therefore not progressive, but reactionary. It was this idea that led the German Social Democratic party to vote against Bismarck’s social security legislation and to frustrate Bismarck’s plan to nationalize the German tobacco industry. From the point of view of the same doctrine, the communists branded the American New Deal as a reactionary plot extremely detrimental to the true interests of the working people.
What we must realize is that the antagonism between the interventionists and the communists is a manifestation of the conflict between the two doctrines of the early Marxism and of the late Marxism. It is the conflict between the Marx of 1848, the author of the Communist Manifesto, and the Marx of 1867, the author of Das Capital. And it is paradoxical indeed that the document in which Marx endorsed the policies of the present-day self-styled anti-communists is called the Communist Manifesto.
There are two methods available for the transformation of capitalism into socialism. One is to expropriate all farms, plants, and shops and to operate them by a bureaucratic apparatus as departments of the government. The whole of society, says Lenin, becomes “one office and one factory, with equal work and equal pay,” the whole economy will be organized “like the postal system.” The second method is the method of the Hindenburg plan, the originally German pattern of the welfare state and of planning. It forces every firm and every individual to comply strictly with the orders issued by the government’s central board of production management. Such was the intention of the National Industrial Recovery Act of 1933 which the resistance of business frustrated and the Supreme Court declared unconstitutional. Such is the idea implied in the endeavors to substitute planning for private enterprise.
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Foreign Exchange ControlThe foremost vehicle for the realization of this second type of socialism in industrial countries like Germany and Great Britain is foreign exchange control. These countries cannot feed and clothe their people out of domestic resources. They must import large quantities of food and raw materials. In order to pay for these badly needed imports, they must export manufactures, most of them produced out of imported raw material. In such countries almost every business transaction directly or indirectly is conditioned either by exporting or importing or by both exporting and importing. Hence the government’s monopoly of buying and selling foreign exchange makes every kind of business activity depend on the discretion of the agency entrusted with foreign exchange control. In this country matters are different. The volume of foreign trade is rather small when compared with the total volume of the nation’s trade. Foreign exchange control would only slightly affect the much greater part of American business. This is the reason why in the schemes of our planners there is hardly any question of foreign exchange control. Their pursuits are directed toward the control of prices, wages, and interest rates, toward the control of investment and the limitation of profits and incomes.
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Progressive TaxationLooking backward on the evolution of income tax rates from the beginning of the Federal income tax in 1913 until the present day, one can hardly expect that the tax will not one day absorb 100 percent of all surplus above the income of the average voter. It is this that Marx and Engels had in mind when in the Communist Manifesto they recommended “a heavy progressive or graduated income tax.”
Another of the suggestions of the Communist Manifesto was “abolition of all right of inheritance.” Now, neither in Great Britain nor in this country have the laws gone up to this point. But again, looking backward upon the past history of the estate taxes, we have to realize that they more and more have approached the goal set by Marx. Estate taxes of the height they have already attained for the upper brackets are no longer to be qualified as taxes. They are measures of expropriation.
The philosophy underlying the system of progressive taxation is that the income and the wealth of the well-to-do classes can be freely tapped. What the advocates of these tax rates fail to realize is that the greater part of the income taxed away would not have been consumed but saved and invested. In fact, this fiscal policy does not only prevent the further accumulation of new capital. It brings about capital decumulation. This is certainly today the state of affairs in Great Britain.
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The Trend Toward SocialismThe course of events in the past thirty years shows a continuous, although sometimes interrupted progress toward the establishment in this country of socialism of the British and German pattern. The United States embarked later than these two other countries upon this decline and is today still farther away from its end. But if the trend of this policy will not change, the final result will only in accidental and negligible points differ from what happened in the England of Attlee and in the Germany of Hitler. The middle-of-the-road policy is not an economic system that can last. It is a method for the realization of socialism by installments.
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Loopholes CapitalismMany people object. They stress the fact that most of the laws which aim at planning or at expropriation by means of progressive taxation have left some loopholes which offer to private enterprise a margin within which it can go on. That such loopholes still exist and that thanks to them this country is still a free country is certainly true. But this “loopholes capitalism” is not a lasting system. It is a respite. Powerful forces are at work to close these loopholes. From day to day the field in which private enterprise is free to operate is narrowed down.
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The Coming of Socialism is Not InevitableOf course, this outcome is not inevitable. The trend can be reversed as was the case with many other trends in history. The Marxian dogma according to which socialism is bound to come “with the inexorability of a law of nature” is just an arbitrary surmise devoid of any proof.
But the prestige which this vain prognostic enjoys not only with the Marxians, but with many self-styled non-Marxians, is the main instrument of the progress of socialism. It spreads defeatism among those who otherwise would gallantly fight the socialist menace. The most powerful ally of Soviet Russia is the doctrine that the “wave of the future” carries us toward socialism and that it is therefore “progressive” to sympathize with all measures that restrict more and more the operation of the market economy.
Even in this country which owes to a century of “rugged individualism” the highest standard of living ever attained by any nation, public opinion condemns laissez-faire. In the last fifty years, thousands of books have been published to indict capitalism and to advocate radical interventionism, the welfare state, and socialism. The few books which tried to explain adequately the working of the free-market economy were hardly noticed by the public. Their authors remained obscure, while such authors as Veblen, Commons, John Dewey, and Laski were exuberantly praised. It is a well-known fact that the legitimate stage as well as the Hollywood industry are no less radically critical of free enterprise than are many novels. There are in this country many periodicals which in every issue furiously attack economic freedom. There is hardly any magazine of opinion that would plead for the system that supplied the immense majority of the people with good food and shelter, with cars, refrigerators, radio sets, and other things which the subjects of other countries call luxuries.
The impact of this state of affairs is that practically very little is done to preserve the system of private enterprise. There are only middle-of-the-roaders who think they have been successful when they have delayed for some time an especially ruinous measure. They are always in retreat. They put up today with measures which only ten or twenty years ago they would have considered as undiscussable. They will in a few years acquiesce in other measures which they today consider as simply out of the question. What can prevent the coming of totalitarian socialism is only a thorough change in ideologies.
What we need is neither anti-socialism nor anti-communism but an open positive endorsement of that system to which we owe all the wealth that distinguishes our age from the comparatively straitened conditions of ages gone by.
Economic Policy: Thoughts for Tomorrow and Today[Ludwig von Mises, Economic Policy: Thoughts for Tomorrow and Today (1979; Washington, D.C.: Regnery Gateway, 2006), Lecture 5, pp. 75–91.]“Foreign Investment”Some people call the programs of economic freedom a negative program. They say: “What do you liberals really want? You are against socialism, government intervention, inflation, labor union violence, protective tariffs. ... You say ‘no’ to everything.”
I would call this statement a one-sided and shallow formulation of the problem. For it is possible to formulate a liberal program in a positive way. If a man says: “I am against censorship,” he is not negative; he is in favor of authors having the right to determine what they want to publish without the interference of government. This is not negativism, this is precisely freedom. (Of course, when I use the term “liberal” with respect to the conditions of the economic system, I mean liberal in the old classical sense of the word.)
Today, most people regard the considerable differences in the standard of living between many countries as unsatisfactory. Two hundred years ago, conditions in Great Britain were much worse than they are today in India. But the British in 1750 did not call themselves “undeveloped” or “backward,” because they were not in a position to compare the conditions of their country with those of countries in which economic conditions were more satisfactory. Today all people who have not attained the average standard of living of the United States believe that there is something wrong with their own economic situation. Many of these countries call themselves “developing countries” and, as such, are asking for aid from the so-called developed or even overdeveloped countries.
Let me explain the reality of this situation. The standard of living is lower in the so-called developing countries because the average earnings for the same type of labor is lower in those countries than it is in some countries of Western Europe, Canada, Japan, and especially in the United States. If we try to find the reasons for this difference, we must realize that it is not due to an inferiority of the workers or other employees. There prevails among some groups of North American workers a tendency to believe that they themselves are better than other people — that it is through their own merit that they are getting higher wages than other people.
It would only be necessary for an American worker to visit another country — let us say, Italy, where many American workers came from — in order to discover that it is not his personal qualities but the conditions in the country that make it possible for him to earn higher wages. If a man from Sicily immigrates to the United States, he can very soon earn the wage rates that are customary in the United States. And if the same man returns to Sicily, he will discover that his visit to the United States did not give him qualities which would permit him to earn higher wages in Sicily than his fellow countrymen.
Nor can one explain this economic situation by assuming any inferiority on the part of the entrepreneurs outside the United States. It is a fact that outside of the United States, Canada, Western Europe, and certain parts of Asia the equipment of the factories and the technological methods employed are, by and large, inferior to those within the United States. But this is not due to the ignorance of the entrepreneurs in those “undeveloped” countries. They know very well that the factories in the United States and Canada are much better equipped. They themselves know everything they must know about technology, and if they do not, they have the opportunity to learn what they must know from textbooks and technical magazines which disseminate this knowledge.
Once again: the difference is not personal inferiority or ignorance. The difference is the supply of capital, the quantity of capital goods available. In other words, the amount of capital invested per unit of the population is greater in the so-called advanced nations than in the developing nations.
A businessman cannot pay a worker more than the amount added by the work of this employee to the value of the product. He cannot pay him more than the customers are prepared to pay for the additional work of this individual worker. If he pays him more, he will not recover his expenditures from the customers. He incurs losses and, as I have pointed out again and again, and as everybody knows, a businessman who suffers losses must change his methods of business, or go bankrupt.
The economists describe this state of affairs by saying “wages are determined by the marginal productivity of labor.” This is only another expression for what I have just said before. It is a fact that the scale of wages is determined by the amount a man’s work increases the value of the product. If a man works with better and more efficient tools, then he can perform in one hour much more than a man who works one hour with less efficient instruments. It is obvious that 100 men working in an American shoe factory, equipped with the most modern tools and machines, produce much more in the same length of time than 100 shoemakers in India, who have to work with old-fashioned tools in a less sophisticated way.
The employers in all of these developing nations know very well that better tools would make their own enterprises more profitable. They would like to build more and better factories. The only thing that prevents them from doing it is the shortage of capital. The difference between the less developed and the more developed nations is a function of time: the British started to save sooner than all other nations: they also started sooner to accumulate capital and to invest it in business. Because they started sooner, there was a higher standard of living in Great Britain when, in all other European countries, there was still a lower standard of living. Gradually, all the other nations began to study British conditions, and it was not difficult for them to discover the reason for Great Britain’s wealth. So they began to imitate the methods of British business.
Since other nations started later, and since the British did not stop investing capital, there remained a large difference between conditions in England and conditions in those other countries. But something happened which caused the headstart of Great Britain to disappear.
What happened was the greatest event in the history of the nineteenth century, and this means not only in the history of an individual country. This great event was the development, in the nineteenth century, of foreign investment. In 1817, the great British economist Ricardo still took it for granted that capital could be invested only within the borders of a country. He took it for granted that capitalists would not try to invest abroad. But a few decades later, capital investment abroad began to play a most important role in world affairs.
Without capital investment it would have been necessary for nations less developed than Great Britain to start with the methods and the technology with which the British had started in the beginning and middle of the eighteenth century, and slowly, step by step — always far below the technological level of the British economy — try to imitate what the British had done.
It would have taken many, many decades for these countries to attain the standard of technological development which Great Britain had reached a hundred years or more before them. But the great event that helped all these countries was foreign investment.
Foreign investment meant that British capitalists invested British capital in other parts of the world. They first invested it in those European countries which, from the point of view of Great Britain, were short of capital and backward in their development. It is a well-known fact that the railroads of most European countries, and also of the United States, were built with the aid of British capital. You know that the same happened in this country, in Argentina.
The gas companies in all the cities of Europe were also British. In the mid 1870s, a British author and poet criticized his countrymen. He said: “The British have lost their old vigor and they have no longer any new ideas. They are no longer an important or leading nation in the world.” To which Herbert Spencer, the great sociologist, answered: “Look at the European continent. All European capitals have light because a British gas company provides them with gas.” This was, of course, in what seems to us the “remote” age of gas lighting. Further answering this British critic, Herbert Spencer added: “You say that the Germans are far ahead of Great Britain. But look at Germany. Even Berlin, the capital of the German Reich, the capital of Geist, would be in the dark if a British gas company had not invaded the country and lighted the streets.”
In the same way, British capital developed the railroads and many branches of industry in the United States. And, of course, as long as a country imports capital its balance of trade is what the noneconomists call “unfavorable.” That means that it has an excess of imports over exports. The reason for the “favorable balance of trade” of Great Britain was that the British factories sent many types of equipment to the United States, and this equipment was not paid for by anything other than shares of American corporations. This period in the history of the United States lasted, by and large, until the 1890s.
But when the United States, with the aid of British capital — and later with the aid of its own procapitalistic policies — developed its own economic system in an unprecedented way, the Americans began to buy back the capital stocks they had once sold to foreigners. Then the United States had a surplus of exports over imports. The difference was paid by the importation — by the repatriation, as one called it — of American common stock.
This period lasted until the First World War. What happened later is another story. It is the story of the American subsidies for the belligerent countries in between and after two world wars: the loans, the investments the United States made in Europe, in addition to lend-lease, foreign aid, the Marshall Plan, food that was sent overseas, and other subsidies. I emphasize this because people sometimes believe that it is shameful or degrading to have foreign capital working in their country. You have to realize that, in all countries except England, foreign capital investment played a considerable part in the development of modern industries.
If I say that foreign investment was the greatest historical event of the nineteenth century, you must think of all those things that would not have come into being if there had not been any foreign investment. All the railroads, the harbors, the factories and mines in Asia, and the Suez Canal and many other things in the Western hemisphere, would not have been constructed had there been no foreign investment.
Foreign investment is made in the expectation that it will not be expropriated. Nobody would invest anything if he knew in advance that somebody would expropriate his investments. At the time when these foreign investments were made in the nineteenth century, and at the beginning of the twentieth century, there was no question of expropriation. From the beginning, some countries showed a certain hostility toward foreign capital, but for the most part they realized very well that they derived an enormous advantage from these foreign investments.
In some cases, these foreign investments were not made directly to foreign capitalists, but indirectly by loans to the foreign government. Then it was the government that used the money for investments. Such was, for instance, the case in Russia. For purely political reasons, the French invested in Russia, in the two decades preceding the First World War, about twenty billion gold francs, lending them chiefly to the Russian government. All the great enterprises of the Russian government — for instance, the railroad that connects Russia from the Ural Mountains, through the ice and snow of Siberia, to the Pacific — were built mostly with foreign capital lent to the Russian government. You will realize that the French did not assume that one day there would be a communist Russian government that would simply declare it would not pay the debts incurred by its predecessor, the tsarist government.
Starting with the First World War, there began a period of worldwide open warfare against foreign investments. Since there is no remedy to prevent a government from expropriating invested capital, there is practically no legal protection for foreign investments in the world today. The capitalists did not foresee this. If the capitalists of the capital exporting countries had realized it, all foreign investments would have come to an end forty or fifty years ago. But the capitalists did not believe that any country would be so unethical as to renege on a debt, to expropriate and confiscate foreign capital. With these acts, a new chapter began in the economic history of the world.
With the end of the great period in the nineteenth century when foreign capital helped to develop, in all parts of the world, modern methods of transportation, manufacturing, mining, and agriculture, there came a new era in which the governments and the political parties considered the foreign investor as an exploiter who should be expelled from the country.
In this anti-capitalist attitude the Russians were not the only sinners. Remember, for example, the expropriation of the American oil fields in Mexico, and all the things that have happened in this country (Argentina) which I have no need to discuss.
The situation in the world today, created by the system of expropriation of foreign capital, consists either of direct expropriation or of indirect expropriation through foreign exchange control or tax discrimination. This is mainly a problem of developing nations.
Take, for instance, the biggest of these nations: India. Under the British system, British capital — predominately British capital, but also capital of other European countries — was invested in India. And the British exported to India something else which also has to be mentioned in this connection; they exported into India modern methods of fighting contagious diseases. The result was a tremendous increase in the Indian population and a corresponding increase in the country’s troubles. Facing such a worsening situation, India turned to expropriation as a means of dealing with its problems. But it was not always direct expropriation; the government harassed foreign capitalists, hampering them in their investments in such a way that these foreign investors were forced to sell out.
India could, of course, accumulate capital by another method: the domestic accumulation of capital. However, India is as hostile to the domestic accumulation of capital as it is to foreign capitalists. The Indian government says it wants to industrialize India, but what it really has in mind is to have socialist enterprises.
A few years ago the famous statesman Jawaharlal Nehru published a collection of his speeches. The book was published with the intention of making foreign investment in India more attractive. The Indian government is not opposed to foreign investment before it is invested. The hostility begins only when it is already invested. In this book — I am quoting literally from the book — Mr. Nehru said: “Of course, we want to socialize. But we are not opposed to private enterprise. We want to encourage in every way private enterprise. We want to promise the entrepreneurs who invest in our country, that we will not expropriate them nor socialize them for ten years, perhaps even for a longer time.” And he thought this was an invitation to come to India!
The problem — as you know — is domestic capital accumulation. In all countries today there are very heavy taxes on corporations. In fact, there is double taxation on corporations. First, the profits of corporations are taxed very heavily, and the dividends which corporations pay to their shareholders are taxed again. And this is done in a progressive way.
Progressive taxation of income and profits means that precisely those parts of the income which people would have saved and invested are taxed away. Take the example of the United States. A few years ago, there was an “excess-profit” tax, which meant that out of one dollar earned, a corporation retained only eighteen cents. When these eighteen cents were paid out to the shareholders, those who had a great number of shares had to pay another sixty or eighty or even greater percent of it in taxes. Out of the dollar of profit they retained about seven cents, and ninety-three cents went to the government. Of this ninety-three percent, the greater part would have been saved and invested. Instead, the government used it for current expenditure. This is the policy of the United States.
I think I have made it clear that the policy of the United States is not an example to be imitated by other countries. This policy of the United States is worse than bad — it is insane. The only thing I would add is that a rich country can afford more bad policies than a poor country. In the United States, in spite of all these methods of taxation, there is still some additional accumulation of capital and investment every year, and therefore there is still a trend toward an improvement of the standard of living.
But in many other countries the problem is very critical. There is no — or not sufficient — domestic saving, and capital investment from abroad is seriously reduced by the fact that these countries are openly hostile to foreign investment. How can they talk about industrialization, about the necessity to develop new plants, to improve conditions, to raise the standard of living, to have higher wage rates, better means of transportation, if they are doing things that will have precisely the opposite effect? What their policies actually accomplish is to prevent or to slow down the accumulation of domestic capital and to put obstacles in the way of foreign capital.
The end result is certainly very bad. Such a situation must bring about a loss of confidence, and there is now more and more distrust of foreign investment in the world. Even if the countries concerned were to change their policies immediately and were to make all possible promises, it is very doubtful that they could once more inspire foreign capitalists to invest.
There are, of course, some methods to avoid this consequence. One could establish some international statutes, not only agreements, that would withdraw the foreign investments from national jurisdiction. This is something the United Nations could do. But the United Nations is simply a meeting place for useless discussions. Realizing the enormous importance of foreign investment, realizing that foreign investment alone can bring about an improvement in political and economical world conditions, one could try to do something from the point of view of international legislation.
This is a technical legal problem, which I only mention, because the situation is not hopeless. If the world really wanted to make it possible for the developing countries to raise their standard of living to the level of the American way of life, then it could be done. It is only necessary to realize how it could be done.
What is lacking in order to make the developing countries as prosperous as the United States is only one thing: capital — and, of course, the freedom to employ it under the discipline of the market and not the discipline of the government. These nations must accumulate domestic capital, and they must make it possible for foreign capital to come into their countries.
For the development of domestic saving it is necessary to mention again that domestic saving by the masses of the population presupposes a stable monetary unit. This implies the absence of any kind of inflation.
A great part of the capital at work in American enterprises is owned by the workers themselves and by other people with modest means. Billions and billions of saving deposits, of bonds, and of insurance policies are operating in these enterprises. On the American money market today it is no longer the banks, it is the insurance companies that are the greatest money lenders. And the money of the insurance company is — not legally, but economically — the property of the insured. And practically everybody in the United States is insured in one way or another.
The prerequisite for more economic equality in the world is industrialization. And this is possible only through increased capital investment, increased capital accumulation. You may be astonished that I have not mentioned a measure which is considered a prime method to industrialize a country. I mean protectionism. But tariffs and foreign exchange controls are exactly the means to prevent the importation of capital and industrialization into the country. The only way to increase industrialization is to have more capital. Protectionism can only divert investments from one branch of business to another branch.
Protectionism, in itself, does not add anything to the capital of a country. To start a new factory one needs capital. To improve an already existing factory one needs capital, and not a tariff.
I do not want to discuss the whole problem of free trade or protectionism. I hope that most of your textbooks on economics represent it in a proper way. Protection does not change the economic situation in a country for the better. And what certainly does not change it for the better is labor unionism. If conditions are unsatisfactory, if wages are low, if the wage earner in a country looks to the United States and reads about what is going on there, if he sees in the movies how the home of an average American is equipped with all modern comforts, he may be envious. He is perfectly right in saying: “We ought to have the same thing.” But the only way to obtain it is through an increase in capital.
Labor unions use violence against entrepreneurs and against people they call strikebreakers. Despite their power and their violence, however, unions cannot raise wages continually for all wage earners. Equally ineffective are government decrees fixing minimum wage rates. What the unions do bring about (if they succeed in raising wage rates) is permanent, lasting unemployment.
But unions cannot industrialize the country, they cannot raise the standard of living of the workers. And this is the decisive point: One must realize that all the policies of a country that wants to improve its standard of living must be directed toward an increase in the capital invested per capital. This per capita investment of capital is still increasing in the United States, in spite of all of the bad policies there. And the same is true in Canada and in some of the West European countries. But it is unfortunately decreasing in countries like India.
We read every day in the newspapers that the population of the world is becoming greater, by perhaps 45 million people — or even more — per year. And how will this end? What will the results and the consequences be? Remember what I said about Great Britain. In 1750 the British people believed that six million constituted a tremendous overpopulation of the British Isles and that they were headed for famines and plagues. But on the eve of the last world war, in 1939, fifty million people were living in the British Isles, and the standard of living was incomparably higher than it had been in 1750. This was the effect of what is called industrialization — a rather inadequate term.
Britain’s progress was brought about by increasing the per capita investment of capital. As I said before, there is only one way a nation can achieve prosperity: if you increase capital, you increase the marginal productivity of labor, and the effect will be that real wages will rise.
In a world without migration barriers, there would be a tendency all over the world toward an equalization of wage rates. If there were no migration barriers today, probably twenty million people would try to reach the United States every year, in order to get higher wages. The inflow would reduce wages in the United States, and raise them in other countries.
I do not have time to deal with this problem of migration barriers. But I do want to say that there is another method toward the equalization of wage rates all over the world. This other method, which operates in the absence of the freedom to migrate, is the migration of capital. Capitalists have the tendency to move towards those countries in which there is plenty of labor available and in which labor is reasonable. And by the fact that they bring capital into these countries, they bring about a trend toward higher wage rates. This has worked in the past, and it will work in the future, in the same way.
When British capital was first invested in, let us say, Austria or Bolivia, wage rates there were much, much lower than they were in Great Britain. But this additional investment brought about a trend toward higher wage rates in those countries. And such a tendency prevailed all over the world. It is a very well-known fact that as soon as, for instance, the United Fruit Company moved into Guatemala, the result was a general tendency toward higher wage rates, beginning with the wages which United Fruit Company paid, which then made it necessary for other employers to pay higher wages also. Therefore, there is no reason at all to be pessimistic in regard to the future of “undeveloped” countries.
I fully agree with the Communists and the labor unions, when they say: “What is needed is to raise the standard of living.” A short time ago, in a book published in the United States, a professor said: “We now have enough of everything, why should people in the world still work so hard? We have everything already.” I do not doubt that this professor has everything. But there are other people in other countries, also many people in the United States, who want and should have a better standard of living.
Outside of the United States — in Latin America, and still more in Asia and Africa — everyone wishes to see conditions improved in his own country. A higher standard of living also brings about a higher standard of culture and civilization.
So I fully agree with the ultimate goal of raising the standard of living everywhere. But I disagree about the measures to be adopted in attaining this goal. What measures will attain this end? Not protection, not government interference, not socialism, and certainly not the violence of the labor unions (euphemistically called collective bargaining, which, in fact, is bargaining at the point of a gun).
To attain the end, as I see it, there is only one way! It is a slow method. Some people may say, it is too slow. But there are no short cuts to an earthly paradise. It takes time, and one has to work. But it does not take as much time as people believe, and finally an equalization will come.
Around 1840, in the western part of Germany — in Swabia and Würtemberg, which was one of the most industrialized areas in the world — it was said: “We can never attain the level of the British. The English have a head start and they will forever be ahead of us.” Thirty years later the British said: “This German competition, we cannot stand it; we have to do something against it.” At that time, of course, the German standard was rapidly rising and was, even then, approaching the British standard. And today the German income per capita is not behind that of Great Britain at all.
In the center of Europe, there is a small country, Switzerland, which nature has endowed very poorly. It has no coal mines, no minerals, and no natural resources. But its people, over the centuries, have continually pursued a capitalistic policy. They have developed the highest standard of living in continental Europe, and their country ranks as one of the world’s great centers of civilization. I do not see why a country such as Argentina — which is much larger than Switzerland both in population and in size — should not attain the same high standard of living after some years of good policies. But — as I pointed out — the policies must be good.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 15: “The Market,” pp. 292–96.]9. Entrepreneurial Profits and Losses in a Progressing EconomyIn the imaginary construction of a stationary economy the total sum of all entrepreneurs’ profits equals the total sum of all entrepreneurs’ losses. What one entrepreneur profits is in the total economic system counterbalanced by another entrepreneur’s loss. The surplus which all the consumers together expend for the acquisition of a certain commodity is counterbalanced by the reduction in their expenditure for the acquisition of other commodities.If we were to apply the faulty concept of a “national income” as used in popular speech, we would have to say that no part of national income goes into profits.
It is different in a progressing economy.
We call a progressing economy an economy in which the per capita quota of capital invested is increasing. In using this term we do not imply value judgments. We adopt neither the “materialistic” view that such a progression is good nor the “idealistic” view that it is bad or at least irrelevant from a “higher point of view.” Of course, it is a well-known fact that the immense majority of people consider the consequences of progress in this sense as the most desirable state of affairs and yearn for conditions which can be realized only in a progressing economy.
In the stationary economy the entrepreneurs, in the pursuit of their specific functions, cannot achieve anything other than to withdraw factors of production, provided that they are still convertible, from one line of business in order to employ them in another line, or to direct the restoration of the equivalent of capital goods used up in the course of production processes toward the expansion of certain branches of industry at the expense of other branches. In the progressing economy the range of entrepreneurial activities includes, moreover, the determination of the employment of the additional capital goods accumulated by new savings. The injection of these additional capital goods is bound to increase the total sum of the income produced, i.e., of that supply of consumers’ goods which can be consumed without diminishing the capital equipment used in its production thereby without impairing the output of future production. The increase of income is effected either by an expansion of production without altering the technological methods of production or by an improvement in technological methods which would not have been feasible under the previous conditions of a less ample supply of capital goods.
It is out of this additional wealth that the surplus of the total sum of entrepreneurial profits over the total sum of entrepreneurial losses flows. But it can be easily demonstrated that this surplus can never exhaust the total increase in wealth brought about by economic progress. The laws of the market divide this additional wealth between the entrepreneurs and the suppliers of labor and those of certain material factors of production in such a way that the lion’s share goes to the nonentrepreneurial groups.
First of all we must realize that entrepreneurial profits are not a lasting phenomenon but only temporary. There prevails an inherent tendency for profits and losses to disappear. The market is always moving toward the emergence of the final prices and the final state of rest. If new changes in the data were not to interrupt this movement and not to create the need for a new adjustment of production to the altered conditions, the prices of all complementary factors of production would — due allowance being made for time preference — finally equal the price of the product, and nothing would be left for profits or losses. In the long run every increase in productivity benefits exclusively the workers and some groups of the owners of land and of capital goods.
In the groups of the owners of capital goods there are benefited:
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Those whose saving has increased the quantity of capital goods available. They own this additional wealth, the outcome of their restraint in consuming.
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The owners of those capital goods already previously existing which, thanks to the improvement in technological methods of production, are now better utilized than before. Such gains are, of course, temporary only. They are bound to disappear as they cause a tendency toward an intensified production of the capital goods concerned.
On the other hand, the increase in the quantity of capital goods available lowers the marginal productivity of capital; it thus brings about a fall in the prices of the capital goods and thereby hurts the interests of all those capitalists who did not share at all or not sufficiently in the process of saving and the accumulation of the additional supply of capital goods.
In the group of the landowners all those are benefited for whom the new state of affairs results in a higher productivity of their farms, forests, fisheries, mines, and so on. On the other hand, all those are hurt whose property may become submarginal on account of the higher return yielded by the land owned by those benefited.
In the group of labor all derive a lasting gain from the increase in the marginal productivity of labor. But, on the other hand, in the short run some may suffer disadvantages. These are people who were specialized in the performance of work which becomes obsolete as a result of technological improvement and are fitted only for jobs in which — in spite of the general rise in wage rates — they earn less than before.
All these changes in the prices of the factors of production begin immediately with the initiation of the entrepreneurial actions designed to adjust the processes of production to the new state of affairs. In dealing with this problem as with the other problems of changes in the market data, we must guard ourselves against the popular fallacy of drawing a sharp line between short-run and long-run effects. What happens in the short run is precisely the first stages of the chain of successive transformations which tend to bring about the long-run effects. The long-run effect is in our case the disappearance of entrepreneurial profits and losses. The short-run effects are the preliminary stages of this process of elimination which finally, if not interrupted by a further change in the data, would result in the emergence of the evenly rotating economy.
It is necessary to comprehend that the very appearance of an excess in the total amount of entrepreneurial profits over the total amount of entrepreneurial losses depends upon the fact that this process of the elimination of entrepreneurial profit and loss begins at the same time as the entrepreneurs begin to adjust the complex of production activities to the changed data. There is never in the whole sequence of events an instant in which the advantages derived from the increase in the amount of capital available and from technical improvements benefit the entrepreneurs only. If the wealth and the income of the other strata were to remain unaffected, these people could buy the additional products only by restricting their purchases of other products accordingly. Then the profits of one group of entrepreneurs would exactly equal the losses incurred by other groups.
What happens is this: The entrepreneurs embarking upon the utilization of the newly accumulated capital goods and the improved technological methods of production are in need of complementary factors of production. Their demand for these factors is a new additional demand which must raise their prices. Only as far as this rise in prices and wage rates occurs, are the consumers in a position to buy the new products without curtailing the purchase of other goods. Only so far can a surplus of the total sum of all entrepreneurial profits over all entrepreneurial losses come into existence.
The vehicle of economic progress is the accumulation of additional capital goods by means of saving and improvement in technological methods of production the execution of which is almost always conditioned by the availability of such new capital. The agents of progress are the promoting entrepreneurs intent upon profiting by means of adjusting the conduct of affairs to the best possible satisfaction of the consumers. In the performance of their projects for the realization of progress they are bound to share the benefits derived from progress with the workers and also with a part of the capitalists and landowners and to increase the portion allotted to these people step by step until their own share melts away entirely.
From this it becomes evident that it is absurd to speak of a “rate of profit” or a “normal rate of profit” or an “average rate of profit.” Profit is not related to or dependent on the amount of capital employed by the entrepreneur. Capital does not “beget” profit. Profit and loss are entirely determined by the success or failure of the entrepreneur to adjust production to the demand of the consumers. There is nothing “normal” in profits and there can never be an “equilibrium” with regard to them. Profit and loss are, on the contrary, always a phenomenon of a deviation from “normalcy,” of changes unforeseen by the majority, and of a “disequilibrium.” They have no place in an imaginary world of normalcy and equilibrium. In a changing economy there prevails always an inherent tendency for profits and losses to disappear. It is only the emergence of new changes which revives them again. Under stationary conditions the “average rate” of profits and losses is zero. An excess of the total amount of profits over that of losses is a proof of the fact that there is economic progress and an improvement in the standard of living of all strata of the population. The greater this excess is, the greater is the increment in general prosperity.
Many people are utterly unfit to deal with the phenomenon of entrepreneurial profit without indulging in envious resentment. In their eyes the source of profit is exploitation of the wage earners and the consumers, i.e., an unfair reduction in wage rates and a no less unfair increase in the prices of the products. By rights there should not be any profits at all.
Economics is indifferent with regard to such arbitrary value judgments. It is not interested in the problem of whether profits are to be approved or condemned from the point of view of an alleged natural law and of an alleged eternal and immutable code of morality about which personal intuition or divine revelation are supposed to convey precise information. Economics merely establishes the fact that entrepreneurial profits and losses are essential phenomena of the market economy. There cannot be a market economy without them. It is certainly possible for the police to confiscate all profits. But such a policy would by necessity convert the market economy into a senseless chaos. Man has, there is no doubt, the power to destroy many things, and he has made in the course of history ample use of this faculty. He could destroy the market economy too.
If those self-styled moralists were not blinded by their envy, they would not deal with profit without dealing simultaneously with its corollary, loss. They would not pass over in silence the fact that the preliminary conditions of economic improvement are an achievement of those whose saving accumulates the additional capital goods and of the inventors, and that the utilization of these conditions for the realization of economic improvement is effected by the entrepreneurs. The rest of the people do not contribute to progress, but they are benefited by the horn of plenty which other people’s activities pour upon them.
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——. The Essential von Mises. Auburn, Ala.: Mises Institute. 2009.
Liberty and Property[Ludwig von Mises, Liberty and Property (1958; Auburn, Ala.: Mises Institute, 1988).]IAt the end of the eighteenth century there prevailed two notions of liberty, each of them very different from what we have in mind today referring to liberty and freedom.
The first of these conceptions was purely academic and without any application to the conduct of political affairs. It was an idea derived from the books of the ancient authors, the study of which was then the sum and substance of higher education. In the eyes of these Greek and Roman writers, freedom was not something that had to be granted to all men. It was a privilege of the minority, to be withheld from the majority. What the Greeks called democracy was, in the light of present-day terminology, not what Lincoln called government by the people, but oligarchy, the sovereignty of full-right citizens in a community in which the masses were meteques or slaves. Even this rather limited freedom after the fourth century before Christ was not dealt with by the philosophers, historians, and orators as a practical constitutional institution. As they saw it, it was a feature of the past irretrievably lost. They bemoaned the passing of this golden age, but they did not know any method of returning to it.
The second notion of liberty was no less oligarchic, although it was not inspired by any literary reminiscences. It was the ambition of the landed aristocracy, and sometimes also of urban patricians, to preserve their privileges against the rising power of royal absolutism. In most parts of continental Europe, the princes remained victorious in these conflicts. Only in England and in the Netherlands did the gentry and the urban patricians succeed in defeating the dynasties. But what they won was not freedom for all, but only freedom for an elite, for a minority of the people.
We must not condemn as hypocrites the men who in those ages praised liberty, while they preserved the legal disabilities of the many, even serfdom and slavery. They were faced with a problem which they did not know how to solve satisfactorily. The traditional system of production was too narrow for a continually rising population. The number of people for whom there was, in a full sense of the term, no room left by the pre-capitalistic methods of agriculture and artisanship was increasing. These supernumeraries were starving paupers. They were a menace to the preservation of the existing order of society and, for a long time, nobody could think of another order, a state of affairs, that would feed all of these poor wretches. There could not be any question of granting them full civil rights, still less of giving them a share of the conduct of affairs of state. The only expedient the rulers knew was to keep them quiet by resorting to force.
IIThe pre-capitalistic system of product was restrictive. Its historical basis was military conquest. The victorious kings had given the land to their paladins. These aristocrats were lords in the literal meaning of the word, as they did not depend on the patronage of consumers buying or abstaining from buying on a market. On the other hand, they themselves were the main customers of the processing industries which, under the guild system, were organized on a corporative scheme. This scheme was opposed to innovation. It forbade deviation from the traditional methods of production. The number of people for whom there were jobs even in agriculture or in the arts and crafts was limited. Under these conditions, many a man, to use the words of Malthus, had to discover that “at nature’s mighty feast there is no vacant cover for him” and that “she tells him to be gone.”[Thomas R. Malthus, An Essay on the Principle of Population, 2d ed. (London, 1803), p. 531.] But some of these outcasts nevertheless managed to survive, begot children, and made the number of destitute grow hopelessly more and more.
But then came capitalism. It is customary to see the radical innovations that capitalism brought about in the substitution of the mechanical factory for the more primitive and less efficient methods of the artisans’ shops. This is a rather superficial view. The characteristic feature of capitalism that distinguishes it from pre-capitalist methods of production was its new principle of marketing. Capitalism is not simply mass production, but mass production to satisfy the needs of the masses. The arts and crafts of the good old days had catered almost exclusively to the wants of the well-to-do. But the factories produced cheap goods for the many. All the early factories turned out was designed to serve the masses, the same strata that worked in the factories. They served them either by supplying them directly or indirectly by exporting and thus providing for them foreign food and raw materials. This principle of marketing was the signature of early capitalism as it is of present-day capitalism. The employees themselves are the customers consuming the much greater part of all goods produced. They are the sovereign customers who are “always right.” Their buying or abstention from buying determines what has to be produced, in what quantity, and of what quality. In buying what suits them best they make some enterprises profit and expand and make other enterprises lose money and shrink. Thereby they are continually shifting control of the factors of production into the hands of those businessmen who are most successful in filling their wants. Under capitalism private property of the factors of production is a social function. The entrepreneurs, capitalists, and land owners are mandataries, as it were, of the consumers, and their mandate is revocable. In order to be rich, it is not sufficient to have once saved and accumulated capital. It is necessary to invest it again and again in those lines in which it best fills the wants of the consumers. The market process is a daily repeated plebiscite, and it ejects inevitably from the ranks of profitable people those who do not employ their property according to the orders given by the public. But business, the target of fanatical hatred on the part of all contemporary governments and self-styled intellectuals, acquires and preserves bigness only because it works for the masses. The plants that cater to the luxuries of the few never attain big size.
The shortcoming of nineteenth-century historians and politicians was that they failed to realize that the workers were the main consumers of the products of industry. In their view, the wage earner was a man toiling for the sole benefit of a parasitic leisure class. They labored under the delusion that the factories had impaired the lot of the manual workers. If they had paid any attention to statistics they would easily have discovered the fallaciousness of their opinion. Infant mortality dropped, the average length of life was prolonged, the population multiplied, and the average common man enjoyed amenities of which even the well-to-do of earlier ages did not dream.
However this unprecedented enrichment of the masses were merely a by-product of the Industrial Revolution. Its main achievement was the transfer of economic supremacy from the owners of land to the totality of the population. The common man was no longer a drudge who had to be satisfied with the crumbs that fell from the tables of the rich. The three pariah castes which were characteristic of the pre-capitalistic ages — the slaves, the serfs, and those people whom patristic and scholastic authors as well as British legislation from the sixteenth to the nineteenth centuries referred to as the poor — disappeared. Their scions became, in this new setting of business, not only free workers, but also customers. This radical change was reflected in the emphasis laid by business on markets. What business needs first of all is markets and again markets. This was the watch-word of capitalistic enterprise. Markets, that means patrons, buyers, consumers. There is under capitalism one way to wealth: to serve the consumers better and cheaper than other people do.
Within the shop and factory the owner — or in the corporations, the representative of the shareholders, the president — is the boss. But this mastership is merely apparent and conditional. It is subject to the supremacy of the consumers. The consumer is king, is the real boss, and the manufacturer is done for if he does not outstrip his competitors in best serving consumers.
It was this great economic transformation that changed the face of the world. It very soon transferred political power from the hands of a privileged minority into the hands of the people. Adult franchise followed in the wake of industrial enfranchisement. The common man, to whom the market process had given the power to choose the entrepreneur and capitalists, acquired the analogous power in the field of government. He became a voter.
It has been observed by eminent economists, I think first by the late Frank A. Fetter, that the market is a democracy in which every penny gives a right to vote. It would be more correct to say that representative government by the people is an attempt to arrange constitutional affairs according to the model of the market, but this design can never be fully achieved. In the political field it is always the will of the majority that prevails, and the minorities must yield to it. It serves also minorities, provided they are not so insignificant in number as to become negligible. The garment industry produces clothes not only for normal people, but also for the stout, and the publishing trade publishes not only westerns and detective stories for the crowd, but also books for discriminating readers.
There is a second important difference. In the political sphere, there is no means for an individual or a small group of individuals to disobey the will of the majority. But in the intellectual field private property makes rebellion possible. The rebel has to pay a price for his independence; there are in this universe no prizes that can be won without sacrifices. But if a man is willing to pay the price, he is free to deviate from the ruling orthodoxy or neo-orthodoxy. What would conditions have been in the socialist commonwealth for heretics like Kierkegaard, Schopenauer, Veblen, or Freud? For Monet, Courbet, Walt Whitman, Rilke, or Kafka? In all ages, pioneers of new ways of thinking and acting could work only because private property made contempt of the majority’s ways possible. Only a few of these separatists were themselves economically independent enough to defy the government into the opinions of the majority. But they found in the climate of the free economy among the public people prepared to aid and support them. What would Marx have done without his patron, the manufacturer Friedrich Engels?
IIIWhat vitiates entirely the socialists’ economic critique of capitalism is their failure to grasp the sovereignty of the consumers in the market economy. They see only hierarchical organization of the various enterprises and plans, and are at a loss to realize that the profit system forces business to serve the consumers. In their dealings with their employers, the unions proceed as if only malice and greed were to prevent what they call management from paying higher wage rates. Their shortsightedness does not see anything beyond the doors of the factory. They and their henchmen talk about the concentration of economic power, and do not realize that economic power is ultimately vested in the hands of the buying public of which the employees themselves form the immense majority. Their inability to comprehend things as they are is reflected in such inappropriate metaphors as industrial kingdom and dukedoms. They are too dull to see the difference between a sovereign king or duke who could be dispossessed only by a more powerful conqueror and a “chocolate king” who forfeits his “kingdom” as soon as the customers prefer to patronize another supplier.
This distortion is at the bottom of all socialist plans. If any of the socialist chiefs had tried to earn his living by selling hot dogs, he would have learned something about the sovereignty of the customers. But they were professional revolutionaries and their only job was to kindle civil war. Lenin’s ideal was to build a nation’s production effort according to the model of the post office, an outfit that does not depend on the consumers, because its deficits are covered by compulsory collection of taxes. “The whole of society,” he said, was to “become one office and one factory.”[V.I.] Lenin, State and Revolution (New York: International Publishers, s.d.) p. 84. He did not see that the very character of the office and the factory is entirely changed when it is alone in the world and no longer grants to people the opportunity to choose among the products and services of various enterprises. Because his blindness made it impossible for him to see the role the market and the consumers play under capitalism, he could not see the difference between freedom and slavery. Because in his eyes the workers were only workers and not also customers, he believed they were already slaves under capitalism, and that one did not change their status when nationalizing all plants and shops. Socialism substitutes the sovereignty of a dictator, or committee of dictators, for the sovereignty of the consumers. Along with the economic sovereignty of the citizens disappears also their political sovereignty. To the unique production plan that annuls any planning on the part of the consumers corresponds in the constitutional sphere the one party principle that deprives the citizens of any opportunity to plan the course of public affairs. Freedom is indivisible. He who has not the faculty to choose among various brands of canned food or soap, is also deprived of the power to choose between various political parties and programs and to elect the officeholders. He is no longer a man; he becomes a pawn in the hands of the supreme social engineer. Even his freedom to rear progeny will be taken away by eugenics. Of course, the socialist leaders occasionally assure us that dictatorial tyranny is to last only for the period of transition from capitalism and representative government to the socialist millennium in which everybody’s wants and wishes will be fully satisfied.[Karl] Marx, Sur Kritik des Sozialdemoskratischen Programms von Gotha, ed. Kreibich (Reichenberg, 1920), p. 23. Once the socialist regime is “sufficiently secure to risk criticism,” Miss Joan Robinson, the eminent representative of the British neo-Cambridge school, is kind enough to promise us, “even independent philharmonic societies” will be allowed to exist.Joan Robinson, Private Enterprise and Public Control (published for the Association for Education in Citizenship by the English Universities Press, Ltd., s.d.), pp. 13–14. Thus the liquidation of all dissenters is the condition that will bring us what the communists call freedom. From this point of view we may also understand what another distinguished Englishman, Mr. J.G. Crowther, had in mind when he praised inquisition as “beneficial to science when it protects a rising class.”J.G. Crowther, Social Relations of Science (London, 1941), p. 333. The meaning of all this is clear. When all people meekly bow to a dictator, there will no longer be any dissenters left for liquidation. Caligula, Torquemada, Robespierre would have agreed with this solution.
The socialists have engineered a semantic revolution in converting the meaning of terms into their opposite. In the vocabulary of their “Newspeak,” as George Orwell called it, there is a term “the one-party principle.” Now etymologically party is derived from the noun part. The brotherless part is no longer different from its antonym, the whole; it is identical with it. A brotherless party is not a party, and the one party principle is in fact a no-party principle. It is a suppression of any kind of opposition. Freedom implies the right to choose between assent and dissent. But in Newspeak it means the duty to assent unconditionally and strict interdiction of dissent. This reversal of the traditional connotation of all words of the political terminology is not merely a peculiarity of the language of the Russian Communists and their Fascist and Nazi disciples. The social order that in abolishing private property deprives the consumers of their autonomy and independence, and thereby subjects every man to the arbitrary discretion of the central planning board, could not win the support of the masses if they were not to camouflage its main character. The socialists would have never duped the voters if they had openly told them that their ultimate end is to cast them into bondage. For exoteric use they were forced to pay lip-service to the traditional appreciation of liberty.
IVIt was different in the esoteric discussions among the inner circles of the great conspiracy. There the initiated did not dissemble their intentions concerning liberty. Liberty was, in their opinion, certainly a good feature in the past in the frame of bourgeois society because it provided them with the opportunity to embark on their schemes. But once socialism has triumphed, there is no longer any need for free thought and autonomous action on the part of individuals. Any further change can only be a deviation from the perfect state that mankind has attained in reaching the bliss of socialism. Under such conditions, it would be simply lunacy to tolerate dissent.
Liberty, says the Bolshevist, is a bourgeois prejudice. The common man does not have any ideas of his own, he does not write books, does not hatch heresies, and does not invent new methods of production. He just wants to enjoy life. He has no use for the class interests of the intellectuals who make a living as professional dissenters and innovators.
This is certainly the most arrogant disdain of the plain citizen ever devised. There is no need to argue this point. For the question is not whether or not the common man can himself take advantage of the liberty to think, to speak, and to write books. The question is whether or not the sluggish routinist profits from the freedom granted to those who eclipse him in intelligence and will power. The common man may look with indifference and even contempt upon the dealings of better people. But he is delighted to enjoy all the benefits which the endeavors of the innovators put at his disposal. He has no comprehension of what in his eyes is merely inane hair-splitting. But as soon as these thoughts and theories are utilized by enterprising businessmen for satisfying some of his latent wishes, he hurries to acquire the new products. The common man is without doubt the main beneficiary of all the accomplishments of modern science and technology.
It is true, a man of average intellectual abilities has no chance to rise to the rank of a captain of industry. But the sovereignty that the market assigns to him in economic affairs stimulates technologists and promoters to convert to his use all the achievements of scientific research. Only people whose intellectual horizon does not extend beyond the internal organization of the factory and who do not realize what makes the businessmen run, fail to notice this fact.
The admirers of the Soviet system tell us again and again that freedom is not the supreme good. It is “not worth having,” if it implies poverty. To sacrifice it in order to attain wealth for the masses, is in their eyes fully justified. But for a few unruly individualists who cannot adjust themselves to the ways of regular fellows, all people in Russia are perfectly happy. We may leave it undecided whether this happiness was also shared by the millions of Ukrainian peasants who died from starvation, by the inmates of the forced labor camps, and by the Marxian leaders who were purged. But we cannot pass over the fact that the standard of living was incomparably higher in the free countries of the West than in the communist East. In giving away liberty as the price to be paid for the acquisition of prosperity, the Russians made a poor bargain. They now have neither the one nor the other.
VRomantic philosophy labored under the illusion that in the early ages of history the individual was free and that the course of historical evolution deprived him of his primordial liberty. As Jean Jacques Rousseau saw it, nature accorded men freedom and society enslaved him. In fact, primeval man was at the mercy of every fellow who was stronger and therefore could snatch away from him the scarce means of subsistence. There is in nature nothing to which the name of liberty could be given. The concept of freedom always refers to social relations between men. True, society cannot realize the illusory concept of the individual’s absolute independence. Within society everyone depends on what other people are prepared to contribute to his well-being in return for his own contribution to their well-being. Society is essentially the mutual exchange of services. As far as individuals have the opportunity to choose, they are free; if they are forced by violence or threat of violence to surrender to the terms of an exchange, no matter how they feel about it, they lack freedom. This slave is unfree precisely because the master assigns him his tasks and determines what he has to receive if he fulfills it.
As regards the social apparatus of repression and coercion, the government, there cannot be any question of freedom. Government is essentially the negation of liberty. It is the recourse to violence or threat of violence in order to make all people obey the orders of the government, whether they like it or not. As far as the government’s jurisdiction extends, there is coercion, not freedom. Government is a necessary institution, the means to make the social system of cooperation work smoothly without being disturbed by violent acts on the part of gangsters whether of domestic or of foreign origin. Government is not, as some people like to say, a necessary evil; it is not an evil, but a means, the only means available to make peaceful human coexistence possible. But it is the opposite of liberty. It is beating, imprisoning, hanging. Whatever a government does it is ultimately supported by the actions of armed constables. If the government operates a school or a hospital, the funds required are collected by taxes, i.e., by payments exacted from the citizens.
If we take into account the fact that, as human nature is, there can neither be civilization nor peace without the functioning of the government apparatus of violent action, we may call government the most beneficial human institution. But the fact remains that government is repression not freedom. Freedom is to be found only in the sphere in which government does not interfere. Liberty is always freedom from the government. It is the restriction of the government’s interference. It prevails only in the fields in which the citizens have the opportunity to choose the way in which they want to proceed. Civil rights are the statutes that precisely circumscribe the sphere in which the men conducting the affairs of state are permitted to restrict the individuals’ freedom to act.
The ultimate end that men aim at by establishing government is to make possible the operation of a definite system of social cooperation under the principle of the division of labor. If the social system which people want to have is socialism (communism, planning) there is no sphere of freedom left. All citizens are in every regard subject to orders of the government. The state is a total state; the regime is totalitarian. The government alone plans and forces everybody to behave according with this unique plan. In the market economy the individuals are free to choose the way in which they want to integrate themselves into the frame of social cooperation. As far as the sphere of market exchange extends, there is spontaneous action on the part of individuals. Under this system that is called laissez-faire, and which Ferdinand Lassalle dubbed as the nightwatchman state, there is freedom because there is a field in which individuals are free to plan for themselves.
The socialists must admit there cannot be any freedom under a socialist system. But they try to obliterate the difference between the servile state and economic freedom by denying that there is any freedom in the mutual exchange of commodities and services on the market. Every market exchange is, in the words of a school of pro-socialist lawyers, “a coercion over other people’s liberty.” There is, in their eyes, no difference worth mentioning between a man’s paying a tax or a fine imposed by a magistrate, or his buying a newspaper or admission to a movie. In each of these cases the man is subject to governing power. He’s not free, for, as professor Hale says, a man’s freedom means “the absence of any obstacle to his use of material goods.”Robert L. Hale, Freedom Through Law, Public Control of Private Governing Power (New York: Columbia University, 1952), pp. 4 ff. This means: I am not free, because a woman who has knitted a sweater, perhaps as a birthday present for her husband, puts an obstacle to my using it. I myself am restricting all other people’s freedom because I object to their using my toothbrush. In doing this I am, according to this doctrine, exercising private governing power, which is analogous to public government power, the powers that the government exercises in imprisoning a man in Sing Sing.
Those expounding this amazing doctrine consistently conclude that liberty is nowhere to be found. They assert that what they call economic pressures do not essentially differ from the pressures the masters practice with regard to their slaves. They reject what they call private governmental power, but they don’t object to the restriction of liberty by public government power. They want to concentrate all what they call restrictions of liberty in the hands of the government. They attack the institution of private property and the laws that, as they say, stand “ready to enforce property rights — that is, to deny liberty to anyone to act in a way which violates them.”Ibid., p. 5.
A generation ago all housewives prepared soup by proceeding in accordance with the recipes that they had got from their mothers or from a cookbook. Today many housewives prefer to buy a canned soup, to warm it and to serve it to their family. But, say our learned doctors, the canning corporation is in a position to restrict the housewife’s freedom because, in asking a price for the tin can, it puts an obstacle to her use of it. People who did not enjoy the privilege of being tutored by these eminent teachers, would say that the canned product was turned out by the cannery, and that the corporation in producing it removed the greatest obstacle to a consumer’s getting and using a can, viz., its nonexistence. The mere essence of a product cannot gratify anybody without its existence. But they are wrong, say the doctors. The corporation dominates the housewife, it destroys by its excessive concentrated power over her individual freedom, and it is the duty of the government to prevent such a gross offense. Corporations, say, under the auspices of the Ford Foundation, another of this group, Professor Berle, must be subjected to the control of the government.A.A. Berle, Jr., Economic Power and the Free Society, a Preliminary Discussion of the Corporation (New York: The Fund for the Republic, 1954).
Why does our housewife buy the canned product rather than cling to the methods of her mother and grandmother? No doubt because she thinks this way of acting is more advantageous for her than the traditional custom. Nobody forced her. There were people — they are called jobbers, promoters, capitalists, speculators, stock exchange gamblers — who had the idea of satisfying a latent wish of millions of housewives by investing in the cannery industry. And there are other equally selfish capitalists who, in many hundreds of other corporations, provide consumers with many hundreds of other things. The better a corporation serves the public, the more customers it gets, the bigger it grows. Go into the home of the average American family and you will see for whom the wheels of the machines are turning.
In a free country nobody is prevented from acquiring riches by serving the consumers better than they are served already. What he needs is only brains and hard work. “Modern civilization, nearly all civilization,” said Edwin Cannan, the last in a long line of eminent British economists, “is based on the principle of making things pleasant for those who please the market, and unpleasant for those who fail to do so.”Edwin Cannan, An Economist’s Protest (London, 1928), pp. VI ff. All this talk about the concentration of economic power is vain. The bigger a corporation is, the more people it serves, the more does it depend on pleasing the consumers, the many, the masses. Economic power, in the market economy, is in the hands of the consumers.
Capitalistic business is not perseverance in the once attained state of production. It is rather ceaseless innovation, daily repeated attempts to improve the provision of the consumers by new, better and cheaper products. Any actual state of production activities is merely transitory. There prevails incessantly the tendency to supplant what is already achieved by something that serves the consumers better. There is consequently under capitalism a continuous circulation of elites. What characterizes the men whom one calls the captains of industry is the ability to contribute new ideas and to put them to work. However big a corporation must be, it is doomed as soon as it does not succeed in adjusting itself daily anew to the best possible methods of serving the consumers. But the politicians and other would-be reformers see only the structure of industry as its exists today. They think that they are clever enough to snatch from business control of the plants as they are today, and to manage them by sticking to already established routines. While the ambitious newcomer, who will be the tycoon of tomorrow, is already preparing plans for things unheard of before, all they have in mind is to conduct affairs along tracks already beaten. There is no record of an industrial innovation contrived and put into practice by bureaucrats. If one does not want to plunge into stagnation, a free hand must be left to those today unknown men who have the ingenuity to lead mankind forward on the way to more and more satisfactory conditions. This is the main problem of a nation’s economic organization.
Private property of the material factors of production is not a restriction of the freedom of all other people to choose what suits them best. It is, on the contrary, the means that assigns to the common man, in his capacity as a buyer, supremacy in all economic affairs. It is the means to stimulate a nation’s most enterprising men to exert themselves to the best of their abilities in the service of all of the people.
VIHowever, one does not exhaustively describe the sweeping changes that capitalism brought about in the conditions of the common man if one merely deals with the supremacy he enjoys on the market as a consumer and in the affairs of state as a voter and with the unprecedented improvement of his standard of living. No less important is the fact that capitalism has made it possible for him to save, to accumulate capital and to invest it. The gulf that in the pre-capitalistic status and caste society separated the owners of property from the penniless poor has been narrowed down. In older ages the journeyman had such a low pay that he could hardly lay by something and, if he nevertheless did so, he could only keep his savings by hoarding and hiding a few coins. Under capitalism his competence makes saving possible, and there are institutions that enable him to invest his funds in business. A not inconsiderable amount of the capital employed in American industries is the counterpart of the savings of employees. In acquiring savings deposits, insurance policies, bonds and also common stock, wage earners and salaried people are themselves earning interest and dividends and thereby, in the terminology of Marxism, are exploiters. The common man is directly interested in the flowering of business not only as a consumer and as an employee, but also as an investor. There prevails a tendency to efface to some extent the once sharp difference between those who own factors of production and those who do not. But, of course, this trend can only develop where the market economy is not sabotaged by allegedly social policies. The welfare state with its methods of easy money, credit expansion and undisguised inflation continually takes bites out of all claims payable in units of the nation’s legal tender. The self-styled champions of the common man are still guided by the obsolete idea that a policy that favors the debtors at the expense of the creditors is very beneficial to the majority of the people. Their inability to comprehend the essential characteristics of the market economy manifests itself also in their failure to see the obvious fact that those whom they feign to aid are creditors in their capacity as savers, policy holders, and owners of bonds.
VIIThe distinctive principle of Western social philosophy is individualism. It aims at the creation of a sphere in which the individual is free to think, to choose, and to act without being restrained by the interference of the social apparatus of coercion and oppression, the State. All the spiritual and material achievements of Western civilization were the result of the operation of this idea of liberty.
This doctrine and the policies of individualism and of capitalism, its application to economic matters, do not need any apologists or propagandists. The achievements speak for themselves.
The case for capitalism and private property rests, apart from other considerations, also upon the incomparable efficiency of its productive effort. It is this efficiency that makes it possible for capitalistic business to support a rapidly increasing population at a continually improving standard of living. The resulting progressive prosperity of the masses creates a social environment in which the exceptionally gifted individuals are free to give to their fellow-citizens all they are able to give. The social system of private property and limited government is the only system that tends to debarbarize all those who have the innate capacity to acquire personal culture.
It is a gratuitous pastime to belittle the material achievements of capitalism by observing that there are things that are more essential for mankind than bigger and speedier motorcars, and homes equipped with central heating, air conditioning, refrigerators, washing machines, and television sets. There certainly are such higher and nobler pursuits. But they are higher and nobler precisely because they cannot be aspired to by any external effort, but require the individual’s personal determination and exertion. Those levelling this reproach against capitalism display a rather crude and materialistic view in assuming that moral and spiritual culture could be built either by the government or by the organization of production activities. All that these external factors can achieve in this regard is to bring about an environment and a competence which offers the individuals the opportunity to work at their own personal perfection and edification. It is not the fault of capitalism that the masses prefer a boxing match to a performance of Sophocles’s Antigone, jazz music to Beethoven symphonies, and comics to poetry. But it is certain that while pre-capitalistic conditions as they still prevail in the much greater part of the world makes these good things accessible only to a small minority of people, capitalism gives to the many a favorable chance of striving after them.
From whatever angle one may look at capitalism there is no reason to lament the passing of the allegedly good old days. Still less is it justified to long for the totalitarian utopias, whether of the Nazi or of the Soviet type.
We are inaugurating tonight the ninth meeting of the Mont Pelerin Society. It is fitting to remember on this occasion that meetings of this kind in which opinions opposed to those of the majority of our contemporaries and to those of their governments are advanced and are possible only in the climate of liberty and freedom that is the most precious mark of Western civilization. Let us hope that this right to dissent will never disappear.
Money, Method, and The Market Process[Ludwig von Mises, Money, Method, and the Market Process: Essays by Ludwig von Mises, ed. Richard M. Ebeling (1950; Norwell, Mass. and Auburn, Ala.: Kluwer Academic Publishers and Mises Institute, 1990), chap. 21, pp. 303–12.]“The Idea of Liberty Is Western”The history of civilization is the record of a ceaseless struggle for liberty.
Social cooperation under the division of labor is the ultimate and sole source of man’s success in his struggle for survival and his endeavors to improve as much as possible the material conditions of his well-being. But as human nature is, society cannot exist if there is no provision for preventing unruly people from actions incompatible with community life. In order to preserve peaceful cooperation, one must be ready to resort to violent suppression of those disturbing the peace. Society cannot do without a social apparatus of coercion and compulsion, i.e., without state and government. Then a further problem emerges: to restrain the men who are in charge of the governmental functions lest they abuse their power and convert all other people into virtual slaves. The aim of all struggles for liberty is to keep in bounds the armed defenders of peace, the governors and their constables. Freedom always means: freedom from arbitrary action on the part of the police power.
The idea of liberty is and has always been peculiar to the West. What separates East and West is first of all the fact that the peoples of the East never conceived the idea of liberty. The imperishable glory of the ancient Greeks was that they were the first to grasp the meaning and significance of institutions warranting liberty. Recent historical research has traced back to Oriental sources the origin of some of the scientific achievements previously credited to the Hellenes. But nobody has ever contested that the idea of liberty was created in the cities of ancient Greece. The writings of Greek philosophers and historians transmitted it to the Romans and later to modern Europe and America. It became the essential concern of all Western plans for the establishment of the good society. It begot the laissez-faire philosophy to which mankind owes all the unprecedented achievements of the age of capitalism.
The meaning of all modern political and judicial institutions is to safeguard the individuals’ freedom against encroachments on the part of the government. Representative government and the rule of law, the independence of courts and tribunals from interference on the part of administrative agencies, habeas corpus, judicial examination and redress of acts of the administration, freedom of speech and the press, separation of state and church, and many other institutions aimed at one end only: to restrain the discretion of the officeholders and to render the individuals free from their arbitrariness.
The age of capitalism has abolished all vestiges of slavery and serfdom. It has put an end to cruel punishments and has reduced the penalty for crimes to the minimum indispensable for discouraging offenders. It has done away with torture and other objectionable methods of dealing with suspects and lawbreakers. It has repealed all privileges and promulgated equality of all men under the law. It has transformed the subjects of tyranny into free citizens.The material improvements were the fruit of these reforms and innovations in the conduct of government affairs. As all privileges disappeared and everybody was granted the right to challenge the vested interests of all other people, a free hand was given to those who had the ingenuity to develop all the new industries which today render the material conditions of people more satisfactory. Population figures multiplied and yet the increased population could enjoy a better life than their ancestors.
Also in the countries of Western civilization there have always been advocates of tyranny — the absolute arbitrary rule of an autocrat or an aristocracy on the one hand and the subjection of all other people on the other hand. But in the Age of Enlightenment the voices of these opponents became thinner and thinner. The cause of liberty prevailed. In the first part of the nineteenth century the victorious advance of the principle of freedom seemed to be irresistible. The most eminent philosophers and historians got the conviction that historical evolution tends toward the establishment of institutions warranting freedom and that no intrigues and machinations on the part of the champions could stop the trend toward liberalism.
IIIn dealing with the preponderance of the liberal social philosophy there is a disposition to overlook the power of an important factor that worked in favor of the idea of liberty, viz., the eminent role assigned to the literature of ancient Greece in the education of the elite. There were among the Greek authors also champions of government omnipotence, such as Plato. But the essential tenor of Greek ideology was the pursuit of liberty. Judged by the standards of modern liberal and democratic institutions, the Greek city-states must be called oligarchies. The liberty which the Greek statesmen, philosophers and historians glorified as the most precious good of man was a privilege reserved to a minority. In denying it to metics and slaves they virtually advocated the despotic rule of an hereditary caste of oligarchs. Yet it would be a grave error to dismiss their hymns to liberty as mendacious. They were no less sincere in their praise and quest of freedom than were, two thousand years later, the slaveholders George Washington and Thomas Jefferson. It was the political literature of the ancient Greeks that begot the ideas of the Monarchomachs, the philosophy of the Whigs, the doctrines of Althusius, Grotius, and John Locke, and the ideology of the fathers of modern constitutions and bills of rights. It was the classical studies, the essential feature of a liberal education, that kept awake the spirit of freedom in England of the Stuarts and George III, in France of the Bourbons, and in Italy, subject to the despotism of a galaxy of princes.
No less a man than Bismarck, among the nineteenth-century statesmen the foremost foe of liberty, bears witness to the fact that even in the Prussia of Frederick William III the Gymnasium was a stronghold of republicanism.Cf. Otto von Bismarck, Gedanken und Erinnerungen, vol. 1 (New York: Cotta, 1898), p. 1. The passionate endeavors to eliminate the classical studies from the curriculum of the liberal education and thus virtually to destroy its very character were one of the major manifestations of the revival of the servile ideology.
It is a fact that a hundred years ago only a few people anticipated the overpowering momentum which the antiliberal ideas were destined to acquire in a very short time. The ideal of liberty seemed to be so firmly rooted that everybody thought that no reactionary movement could ever succeed in eradicating it. It is true, it would have been a hopeless venture to attack freedom openly and to advocate unfeignedly a return to subjection and bondage. But antiliberalism got hold of people’s minds camouflaged as superliberalism, as the fulfillment and consummation of the very ideas of freedom and liberty. It came disguised as socialism, communism, and planning.
No intelligent man could fail to recognize that what the socialists, communists, and planners were aiming at was the most radical abolition of the individual’s freedom and the establishment of government omnipotence. Yet the immense majority of the socialist intellectuals were convinced that in fighting for socialism they were fighting for freedom. They called themselves left-wingers and democrats, and nowadays they are even claiming for themselves the epithet liberals.
These intellectuals and the masses who followed their lead were in their subconsciousness fully aware of the fact that their failure to attain the far-flung goals which their ambition impelled them to aim at was due to deficiencies of their own. They were either not bright enough or not industrious enough. But they were eager not to avow their inferiority both to themselves and to their fellow men and to search for a scapegoat. They consoled themselves and tried to convince other people that the cause of their failure was not their own inferiority but the injustice of society’s economic organization. Under capitalism, they declared, self-realization is only possible for the few. “Liberty in a laissez-faire society is attainable only by those who have the wealth or opportunity to purchase it.”Cf. H. Laski, “Liberty” in Encyclopaedia of the Social Sciences (New York: Macmillan, 1930), vol. 9, p. 448. Hence, they concluded, the state must interfere in order to realize “social justice.” What they really meant is, in order to give to the frustrated mediocrity “according to his needs.”
IIIAs long as the problems of socialism were merely a matter of debates people who lack clear judgment and understanding could fall prey to the illusion that freedom could be preserved even under a socialist regime. Such self-deceit can no longer be nurtured since the Soviet experience has shown to everybody what conditions are in a socialist commonwealth. Today the apologists of socialism are forced to distort facts and to misrepresent the manifest meaning of words when they want to make people believe in the compatibility of socialism and freedom.
The late Professor Laski — a self-styled noncommunist or even anticommunist — told us that “no doubt in Soviet Russia a Communist has a full sense of liberty; no doubt also he has a keen sense that liberty is denied him in Fascist Italy.”Cf. Ibid., pp. 445–46. The truth is that a Russian is free to obey all the orders issued by the great dictator. But as soon as he deviates a hundredth of an inch from the correct way of thinking as laid down by the authorities, he is mercilessly liquidated. All those politicians, office-holders, authors, musicians, and scientists who were “purged” were — to be sure — not anticommunists. They were, on the contrary, fanatical communists, party members in good standing, whom the supreme authorities, in due recognition of their loyalty to the Soviet creed, had promoted to high positions. The only offense they had committed was that they were not quick enough in adjusting their ideas, policies, books or compositions to the latest changes in the ideas and tastes of Stalin. It is difficult to believe that these people had “a full sense of liberty” if one does not attach to the word liberty a sense which is precisely the contrary of the sense which all people always used to attach to it.
Fascist Italy was certainly a country in which there was no liberty. It had adopted the notorious Soviet pattern of the “one party principle” and accordingly suppressed all dissenting views. Yet there was still a conspicuous difference between the Bolshevik and the Fascist application of this principle. For instance, there lived in Fascist Italy a former member of the parliamentary group of communist deputies, who remained loyal unto death to his communist tenets, Professor Antonio Graziadei. He regularly received the pension which he was entitled to claim as professor emeritus, and he was free to write and to publish, with the most eminent Italian publishing firms, books which were orthodox Marxian. His lack of liberty was certainly less rigid than that of the Russian communists who, as Professor Laski chose to say, “no doubt” have “a full sense of liberty.”
Professor Laski took pleasure in repeating the truism that liberty in practice always means liberty within law. He went on saying that the law always aims at “the conference of security upon a way of life which is deemed satisfactory by those who dominate the machinery of state.”Cf. Ibid., p. 446. This is a correct description of the laws of a free country if it means that the law aims at protecting society against conspiracies intent upon kindling civil war and upon overthrowing the government by violence. But it is a serious misstatement when Professor Laski adds that in a capitalistic society “an effort on the part of the poor to alter in a radical way the property rights of the rich at once throws the whole scheme of liberties into jeopardy.”Cf. Ibid., p. 446.
Take the case of the great idol of Professor Laski and all his friends, Karl Marx. When in 1848 and 1849 he took an active part in the organization and the conduct of the revolution, first in Prussia and later also in other German states, he was — being legally an alien — expelled and moved, with his wife, his children, and his maid, first to Paris and then to London.About Marx’s activities in the years 1848 and 1849 see: Karl Marx, “Chronikseines Lebens in Einzeldaten” (Moscow: Marx-Engels-Lenin-Institute, 1934), pp. 48–81. Later, when peace returned and the abettors of the abortive revolution were amnestied, he was free to return to all parts of Germany and often made use of this opportunity. He was no longer an exile, and he chose of his own account to make his home in London.In 1845 Marx voluntarily renounced his Prussian citizenship. When later, in the early 1860s, he considered a political career in Prussia, the ministry denied his application for restoring his citizenship. Thus a political career was closed to him. Perhaps this fact decided him to remain in London. Nobody molested him when he founded, in 1864, the International Working Men’s Association, a body whose avowed sole purpose it was to prepare the great world revolution. He was not stopped when on behalf of this association he visited various Continental countries. He was free to write and to publish books and articles which, to use the words of Professor Laski, were certainly an effort “to alter in a radical way the property rights of the rich.” And he died quietly in his home, 41, Maitland Park Road, on March 14, 1883.
Or take the case of the British Labor Party. Their effort “to alter in a radical way the property rights of the rich” was, as professor Laski knew very well, not hindered by any action incompatible with the principle of liberty.
Marx, the dissenter, could at ease live, write and advocate revolution in Victorian England just as the Labor Party could at ease engage in all political activities in post-Victorian England. In Soviet Russia not the slightest opposition is tolerated. This is what the difference between liberty and slavery means.
IVThe critics of the legal and constitutional concept of liberty and the institutions devised for its practical realization are right in their assertion that freedom from arbitrary action on the part of the officeholders is in itself not yet sufficient to make an individual free. But in emphasizing this indisputable truth they are running against open doors. For no advocate of liberty ever contended that to restrain the arbitrariness of officialdom is all that is needed to make the citizens free. What gives to the individuals as much freedom as is compatible with life in society is the operation of the market system. The constitutions and bills of rights do not create freedom. They merely protect the freedom that the competitive economic system grants to the individuals against encroachments on the part of the police power.
In the market economy people have the opportunity to strive after the station they want to attain in the structure of the social division of labor. They are free to choose the vocation in which they plan to serve their fellow men. In a planned economy they lack this right. Here the authorities determine each man’s occupation. The discretion of the superiors promotes a man to a better position or denies him such promotion. The individual entirely depends on the good graces of those in power. But under capitalism everybody is free to challenge the vested interests of everybody else. If he thinks that he has the ability to supply the public better or more cheaply than other people do, he may try to demonstrate his efficiency. Lack of funds cannot frustrate his projects. For the capitalists are always in search of men who can utilize their funds in the most profitable way. The outcome of his business activities depends alone on the conduct of the consumers who buy what fits them best.
Neither does the wage earner depend on the employer’s arbitrariness. An entrepreneur who fails to hire those workers who are best fitted for the job concerned and to pay them enough to prevent them from taking another job is penalized by a reduction of net revenue. The employer does not grant to his employees a favor. He hires them as an indispensable means for the success of his business in the same way in which he buys raw materials and factory equipment. The worker is free to find the employment which suits him best.
The process of social selection that determines each individual’s position and income is continuously going on in the capitalist society. Great fortunes are shrinking and finally melting away completely while other people, born in poverty, ascend to eminent positions and considerable incomes. Where there are no privileges and governments do not grant protection to vested interests threatened by the superior efficiency of newcomers, those who have acquired wealth in the past are forced to acquire it every day anew in competition with all other people.
Within the framework of social cooperation under the division of labor everybody depends on the recognition of his services on the part of the buying public of which he himself is a member. Everybody in buying or abstaining from buying is a member of the supreme court which assigns to all people — and thereby also to himself — a definite place in society. Everybody is instrumental in the process that assigns to some people a higher and to others a smaller income. Everybody is free to make a contribution which his fellow men are prepared to reward by the allocation of a higher income. Freedom under capitalism means: not to depend more on other people’s discretion than these others depend on one’s own. No other freedom is conceivable where production is performed under the division of labor and there is no perfect economic autarky of everybody.
There is need to stress the point that the essential argument advanced in favor of capitalism and against socialism is not the fact that socialism must necessarily abolish all vestiges of freedom and convert all people into slaves of those in power. Socialism is unrealizable as an economic system because a socialist society would not have any possibility of resorting to economic calculation. This is why it cannot be considered as a system of society’s economic organization. It is a means to disintegrate social cooperation and to bring about poverty and chaos.
VIn dealing with the liberty issue one does not refer to the essential economic problem of the antagonism between capitalism and socialism. One rather points out that Western man as different from the Asiatics is entirely a being adjusted to life in freedom and formed by life in freedom. The civilizations of China, Japan, India, and the Mohammedan countries of the Near East as they existed before these nations became acquainted with Western ways of life certainly cannot be dismissed as barbarism. These peoples already many hundreds, even thousands of years ago brought about marvelous achievements in the industrial arts, in architecture, in literature and philosophy and in the development of educational institutions. They founded and organized powerful empires. But then their effort was arrested, their cultures became numb and torpid, and they lost the ability to cope successfully with economic problems. Their intellectual and artistic genius withered away. Their artists and authors bluntly copied traditional patterns. Their theologians, philosophers, and lawyers indulged in unvarying exegesis of old works. The monuments erected by their ancestors crumbled. Their empires disintegrated. Their citizens lost vigor and energy and became apathetic in the face of progressing decay and impoverishment.
The ancient works of Oriental philosophy and poetry can compare with the most valuable works of the West. But for many centuries the East has not generated any book of importance. The intellectual and literary history of modern ages hardly records any name of an Oriental author. The East has no longer contributed anything to the intellectual effort of mankind. The problems and controversies that agitated the West remained unknown to the East. In Europe there was commotion; in the East there was stagnation, indolence, and indifference.
The reason is obvious. The East lacked the primordial thing, the idea of freedom from the state. The East never raised the banner of freedom, it never tried to stress the rights of the individual against the power of the rulers. It never called into question the arbitrariness of the despots. And, first of all, it never established the legal framework that would protect the private citizens’ wealth against confiscation on the part of the tyrants. On the contrary, deluded by the idea that the wealth of the rich is the cause of the poverty of the poor, all people approved of the practice of the governors of expropriating successful businessmen. Thus big scale capital accumulation was prevented, and the nations had to miss all those improvements that require considerable investment of capital. No “bourgeoisie” could develop, and consequently there was no public to encourage and to patronize authors, artists, and inventors.
To the sons of the people all roads toward personal distinction were closed but one. They could try to make their way in serving the princes. Western society was a community of individuals who could compete for the highest prizes. Eastern society was an agglomeration of subjects entirely depending on the good graces of the sovereigns. The alert youth of the West looks upon the world as a field of action in which he can win fame, eminence, honors, and wealth; nothing appears too difficult for his ambition. The meek progeny of Eastern parents know of nothing else than to follow the routine of their environment. The noble self-reliance of Western man found triumphant expression in such dithyrambs as Sophocles’s choric Antigone hymn upon man and his enterprising effort and Beethoven’s Ninth Symphony. Nothing of the kind has ever been heard in the Orient.
Is it possible that the scions of the builders of the white man’s civilization should renounce their freedom and voluntarily surrender to the suzerainty of omnipotent government? That they should seek contentment in a system in which their only task will be to serve as cogs in a vast machine designed and operated by an almighty planmaker? Should the mentality of the arrested civilizations sweep the ideals for the ascendancy of which thousands and thousands have sacrificed their lives?
Ruere in servitium, they plunged into slavery, Tacitus sadly observed in speaking of the Romans of the age of Tiberius.
Interventionism: An Economic Analysis[Ludwig von Mises, Interventionism: An Economic Analysis (Irvington-on-Hudson, N.Y.: The Foundation for Economic Education, 1998), chap. 3, “Inflation and Credit Expansion,” pp. 39–44.]2. Credit ExpansionIt is a fundamental fact of human behavior that people value present goods higher than future goods. An apple available for immediate consumption is valued higher than an apple which will be available next year. And an apple which will be available in a year is in turn valued higher than an apple which will become available in five years. This difference in valuation appears in the market economy in the form of the discount, to which future goods are subject as compared to present goods. In money transactions this discount is called interest.
Interest therefore cannot be abolished. In order to do away with interest we would have to prevent people from valuing a house, which today is habitable, more highly than a house which will not be ready for use for ten years. Interest is not peculiar to the capitalistic system only. In a socialist community too the fact will have to be considered that a loaf of bread which will not be ready for consumption for another year does not satisfy present hunger.
Interest does not have its origin in the meeting of supply and demand of money loans in the capital market. It is rather the function of the loan market, which in business terms is called the money market (for short-term credit) and the capital market (for long-term credit), to adjust the interest rates for loans transacted in money to the difference in the valuation of present and future goods. This difference in valuation is the real source of interest. An increase in the quantity of money, no matter how large, cannot in the long run influence the rate of interest.
No other economic law is less popular than this, that interest rates are, in the long run, independent of the quantity of money. Public opinion is reluctant to recognize interest as a market phenomenon. Interest is thought to be an evil, an obstacle to human welfare, and, therefore, it is demanded that it be eliminated or at least considerably reduced. And credit expansion is considered the proper means to bring about “easy money.”
There is no doubt that credit expansion leads to a reduction of the interest rate in the short run. At the beginning, the additional supply of credit forces the interest rate for money loans below the point which it would have in an unmanipulated market. But it is equally clear that even the greatest expansion of credit cannot change the difference in the valuation of future and present goods. The interest rate must ultimately return to the point at which it corresponds to this difference in the valuation of goods. The description of this process of adjustment is the task of that part of economics which is called the theory of the business cycle.
At every constellation of prices, wages, and interest rates, there are projects which will not be carried out because a calculation of their profitability shows that there is no chance for the success of such undertakings. The businessman does not have the courage to start the enterprise because his calculations convince him that he will not gain, but will lose by it.
This unattractiveness of the project is not a consequence of money or credit conditions; it is due to the scarcity of economic goods and labor and to the fact that they have to be devoted to more urgent and therefore more attractive uses.
When the interest rate is artificially lowered by credit expansion the false impression is created that enterprises which previously had been regarded as unprofitable now become profitable. Easy money induces the entrepreneurs to embark upon businesses which they would not have undertaken at a higher interest rate. With the money borrowed from the banks they enter the market with additional demand and cause a rise in wages and in the prices of the means of production. This boom of course would have to collapse immediately in the absence of further credit expansion, because these price increases would make the new enterprises appear unprofitable again. But if the banks continue with the credit expansion this brake fails to work. The boom continues.
But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system.As explained in this section on “Credit Expansion.” Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.
It is obvious that a mere banking process like credit expansion cannot create more goods and wealth. What the credit expansion actually accomplishes is to introduce a source of error in the calculations of the entrepreneurs and thus causes them to misjudge business and investment projects. The entrepreneurs act as if more producers’ goods were available than are actually at hand. They plan expansion of production on a scale for which the available quantities of producers’ goods are not sufficient. These plans are bound to fail because of the deficiency in the available amount of producers’ goods. The result is that there are plants which cannot be used because the complementary facilities are lacking; there are plants which cannot be completed; there are other plants again whose products cannot be sold because consumers desire other products more urgently which cannot be produced in sufficient quantities because the necessary productive facilities are not ready. The boom is not over-investment, it is misdirected investment.
It is frequently argued against this conclusion that it would hold true only if at the beginning of the credit expansion there were neither unused capacity nor unemployment. If there were unemployment and idle capacity, things would be different, they claim. But these assumptions do not affect the argument.
The fact that a part of the productive capacity which cannot be diverted to other uses is unused is the consequence of errors of the past. Investments were made in the past under assumptions which proved to be incorrect; the market now demands something else than what can be produced by these facilities.In the absence of credit expansion there also may be plants which are not fully utilized. But they do not disturb the market any more than does the unused submarginal land. The accumulation of inventories is speculation. The owner does not want to sell the goods at the current market price because he hopes to realize a higher price at a future date. Unemployment of workers is also an aspect of speculation. The worker does not want to change his location or occupation, nor does he want to lower his wage demands because he hopes to find the work he prefers at the place he prefers and at higher wages. Both the owners of merchandise and the unemployed refuse to adjust themselves to market conditions because they hope for new data which would change market conditions to their advantage. Because they do not make the necessary adjustments the economic system cannot reach “equilibrium.”
In the opinion of the advocates of credit expansion, what is necessary fully to utilize the unused capacity, to sell the supply at prices acceptable to the owners, and to enable the unemployed to find work at wages satisfactory to them is merely additional credit which such expansion could provide. This is the view which underlies all plans for “pump priming.” It would be correct for the stocks of goods and for the unemployed under two conditions: (1) if the price rises caused by the additional quantity of money and credit would uniformly and simultaneously affect all other prices and wages, and (2) if the owners of the excessive supplies and the unemployed would not increase their prices and wage demands. This would cause the exchange ratios between these goods and services and other goods and services to change in the same way as they would have to be changed in the absence of credit expansion, by reducing the price and wage demands in order to find buyers and employers.
The course of the boom is not any different because, at its inception, there are unused productive capacity, unsold stocks of goods, and unemployed workers. We might assume, for instance, that we are dealing with copper mines, copper inventories, and copper miners. The price of copper is at a point at which a number of mines cannot profitably continue their production; their workers must remain idle if they do not want to change jobs; and the owners of the copper stocks can only sell part of it if they are unwilling to accept a lower price. What is needed to put the idle mines and miners back to work and to dispose of the copper supply without a price drop is an increase (p) in producers’ goods in general, which would permit an expansion of overall production, so that an increase in the price, sales, and production of copper would follow. If this increase (p) does not occur, but the entrepreneurs are induced by credit expansion to act as if it had occurred, the effects on the copper market will first be the same as if p actually had appeared. But everything that has been said before of the effects of credit expansion develops in this case as well. The sole difference is that misdirected capital investment, as far as copper is concerned, does not necessitate the withdrawal of capital and labor from other branches of production, which under existing conditions are considered more important by the consumers. But this is only due to the fact that, as far as copper is concerned, the credit expansion boom impinges upon previously misdirected capital and labor which have not yet been adjusted by the normal corrective processes of the price mechanism.
The true meaning of the argument of unused capacity, unsold — or, as it is said inaccurately, unsalable — inventories, and idle labor, now becomes apparent. The beginning of every credit expansion encounters such remnants of older, misdirected capital investments and apparently “corrects” them. In actuality, it does nothing but disturb the workings of the adjustment process. The existence of unused means of production does not invalidate the conclusions of the monetary theory of the business cycle. The advocates of credit expansion are mistaken when they believe that, in view of unused means of production, the suppression of all possibilities of credit expansion would perpetuate the depression. The measures they propose would not perpetuate real prosperity, but would constantly interfere with the process of readjustment and the return of normal conditions.
It is impossible to explain the cyclical changes of business on any basis other than the theory which commonly is referred to as the monetary theory of the business cycle. Even those economists who refuse to recognize in the monetary theory the proper explanation of the business cycle have never attempted to deny the validity of its conclusions about the effects of credit expansion. In order to defend their theories about the business cycle, which differ from the monetary theory, they still have to admit that the upswing cannot occur without simultaneous credit expansion, and that the end of the credit expansion also marks the turning point of the cycle. The opponents of the monetary theory actually confine themselves to the assertion that the upswing of the cycle is not caused by credit expansion, but by other factors, and that the credit expansion, without which the upswing would be impossible, is not the result of a policy intended to lower the interest rate and to invite the execution of additional business plans, but that it is released somehow by conditions leading to the upswing without intervention by the banks or by the authorities.
It has been asserted that the credit expansion is released by the rise in the rate of interest through the failure of the banks to raise their interest rates in accordance with the rise in the “natural” rate.[Fritz] Machlup, (The Stock Market, Credit and Capital Formation, London, 1940), p. 248, speaks of “passive inflationism.” This argument too misses the main point of the monetary theory of the cycle. Whether the credit expansion gets under way because the banks ease credit terms, or because they fail to stiffen the terms in accordance with changed market conditions, is of minor importance.If a bank is unable to expand credit it cannot create an upswing even if it lowers its interest rate below the market rate. It would merely make a gift to its debtors. The conclusion to be drawn from the monetary theory of the cycle with regard to stabilizing measures is not the postulate that the banks should not lower the interest rate, but that they should not expand credit. This [Gottfried] Haberler (Prosperity and Depression, League of Nations, Geneva, 1939, pp. 65 ff.) misunderstood and therefore his criticisms are untenable. Decisive only is the fact that there is credit expansion because there exist institutions which consider it their task to influence interest rates by the granting of additional credit. Whoever believes that credit expansion is a necessary factor in the movement which forces the economy into the upswing, which must be followed by a crisis and depression, would have to admit that the surest means to achieve a cycle-proof economic system lies in preventing credit expansion. But despite the general agreement that measures should be taken to smooth the wave-like movements of the cycle, measures to prevent credit expansion do not receive consideration. Business cycle policy is given the task to perpetuate the upswing created by the credit expansion and yet to prevent the breakdown. Proposals to prevent credit expansion are refuted because supposedly they would perpetuate the depression. Nothing could be a more convincing proof of the theory which explains the business cycle as originating from interventions in favor of easy money than the obstinate refusal to abandon credit expansion.
One would have to ignore all facts of recent economic history were one to deny that measures to lower rates are considered desirable and that credit expansion is regarded as the most reliable means to achieve this aim. The fact that the smooth functioning and the development and steady progress of the economy is over and over again disturbed by artificial booms and ensuing depressions is not a necessary characteristic of the market economy. It is rather the inevitable consequence of repeated interventions which intend to create easy money by credit expansion.
The Causes of the Economic Crisis and Other Essays Before and After the Great Depression[Ludwig von Mises, “Monetary Stabilization and Cyclical Policy,” in The Causes of the Economic Crisis and Other Essays Before and After the Great Depression, ed. Percy L. Greaves, Jr. (1928; Auburn, Ala.: Mises Institute, 2006), chap. 2: “Circulation Credit Theory,” pp. 103–15.]“Monetary Stabilization and Cyclical Policy”
- The Banking School FallacyIf notes are issued by the banks, or if bank deposits subject to check or other claim are opened, in excess of the amount of money kept in the vaults as cover, the effect on prices is similar to that obtained by an increase in the quantity of money. Since these fiduciary media, as notes and bank deposits not backed by metal are called, render the service of money as safe and generally accepted, payable on demand monetary claims, they may be used as money in all transactions. On that account, they are genuine money substitutes. Since they are in excess of the given total quantity of money in the narrower sense, they represent an increase in the quantity of money in the broader sense.
The practical significance of these undisputed and indisputable conclusions in the formation of prices is denied by the Banking School with its contention that the issue of such fiduciary media is strictly limited by the demand for money in the economy. The Banking School doctrine maintains that if fiduciary media are issued by the banks only to discount short-term commodity bills, then no more would come into circulation than were “needed” to liquidate the transactions. According to this doctrine, bank management could exert no influence on the volume of the commodity transactions activated. Purchases and sales from which short-term commodity bills originate would, by this very transaction, already have brought into existence paper credit which can be used, through further negotiation, for the exchange of goods and services. If the bank discounts the bill and, let us say, issues notes against it, that is, according to the Banking School, a neutral transaction as far as the market is concerned. Nothing more is involved than replacing one instrument which is technically less suitable for circulation, the bill of exchange, with a more suitable one, the note. Thus, according to this School, the effect of the issue of notes need not be to increase the quantity of money in circulation. If the bill of exchange is retired at maturity, then notes would flow back to the bank and new notes could enter circulation again only when new commodity bills came into being once more as a result of new business.
The weak link in this well-known line of reasoning lies in the assertion that the volume of transactions completed, as sales and purchases from which commodity bills can derive, is independent of the behavior of the banks. If the banks discount at a lower, rather than at a higher, interest rate, then more loans are made. Enterprises which are unprofitable at 5 percent, and hence are not undertaken, may be profitable at 4 percent. Therefore, by lowering the interest rate they charge, banks can intensify the demand for credit. Then, by satisfying this demand, they can increase the quantity of fiduciary media in circulation. Once this is recognized, the Banking Theory’s only argument, that prices are not influenced by the issue of fiduciary media, collapses.
One must be careful not to speak simply of the effects of credit in general on prices, but to specify clearly the effects of “increased credit” or “credit expansion.” A sharp distinction must be made between (1) credit which a bank grants by lending its own funds or funds placed at its disposal by depositors, which we call “commodity credit,” and (2) that which is granted by the creation of fiduciary media, i.e., notes and deposits not covered by money, which we call “circulation credit.” It is only through the granting of circulation credit that the prices of all commodities and services are directly affected.
If the banks grant circulation credit by discounting a three month bill of exchange, they exchange a future good — a claim payable in three months — for a present good that they produce out of nothing. It is not correct, therefore, to maintain that it is immaterial whether the bill of exchange is discounted by a bank of issue or whether it remains in circulation, passing from hand to hand. Whoever takes the bill of exchange in trade can do so only if he has the resources. But the bank of issue discounts by creating the necessary funds and putting them into circulation. To be sure, the fiduciary media flow back again to the bank at expiration of the note. If the bank does not give the fiduciary media out again, precisely the same consequences appear as those which come from a decrease in the quantity of money in its broader sense.
- Early Effects of Credit ExpansionThe fact that in the regular course of banking operations the banks issue fiduciary media only as loans to producers and merchants means that they are not used directly for purposes of consumption. Rather, these fiduciary media are used first of all for production, that is to buy factors of production and pay wages. The first prices to rise, therefore, as a result of an increase of the quantity of money in the broader sense, caused by the issue of such fiduciary media, are those of raw materials, semimanufactured products, other goods of higher orders, and wage rates. Only later do the prices of goods of the first order [consumers’ goods] follow. Changes in the purchasing power of a monetary unit, brought about by the issue of fiduciary media, follow a different path and have different accompanying social side effects from those produced by a new discovery of precious metals or by the issue of paper money. Still in the last analysis, the effect on prices is similar in both instances.
Changes in the purchasing power of the monetary unit do not directly affect the height of the rate of interest. An indirect influence on the height of the interest rate can take place as a result of the fact that shifts in wealth and income relationships, appearing as a result of the change in the value of the monetary unit, influence savings and, thus, the accumulation of capital. If a depreciation of the monetary unit favors the wealthier members of society at the expense of the poorer, its effect will probably be an increase in capital accumulation since the well-to-do are the more important savers. The more they put aside, the more their incomes and fortunes will grow.
If monetary depreciation is brought about by an issue of fiduciary media, and if wage rates do not promptly follow the increase in commodity prices, then the decline in purchasing power will certainly make this effect much more severe. This is the “forced savings” which is quite properly stressed in recent literature.Albert Hahn and Joseph Schumpeter have given me credit for the expression “forced savings” or “compulsory savings.” However, three things should not be forgotten. First, it always depends upon the data of the particular case whether shifts of wealth and income, which lead to increased saving, are actually set in motion. Second, under circumstances which need not be discussed further here, by falsifying economic calculation, based on monetary bookkeeping calculations, a very substantial devaluation can lead to capital consumption (such a situation did take place temporarily during the recent inflationary period). Third, as advocates of inflation through credit expansion should observe, any legislative measure which transfers resources to the “rich” at the expense of the “poor” will also foster capital formation.
Eventually, the issue of fiduciary media in such manner can also lead to increased capital accumulation within narrow limits and, hence, to a further reduction of the interest rate. In the beginning, however, an immediate and direct decrease in the loan rate appears with the issue of fiduciary media, but this immediate decrease in the loan rate is distinct in character and degree from the later reduction. The new funds offered on the money market by the banks must obviously bring pressure to bear on the rate of interest. The supply and demand for loan money were adjusted at the interest rate prevailing before the issue of any additional supply of fiduciary media. Additional loans can be placed only if the interest rate is lowered. Such loans are profitable for the banks because the increase in the supply of fiduciary media calls for no expenditure except for the mechanical costs of banking (i.e., printing the notes and bookkeeping). The banks can, therefore, undercut the interest rates which would otherwise appear on the loan market, in the absence of their intervention. Since competition from them compels other money lenders to lower their interest charges, the market interest rate must therefore decline. But can this reduction be maintained? That is the problem.
- Inevitable Effects of Credit Expansion on Interest RatesIn conformity with Wicksell’s terminology, we shall use “natural interest rate” to describe that interest rate which would be established by supply and demand if real goods were loaned in natura [directly, as in barter] without the intermediary of money. “Money rate of interest” will be used for that interest rate asked on loans made in money or money substitutes. Through continued expansion of fiduciary media, it is possible for the banks to force the money rate down to the actual cost of the banking operations, practically speaking that is almost to zero. As a result, several authors have concluded that interest could be completely abolished in this way. Whole schools of reformers have wanted to use banking policy to make credit gratuitous and thus to solve the “social question.” No reasoning person today, however, believes that interest can ever be abolished, nor doubts but what, if the “money interest rate” is depressed by the expansion of fiduciary media, it must sooner or later revert once again to the “natural interest rate.” The question is only how this inevitable adjustment takes place. The answer to this will explain at the same time the fluctuations of the business cycle.
The Currency Theory limited the problem too much. It only considered the situation that was of practical significance for the England of its time — that is, when the issue of fiduciary media is increased in one country while remaining unchanged in others. Under these assumptions, the situation is quite clear: General price increases at home; hence an increase in imports, a drop in commodity exports; and with this, as notes can circulate only within the country, an outflow of metallic money. To obtain metallic money for export, holders of notes present them for redemption; the metallic reserves of the banks decline; and consideration for their own solvency then forces them to restrict the credit offered.
That is the instant at which the business upswing, brought about by the availability of easy credit, is demonstrated to be illusory prosperity. An abrupt reaction sets in. The “money rate of interest” shoots up; enterprises from which credit is withdrawn collapse and sweep along with them the banks which are their creditors. A long persisting period of business stagnation now follows. The banks, warned by this experience into observing restraint, not only no longer underbid the “natural interest rate” but exercise extreme caution in granting credit.
- The Price PremiumIn order to complete this interpretation, we must, first of all, consider the price premium. As the banks start to expand the circulation credit, the anticipated upward movement of prices results in the appearance of a positive price premium. Even if the banks do not lower the actual interest rate any more, the gap widens between the “money interest rate” and the “natural interest rate” which would prevail in the absence of their intervention. Since loan money is now cheaper to acquire than circumstances warrant, entrepreneurial ambitions expand.
New businesses are started in the expectation that the necessary capital can be secured by obtaining credit. To be sure, in the face of growing demand, the banks now raise the “money interest rate.” Still they do not discontinue granting further credit. They expand the supply of fiduciary media issued, with the result that the purchasing power of the monetary unit must decline still further. Certainly the actual “money interest rate” increases during the boom, but it continues to lag behind the rate which would conform to the market, i.e., the “natural interest rate” augmented by the positive price premium.
So long as this situation prevails, the upswing continues. Inventories of goods are readily sold. Prices and profits rise. Business enterprises are overwhelmed with orders because everyone anticipates further price increases and workers find employment at increasing wage rates. However, this situation cannot last forever!
- Malinvestment of Available Capital GoodsThe “natural interest rate” is established at that height which tends toward equilibrium on the market. The tendency is toward a condition where no capital goods are idle, no opportunities for starting profitable enterprises remain unexploited and the only projects not undertaken are those which no longer yield a profit at the prevailing “natural interest rate.” Assume, however, that the equilibrium, toward which the market is moving, is disturbed by the interference of the banks. Money may be obtained below the “natural interest rate.” As a result businesses may be started which weren’t profitable before, and which become profitable only through the lower than “natural interest rate” which appears with the expansion of circulation credit.
Here again, we see the difference which exists between a drop in purchasing power, caused by the expansion of circulation credit, and a loss of purchasing power, brought about by an increase in the quantity of money. In the latter case [i.e., with an increase in the quantity of money in the narrower sense] the prices first affected are either (1) those of consumers’ goods only or (2) the prices of both consumers’ and producers’ goods. Which it will be depends on whether those first receiving the new quantities of money use this new wealth for consumption or production. However, if the decrease in purchasing power is caused by an increase in bank created fiduciary media, then it is the prices of producers’ goods which are first affected. The prices of consumers’ goods follow only to the extent that wages and profits rise.
Since it always requires some time for the market to reach full “equilibrium,” the “static” or “natural”In the language of Knut Wicksell and the classical economists. prices, wage rates and interest rates never actually appear. The process leading to their establishment is never completed before changes occur which once again indicate a new “equilibrium.” At times, even on the unhampered market, there are some unemployed workers, unsold consumers’ goods and quantities of unused factors of production, which would not exist under “static equilibrium.” With the revival of business and productive activity, these reserves are in demand right away. However, once they are gone, the increase in the supply of fiduciary media necessarily leads to disturbances of a special kind.
In a given economic situation, the opportunities for production, which may actually be carried out, are limited by the supply of capital goods available. Roundabout methods of production can be adopted only so far as the means for subsistence exist to maintain the workers during the entire period of the expanded process. All those projects, for the completion of which means are not available, must be left uncompleted, even though they may appear technically feasible — that is, if one disregards the supply of capital. However, such businesses, because of the lower loan rate offered by the banks, appear for the moment to be profitable and are, therefore, initiated. However, the existing resources are insufficient. Sooner or later this must become evident. Then it will become apparent that production has gone astray, that plans were drawn up in excess of the economic means available, that speculation, i.e., activity aimed at the provision of future goods, was misdirected.
- “Forced Savings”In recent years, considerable significance has been attributed to the fact that “forced savings,” which may appear as a result of the drop in purchasing power that follows an increase of fiduciary media, leads to an increase in the supply of capital. The subsistence fund is made to go farther, due to the fact that (1) the workers consume less because wage rates tend to lag behind the rise in the prices of commodities, and (2) those who reap the advantage of this reduction in the workers’ incomes save at least a part of their gain. Whether “forced savings” actually appear depends, as noted above, on the circumstances in each case. There is no need to go into this any further.
Nevertheless, establishing the existence of “forced savings” does not mean that bank expansion of circulation credit does not lead to the initiation of more roundabout production than available capabilities would warrant. To prove that, one must be able to show that the banks are only in a position to depress the “money interest rate” and expand the issue of fiduciary media to the extent that the “natural interest rate” declines as a result of “forced savings.” This assumption is simply absurd and there is no point in arguing it further. It is almost inconceivable that anyone should want to maintain it.
What concerns us is the problem brought about by the banks, in reducing the “money rate of interest” below the “natural rate.” For our problem, it is immaterial how much the “natural interest rate” may also decline under certain circumstances and within narrow limits, as a result of this action by the banks. No one doubts that “forced savings” can reduce the “natural interest rate” only fractionally, as compared with the reduction in the “money interest rate” which produces the “forced savings.”I believe this should be pointed out here again, although I have exhausted everything to be said on the subject [see section 2. Early Effects of Credit Expansion] and in The Theory of Money and Credit. Anyone who has followed the discussions of recent years will realize how important it is to stress these things again and again.
The resources which are claimed for the newly initiated longer time consuming methods of production are unavailable for those processes where they would otherwise have been put to use. The reduction in the loan rate benefits all producers, so that all producers are now in a position to pay higher wage rates and higher prices for the material factors of production. Their competition drives up wage rates and the prices of the other factors of production. Still, except for the possibilities already discussed, this does not increase the size of the labor force or the supply of available goods of the higher order. The means of subsistence are not sufficient to provide for the workers during the extended period of production. It becomes apparent that the proposal for the new, longer, roundabout production was not adjusted with a view to the actual capital situation. For one thing, the enterprises realize that the resources available to them are not sufficient to continue their operations. They find that “money” is scarce.
That is precisely what has happened. The general increase in prices means that all businesses need more funds than had been anticipated at their “launching.” More resources are required to complete them. However, the increased quantity of fiduciary media loaned out by the banks is already exhausted. The banks can no longer make additional loans at the same interest rates. As a result, they must raise the loan rate once more for two reasons. In the first place, the appearance of the positive price premium forces them to pay higher interest for outside funds which they borrow. Then also, they must discriminate among the many applicants for credit. Not all enterprises can afford this increased interest rate. Those which cannot run into difficulties.
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A Habit-Forming PolicyNow, in extending circulation credit, the banks do not proceed by pumping a limited dosage of new fiduciary media into circulation and then stop. They expand the fiduciary media continuously for some time, sending, so to speak, after the first offering, a second, third, fourth, and so on. They do not simply undercut the “natural interest rate” once, and then adjust promptly to the new situation. Instead they continue the practice of making loans below the “natural interest rate” for some time. To be sure, the increasing volume of demands on them for credit may cause them to raise the “money rate of interest.” Yet, even if the banks revert to the former “natural rate,” the rate which prevailed before their credit expansion affected the market, they still lag behind the rate which would now exist on the market if they were not continuing to expand credit. This is because a positive price premium must now be included in the new “natural rate.” With the help of this new quantity of fiduciary media, the banks now take care of the businessman’s intensified demand for credit. Thus, the crisis does not appear yet. The enterprises using more roundabout methods of production, which have been started, are continued. Because prices rise still further, the earlier calculations of the entrepreneurs are realized. They make profits. In short, the boom continues.
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The Inevitable Crisis and CycleThe crisis breaks out only when the banks alter their conduct to the extent that they discontinue issuing any more new fiduciary media and stop undercutting the “natural interest rate.” They may even take steps to restrict circulation credit. When they actually do this, and why, is still to be examined. First of all, however, we must ask ourselves whether it is possible for the banks to stay on the course upon which they have embarked, permitting new quantities of fiduciary media to flow into circulation continuously and proceeding always to make loans below the rate of interest which would prevail on the market in the absence of their interference with newly created fiduciary media.
If the banks could proceed in this manner, with businesses improving continually, could they then provide for lasting good times? Would they then be able to make the boom eternal?
They cannot do this. The reason they cannot is that inflationism carried on ad infinitum is not a workable policy. If the issue of fiduciary media is expanded continuously, prices rise ever higher and at the same time the positive price premium also rises. (We shall disregard the fact that consideration for (1) the continually declining monetary reserves relative to fiduciary media and (2) the banks’ operating costs must sooner or later compel them to discontinue the further expansion of circulation credit.) It is precisely because, and only because, no end to the prolonged “flood” of expanding fiduciary media is foreseen, that it leads to still sharper price increases and, finally, to a panic in which prices and the loan rate move erratically upward.
Suppose the banks still did not want to give up the race? Suppose, in order to depress the loan rate, they wanted to satisfy the continuously expanding desire for credit by issuing still more circulation credit? Then they would only hasten the end, the collapse of the entire system of fiduciary media. The inflation can continue only so long as the conviction persists that it will one day cease. Once people are persuaded that the inflation will not stop, they turn from the use of this money. They flee then to “real values,” foreign money, the precious metals, and barter.
Sooner or later, the crisis must inevitably break out as the result of a change in the conduct of the banks. The later the crack-up comes, the longer the period in which the calculation of the entrepreneurs is misguided by the issue of additional fiduciary media. The greater this additional quantity of fiduciary money, the more factors of production have been firmly committed in the form of investments which appeared profitable only because of the artificially reduced interest rate and which prove to be unprofitable now that the interest rate has again been raised. Great losses are sustained as a result of misdirected capital investments. Many new structures remain unfinished. Others, already completed, close down operations. Still others are carried on because, after writing off losses which represent a waste of capital, operation of the existing structure pays at least something.
The crisis, with its unique characteristics, is followed by stagnation. The misguided enterprises and businesses of the boom period are already liquidated. Bankruptcy and adjustment have cleared up the situation. The banks have become cautious. They fight shy of expanding circulation credit. They are not inclined to give an ear to credit applications from schemers and promoters. Not only is the artificial stimulus to business, through the expansion of circulation credit, lacking, but even businesses which would be feasible, considering the capital goods available, are not attempted because the general feeling of discouragement makes every innovation appear doubtful. Prevailing “money interest rates” fall below the “natural interest rates.”
When the crisis breaks out, loan rates bound sharply upward because threatened enterprises offer extremely high interest rates for the funds to acquire the resources, with the help of which they hope to save themselves. Later, as the panic subsides, a situation develops, as a result of the restriction of circulation credit and attempts to dispose of large inventories, causing prices [and the “money interest rate”] to fall steadily and leading to the appearance of a negative price premium. This reduced rate of loan interest is adhered to for some time, even after the decline in prices comes to a standstill, when a negative price premium no longer corresponds to conditions. Thus, it comes about that the “money interest rate” is lower than the “natural rate.” Yet, because the unfortunate experiences of the recent crisis have made everyone uneasy, the incentive to business activity is not as strong as circumstances would otherwise warrant. Quite a time passes before capital funds, increased once again by savings accumulated in the meantime, exert sufficient pressure on the loan interest rate for an expansion of entrepreneurial activity to resume. With this development, the low point is passed and the new boom begins.
Economic Policy: Thoughts for Tomorrow and Today[Ludwig von Mises, Economic Policy: Thoughts for Tomorrow and Today (1979; Washington, D.C.: Regnery Gateway, 2006), Lecture 1, pp. 1–15.]“Capitalism”
Descriptive terms which people use are often quite misleading. In talking about modern captains of industry and leaders of big business, for instance, they call a man a “chocolate king” or a “cotton king” or an “automobile king.” Their use of such terminology implies that they see practically no difference between the modern heads of industry and those feudal kings, dukes or lords of earlier days. But the difference is in fact very great, for a chocolate king does not rule at all, he serves. He does not reign over conquered territory, independent of the market, independent of his customers. The chocolate king — or the steel king or the automobile king or any other king of modern industry — depends on the industry he operates and on the customers he serves. This “king” must stay in the good graces of his subjects, the consumers; he loses his “kingdom” as soon as he is no longer in a position to give his customers better service and provide it at lower cost than others with whom he must compete.
Two hundred years ago, before the advent of capitalism, a man’s social status was fixed from the beginning to the end of his life; he inherited it from his ancestors, and it never changed. If he was born poor, he always remained poor, and if he was born rich — a lord or a duke — he kept his dukedom and the property that went with it for the rest of his life.
As for manufacturing, the primitive processing industries of those days existed almost exclusively for the benefit of the wealthy. Most of the people (ninety percent or more of the European population) worked the land and did not come in contact with the city-oriented processing industries. This rigid system of feudal society prevailed in the most developed areas of Europe for many hundreds of years.
However, as the rural population expanded, there developed a surplus of people on the land. For this surplus of population without inherited land or estates, there was not enough to do, nor was it possible for them to work in the processing industries; the kings of the cities denied them access. The numbers of these “outcasts” continued to grow, and still no one knew what to do with them. They were, in the full sense of the word, “proletarians,” outcasts whom the government could only put into the workhouse or the poorhouse. In some sections of Europe, especially in the Netherlands and in England, they became so numerous that, by the eighteenth century, they were a real menace to the preservation of the prevailing social system.
Today, in discussing similar conditions in places like India or other developing countries, we must not forget that, in eighteenth-century England, conditions were much worse. At that time, England had a population of six or seven million people, but of those six or seven million people, more than one million, probably two million, were simply poor outcasts for whom the existing social system made no provision. What to do with these outcasts was one of the great problems of eighteenth-century England.
Another great problem was the lack of raw materials. The British, very seriously, had to ask themselves this question: what are we going to do in the future, when our forests will no longer give us the wood we need for our industries and for heating our houses? For the ruling classes it was a desperate situation. The statesmen did not know what to do, and the ruling gentry were absolutely without any ideas on how to improve conditions.
Out of this serious social situation emerged the beginnings of modern capitalism. There were some persons among those outcasts, among those poor people, who tried to organize others to set up small shops which could produce something. This was an innovation. These innovators did not produce expensive goods suitable only for the upper classes; they produced cheaper products for everyone’s needs. And this was the origin of capitalism as it operates today. It was the beginning of mass production, the fundamental principle of capitalistic industry. Whereas the old processing industries serving the rich people in the cities had existed almost exclusively for the demands of the upper classes, the new capitalist industries began to produce things that could be purchased by the general population. It was mass production to satisfy the needs of the masses.
This is the fundamental principle of capitalism as it exists today in all of those countries in which there is a highly developed system of mass production: Big business, the target of the most fanatic attacks by the so-called leftists, produces almost exclusively to satisfy the wants of the masses. Enterprises producing luxury goods solely for the well-to-do can never attain the magnitude of big businesses. And today, it is the people who work in large factories who are the main consumers of the products made in those factories. This is the fundamental difference between the capitalistic principles of production and the feudalistic principles of the preceding ages.
When people assume, or claim, that there is a difference between the producers and the consumers of the products of big businesses, they are badly mistaken. In American department stores you hear the slogan, “the customer is always right.” And this customer is the same man who produces in the factory those things which are sold in the department stores. The people who think that the power of big business is enormous are mistaken also, since big business depends entirely on the patronage of those who buy its products: the biggest enterprise loses its power and its influence when it loses its customers.
Fifty or sixty years ago it was said in almost all capitalist countries that the railroad companies were too big and too powerful; they had a monopoly; it was impossible to compete with them. It was alleged that, in the field of transportation, capitalism had already reached a stage at which it had destroyed itself, for it had eliminated competition. What people overlooked was the fact that the power of the railroads depended on their ability to serve people better than any other method of transportation. Of course it would have been ridiculous to compete with one of these big railroad companies by building another railroad parallel to the old line, since the old line was sufficient to serve existing needs. But very soon there came other competitors. Freedom of competition does not mean that you can succeed simply by imitating or copying precisely what someone else has done. Freedom of the press does not mean that you have the right to copy what another man has written and thus to acquire the success which this other man has duly merited on account of his achievements. It means that you have the right to write something different. Freedom of competition concerning railroads, for example, means that you are free to invent something, to do something, which will challenge the railroads and place them in a very precarious competitive situation.
In the United States the competition to the railroads — in the form of buses, automobiles, trucks, and airplanes — has caused the railroads to suffer and to be almost completely defeated, as far as passenger transportation is concerned.
The development of capitalism consists in everyone’s having the right to serve the customer better and/or more cheaply. And this method, this principle, has, within a comparatively short time, transformed the whole world. It has made possible an unprecedented increase in world population.In eighteenth-century England, the land could support only six million people at a very low standard of living. Today more than fifty million people enjoy a much higher standard of living than even the rich enjoyed during the eighteenth-century. And today’s standard of living in England would probably be still higher, had not a great deal of the energy of the British been wasted in what were, from various points of view, avoidable political and military “adventures.”
These are the facts about capitalism. Thus, if an Englishman — or, for that matter, any other man in any country of the world — says today to his friends that he is opposed to capitalism, there is a wonderful way to answer him: “You know that the population of this planet is now ten times greater than it was in the ages preceding capitalism; you know that all men today enjoy a higher standard of living than your ancestors did before the age of capitalism. But how do you know that you are the one out of ten who would have lived in the absence of capitalism? The mere fact that you are living today is proof that capitalism has succeeded, whether or not you consider your own life very valuable.”
In spite of all its benefits, capitalism has been furiously attacked and criticized. It is necessary that we understand the origin of this antipathy. It is a fact that the hatred of capitalism originated not with the masses, not among the workers themselves, but among the landed aristocracy — the gentry, the nobility, of England and the European continent. They blamed capitalism for something that was not very pleasant for them: at the beginning of the nineteenth century, the higher wages paid by industry to its workers forced the landed gentry to pay equally higher wages to their agricultural workers. The aristocracy attacked the industries by criticising the standard of living of the masses of the workers.
Of course — from our viewpoint, the workers’ standard of living was extremely low; conditions under early capitalism were absolutely shocking, but not because the newly developed capitalistic industries had harmed the workers. The people hired to work in factories had already been existing at a virtually subhuman level.
The famous old story, repeated hundreds of times, that the factories employed women and children and that these women and children, before they were working in factories, had lived under satisfactory conditions, is one of the greatest falsehoods of history. The mothers who worked in the factories had nothing to cook with; they did not leave their homes and their kitchens to go into the factories, they went into factories because they had no kitchens, and if they had a kitchen they had no food to cook in those kitchens. And the children did not come from comfortable nurseries. They were starving and dying. And all the talk about the so-called unspeakable horror of early capitalism can be refuted by a single statistic: precisely in these years in which British capitalism developed, precisely in the age called the Industrial Revolution in England, in the years from 1760 to 1830, precisely in those years the population of England doubled, which means that hundreds or thousands of children — who would have died in preceding times — survived and grew to become men and women.
There is no doubt that the conditions of the preceding times were very unsatisfactory. It was capitalist business that improved them. It was precisely those early factories that provided for the needs of their workers, either directly or indirectly by exporting products and importing food and raw materials from other countries. Again and again, the early historians of capitalism have — one can hardly use a milder word — falsified history.
One anecdote they used to tell, quite possibly invented, involved Benjamin Franklin. According to the story, Ben Franklin visited a cotton mill in England, and the owner of the mill told him, full of pride: “Look, here are cotton goods for Hungary.” Benjamin Franklin, looking around, seeing that the workers were shabbily dressed, said: “Why don’t you produce also for your own workers?”
But those exports of which the owner of the mill spoke really meant that he did produce for his own workers, because England had to import all its raw materials. There was no cotton either in England or in continental Europe. There was a shortage of food in England, and food had to be imported from Poland, from Russia, from Hungary. These exports were the payment for the imports of the food which made the survival of the British population possible. Many examples from the history of those ages will show the attitude of the gentry and aristocracy toward the workers. I want to cite only two examples. One is the famous British “Speenhamland” system. By this system, the British government paid all workers who did not get the minimum wage (determined by the government) the difference between the wages they received and this minimum wage. This saved the landed aristocracy the trouble of paying higher wages. The gentry would pay the traditionally low agricultural wage, and the government would supplement it, thus keeping workers from leaving rural occupations to seek urban factory employment.
Eighty years later, after capitalism’s expansion from England to continental Europe, the landed aristocracy again reacted against the new production system. In Germany the Prussian Junkers, having lost many workers to the higher-paying capitalistic industries, invented a special term for the problem: “flight from the countryside” — Landflucht. And in the German Parliament, they discussed what might be done against this evil, as it was seen from the point of view of the landed aristocracy.
Prince Bismarck, the famous chancellor of the German Reich, in a speech one day said, “I met a man in Berlin who once had worked on my estate, and I asked this man, ‘Why did you leave the estate; why did you go away from the country; why are you now living in Berlin?’ ” And according to Bismarck, this man answered, “You don’t have such a nice Biergarten in the village as we have here in Berlin, where you can sit, drink beer, and listen to music.” This is, of course, a story told from the point of view of Prince Bismarck, the employer. It was not the point of view of all his employees. They went into industry because industry paid them higher wages and raised their standard of living to an unprecedented degree.
Today, in the capitalist countries, there is relatively little difference between the basic life of the so-called higher and lower classes; both have food, clothing, and shelter. But in the eighteenth century and earlier, the difference between the man of the middle class and the man of the lower class was that the man of the middle class had shoes and the man of the lower class did not have shoes. In the United States today the difference between a rich man and a poor man means very often only the difference between a Cadillac and a Chevrolet. The Chevrolet may be bought secondhand, but basically it renders the same services to its owner: he, too, can drive from one point to another. More than fifty percent of the people in the United States are living in houses and apartments they own themselves.
The attacks against capitalism — especially with respect to the higher wage rates — start from the false assumption that wages are ultimately paid by people who are different from those who are employed in the factories. Now it is all right for economists and for students of economic theories to distinguish between the worker and the consumer and to make a distinction between them. But the fact is that every consumer must, in some way or the other, earn the money he spends, and the immense majority of the consumers are precisely the same people who work as employees in the enterprises that produce the things which they consume. Wage rates under capitalism are not set by a class of people different from the class of people who earn the wages; they are the same people. It is not the Hollywood film corporation that pays the wages of a movie star; it is the people who pay admission to the movies. And it is not the entrepreneur of a boxing match who pays the enormous demands of the prize fighters; it is the people who pay admission to the fight. Through the distinction between the employer and the employee, a distinction is drawn in economic theory, but it is not a distinction in real life; here, the employer and the employee ultimately are one and the same person.
There are people in many countries who consider it very unjust that a man who has to support a family with several children will receive the same salary as a man who has only himself to take care of. But the question is not whether the employer should bear greater responsibility for the size of a worker’s family.
The question we must ask in this case is: Are you, as an individual, prepared to pay more for something, let us say, a loaf of bread, if you are told that the man who produced this loaf of bread has six children? The honest man will certainly answer in the negative and say, “In principle I would, but in fact if it costs less I would rather buy the bread produced by a man without any children.” The fact is that, if the buyers do not pay the employer enough to enable him to pay his workers, it becomes impossible for the employer to remain in business.
The capitalist system was termed “capitalism” not by a friend of the system, but by an individual who considered it to be the worst of all historical systems, the greatest evil that had ever befallen mankind. That man was Karl Marx. Nevertheless, there is no reason to reject Marx’s term, because it describes clearly the source of the great social improvements brought about by capitalism. Those improvements are the result of capital accumulation; they are based on the fact that people, as a rule, do not consume everything they have produced, that they save — and invest — a part of it. There is a great deal of misunderstanding about this problem and — in the course of these lectures — I will have the opportunity to deal with the most fundamental misapprehensions which people have concerning the accumulation of capital, the use of capital, and the universal advantages to be gained from such use. I will deal with capitalism particularly in my lectures about foreign investment and about that most critical problem of present-day politics, inflation. You know, of course, that inflation exists not only in this country. It is a problem all over the world today.
An often unrealized fact about capitalism is this: savings mean benefits for all those who are anxious to produce or to earn wages. When a man has accrued a certain amount of money — let us say, one thousand dollars — and, instead of spending it, entrusts these dollars to a savings bank or an insurance company, the money goes into the hands of an entrepreneur, a businessman, enabling him to go out and embark on a project which could not have been embarked on yesterday, because the required capital was unavailable.
What will the businessman do now with the additional capital? The first thing he must do, the first use he will make of this additional capital, is to go out and hire workers and buy raw materials — in turn causing a further demand for workers and raw materials to develop, as well as a tendency toward higher wages and higher prices for raw materials. Long before the saver or the entrepreneur obtains any profit from all of this, the unemployed worker, the producer of raw materials, the farmer, and the wage-earner are all sharing in the benefits of the additional savings.
When the entrepreneur will get something out of the project depends on the future state of the market and on his ability to anticipate correctly the future state of the market. But the workers as well as the producers of raw materials get the benefits immediately. Much was said, thirty or forty years ago, about the “wage policy,” as they called it, of Henry Ford. One of Mr. Ford’s great accomplishments was that he paid higher wages than did other industrialists or factories. His wage policy was described as an “invention,” yet it is not enough to say that this new “invented” policy was the result of the liberality of Mr. Ford. A new branch of business, or a new factory in an already existing branch of business, has to attract workers from other employments, from other parts of the country, even from other countries. And the only way to do this is to offer the workers higher wages for their work. This is what took place in the early days of capitalism, and it is still taking place today.
When the manufacturers in Great Britain first began to produce cotton goods, they paid their workers more than they had earned before. Of course, a great percentage of these new workers had earned nothing at all before that and were prepared to take anything they were offered. But after a short time — when more and more capital was accumulated and more and more new enterprises were developed — wage rates went up, and the result was the unprecedented increase in British population which I spoke of earlier.
The scornful depiction of capitalism by some people as a system designed to make the rich become richer and the poor become poorer is wrong from beginning to end. Marx’s thesis regarding the coming of socialism was based on the assumption that workers were getting poorer, that the masses were becoming more destitute, and that finally all the wealth of a country would be concentrated in a few hands or in the hands of one man only. And then the masses of impoverished workers would finally rebel and expropriate the riches of the wealthy proprietors. According to this doctrine of Karl Marx, there can be no opportunity, no possibility within the capitalistic system for any improvement of the conditions of the workers.
In 1864, speaking before the International Workingmen’s Association in England, Marx said the belief that labor unions could improve conditions for the working population was “absolutely in error.” The union policy of asking for higher wage rates and shorter work hours he called conservative — conservatism being, of course, the most condemnatory term which Karl Marx could use. He suggested that the unions set themselves a new, revolutionary goal: that they “do away with the wage system altogether,” that they substitute “socialism” — government ownership of the means of production — for the system of private ownership.
If we look upon the history of the world, and especially upon the history of England since 1865, we realize that Marx was wrong in every respect. There is no western, capitalistic country in which the conditions of the masses have not improved in an unprecedented way. All these improvements of the last eighty or ninety years were made in spite of the prognostications of Karl Marx. For the Marxian socialists believed that the conditions of the workers could never be ameliorated. They followed a false theory, the famous “iron law of wages” — the law which stated that a worker’s wages, under capitalism, would not exceed the amount he needed to sustain his life for service to the enterprise.
The Marxians formulated their theory in this way: if the workers’ wage rates go up, raising wages above the subsistence level, they will have more children; and these children, when they enter the labor force, will increase the number of workers to the point where the wage rates will drop, bringing the workers once more down to the subsistence level — to that minimal sustenance level which will just barely prevent the working population from dying out. But this idea of Marx, and of many other socialists, is a concept of the working man precisely like that which biologists use — and rightly so — in studying the life of animals. Of mice, for instance.
If you increase the quantity of food available for animal organisms or for microbes, then more of them will survive. And if you restrict their food, then you will restrict their numbers. But man is different. Even the worker — in spite of the fact that Marxists do not acknowledge it — has human wants other than food and reproduction of his species. An increase in real wages results not only in an increase in population, it results also, and first of all, in an improvement in the average standard of living. That is why today we have a higher standard of living in Western Europe and in the United States than in the developing nations of, say, Africa.
We must realize, however, that this higher standard of living depends on the supply of capital. This explains the difference between conditions in the United States and conditions in India; modern methods of fighting contagious diseases have been introduced in India — at least, to some extent — and the effect has been an unprecedented increase in population but, since this increase in population has not been accompanied by a corresponding increase in the amount of capital invested, the result has been an increase in poverty. A country becomes more prosperous in proportion to the rise in the invested capital per unit of its population.
I hope that in my other lectures I will have the opportunity to deal in greater detail with these problems and will be able to clarify them, because some terms — such as “the capital invested per capita” — require a rather detailed explanation.
But you have to remember that, in economic policies, there are no miracles. You have read in many newspapers and speeches, about the so-called German economic miracle — the recovery of Germany after its defeat and destruction in the Second World War. But this was no miracle. It was the application of the principles of the free market economy, of the methods of capitalism, even though they were not applied completely in all respects. Every country can experience the same “miracle” of economic recovery, although I must insist that economic recovery does not come from a miracle; it comes from the adoption of — and is the result of — sound economic policies.
Planning for Freedom and Other Essays and Addresses[Ludwig von Mises, Planning for Freedom and Sixteen Other Essays and Addresses (1952; South Holland, Ill.: Libertarian Press, 1980), chap. 9: “Profit and Loss,” section A: “The Economic Nature of Profit and Loss,” pp. 108–28.]“Profit and Loss”
- The Emergence of Profit and LossIn the capitalist system of society’s economic organization the entrepreneurs determine the course of production. In the performance of this function they are unconditionally and totally subject to the sovereignty of the buying public, the consumers. If they fail to produce in the cheapest and best possible way those commodities which the consumers are asking for most urgently, they suffer losses and are finally eliminated from their entrepreneurial position. Other men who know better how to serve the consumers replace them.
If all people were to anticipate correctly the future state of the market, the entrepreneurs would neither earn any profits nor suffer any losses. They would have to buy the complementary factors of production at prices which would, already at the instant of the purchase, fully reflect the future prices of the products. No room would be left either for profit or for loss. What makes profit emerge is the fact that the entrepreneur who judges the future prices of the products more correctly than other people do buys some or all of the factors of production at prices which, seen from the point of view of the future state of the market, are too low. Thus the total costs of production — including interest on the capital invested — lag behind the prices which the entrepreneur receives for the product. This difference is entrepreneurial profit.
On the other hand, the entrepreneur who misjudges the future prices of the products allows for the factors of production prices which, seen from the point of view of the future state of the market, are too high. His total costs of production exceed the prices at which he can sell the product. This difference is entrepreneurial loss.
Thus profit and loss are generated by success or failure in adjusting the course of production activities to the most urgent demand of the consumers. Once this adjustment is achieved, they disappear. The prices of the complementary factors of production reach a height at which total costs of production coincide with the price of the product. Profit and loss are ever-present features only on account of the fact that ceaseless change in the economic data makes again and again new discrepancies, and consequently the need for new adjustments originate.
- The Distinction Between Profits and Other ProceedsMany errors concerning the nature of profit and loss were caused by the practice of applying the term profit to the totality of the residual proceeds of an entrepreneur.
Interest on the capital employed is not a component part of profit. The dividends of a corporation are not profit. They are interest on the capital invested plus profit or minus loss.
The market equivalent of work performed by the entrepreneur in the conduct of the enterprise’s affairs is entrepreneurial quasi-wages but not profit.
If the enterprise owns a factor on which it can earn monopoly prices, it makes a monopoly gain. If this enterprise is a corporation, such gains increase the dividend. Yet they are not profit proper.
Still more serious are the errors due to the confusion of entrepreneurial activity and technological innovation and improvement.
The maladjustment, the removal of which is the essential function of entrepreneurship, may often consist in the fact that new technological methods have not yet been utilized to the full extent to which they should be in order to bring about the best possible satisfaction of consumers’ demand. But this is not necessarily always the case. Changes in the data, especially in consumers’ demand, may require adjustments which have no reference at all to technological innovations and improvements. The entrepreneur who simply increases the production of an article by adding to the existing production facilities a new outfit without any change in the technological method of production is no less an entrepreneur than the man who inaugurates a new way of producing. The business of the entrepreneur is not merely to experiment with new technological methods, but to select from the multitude of technologically feasible methods those which are best fit to supply the public in the cheapest way with the things they are asking for most urgently. Whether a new technological procedure is or is not fit for this purpose is to be provisionally decided by the entrepreneur and will be finally decided by the conduct of the buying public. The question is not whether a new method is to be considered as a more “elegant” solution of a technological problem. It is whether, under the given state of economic data, it is the best possible method of supplying the consumers in the cheapest way.
The activities of the entrepreneur consist in making decisions. He determines for what purpose the factors of production should be employed. Any other acts which an entrepreneur may perform are merely accidental to his entrepreneurial function. It is this that laymen often fail to realize. They confuse the entrepreneurial activities with the conduct of the technological and administrative affairs of a plant. In their eyes not the stockholders, the promoters and speculators, but hired employees are the real entrepreneurs. The former are merely idle parasites who pocket the dividends.
Now nobody ever contended that one could produce without working. But neither is it possible to produce without capital goods, the previously produced factors of further production. These capital goods are scarce, i.e., they do not suffice for the production of all things which one would like to have produced. Hence the economic problem arises: to employ them in such a way that only those goods should be produced which are fit to satisfy the most urgent demands of the consumers. No good should remain unproduced on account of the fact that the factors required for its production were used — wasted — for the production of another good for which the demand of the public is less intense. To achieve this is, under capitalism, the function of entrepreneurship that determines the allocation of capital to the various branches of production. Under socialism it would be a function of the state, the social apparatus of coercion and oppression. The problem whether a socialist directorate, lacking any method of economic calculation, could fulfill this function is not to be dealt with in this essay.
There is a simple rule of thumb to tell entrepreneurs from non-entrepreneurs. The entrepreneurs are those on whom the incidence of losses on the capital employed falls. Amateur-economists may confuse profits with other kinds of intakes. But it is impossible to fail to recognize losses on the capital employed.
- Non-Profit Conduct of AffairsWhat has been called the democracy of the market manifests itself in the fact that profit-seeking business is unconditionally subject to the supremacy of the buying public.
Non-profit organizations are sovereign unto themselves. They are, within the limits drawn by the amount of capital at their disposal, in a position to defy the wishes of the public.
A special case is that of the conduct of government affairs, the administration of the social apparatus of coercion and oppression, viz., the police power. The objectives of government, the protection of the inviolability of the individuals’ lives and health and of their efforts to improve the material conditions of their existence, are indispensable. They benefit all and are the necessary prerequisite of social cooperation and civilization. But they cannot be sold and bought in the way merchandise is sold and bought; they have therefore no price on the market. With regard to them there cannot be any economic calculation. The costs expended for their conduct cannot be confronted with a price received for the product. This state of affairs would make the officers entrusted with the administration of governmental activities irresponsible despots if they were not curbed by the budget system. Under this system the administrators are forced to comply with detailed instructions enjoined upon them by the sovereign, be it a self-appointed autocrat or the whole people acting through elected representatives. To the officers limited funds are assigned which they are bound to spend only for those purposes which the sovereign has ordered. Thus the management of public administration becomes bureaucratic, i.e., dependent on definite detailed rules and regulations.
Bureaucratic management is the only alternative available where there is no profit and loss management.
- The Ballot of the MarketThe consumers by their buying and abstention from buying elect the entrepreneurs in a daily repeated plebiscite as it were. They determine who should own and who not, and how much each owner should own.
As is the case with all acts of choosing a person — choosing holders of public office, employees, friends or a consort — the decision of the consumers is made on the ground of experience and thus necessarily always refers to the past. There is no experience of the future. The ballot of the market elevates those who in the immediate past have best served the consumers. However, the choice is not unalterable and can daily be corrected. The elected who disappoints the electorate is speedily reduced to the ranks.
Each ballot of the consumers adds only a little to the elected man’s sphere of action. To reach the upper levels of entrepreneurship he needs a great number of votes, repeated again and again over a long period of time, a protracted series of successful strokes. He must stand every day a new trial, must submit anew to reelection as it were.
It is the same with his heirs. They can retain their eminent position only by receiving again and again confirmation on the part of the public. Their office is revocable. If they retain it, it is not on account of the deserts of their predecessor, but on account of their own ability to employ the capital for the best possible satisfaction of the consumers.
The entrepreneurs are neither perfect nor good in any metaphysical sense. They owe their position exclusively to the fact that they are better fit for the performance of the functions incumbent upon them than other people are. They earn profit not because they are clever in performing their tasks, but because they are more clever or less clumsy than other people are. They are not infallible and often blunder. But they are less liable to error and blunder less than other people do. Nobody has the right to take offense at the errors made by the entrepreneurs in the conduct of affairs and to stress the point that people would have been better supplied if the entrepreneurs had been more skillful and prescient. If the grumbler knew better, why did he not himself fill the gap and seize the opportunity to earn profits? It is easy indeed to display foresight after the event. In retrospect all fools become wise.
A popular chain of reasoning runs this way: The entrepreneur earns profit not only on account of the fact that other people were less successful than he in anticipating correctly the future state of the market. He himself contributed to the emergence of profit by not producing more of the article concerned; but for intentional restriction of output on his part, the supply of this article would have been so ample that the price would have dropped to a point at which no surplus of proceeds over costs of production expended would have emerged. This reasoning is at the bottom of the spurious doctrines of imperfect and monopolistic competition. It was resorted to a short time ago by the American Administration when it blamed the enterprises of the steel industry for the fact that the steel production capacity of the United States was not greater than it really was.
Certainly those engaged in the production of steel are not responsible for the fact that other people did not likewise enter this field of production. The reproach on the part of the authorities would have been sensible if they had conferred on the existing steel corporations the monopoly of steel production. But in the absence of such a privilege, the reprimand given to the operating mills is not more justified than it would be to censure the nation’s poets and musicians for the fact that there are not more and better poets and musicians. If somebody is to blame for the fact that the number of people who joined the voluntary civilian defense organization is not larger, then it is not those who have already joined but only those who have not.
That the production of a commodity p is not larger than it really is, is due to the fact that the complementary factors of production required for an expansion were employed for the production of other commodities. To speak of an insufficiency of the supply of p is empty rhetoric if it does not indicate the various products m which were produced in too large quantities with the effect that their production appears now, i.e., after the event, as a waste of scarce factors of production. We may assume that the entrepreneurs who instead of producing additional quantities of p turned to the production of excessive amounts of m and consequently suffered losses did not intentionally make their mistake.
Neither did the producers of p intentionally restrict the production of p. Every entrepreneur’s capital is limited; he employs it for those projects which, he expects, will, by filling the most urgent demand of the public, yield the highest profit.
An entrepreneur at whose disposal are 100 units of capital employs, for instance, 50 units for the production of p and 50 units for the production of q. If both lines are profitable, it is odd to blame him for not having employed more, e.g., 75 units, for the production of p. He could increase the production of p only by curtailing correspondingly the production of q. But with regard to q the same fault could be found by the grumblers. If one blames the entrepreneur for not having produced more p, one must blame him also for not having produced more q. This means: one blames the entrepreneur for the facts that there is a scarcity of the factors of production and that the earth is not a land of Cockaigne.
Perhaps the grumbler will object on the ground that he considers p a vital commodity, much more important than q, and that therefore the production of p should be expanded and that of q restricted. If this is really the meaning of his criticism, he is at variance with the valuations of the consumers. He throws off his mask and shows his dictatorial aspirations. Production should not be directed by the wishes of the public but by his own despotic discretion.
But if our entrepreneur’s production of q involves a loss, it is obvious that his fault was poor foresight and not intentional.
Entrance into the ranks of the entrepreneurs in a market society, not sabotaged by the interference of government or other agencies resorting to violence, is open to everybody. Those who know how to take advantage of any business opportunity cropping up will always find the capital required. For the market is always full of capitalists anxious to find the most promising employment for their funds and in search of the ingenious newcomers, in partnership with whom they could execute the most remunerative projects.
People often failed to realize this inherent feature of capitalism because they did not grasp the meaning and the effects of capital scarcity. The task of the entrepreneur is to select from the multitude of technologically feasible projects those which will satisfy the most urgent of the not yet satisfied needs of the public. Those projects for the execution of which the capital supply does not suffice must not be carried out. The market is always crammed with visionaries who want to float such impracticable and unworkable schemes. It is these dreamers who always complain about the blindness of the capitalists who are too stupid to look after their own interests. Of course, the investors often err in the choice of their investments. But these faults consist precisely in the fact that they preferred an unsuitable project to another that would have satisfied more urgent needs of the buying public.
People often err very lamentably in estimating the work of the creative genius. Only a minority of men are appreciative enough to attach the right value to the achievement of poets, artists and thinkers. It may happen that the indifference of his contemporaries makes it impossible for a genius to accomplish what he would have accomplished if his fellow-men had displayed better judgment. The way in which the poet laureate and the philosopher à la mode are selected is certainly questionable.
But it is impermissible to question the free market’s choice of the entrepreneurs. The consumers’ preference for definite articles may be open to condemnation from the point of view of a philosopher’s judgment. But judgments of value are necessarily always personal and subjective. The consumer chooses what, as he thinks, satisfies him best. Nobody is called upon to determine what could make another man happier or less unhappy. The popularity of motor cars, television sets and nylon stockings may be criticized from a “higher” point of view. But these are the things that people are asking for. They cast their ballots for those entrepreneurs who offer them this merchandise of the best quality at the cheapest price.
In choosing between various political parties and programs for the commonwealth’s social and economic organization most people are uninformed and groping in the dark. The average voter lacks the insight to distinguish between policies suitable to attain the ends he is aiming at and those unsuitable. He is at a loss to examine the long chains of aprioristic reasoning which constitute the philosophy of a comprehensive social program. He may at best form some opinion about the short-run effects of the policies concerned. He is helpless in dealing with the long-run effects. The socialists and communists in principle often assert the infallibility of majority decisions. However, they belie their own words in criticizing parliamentary majorities rejecting their creed, and in denying to the people, under the one-party system, the opportunity to choose between different parties.
But in buying a commodity or abstaining from its purchase there is nothing else involved than the consumer’s longing for the best possible satisfaction of his instantaneous wishes. The consumer does not — like the voter in political voting — choose between different means whose effects appear only later. He chooses between things which immediately provide satisfaction. His decision is final.
An entrepreneur earns profit by serving the consumers, the people, as they are and not as they should be according to the fancies of some grumbler or potential dictator.
- The Social Function of Profit and LossProfits are never normal. They appear only where there is a maladjustment, a divergence between actual production and production as it should be in order to utilize the available material and mental resources for the best possible satisfaction of the wishes of the public. They are the prize of those who remove this maladjustment; they disappear as soon as the maladjustment is entirely removed. In the imaginary construction of an evenly rotating economy there are no profits. There the sum of the prices of the complementary factors of production, due allowance being made for time preference, coincides with the price of the product.
The greater the preceding maladjustments, the greater the profit earned by their removal. Maladjustments may sometimes be called excessive. But it is inappropriate to apply the epithet “excessive” to profits.
People arrive at the idea of excessive profits by confronting the profit earned with the capital employed in the enterprise and measuring the profit as a percentage of the capital. This method is suggested by the customary procedure applied in partnerships and corporations for the assignment of quotas of the total profit to the individual partners and shareholders. These men have contributed to a different extent to the realization of the project and share in the profits and losses according to the extent of their contribution.
But it is not the capital employed that creates profits and losses. Capital does not “beget profit” as Marx thought. The capital goods as such are dead things that in themselves do not accomplish anything. If they are utilized according to a good idea, profit results. If they are utilized according to a mistaken idea, no profit or losses result. It is the entrepreneurial decision that creates either profit or loss. It is mental acts, the mind of the entrepreneur, from which profits ultimately originate. Profit is a product of the mind, of success in anticipating the future state of the market. It is a spiritual and intellectual phenomenon.
The absurdity of condemning any profits as excessive can easily be shown. An enterprise with a capital of the amount c produced a definite quantity of p which it sold at prices that brought a surplus of proceeds over costs of s and consequently a profit of n per cent. If the entrepreneur had been less capable, he would have needed a capital of 2c for the production of the same quantity of p. For the sake of argument we may even neglect the fact that this would have necessarily increased costs of production as it would have doubled the interest on the capital employed, and we may assume that s would have remained unchanged. But at any rate s would have been confronted with 2c instead of c and thus the profit would have been only n/2 per cent of the capital employed. The “excessive” profit would have been reduced to a “fair” level. Why? Because the entrepreneur was less efficient and because his lack of efficiency deprived his fellow-men of all the advantages they could have got if an amount c of capital goods had been left available for the production of other merchandise.
In branding profits as excessive and penalizing the efficient entrepreneurs by discriminatory taxation, people are injuring themselves. Taxing profits is tantamount to taxing success in best serving the public. 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. But the better an entrepreneur succeeds in this regard, the more is he vilified and the more is he soaked by taxation. Increasing costs per unit of output, that is, waste, is praised as a virtue.
The most amazing manifestation of this complete failure to grasp the task of production and the nature and functions of profit and loss is shown in the popular superstition that profit is an addendum to the costs of production, the height of which depends uniquely on the discretion of the seller. It is this belief that guides governments in controlling prices. It is the same belief that has prompted many governments to make arrangements with their contractors according to which the price to be paid for an article delivered is to equal costs of production expended by the seller increased by a definite percentage. The effect was that the purveyor got a surplus the higher, the less he succeeded in avoiding superfluous costs. Contracts of this type enhanced considerably the sums the United States had to expend in the two world wars. But the bureaucrats, first of all the professors of economics who served in the various war agencies, boasted of their clever handling of the matter.
All people, entrepreneurs as well as non-entrepreneurs, look askance upon any profits earned by other people. Envy is a common weakness of men. People are loath to acknowledge the fact that they themselves could have earned profits if they had displayed the same foresight and judgment the successful businessman did. Their resentment is the more violent the more they are subconsciously aware of this fact.
There would not be any profits but for the eagerness of the public to acquire the merchandise offered for sale by the successful entrepreneur. But the same people who scramble for these articles vilify the businessman and call his profit ill got.
The semantic expression of this enviousness is the distinction between earned and unearned income. It permeates the textbooks, the language of the laws and administrative procedure. Thus, for instance, the official Form 201 for the New York state income tax return calls “earnings” only the compensation received by employees and, by implication, all other income, also that resulting from the exercise of a profession, unearned income. Such is the terminology of a state whose governor is a Republican and whose state assembly has a Republican majority.
Public opinion condones profits only as far as they do not exceed the salary paid to an employee. All surplus is rejected as unfair. The objective of taxation is, under the ability-to-pay principle, to confiscate this surplus.
Now one of the main functions of profits is to shift the control of capital to those who know how to employ it in the best possible way for the satisfaction of the public. The more profits a man earns, the greater his wealth consequently becomes, the more influential does he become in the conduct of business affairs. Profit and loss are the instruments by means of which the consumers pass the direction of production activities into the hands of those who are best fit to serve them. Whatever is undertaken to curtail or to confiscate profits impairs this function. The result of such measures is to loosen the grip the consumers hold over the course of production. The economic machine becomes, from the point of view of the people, less efficient and less responsive.
The jealousy of the common man looks upon the profits of the entrepreneurs as if they were totally used for consumption. A part of them is, of course, consumed. But only those entrepreneurs attain wealth and influence in the realm of business who consume merely a fraction of their proceeds and plough back the much greater part into their enterprises. What makes small business develop into big business is not spending, but saving and capital accumulation.
- Profit and Loss in the Progressing and in the Retrogressing EconomyWe call a stationary economy an economy in which the per head quota of the income and wealth of the individuals remains unchanged. In such an economy what the consumers spend more for the purchase of some articles must be equal to what they spend less for other articles. The total amount of the profits earned by one part of the entrepreneurs equals the total amount of losses suffered by other entrepreneurs.
A surplus of the sum of all profits earned in the whole economy above the sum of all losses suffered emerges only in a progressing economy, that is, in an economy in which the per head quota of capital increases. This increment is an effect of saving that adds new capital goods to the quantity already previously available. The increase of capital available creates maladjustments insofar as it brings about a discrepancy between the actual state of production and that state which the additional capital makes possible. Thanks to the emergence of additional capital, certain projects which hitherto could not be executed become feasible. In directing the new capital into those channels in which it satisfies the most urgent among the previously not satisfied wants of the consumers, the entrepreneurs earn profits which are not counterbalanced by the losses of other entrepreneurs.
The enrichment which the additional capital generates goes only in part to those who have created it by saving. The rest goes, by raising the marginal productivity of labor and thereby wage rates, to the earners of wages and salaries and, by raising the prices of definite raw materials and foodstuffs, to the owners of land, and, finally, to the entrepreneurs who integrate this new capital into the most economical production processes. But while the gain of the wage earners and of the landowners is permanent, the profits of the entrepreneurs disappear once this integration is accomplished. Profits of the entrepreneurs are, as has been mentioned already, a permanent phenomenon only on account of the fact that maladjustments appear daily anew by the elimination of which profits are earned.
Let us for the sake of argument resort to the concept of national income as employed in popular economics. Then it is obvious that in a stationary economy no part of the national income goes into profits. Only in a progressing economy is there a surplus of total profits over total losses. The popular belief that profits are a deduction from the income of workers and consumers is entirely fallacious. If we want to apply the term deduction to the issue, we have to say that this surplus of profits over losses as well as the increments of the wage earners and the landowners is deducted from the gains of those whose saving brought about the additional capital. It is their saving that is the vehicle of economic improvement, that makes the employment of technological innovations possible and raises productivity and the standard of living. It is the entrepreneurs whose activity takes care of the most economical employment of the additional capital. As far as they themselves do not save, neither the workers nor the landowners contribute anything to the emergence of the circumstances which generate what is called economic progress and improvement. They are benefited by other peoples’ saving that creates additional capital on the one hand and by the entrepreneurial action that directs this additional capital toward the satisfaction of the most urgent wants on the other hand.
A retrogressing economy is an economy in which the per head quota of capital invested is decreasing. In such an economy the total amount of losses incurred by entrepreneurs exceeds the total amount of profits earned by other entrepreneurs.
- The Competition of Profit and LossThe originary praxeological categories of profit and loss are psychic qualities and not reducible to any interpersonal description in quantitative terms. They are intensive magnitudes. The difference between the value of the end attained and that of the means applied for its attainment is profit if it is positive and loss if it is negative.
Where there are social division of efforts and cooperation as well as private ownership of the means of production, economic calculation in terms of monetary units becomes feasible and necessary. Profit and loss are computable as social phenomena. The psychic phenomena of profit and loss, from which they are ultimately derived, remain, of course, incalculable intensive magnitudes.
The fact that in the frame of the market economy entrepreneurial profit and loss are determined by arithmetical operations has misled many people. They fail to see that essential items that enter into this calculation are estimates emanating from the entrepreneur’s specific understanding of the future state of the market. They think that these computations are open to examination and verification or alteration on the part of a disinterested expert. They ignore the fact that such computations are as a rule an inherent part of the entrepreneur’s speculative anticipation of uncertain future conditions.
For the task of this essay it suffices to refer to one of the problems of cost accounting. One of the items of a bill of costs is the establishment of the difference between the price paid for the acquisition of what is commonly called durable production equipment and its present value. This present value is the money equivalent of the contribution this equipment will make to future earnings. There is no certainty about the future state of the market and about the height of these earnings. They can only be determined by a speculative anticipation on the part of the entrepreneur. It is preposterous to call in an expert and to substitute his arbitrary judgment for that of the entrepreneur. The expert is objective insofar as he is not affected by an error made. But the entrepreneur exposes his own material well-being.
Of course, the law determines magnitudes which it calls profit and loss. But these magnitudes are not identical with the economic concepts of profit and loss and must not be confused with them. If a tax law calls a magnitude profit, it in effect determines the height of taxes due. It calls this magnitude profit because it wants to justify its tax policy in the eyes of the public. It would be more correct for the legislator to omit the term profit and simply to speak of the basis for the computation of the tax due.
The tendency of the tax laws is to compute what they call profit as high as possible in order to increase immediate public revenue. But there are other laws which are committed to the tendency to restrict the magnitude they call profit. The commercial codes of many nations were and are guided by the endeavor to protect the rights of creditors. They aimed at restricting what they called profit in order to prevent the entrepreneur from withdrawing to the prejudice of creditors too much from the firm or corporation for his own benefit. It was these tendencies which were operative in the evolution of the commercial usages concerning the customary height of depreciation quotas.
There is no need today to dwell upon the problem of the falsification of economic calculation under inflationary conditions. All people begin to comprehend the phenomenon of illusory profits, the offshoot of the great inflations of our age.
Failure to grasp the effects of inflation upon the customary methods of computing profits originated the modern concept of profiteering. An entrepreneur is dubbed a profiteer if his profit and loss statement, calculated in terms of a currency subject to a rapidly progressing inflation, shows profits which other people deem “excessive.” It has happened very often in many countries that the profit and loss statement of such a profiteer, when calculated in terms of a non-inflated or less inflated currency, showed not only no profit at all but considerable losses.
Even if we neglect for the sake of argument any reference to the phenomenon of merely inflation-induced illusory profits, it is obvious that the epithet profiteer is the expression of an arbitrary judgment of value. There is no other standard available for the distinction between profiteering and earning fair profits than that provided by the censor’s personal envy and resentment. ...
- The Consequences of the Abolition of Profit[Ibid., section B: “The Condemnation of Profit,” pp. 132–43.]The idea to abolish profit for the advantage of the consumers involves that the entrepreneur should be forced to sell the products at prices not exceeding the costs of production expended. As such prices are, for all articles the sale of which would have brought profit, below the potential market price, the available supply is not sufficient to make it possible for all those who want to buy at these prices to acquire the articles. The market is paralyzed by the maximum price decree. It can no longer allocate the products to the consumers. A system of rationing must be adopted.
The suggestion to abolish the entrepreneur’s profit for the benefit of the employees aims not at the abolition of profit. It aims at wresting it from the hands of the entrepreneur and handing it over to his employees.
Under such a scheme the incidence of losses incurred falls upon the entrepreneur, while profits go to the employees. It is probable that the effect of this arrangement would consist in making losses increase and profits dwindle. At any rate, a greater part of the profits would be consumed and less would be saved and ploughed back into the enterprise. No capital would be available for the establishment of new branches of production and for the transfer of capital from branches which — in compliance with the demand of the customers — should shrink into branches which should expand. For it would harm the interests of those employed in a definite enterprise or branch to restrict the capital employed in it and to transfer it into another enterprise or branch. If such a scheme had been adopted half a century ago, all the innovations accomplished in this period would have been rendered impossible. If, for the sake of argument, we were prepared to neglect any reference to the problem of capital accumulation, we would still have to realize that giving profit to the employees must result in rigidity of the once attained state of production and preclude any adjustment, improvement and progress.
In fact, the scheme would transfer ownership of the capital invested into the hands of the employees. It would be tantamount to the establishment of syndicalism and would generate all the effects of syndicalism, a system which no author or reformer ever had the courage to advocate openly.
A third solution of the problem would be to confiscate all the profits earned by the entrepreneurs for the benefit of the state. A one hundred per cent tax on profits would accomplish this task. It would transform the entrepreneurs into irresponsible administrators of all plants and workshops. They would no longer be subject to the supremacy of the buying public. They would just be people who have the power to deal with production as it pleases them.
The policies of all contemporary governments which have not adopted outright socialism apply all these three schemes jointly. They confiscate by various measures of price control a part of the potential profits for the alleged benefit of the consumers. They support the labor unions in their endeavors to wrest, under the ability-to-pay principle of wage determination, a part of the profits from the entrepreneurs. And, last but not least, they are intent upon confiscating, by progressive income taxes, special taxes on corporation income, and “excess profits” taxes, an ever-increasing part of profits for public revenue. It can easily be seen that these policies if continued will very soon succeed in abolishing entrepreneurial profit altogether.
The joint effect of the application of these policies is already today rising chaos. The final effect will be the full realization of socialism by smoking out the entrepreneurs. Capitalism cannot survive the abolition of profit. It is profit and loss that force the capitalists to employ their capital for the best possible service to the consumers. It is profit and loss that make those people supreme in the conduct of business who are best fit to satisfy the public. If profit is abolished, chaos results.
Epistemological Problems of Economics[Ludwig von Mises, Epistemological Problems of Economics, 3rd ed. (1933; Auburn, Ala.: Mises Institute, 2003), chap. 1, sec. 2: “The Scope and Meaning of the System of A Priori Theorems,” pp. 24–27, 33–37.]1. The Basic Concept of Action and its Categorial ConditionsThe starting point of our reasoning is not behavior, but action, or, as it is redundantly designated, rational action. Human action is conscious behavior on the part of a human being. Conceptually it can be sharply and clearly distinguished from unconscious activity, even though in some cases it is perhaps not easy to determine whether given behavior is to be assigned to one or the other category.
As thinking and acting men, we grasp the concept of action. In grasping this concept we simultaneously grasp the closely correlated concepts of value, wealth, exchange, price, and cost. They are all necessarily implied in the concept of action, and together with them the concepts of valuing, scale of value and importance, scarcity and abundance, advantage and disadvantage, success, profit, and loss. The logical unfolding of all these concepts and categories in systematic derivation from the fundamental category of action and the demonstration of the necessary relations among them constitutes the first task of our science. The part that deals with the elementary theory of value and price serves as the starting point in its exposition. There can be no doubt whatever concerning the aprioristic character of these disciplines.
The most general prerequisite of action is a state of dissatisfaction, on the one hand, and, on the other, the possibility of removing or alleviating it by taking action. (Perfect satisfaction and its concomitant, the absence of any stimulus to change and action, belong properly to the concept of a perfect being. This, however, is beyond the power of the human mind to conceive. A perfect being would not act.) Only this most general condition is necessarily implied in the concept of action. The other categorial conditions of action are independent of the basic concept; they are not necessary prerequisites of concrete action. Whether or not they are present in a particular case can be shown by experience only. But where they are present, the action necessarily falls under definite laws that flow from the categorial determinacy of these further conditions.
It is an empirical fact that man grows old and dies and that therefore he cannot be indifferent to the passage of time. That this has been man’s experience thus far without exception, that we do not have the slightest evidence to the contrary, and that scarcely any other experience points more obviously to its foundation in a law of nature — all this in no way changes its empirical character. The fact that the passage of time is one of the conditions under which action takes place is established empirically and not a priori. We can without contradiction conceive of action on the part of immortal beings who would never age. But in so far as we take into consideration the action of men who are not indifferent to the passage of time and who therefore economize time because it is important to them whether they attain a desired end sooner or later, we must attribute to their action everything that necessarily follows from the categorial nature of time. The empirical character of our knowledge that the passage of time is a condition of any given action in no way affects the aprioristic character of the conclusions that necessarily follow from the introduction of the category of time. Whatever follows necessarily from empirical knowledge — e.g., the propositions of the agio theory of interest — lies outside the scope of empiricism.
Whether the exchange of economic goods (in the broadest sense, which also includes services) occurs directly, as in barter, or indirectly, through a medium of exchange, can be established only empirically. However, where and in so far as media of exchange are employed, all the propositions that are essentially valid with regard to indirect exchange must hold true. Everything asserted by the quantity theory of money, the theory of the relation between the quantity of money and interest, the theory of fiduciary media, and the circulation-credit theory of the business cycle, then becomes inseparably connected with action. All these theorems would still be meaningful even if there had never been any indirect exchange; only their practical significance for our action and for the science that explains it would then have to be appraised differently. However, the heuristic importance of experience for the analysis of action is not to be disregarded. Perhaps if there had never been indirect exchange, we would not have been able to conceive of it as a possible form of action and to study it in all its ramifications. But this in no way alters the aprioristic character of our science.
These considerations enable us to assess critically the thesis that all or most of the doctrines of economics hold only for a limited period of history and that, consequently, theorems whose validity is thus limited historically or geographically should replace, or at least supplement, those of the universally valid theory. All the propositions established by the universally valid theory hold to the extent that the conditions that they presuppose and precisely delimit are given. Where these conditions are present, the propositions hold without exception. This means that these propositions concern action as such; that is, that they presuppose only the existence of a state of dissatisfaction, on the one hand, and the recognized possibility, on the other, of relieving this dissatisfaction by conscious behavior, and that, therefore, the elementary laws of value are valid without exception for all human action. When an isolated person acts, his action occurs in accordance with the laws of value. Where, in addition, goods of higher order are introduced into action, all the laws of the theory of imputation are valid. Where indirect exchange takes place, all the laws of monetary theory are valid. Where fiduciary media are created, all the laws of the theory of fiduciary media (the theory of credit) are valid. There would be no point in expressing this fact by saying that the doctrines of the theory of money are true only in those periods of history in which indirect exchange takes place. ...
- The Distinction Between Means and Ends: The “Irrational”Most of the objections raised against the science of action stem from a misconception of the distinction between means and ends. In the strict sense, the end is always the removal of a dissatisfaction. However, we can doubtless also designate as an end the attainment of that condition of the external world which brings about our state of satisfaction either directly or indirectly, or which enables us to perform, without further difficulties, the act through which satisfaction is to be obtained. If the removal of the feeling of hunger is the end sought, the procuring of food and its preparation for eating can also be considered as ends; if one seeks the removal of the feeling of cold as an end, the heating of one’s quarters can just as well be called an end. If additional measures are needed for the removal of dissatisfaction, then the attainment of any particular step along the way toward the desired final condition is also designated as an end. In this sense the acquisition of money in the market economy and, proximately, the division of labor are designated as ends of action; in this sense too the attainment of all things that indirectly promote the end of want-satisfaction appear as proximate or intermediate ends.
In the course of attaining the primary end, secondary ends are attained. A man walks from A to B. He would choose the shortest route if other, secondary ends did not demand satisfaction. He makes a detour if he can walk in the shade a little longer; if he can include in his walk another place, C, which he wants to look for; if, by doing so, he can avoid dangers that may be lying in wait for him on the shortest route; or if he just happens to like the longer route. If he decides on a detour, we must infer that at the moment of decision the attainment of such secondary ends was of greater importance in his judgment than the saving of distance. Consequently, for him the “detour” was no detour at all, since his walk brought him greater satisfaction or — at least from the point of view that he took of his situation at the moment of decision — was expected to bring greater satisfaction than the attainment of his destination by the shorter route. Only one who does not have these secondary ends in mind can call the longer way a detour. As far as our stroller was concerned, it was the correct route, that is, the route that promised the greatest satisfactions.Cf. Lionel Robbins, An Essay on the Nature and Significance of Economic Science (London, 1932), p. 23.
Since satisfaction and dissatisfaction depend only on the subjective view of the individual, there is no room for argument on this question in a science that does not presume to establish a scale of values or to make judgments of value. Its conception of an end, in the strict sense, is more deductive than empirical: ends are determined by the wishes and the desires of the individual. Whenever reference is made to the greater or lesser appropriateness of means, this can only be from the point of view of the acting individual.
We must next deal with the objection of those who never weary of asserting that man does not act rationally at all. It has never been disputed that man does not always act correctly from the objective point of view; that is, that either from ignorance of causal relations or because of an erroneous judgment of the given situation, in order to realize his ends he acts differently from the way in which he would act if he had correct information. In 1833 the method of healing wounds was different from that used in 1933, and in 2033 still another way will presumably be thought suitable. Statesmen, field marshals, and stock-market speculators act differently at present from the way in which they would act if they knew exactly all the data needed for an accurate judgment of conditions. Only a perfect being, whose omniscience and omnipresence would enable him to survey all the data and every causal relationship, could know how each erring human being would have to act at every moment if he wanted to possess the divine attribute of omniscience. If we were to attempt to distinguish rational action from irrational action, we should not only be setting ourselves up as a judge over the scales of value of our fellow men, but we should also be declaring our own knowledge to be the only correct, objective standard of knowledge. We should be arrogating to ourselves the position that only an all-knowing being has the power to occupy.
The assertion that there is irrational action is always rooted in an evaluation of a scale of values different from our own. Whoever says that irrationality plays a role in human action is merely saying, that his fellow men behave in a way that he does not consider correct. If we do not wish to pass judgment on the ends and the scales of value of other people and to claim omniscience for ourselves, the statement, “He acts irrationally,” is meaningless, because it is not compatible with the concept of action. The “seeking to attain an end” and the “striving after a goal” cannot be eliminated from the concept of action. Whatever does not strive after goals or seek the attainment of ends reacts with absolute passivity to an external stimulus and is without a will of its own, like an automaton or a stone. To be sure, man too is as far outside the effective range of his action as a reed in the wind. But in so far as he is able to do anything, he always acts: even negligence and passivity are action if another course of conduct could have been chosen. And the conduct that is determined by the unconscious, in the Freudian sense, or by the subconscious, is also action in so far as conscious behavior could prevent it but neglects to do so. Even in the unconscious and apparently senseless behavior of the neurotic and the psychopath there is meaning, i.e., there is striving after ends and goals.Cf. Sigmund Freud, Lectures on the Introduction to Psychoanalysis, 17th lecture.
Everything that we say about action is independent of the motives that cause it and of the goals toward which it strives in the individual case. It makes no difference whether action springs from altruistic or from egoistic motives, from a noble or from a base disposition; whether it is directed toward the attainment of materialistic or idealistic ends; whether it arises from exhaustive and painstaking deliberation or follows fleeting impulses and passions. The laws of catallactics that economics expounds are valid for every exchange regardless of whether those involved in it have acted wisely or unwisely or whether they were actuated by economic or noneconomic motives. The causes of action and the goals toward which it strives are data for the theory of action: upon their concrete configuration depends the course of action taken in the individual case, but the nature of action as such is not thereby affected.
These considerations have an evident bearing on the widespread tendency of the present age to appeal to the irrational. The concepts rational and irrational are not applicable to ends at all. Whoever wishes to pass judgment on ends may praise or condemn them as good or evil, fine or vulgar, etc. When the expressions “rational” and “irrational” are applied to the means employed for the attainment of an end, such a usage has significance only from the standpoint of a definite technology. However, the use of means other than those prescribed as “rational” by this technology can be accounted for in only two possible ways: either the “rational” means were not known to the actor, or he did not employ them because he wished to attain still other ends — perhaps very foolish ones from the point of view of the observer. In neither of these two cases is one justified in speaking of “irrational” action.
Action is, by definition, always rational. One is unwarranted in calling goals of action irrational simply because they are not worth striving for from the point of view of one’s own valuations. Such a mode of expressions leads to gross misunderstandings. Instead of saying that irrationality plays a role in action, one should accustom oneself to saying merely: There are people who aim at different ends from those that I aim at, and people who employ different means from those I would employ in their situation.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 1: “Acting Man,” pp. 11–16.]1. Purposeful Action and Animal ReactionHuman 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. Such paraphrases may clarify the definition given and prevent possible misinterpretations. But the definition itself is adequate and does not need complement or commentary.
Conscious or purposeful behavior is in sharp contrast to unconscious behavior, i.e., the reflexes and the involuntary responses of the body’s cells and nerves to stimuli. People are sometimes prepared to believe that the boundaries between conscious behavior and the involuntary reaction of the forces operating within man’s body are more or less indefinite. This is correct only as far as it is sometimes not easy to establish whether concrete behavior is to be considered voluntary or involuntary. But the distinction between consciousness and unconsciousness is nonetheless sharp and can be clearly determined.
The unconscious behavior of the bodily organs and cells is for the acting ego no less a datum than any other fact of the external world. Acting man must take into account all that goes on within his own body as well as other data, e.g., the weather or the attitudes of his neighbors. There is, of course, a margin within which purposeful behavior has the power to neutralize the working of bodily factors. It is feasible within certain limits to get the body under control. Man can sometimes succeed through the power of his will in overcoming sickness, in compensating for the innate or acquired insufficiency of his physical constitution, or in suppressing reflexes. As far as this is possible, the field of purposeful action is extended. If a man abstains from controlling the involuntary reaction of cells and nerve centers, although he would be in a position to do so, his behavior is from our point of view purposeful.
The field of our science is human action, not the psychological events which result in an action. It is precisely this which distinguishes the general theory of human action, praxeology, from psychology. The theme of psychology is the internal events that result or can result in a definite action. The theme of praxeology is action as such. This also settles the relation of praxeology to the psychoanalytical concept of the subconscious. Psychoanalysis too is psychology and does not investigate action but the forces and factors that impel a man toward a definite action. The psychoanalytical subconscious is a psychological and not a praxeological category. Whether an action stems from clear deliberation, or from forgotten memories and suppressed desires which from submerged regions, as it were, direct the will, does not influence the nature of the action. The murderer whom a subconscious urge (the Id) drives toward his crime and the neurotic whose aberrant behavior seems to be simply meaningless to an untrained observer both act; they like anybody else are aiming at certain ends. It is the merit of psychoanalysis that it has demonstrated that even the behavior of neurotics and psychopaths is meaningful, that they too act and aim at ends, although we who consider ourselves normal and sane call the reasoning determining their choice of ends nonsensical and the means they choose for the attainment of these ends contrary to purpose.
The term “unconscious” as used by praxeology and the term “subconscious” as applied by psychoanalysis belong to two different systems of thought and research. Praxeology no less than other branches of knowledge owes much to psychoanalysis. The more necessary is it then to become aware of the line which separates praxeology from psychoanalysis.
Action is not simply giving preference. Man also shows preference in situations in which things and events are unavoidable or are believed to be so. Thus a man may prefer sunshine to rain and may wish that the sun would dispel the clouds. He who only wishes and hopes does not interfere actively with the course of events and with the shaping of his own destiny. But acting man chooses, determines, and tries to reach an end. Of two things both of which he cannot have together he selects one and gives up the other. Action therefore always involves both taking and renunciation.
To express wishes and hopes and to announce planned action may be forms of action in so far as they aim in themselves at the realization of a certain purpose. But they must not be confused with the actions to which they refer. They are not identical with the actions they announce, recommend, or reject. Action is a real thing. What counts is a man’s total behavior, and not his talk about planned but not realized acts. On the other hand action must be clearly distinguished from the application of labor. Action means the employment of means for the attainment of ends. As a rule one of the means employed is the acting man’s labor. But this is not always the case. Under special conditions a word is all that is needed. He who gives orders or interdictions may act without any expenditure of labor. To talk or not to talk, to smile or to remain serious, may be action. To consume and to enjoy are no less action than to abstain from accessible consumption and enjoyment.
Praxeology consequently does not distinguish between “active” or energetic and “passive” or indolent man. The vigorous man industriously striving for the improvement of his condition acts neither more nor less than the lethargic man who sluggishly takes things as they come. For to do nothing and to be idle are also action, they too determine the course of events. Wherever the conditions for human interference are present, man acts no matter whether he interferes or refrains from interfering. He who endures what he could change acts no less than he who interferes in order to attain another result. A man who abstains from influencing the operation of physiological and instinctive factors which he could influence also acts. Action is not only doing but no less omitting to do what possibly could be done.
We may say that action is the manifestation of a man’s will. But this would not add anything to our knowledge. For the term will means nothing else than man’s faculty to choose between different states of affairs, to prefer one, to set aside the other, and to behave according to the decision made in aiming at the chosen state and forsaking the other.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 19: “Interest,” pp. 523–29.]1. The Phenomenon of InterestIt has been shown that time preference is a category inherent in every human action. Time preference manifests itself in the phenomenon of originary interest, i.e., the discount of future goods as against present goods.
Interest is not merely interest on capital. Interest is not the specific income derived from the utilization of capital goods. The correspondence between three factors of production — labor, capital, and land — and three classes of income — wages, profit, and rent — as taught by the classical economists is untenable. Rent is not the specific revenue from land. Rent is a general catallactic phenomenon; it plays in the yield of labor and capital goods the same role it plays in the yield of land. Furthermore there is no homogeneous source of income that could be called profit in the sense in which the classical economists applied this term. Profit (in the sense of entrepreneurial profit) and interest are no more characteristic of capital than they are of land.
The prices of consumers’ goods are by the interplay of the forces operating on the market apportioned to the various complementary factors cooperating in their production. As the consumers’ goods are present goods, while the factors of production are means for the production of future goods, and as present goods are valued higher than future goods of the same kind and quantity, the sum thus apportioned, even in the imaginary construction of the evenly rotating economy, falls behind the present price of the consumers’ goods concerned. This difference is the originary interest. It is not specifically connected with any of the three classes of factors of production which the classical economists distinguished. Entrepreneurial profit and loss are produced by changes in the data and the resulting price changes which occur in the passing of the period of production.
Naïve reasoning does not see any problem in the current revenue derived from hunting, fishing, cattle breeding, forestry, and agriculture. Nature generates deer, fish, and cattle and makes them grow, causes the cows to give milk and the chickens to lay eggs, the trees to put on wood and to bear fruit, and the seeds to shoot into ears. He who has a title to appropriate for himself this recurring wealth enjoys a steady income. Like a stream which continually carries new water, the “stream of income” flows continually and conveys again and again new wealth. The whole process appears as a natural phenomenon. But for the economist a problem is presented in the determination of prices for land, cattle, and all the rest. If future goods were not bought and sold at a discount as against present goods, the buyer of land would have to pay a price which equals the sum of all future net revenues and which would leave nothing for a current reiterated income.
The yearly recurring proceeds of the owners of land and cattle are not marked by any characteristic which would catallactically distinguish them from the proceeds stemming from produced factors of production which are used up sooner or later in the processes of production. The power of disposal over a piece of land is the control of this field’s cooperation in the production of all the fruit which can ever be grown on it, and the power of disposal over a mine is the control of its cooperation in the extraction of all the minerals which can ever be brought to the surface from it. In the same way the ownership of a machine or a bale of cotton is the control of its cooperation in the manufacture of all goods which are produced with its cooperation. The fundamental fallacy implied in all the productivity and use approaches to the problem of interest was that they traced back the phenomenon of interest to these productive services rendered by the factors of production. However, the serviceableness of the factors of production determines the prices paid for them, not interest. These prices exhaust the whole difference between the productivity of a process aided by a definite factor’s cooperation and that of a process lacking this cooperation. The difference between the sum of the prices of the complementary factors of production and the products which emerges even in the absence of changes in the market data concerned, is an outcome of the higher valuation of present goods as compared with future goods. As production goes on, the factors of production are transformed or ripen into present goods of a higher value. This increment is the source of specific proceeds flowing into the hands of the owners of the factors of production, of originary interest.
The owners of the material factors of production — as distinct from the pure entrepreneurs of the imaginary construction of an integration of catallactic functions — harvest two catallactically different items: the prices paid for the productive cooperation of the factors they control on the one hand and interest on the other hand. These two things must not be confused. It is not permissible to refer, in the explanation of interest, to the services rendered by the factors of production in the turning out of products.
Interest is a homogeneous phenomenon. There are no different sources of interest. Interest on durable goods and interest on consumption-credit are like other kinds of interest an outgrowth of the higher valuation of present goods as against future goods.
- Originary InterestOriginary interest is the ratio of the value assigned to want-satisfaction in the immediate future and the value assigned to want-satisfaction in remoter periods of the future. It manifests itself in the market economy in the discount of future goods as against present goods. It is a ratio of commodity prices, not a price in itself. There prevails a tendency toward the equalization of this ratio for all commodities. In the imaginary construction of the evenly rotating economy the rate of originary interest is the same for all commodities.
Originary interest is not “the price paid for the services of capital.”This is the popular definition of interest as, for instance, given by [Richard T.] Ely, [Thomas] Adams, [Max]Lorenz, and [Allyn] Young, Outlines of Economics (3d ed. New York, 1920), p. 493. The higher productivity of more time-consuming roundabout methods of production which is referred to by Böhm-Bawerk and by some later economists in the explanation of interest, does not explain the phenomenon. It is, on the contrary, the phenomenon of originary interest that explains why less time-consuming methods of production are resorted to in spite of the fact that more time-consuming methods would render a higher output per unit of input. Moreover, the phenomenon of originary interest explains why pieces of usable land can be sold and bought at finite prices. If the future services which a piece of land can render were to be valued in the same way in which its present services are valued, no finite price would be high enough to impel its owner to sell it. Land could neither be bought nor sold against definite amounts of money, nor bartered against goods which can render only a finite number of services. Pieces of land would be bartered only against other pieces of land. A superstructure that can yield during a period of ten years an annual revenue of one hundred dollars would be priced (apart from the soil on which it is built) at the beginning of this period at one thousand dollars, at the beginning of the second year at nine hundred dollars, and so on.
Originary interest is not a price determined on the market by the interplay of the demand for and the supply of capital or capital goods. Its height does not depend on the extent of this demand and supply. It is rather the rate of originary interest that determines both the demand for and the supply of capital and capital goods. It determines how much of the available supply of goods is to be devoted to consumption in the immediate future and how much to provision for remoter periods of the future.
People do not save and accumulate capital because there is interest. Interest is neither the impetus to saving nor the reward or the compensation granted for abstaining from immediate consumption. It is the ratio in the mutual valuation of present goods as against future goods.
The loan market does not determine the rate of interest. It adjusts the rate of interest on loans to the rate of originary interest as manifested in the discount of future goods.
Originary interest is a category of human action. It is operative in any valuation of external things and can never disappear. If one day the state of affairs were to return which was actual at the close of the first millennium of the Christian era when people believed that the ultimate end of all earthly things was impending, men would stop providing for future secular wants. The factors of production would in their eyes become useless and worthless. The discount of future goods as against present goods would not vanish. It would, on the contrary, increase beyond all measure. On the other hand, the fading away of originary interest would mean that people do not care at all for want-satisfaction in nearer periods of the future. It would mean that they prefer to an apple available today, tomorrow, in one year or in ten years, two apples available in a thousand or ten thousand years.
We cannot even think of a world in which originary interest would not exist as an inexorable element in every kind of action. Whether there is or is not division of labor and social cooperation and whether society is organized on the basis of private or of public control of the means of production, originary interest is always present. In a socialist commonwealth its role would not differ from that in the market economy.
Böhm-Bawerk has once for all unmasked the fallacies of the naïve productivity explanations of interest, i.e., of the idea that interest is the expression of the physical productivity of factors of production. However, Böhm-Bawerk has himself based his own theory to some extent on the productivity approach. In referring in his explanation to the technological superiority of more time-consuming, roundabout processes of production, he avoids the crudity of the naïve productivity fallacies. But in fact he returns, although in a subtler form, to the productivity approach. Those later economists who, neglecting the time-preference idea, have stressed exclusively the productivity idea contained in Böhm-Bawerk’s theory cannot help concluding that originary interest must disappear if men were one day to reach a state of affairs in which no further lengthening of the period of production could bring about a further increase in productivity.Cf. [Friedrich A.] Hayek, “The Mythology of Capital,” The Quarterly Journal of Economics 50 (1936): 223 ff. However Professor Hayek has since partly changed his point of view. (Cf. his article “Time-Preference and Productivity, a Reconsideration,” Economica 12 [1945]: 22–25.) But the idea criticized in the text is still widely held by economists. This is, however, utterly wrong. Originary interest cannot disappear as long as there is scarcity and therefore action.
As long as the world is not transformed into a land of Cockaigne, men are faced with scarcity and must act and economize; they are forced to choose between satisfaction in nearer and in remoter periods of the future because neither for the former nor for the latter can full contentment be attained. Then a change in the employment of factors of production which withdraws such factors from their employment for want-satisfaction in the nearer future and devotes them to want-satisfaction in the remoter future must necessarily impair the state of satisfaction in the nearer future and improve it in the remoter future. If we were to assume that this is not the case, we should become embroiled in insoluble contradictions. We may at best think of a state of affairs in which technological knowledge and skill have reached a point beyond which no further progress is possible for mortal men. No new processes increasing the output per unit of input can henceforth be invented. But if we suppose that some factors of production are scarce, we must not assume that all processes which — apart from the time they absorb — are the most productive ones are fully utilized, and that no process rendering a smaller output per unit of input is resorted to merely because of the fact that it produces its final result sooner than other, physically more productive processes. Scarcity of factors of production means that we are in a position to draft plans for the improvement of our well-being the realization of which is unfeasible because of the insufficient quantity of the means available. It is precisely the unfeasibility of such desirable improvements that constitutes the element of scarcity. The reasoning of the modern supporters of the productivity approach is misled by the connotations of Böhm-Bawerk’s term roundabout methods of production and the idea of technological improvement which it suggests. However, if there is scarcity, there must always be an unused technological opportunity to improve the state of well-being by a lengthening of the period of production in some branches of industry, regardless of whether or not the state of technological knowledge has changed. If the means are scarce, if the praxeological correlation of ends and means still exists, there are by logical necessity unsatisfied wants with regard both to nearer and to remoter periods of the future. There are always goods the procurement of which we must forego because the way that leads to their production is too long and would prevent us from satisfying more urgent needs. The fact that we do not provide more amply for the future is the outcome of a weighing of satisfaction in nearer periods of the future against satisfaction in remoter periods of the future. The ratio which is the outcome of this valuation is originary interest.
In such a world of perfect technological knowledge a promoter drafts a plan A according to which a hotel in picturesque, but not easily accessible, mountain districts and the roads leading to it should be built. In examining the practicability of this plan he discovers that the means available are not sufficient for its execution. Calculating the prospects of the profitability of the investment, he comes to the conclusion that the expected proceeds are not great enough to cover the costs of material and labor to be expended and interest on the capital to be invested. He renounces the execution of project A and embarks instead upon the realization of another plan, B. According to plan B the hotel is to be erected in a more easily accessible location which does not offer all the advantages of the picturesque landscape which plan A had selected, but in which it can be built either with lower costs of construction or finished in a shorter time. If no interest on the capital invested were to enter into the calculation, the illusion could arise that the state of the market data — supply of capital goods and the valuations of the public — allows for the execution of plan A. However, the realization of plan A would withdraw scarce factors of production from employments in which they could satisfy wants considered more urgent by the consumers. It would mean a manifest malinvestment, a squandering of the means available.
A lengthening of the period of production can increase the quantity of output per unit of input or produce goods which cannot be produced at all within a shorter period of production. But it is not true that the imputation of the value of this additional wealth to the capital goods required for the lengthening of the period of production generates interest. If one were to assume this, one would relapse into the crassest errors of the productivity approach, irrefutably exploded by Böhm-Bawerk. The contribution of the complementary factors of production to the result of the process is the reason for their being considered as valuable; it explains the prices paid for them and is fully taken into account in the determination of these prices. No residuum is left that is not accounted for and could explain interest.
It has been asserted that in the imaginary construction of the evenly rotating economy no interest would appear.Cf. [Joseph] Schumpeter, The Theory of Economic Development, trans. by R. Opie (Cambridge, 1934), pp. 34–46, 54. However, it can be shown that this assertion is incompatible with the assumptions on which the construction of the evenly rotating economy is based.
We begin with the distinction between two classes of saving: plain saving and capitalist saving. Plain saving is merely the piling up of consumers’ goods for later consumption. Capitalist saving is the accumulation of goods which are designed for an improvement of production processes. The aim of plain saving is later consumption; it is merely postponement of consumption. Sooner or later the goods accumulated will be consumed and nothing will be left. The aim of capitalist saving is first an improvement in the productivity of effort. It accumulates capital goods which are employed for further production and are not merely reserves for later consumption. The boon derived from plain saving is later consumption of the stock not instantly consumed but accumulated for later use. The boon derived from capitalist saving is the increase of the quantity of goods produced or the production of goods which could not be produced at all without its aid. In constructing the image of an evenly rotating (static) economy, economists disregard the process of capital accumulation; the capital goods are given and remain, as, according to the underlying assumptions, no changes occur in the data. There is neither accumulation of new capital through saving, nor consumption of capital available through a surplus of consumption over income, i.e., current production minus the funds required for the maintenance of capital. It is now our task to demonstrate that these assumptions are incompatible with the idea that there is no interest.
There is no need to dwell, in this reasoning, upon plain saving. The objective of plain saving is to provide for a future in which the saver could possibly be less amply supplied than in the present. Yet, one of the fundamental assumptions characterizing the imaginary construction of the evenly rotating economy is that the future does not differ at all from the present, that the actors are fully aware of this fact and act accordingly. Hence, in the frame of this construction, no room is left for the phenomenon of plain saving.
It is different with the fruit of capitalist saving, the accumulated stock of capital goods. There is in the evenly rotating economy neither saving and accumulation of additional capital goods nor eating up of already existing capital goods. Both phenomena would amount to a change in the data and would thus disturb the even rotation of the imaginary system. Now, the magnitude of saving and capital accumulation in the past — i.e., in the period preceding the establishment of the evenly rotating economy — was adjusted to the height of the rate of interest. If — with the establishment of the conditions of the evenly rotating economy — the owners of the capital goods were no longer to receive any interest, the conditions which were operative in the allocation of the available stocks of goods to the satisfaction of wants in the various periods of the future would be upset. The altered state of affairs requires a new allocation. Also in the evenly rotating economy the difference in the valuation of want-satisfaction in various periods of the future cannot disappear. Also in the frame of this imaginary construction, people will assign a higher value to an apple available today as against an apple available in ten or a hundred years. If the capitalist no longer receives interest, the balance between satisfaction in nearer and remoter periods of the future is disarranged. The fact that a capitalist has maintained his capital at just 100,000 dollars was conditioned by the fact that 100,000 present dollars were equal to 105,000 dollars available twelve months later. These 5,000 dollars were in his eyes sufficient to outweigh the advantages to be expected from an instantaneous consumption of a part of this sum. If interest payments are eliminated, capital consumption ensues.
This is the essential deficiency of the static system as Schumpeter depicts it. It is not sufficient to assume that the capital equipment of such a system has been accumulated in the past, that it is now available to the extent of this previous accumulation and is henceforth unalterably maintained at this level. We must also assign in the frame of this imaginary system a role to the operation of forces which bring about such a maintenance. If one eliminates the capitalist’s role as receiver of interest, one replaces it by the capitalist’s role as consumer of capital. There is no longer any reason why the owner of capital goods should abstain from employing them for consumption. Under the assumptions implied in the imaginary construction of static conditions (the evenly rotating economy) there is no need to keep them in reserve for rainy days. But even if, inconsistently enough, we were to assume that a part of them is devoted to this purpose and therefore withheld from current consumption, at least that part of capital will be consumed which corresponds to the amount that capitalist saving exceeds plain saving.Cf. [Lionel] Robbins, “On a Certain Ambiguity in the Conception of Stationary Equilibrium,” The Economic Journal 40 (1930): 211 ff.
If there were no originary interest, capital goods would not be devoted to immediate consumption and capital would not be consumed. On the contrary, under such an unthinkable and unimaginable state of affairs there would be no consumption at all, but only saving, accumulation of capital, and investment. Not the impossible disappearance of originary interest, but the abolition of payment of interest to the owners of capital, would result in capital consumption. The capitalists would consume their capital goods and their capital precisely because there is originary interest and present want-satisfaction is preferred to later satisfaction.
Therefore there cannot be any question of abolishing interest by any institutions, laws, and devices of bank manipulation. He who wants to “abolish” interest will have to induce people to value an apple available in a hundred years no less than a present apple. What can be abolished by laws and decrees is merely the right of the capitalists to receive interest. But such laws would bring about capital consumption and would very soon throw mankind back into the original state of natural poverty.
Selected Writings of Ludwig von Mises[In Selected Writings of Ludwig von Mises, vol. 3: The Political Economy of International Reform and Reconstruction, ed. Richard M. Ebeling (1946; Indianapolis, Ind.: Liberty Fund, 2000), pp. 119–32.]“The Main Issues in Present-Day Monetary Controversies”
Introductory Remarks
This is not a systematic presentation of the problems of money and credit. Neither is it a complete exposition of the theories and doctrines dealt with. The aim of this paper is merely to enumerate certain topics that should not be neglected in a discussion of money and credit.
I. The Purchasing Power ControversyA. Is Money “Neutral”?
The older economists believed that — other things being equal — changes in the supply or demand of money make all commodity prices and wage rates simultaneously rise or fall in exact proportion to these changes. The price “level” changes, but the relations among the prices of individual commodities and services remain the same. Those mathematical economists whose theorizing culminates in the formulation of an equation of exchange still maintain this thesis.
Modern economic analysis rejects this assumption. The changes in the supply or demand of money do not affect all individuals at the same time and to the same extent. In the case of inflation, for instance, the additional quantity of money does not find its way at first into the pockets of all individuals, nor does every individual of those benefited first with the increase in the quantity of money get the same amount; and not every individual reacts to the same additional quantity in the same way. Consequently, the prices of various commodities and services rise neither at the same time nor to the same extent. The nonsimultaneous appearance and unevenness of the price changes brought about by increases in the quantity of money results in a shift of income and wealth from some groups of the population to other groups. Monetary fluctuations are not neutral, even apart from their repercussions on all contracts stipulating some form of deferred payments. Monetary changes are a source of economic and social change.
B. Are Changes in the Purchasing Power of Money Measurable?
Even if we were prepared to leave out consideration of the nonsimultaneous appearance and unevenness of the price changes brought about by changes in the supply of or demand for money, we must realize that the index-number method does not provide a faithful criterion for the measurement of changes in the purchasing power of the monetary unit. Economic conditions are not rigid; they are — also apart from any changes occurring in monetary matters — continuously changing. New commodities appear, old commodities disappear. The quality of the various commodities is subject to change. Tastes, wants, and desires are changing and with them the valuation of the various goods offered on the market. A motorcar of 1920 and a motorcar of 1940 are entirely different things. Twenty-five years ago, where were vitamins, refrigerators, and talking pictures? How different is the role played today in the average American household by canned food, rayon, and radio sets? How much do clothes and shoes change from one year to the next? Even standard foods like milk, butter, meat, and vegetables have in the last decades improved in quality to such an extent that it is impermissible to take them as equivalent with those marketed in the past. A method which tacitly assumes that nothing else had changed in the economic system than the available quantity of money is utterly illusory. The chairman of our committee has provided us with the results of an investigation undertaken in his corporation. According to this information, only a fraction of the products manufactured today are of the same kind as the goods manufactured a few years ago. This is a typical case, more or less representative for all American processing industries.
Besides, mathematics provides us with various methods for the computation of averages from a given set of figures. Each of these methods has, with regard to the problem in question, some merits and some defects. Each of them yields different results. As it is impossible to declare one of these methods as the only adequate one and to discard all the others as manifestly unsuitable, it is obvious that the index-number approach does not provide an indisputable and uncontested solution that could command general acceptance.
C. Is It Possible to Adjust Monetary Manipulation to a Nonarbitrary Standard?
The advocates of a manipulated currency pretend to aim at the stability of the monetary unit’s purchasing power. They fail, however, to realize that in a changing economic world, the concept of a stable purchasing power is devoid of any real meaning.
There are three main objections to be raised against the proposals for a manipulated currency.
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The various methods suggested for a measurement of changes in the monetary unit’s purchasing power are arbitrary. Their results are contested by all those whose material interests would be hurt if they were to be used as a basis of monetary manipulation. In advocating the application of a certain index-number system, the results of which happen at the moment to provide a quasi-scientific justification of their particular interests, every pressure group and political party will always be in a position to cite the doctrine of some economists and statisticians. On the other hand, their adversaries will quote dissenting opinions of no less renowned experts. There is no means to free a tabular standard from the faults of purely arbitrary and party-ridden bias.
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It is impossible to know beforehand to what extent and at what date a definite amount of inflation or deflation (an increase or a reduction in the quantity of money and credit) will increase or reduce the prices of various commodities and services.
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Apart from other deficiencies, the proposals for stabilization are faulty because they are based on the idea of money’s neutrality. They all suggest methods to undo changes in the purchasing power of money that have already had their effects. If there has been an inflation, they wish to deflate to the same extent and vice versa. They do not realize that by this procedure, they do not undo the social consequences of monetary changes (that is, the shift of income and wealth from some groups to others), but simply add to them the social consequences of a new change. If a man has been hurt by being run over by an automobile, it is no remedy to let the car go back over him in the opposite direction.
D. The Case Against Flexible Foreign Exchange Parities
If the purchasing power of an individual country’s domestic currency changes, while the other countries’ currencies do not change at all or not to the same extent, foreign trade is affected. As a rule, foreign exchange rates are adjusted at an early stage of the inflationary or deflationary process to the new state of the domestic money supply, even while the prices of some commodities and services still lag behind and are not fully adjusted for a time. As long as the inflationary or deflationary changes have not exhausted all their effects on the structure of prices, the comparatively low or high state of some prices results — in the case of inflation — in encouraging exports and discouraging imports. From the viewpoint of mercantilist fallacies, a fall of the domestic monetary unit’s purchasing power is, therefore, considered as a very fortunate occurrence.
What really happens is this: The country exports more than it did before, and it gets, as compensation for these increased exports, a smaller amount of foreign products. Exports are, as it were, subsidized and imports penalized to the burden of the natives. The inflation is, by and large, tantamount to a tax imposed upon the domestic consumers in order to cheapen the consumption of domestic products by foreigners.
Nowadays, currency devaluation is mostly advocated as a remedy against the rigidity of wage rates. People are afraid of fighting openly the inappropriate policies of labor unions. They resort to an indirect attack. They hope that currency devaluation will, notwithstanding the rise of domestic commodity prices, not raise money wage rates and thus reduce real wage rates. Lord Keynes believes that “a gradual and automatic lowering or real wages as a result of rising prices” would not be “strongly resisted” by labor. He does not see that wage rates are rigid only on the downside, not on the upside, too.
E. The Case for the Gold Standard
The gold standard is not perfect. No human institution is.
The main argument in favor of the gold standard is that it renders the formation of the monetary unit’s purchasing power independent of arbitrary action on the part of governments, political parties, and pressure groups. It places a check upon inflationary policies, and is the only standard which can possibly become an international, a world standard.
II. The Credit ControversyA. The Banking Principle
Some economists of the “Banking School” ventured to deny flatly that changes in the quantity of money available can affect prices and interest rates. They introduced into their reasoning the idea of monetary “hoards” as a deus ex machina. The amount of money kept in these mythical hoards changes in such a way as to neutralize automatically changes in the quantity of money. A surplus of money is swallowed by these hoards; a deficiency of money is made good by a restriction of the amount hoarded. This fable has long since been abandoned.
The bulk of the older Banking School economists and all contemporary representatives of this school do not deny that an increase in the quantity of money (metallic money, government paper money, irredeemable bank notes, and deposit currency) must — other things being equal — result in a general rise of prices. The core of their teachings is: Short-term credits granted by commercial banks in the form of bank notes or deposits created for this purpose do not affect prices and interest rates, provided they do not exceed “the needs of trade.” Such loans provide the debtor with the funds required for the production and the marketing of goods. They are self-liquidating. If the purchased raw materials are made up and sold, or if the buyer of products settles his balance, the loan is paid off, and the bank notes or deposits disappear again. An actual need has brought them into existence. With the cessation of this need, they go off the stage. The amount of credit of this type which the market can absorb is determined by the volume of production and business activity. It is beyond the power of the banks to alter this volume. No credit expansion is to be feared if the banks strictly abide by the rule to limit their lending to satisfy the demand of producers or merchants for short-term credit.
The reasoning of the Banking School misses the essential problem. It is obvious that no credit expansion takes place if the banks keep the total amount of their lending at the same level. But if a new bank enters the field or if an existing bank embarks upon the granting of additional credit above the amount of its previous credits, credit expansion results.
It is not true that the volume of credit that the banks are in a position to grant, if strictly abiding by the aforementioned rules, is independent of the bank’s policy. The market is always in a position to absorb a surplus of credit supply. An increase in the supply of credit brings about a tendency toward a lowering of the rate of interest. With the lower rate of interest, many projects appear attractive that did not appear so with a higher rate. The lowering of the rate of interest encourages the expansion of precisely those business activities that — according to the banking doctrine — are viewed as proper instances for the granting of bank credit. Thus the credit expansion automatically increases the “needs of trade.” It stimulates business activities because it cheapens the exchange of future purchasing power for present purchasing power. While the supply of capital goods remained unaltered, there is now a greater demand for them on the part of business. Prices must, consequently, rise. A boom starts.
B. The Currency Principle
The “Currency School” intended to provide an explanation of the recurrence of economic crises. Its proponents first observed that the root cause of the depression is the preceding boom and substituted for the study of crises the study of the trade cycle.
Their reasoning ran this way: If the British banks expanded credit while conditions in the other countries remained unchanged, British prices would begin to rise, and these on the world market would lag behind them. Consequently, there would be an excess of British imports over exports. As the surplus of imported goods could not be paid for by shipping bank notes, the importers would have to export gold. Hence, gold would be withdrawn from the banks; their reserves would dwindle. This “external drain” would force upon the banks a restriction of their lending activities. The artificial boom would come to an end and give way to a depression.
The main fault of the Currency School was that it dealt with bank notes only and did not realize that deposits subject to check are only technically different from bank notes, while their economic significance is equal to that of bank notes. This failure vitiated the British Bank Act of 1844. But it is easy to rectify this error by a simple extension of the theory.
C. Austrian Theory of the Trade Cycle
Currency theory did not consider the problem of the consequences of credit expansion within an isolated country or of a synchronous credit expansion in all countries. It did not enter into a discussion of the way in which the market and the whole apparatus of production and distribution react to credit expansion. This task was accomplished by Austrian theory.
The rate of interest established on a market not hampered by credit expansion, says Austrian theory, separates those business projects that can be carried out under the existing state of the supply of capital goods and consumers’ preferences from those that cannot. With the lowering of the rate of interest brought about by credit expansion, the entrepreneurs embark upon projects for the realization of which the available amount of factors of production does not suffice.It is necessary to keep in mind that interest rates, in the course of a credit expansion, are — with the exception of the very beginning of the process — not always low when compared with the level which business used to consider as normal. But they are always low when measured by the standard that they would have to reach in a period of progressive inflation and its corollary, a general rise of prices, since they would have to include at such a time a compensation for the depreciation of the money unit going on in the period of the loan. They are deceived by the appearance of a nonexistent richness in the supply of material factors of production. They behave like a master builder who has overestimated the amount of building material available, has used up too much for the foundations and cannot complete his plan on account of a lack of material. Some of the new projects will never be finished; others, when finished, will be useless for lack of the plants producing the required complementary producers’ goods; others will not yield an adequate return on the capital invested.
It is true, the banks (or the governments) are in a position to prolong the boom for some time by injecting progressively increasing quantities of bank notes and deposits into the market. But the artificially created prosperity cannot last forever. Sooner or later it must come to an end. There are only two alternatives:
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The banks do not stop and go on expanding credit at a progressively accelerated pace. But the spell of inflation breaks once the public has the conviction that the banks and the authorities are resolved not to stop. If no limit of the inflation and, consequently, of the general rise of prices can be foreseen, a general Flucht in die Sachwerte starts. Everybody becomes aware of the fact that to hold cash and deposit balances with the banks involves loss, and that he does better to buy and store goods. Everybody is anxious to get rid of money and to exchange it for some other commodities, no matter how much he must pay for them. Prices are running away, and the purchasing power of the monetary unit drops to zero. The national currency system cracks up.
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As a rule, the banks do not let things go so far. They stop sooner by restricting credit. Then the day of reckoning dawns. The illusions disappear, people begin again to see reality as it is. The blunders committed in the boom become visible.
In every case, the slump is unavoidable. There is no means to make permanent a boom created by credit expansion and inflation.
The slump does not destroy values, but merely illusions. It does not make people poorer, it merely makes them aware of the impoverishment brought about by the malinvestment of the boom. It is not the depression that is an evil, but the preceding boom. The depression is the process of adjustment of economic conditions to the real market state-of-affairs. The fall in prices and wage rates is the preliminary step toward recovery and future real prosperity. He who wants to prevent the recurrence of economiccrises must prevent the resumption of credit expansion.
In short, credit expansion is doomed to failure at any rate. There is no means to substitute fictitious capital created by monetary and credit manipulation for nonexisting capital goods. The only method to increase a nation’s wealth and income is to save and to accumulate more real capital goods.
The rate of interest is a market phenomenon. In the long run, its height does not depend on the supply of money and credit. It is determined by the difference in the valuation of present goods and future goods. An increase in the supply of money and credit only temporarily lowers the rate of interest. In bringing about malinvestments, it finally results in a reduction in the amount of capital goods available. The economy has to pay heavily for the orgy of the artificial boom.
D. The Socialists’ Rejection of Austrian Theory
In the eyes of the socialists, there is no such thing as a scarcity of material factors of production. Mankind could enjoy a life in plenty. Scarcity is merely an outcome of the capitalist mode of production and distribution. Economic crises are an evil inherent in capitalism. They have nothing at all to do with the endeavors to expand credit and to lower the rate of interest by bank manipulation.
The consistent supporters of these tenets blithely assert that interest is a purely monetary phenomenon that could not exist in a barter economy. (Such were, for instance, the ideas of Silvio Gesell, the minister of finance of the short-lived communist Soviet regime in Munich; Lord Keynes is full of praise for Gesell and calls him an “unduly neglected prophet.”) Others are less outspoken and cling to a more cautious language. But a faulty doctrine does not gain anything from the fact that its advocates lack the courage to profess frankly all the conclusions which must be drawn logically from the principles they have espoused.
Whoever does not share the opinion that the rate of interest is only a monetary phenomenon is under the necessity to demonstrate the mechanism by which that level of the rate of interest, which corresponds to the whole structure of market conditions, reestablishes itself when temporarily disarranged by an easy money policy. The only solution of this problem provided up to now is that of the Austrian theory.
All those economists who want to explain the trade cycle as being caused by factors other than credit expansion must admit that no boom could arise if the amount of money and credit available were not increased. This implies that they cannot help admitting the fundamental thesis of Austrian theory.
E. Salvation Through Credit Manipulation
Consistent supporters of the doctrine that the rate of interest is a monetary phenomenon only and that there is no harm in the endeavors to abolish it by credit manipulation cannot help approving plans to establish the millennium by a reform of the monetary and banking system. The best known of the older projects of this type was that of the French socialist Proudhon, the man who coined the phrase “Property is theft.”
Such ideas are very popular with many successful businessmen. The Belgian Ernest Solvay advocated “social compatabilism,” a system hardly distinguished from that of Proudhon. More than twenty years ago, Thomas A. Edison and Henry Ford suggested that the construction of roads be financed by the issue of additional paper money in order to avoid the payment of interest to the banks or the public.
The present-day variety of this old superstition is embodied in the doctrine of unbalanced budgets and government spending. As far as the government procures the means required for spending by taxing the citizens and by borrowing from the public, its spending curtails individuals’ capacity to invest to the same extent that it increases that of the government. As far as the government borrows from the commercial banks or issues additional paper money, it embarks upon credit expansion and inflation.In the early stages of every instance of credit expansion and inflation, there is always optimism. People do not want to pay attention to the warning voices of economists. They stubbornly insist that their present situation has nothing in common with the boom periods of the past, and that the theorists are wrong in predicting the breakdown of the “prosperity.” But when the crisis comes, people become desperate; then they impeach not the faulty monetary and credit policies but the capitalist system as such.
III. The Foreign Exchange ControversyA. Purchasing Power Parity Theory
The exchange ratio between two different kinds of money tends to correspond to the exchange ratio between each of them and commodities and services. It is usual to call this ratio the static or natural ratio. If this exchange ratio between two kinds of money is disturbed, people will start operations — buying and selling — in order to profit from existing discrepancies. These transactions tend to reestablish the natural ratio.
It does not make any difference whether the two kinds of money are used in the same country simultaneously (as was the case under the old parallel gold and silver standard) or whether each country uses one of them only. The natural rate of foreign exchange is determined by the purchasing power of each of the two kinds of money.
If a payment has to be effected in a distant place, the transaction is burdened with the cost of shipping the money. These costs are avoided if claims and debts of various people in the two places can be cleared. If complete settlement of all payments due can be achieved in this way, no actual shipping of money is required. If an unsettled surplus turns up, it must be settled by transfers from place to place.The balance of payments does not determine the exchange ratio. It only determines how much of the cost of shipping money can be saved. If the two places or countries in question use the same precious metal as the standard, the balance of payments determines the fluctuations of the rate-of-exchange within the rigid limits set by the cost of shipping money (gold points or shipping points).
B. Balance of Payment Theory
Balance of payment theory asserts that foreign exchange rates are determined by the balance of payments.
This doctrine fails to realize that the amount of foreign trade depends on the structure of prices. If Atlantis imports from Thule a commodity A, for the unit of which two ducats must be paid in Atlantis, the commodity must be sold in Thule at the equivalent of two ducats in its local currency, that is, ten florins. If, without any inflation in Thule, the price of the ducat goes up to three florins, the importation of A must drop or stop altogether because at the price of fifteen florins, the demand for A in Thule shrinks or disappears altogether. A rise of foreign exchange rates that does not correspond to a rise of domestic prices (a fall of the purchasing power of the domestic currency) thus has the tendency to render the country’s balance of payment “favorable.”
But, object the supporters of balance of payment theory, things are certainly different if A is a vital necessity for the citizens of Thule. Then, they must import A, no matter how much its price goes up. This, too, is a fallacy. If the individual citizens of Thule spend more florins for the purchase of A, they must, if there is no domestic inflation, restrict their buying of other commodities, either domestic or imported. In the first case, the prices of these domestic commodities drop, and they become available forexport. In the second case, the amount of foreign exchange that would have been absorbed by the importation of other goods becomes available for the purchase of A.
If there is domestic inflation in Thule, then — and only then — a rise of the price of A (in florins) will not hinder the importation of A, as soon as the price of A (in Thule) is affected by the general rise of prices.
C. The Requirements of Foreign Exchange Stability
There is but one means to keep a nation’s domestic currency at par with gold and the sound currency of other countries: to abstain from credit expansion and inflation.
Money, Method, and the Money Process[Ludwig von Mises, Money, Method, and the Market Process: Essays by Ludwig von Mises, ed. Richard M. Ebeling (1938; Boston: Kluwer, 1990), chap. 5, pp. 69–77.]“The Non-Neutrality of Money”The monetary economists of the sixteenth and seventeenth centuries succeeded in dissipating the popular fallacies concerning an alleged stability of money. The old error disappeared, but a new one originated, the illusion of money’s neutrality.
Of course, classical economics did its best to dispose of these mistakes. David Hume, the founder of British Political Economy, and John Stuart Mill, the last in the line of classical economists, both dealt with the problem in a masterful way. And then we should not forget Cairnes, who in his essay on the course of depreciation paved the way for a realistic view of the issue involved.
Notwithstanding these first steps towards a more correct grasp, modern economists incorporated the fallacy of money neutrality into their system of thought.
The reasoning of modern marginal utility economics begins from the assumption of a state of pure barter. The mechanism of exchanging commodities and of market transactions is considered on the supposition that direct exchange alone prevails. The economists depict a purely hypothetical entity, a market without indirect exchange, without a medium of exchange, without money. There is no doubt that this method is the only possible one, that the elimination of money is necessary and that we cannot do without this concept of a market with direct exchange only. But we have to realize that it is a hypothetical concept which has no counterpart in reality. The actual market is necessarily a market of indirect exchange and money transactions.
From this assumption of a market without money, the fallacious idea of neutral money is derived. The economists were so fond of the tool which this hypothetical concept provided that they overestimated the extent of its applicability. They began to believe that all problems of catallactics could be analyzed by means of this fictitious concept. In accordance with this view, they considered that the main work of economic analysis was the study of direct exchange. After that all that was left was to introduce the monetary terms into the formulas obtained. But this was, in their eyes, a work of only secondary importance, because, as they were convinced, the introduction of monetary terms did not affect the substantial operation of the mechanism they had described. The functioning of the market mechanism as demonstrated by the concept of pure barter was not affected by monetary factors.
Of course, the economists knew that the exchange ratio between money and commodities was subject to change. But they believed — and this is exactly the essence of the fallacy of money’s neutrality — that these changes in purchasing power were brought about simultaneously in the whole market and that they affected all commodities to the same extent. The most striking expression of this point of view is to be found in the current metaphorical use of the term “level” in reference to prices. Changes in the supply or demand of money — other things remaining equal — make all prices and wages simultaneously rise or fall. The purchasing power of the monetary unit changes, but the relations among the prices of individual commodities remain the same.
Of course, economists have developed for more than a hundred years the method of index numbers in order to measure changes in purchasing power in a world where the ratios between the prices of individual commodities are in continuous transition. But in doing so, they did not give up the assumption that the consequences of a change in the supply or demand of money were a proportional and simultaneous modification of prices. The method of index numbers was designed to provide them with a means of distinguishing between the consequences of those changes in prices which take their origins from the side of the demand for or supply of individual commodities and those which start from the side of demand for or supply of money.
The erroneous assumption of money neutrality is at the root of all endeavors to establish the formula of a so-called equation of exchange. In dealing with such an equation the mathematical economist assumes that something— one of the elements of the equation — changes and that corresponding changes in the other values must needs follow. These elements of the equation are not items in the individual’s economy, but items of the whole economic system, and consequently the changes occur not with individuals but with the whole economic system, with the Volkswirtschaft as a whole. Proceeding thus, the economists apply unawares for the treatment of monetary problems a method radically different from the modern catallactic method. They revert to the old manner of reasoning which doomed to failure the work of older economists. In those early days philosophers dealt in their speculations with universal concepts, such as mankind and other generic notions. They asked: What is the value of gold or of iron, that is: value in general, for all times and for all people, and again gold or iron in general, all the gold or iron available or even not yet mined. They could not succeed in this way; they discovered only alleged autinomies which were insoluble for them.
All the successful achievements of modern economic theory have to be ascribed to the fact that we have learned to proceed in a different way. We realize that individuals acting in the market are never presented with the choice between all the gold existing and all the iron existing. They do not have to decide whether gold or iron is more useful for mankind as a whole, but they have to choose between two limited quantities both of which they cannot have together. They decide which of these two alternatives is more favorable for them under the conditions and at the moment when they make their decision. These acts of choice performed by individuals faced with alternatives are the ultimate causes of the exchange ratios established in the market. We have to direct our attention to these acts of choice and are not at all interested in the metaphysical and purely academic, nay, vain question of which commodity in general appears more useful in the eyes of a superhuman intelligence surveying earthly conditions from a transcendental point of view.
Monetary problems are economic problems and have to be dealt with in the same way as all other economic problems. The monetary economist does not have to deal with universal entities like volume of trade meaning total volume of trade or quantity of money meaning all the money current in the whole economic system. Still less can he make use of the nebulous metaphor “velocity of circulation.” He has to realize that the demand for money arises from the preferences of individuals within a market society. Because everybody wishes to have a certain amount of cash, sometimes more, sometimes less, there is a demand for money. Money is never simply in the economic system, in the Volkswirtschaft, money is never simply circulating. All the money available is always in the cash holdings of somebody. Every piece of money may one day — sometimes oftener, sometimes more seldom — pass from one man’s cash holding to another man’s. But at every moment it is owned by somebody and is a part of his cash holdings. The decisions of individuals regarding the magnitude of their cash holdings constitute the ultimate factor in the formation of purchasing power.
Changes in the quantity of money and in the demand for money for cash holding do not occur in the economic system as a whole if they do not occur in the households of individuals. These changes in the households of individuals never occur for all individuals at the same time and to the same degree and they therefore never affect their judgments of value to the same extent and at the same time. It is exactly the merit of Hume and Mill that they tried to construct a hypothetical case where the changes in the supply of money could affect all individuals in such a way that the prices of all commodities would rise or fall at the same time and in the same proportion. The failure of their attempts provided a negative proof, and modern economics has added to this the positive proof that the prices of different commodities are not influenced at the same time and to the same extent. The oversimple formula both of the old quantity theory and of contemporary mathematical economists according to which prices, that is all prices, rise or fall in the proportion of the increase or decrease in the quantity of money, is disproved.
To simplify and to shorten our analysis let us look at the case of inflation only. The additional quantity of money does not find its way at first into the pockets of all individuals; not every individual of those benefited first gets the same amount and not every individual reacts to the same additional quantity in the same way. Those first benefited — in the case of gold, the owners of the mines, in the case of government paper money, the treasury — now have greater cash holdings and they are now in a position to offer more money on the market for goods and services they wish to buy. The additional amount of money offered by them on the market makes prices and wages go up. But not all the prices and wages rise, and those which do rise do not rise to the same degree. If the additional money is spent for military purposes, the prices of some commodities only and the wages of only some kinds of labor rise, others remain unchanged or may even temporarily fall. They may fall because there are now on the market some groups of men whose incomes have not risen but who nevertheless are obliged to pay more for some commodities, namely for those asked by the men first benefited by the inflation. Thus, price changes which are the result of the inflation start with some commodities and services only, and are diffused more or less slowly from one group to the others. It takes time till the additional quantity of money has exhausted all its price changing possibilities. But even in the end the different commodities are not affected to the same extent. The process of progressive depreciation has changed the income and the wealth of the different social groups. As long as this depreciation is still going on, as long as the additional quantity of money has not yet exhausted all its possibilities of influencing prices, as long as there are still prices left unchanged at all or not yet changed to the extent that they will be, there are in the community some groups favored and some at a disadvantage. Those selling the commodities or services whose prices rise first are in a position to sell at the new higher prices and to buy what they want to buy at the old still unchanged prices. On the other hand, those who sell commodities or services whose prices remain for some time unchanged are selling at the old prices whereas they already have to buy at the new higher prices. The former are making a specific gain, they are profiteers, the latter are losing, they are the losers, out of whose pockets the extra-gains of the profiteers must come. As long as the inflation is in progress, there is a perpetual shift in income and wealth from some social group, to other social groups. When all price consequences of the inflation are consummated, a transfer of wealth between social groups has taken place. The result is that there is in the economic system a new dispersion of wealth and income and in this new social order the wants of individuals are satisfied to different relative degrees, than formerly. Prices in this new order cannot simply be a multiple of the previous prices.
The social consequences of a change in the purchasing power of money are twofold: first, as money is the standard of deferred payments, the relations between creditors and debtors is changed. Second, as the changes in purchasing power do not affect all prices and wages at the same moment and to the same extent, there is a shift of wealth and income between different social groups. It was one of the errors of all proposals to stabilize purchasing power that they did not take into account this second consequence. We may say that economic theory in general did not pay enough attention to this matter. As far as it did, it principally considered it only in reference to the reaction of a change in a country’s currency on its foreign trade. But this is only a special application of a problem which has a much wider scope.
What is fundamental for economic theory is that there is no constant relation between changes in the quantity of money and in prices. Changes in the supply of money affect individual prices and wages in different ways. The metaphorical use of the term price level is misleading.
The erroneous opinion to the contrary was based on a consideration which may be represented thus: let us think of two absolutely independent systems of static equilibrium A and B. Both are in every respect alike except that to the total quantity of money (M) in A and to every individual cash holding (m) in A there correspond in B a total quantity of Mn and individual cash holdings mn. On these assumptions of course all the prices and wages in B are n times those in A. But they are exactly thus because these are our hypothetical assumptions. But nobody can devise a way by which the system A can be transformed into the system B. Of course it is unpermissible to operate with static equilibrium if we wish to approach a dynamic problem.
Setting aside all qualms about the use of the terms dynamic and static, I wish to say: money is necessarily a dynamic agent and it was a mistake to deal with monetary problems in a static way.
Of course there is no room left for money in a concept of static equilibrium. In forming the concept of a static society we assume that no changes are taking place. Everything is going on in the same old manner. Today is like yesterday and tomorrow will be like today. But under these conditions nobody needs a cash holding. Cash holding is necessary only when the individual does not know what situation he will have to face in an uncertain future. If everybody knows when and what he will have to buy, he does not need a private cash holding and can entrust all his money to the central bank as time deposits due on the dates and in the amounts necessary for his future payments. As everybody would proceed in the same way, the central bank does not need any reserves to meet its obligations. Of course, the total amount which it has to pay out to the buyers every day exactly balances the amount which it receives as deposits from the sellers. If we assume that in this world of static equilibrium once, before the equilibrium was attained, there was metallic currency only, let us say gold, we have to assume that with the gradual approach towards conditions of equilibrium the citizens deposited more and more of their gold and that the bank, which had no need for it, sold the gold to jewelers and others for industrial consumption. With the advent of equilibrium there is no more metallic money, there is in fact no more money at all, but an unsubstantial and immaterial clearing system, which cannot be considered as money in the ordinary sense. It is rather an unrealizable and even unthinkable system of accounting, a numeraire as some economists believed ideal money ought to be. This, if it could be called money, would be neutral money. But we should never forget, that the state of equilibrium is purely hypothetical, that this concept is nothing but a tool for our mental work. Not being able to make experiments, the social sciences have to forge such tools. But we must be very careful in their use. We have to be aware that the state of static equilibrium can never be attained in real life. Still more important is the fact, that in this hypothetical state the individual does not make choices, does not act and does not have to decide between incompatible alternatives. Life in this hypothetical state is therefore robbed of its essential element. In constructing this hypothetical state we want merely to understand the incentives of action, which always implies change, by conceiving conditions, in which no action takes place. But a changeless world would be a dead world. We do not just have to deal with death, but with life, action, and change. In a living world there is no room for neutrality of money.
Money, of course, is a dynamic factor and as such cannot be discussed in terms of static equilibrium.
Let me now briefly point out some of the major conclusions derived from an insight into the non-neutrality of money.
First we have to realize that the abandonment of the fallacious concept of neutral money destroys the last stronghold of the advocates of quantitative economics. For a very long time eminent economists have believed that it will be possible one day to replace qualitative economics by quantitative economics. What renders these hopes vain, is the fact, that in economic quantities we never have any constant ratios among magnitudes. What the economist discovers when he studies relations between demand and prices is not comparable with the work of the natural scientist who determines by experiments in his laboratory constant relations, e.g., the specific gravity of different substances. What the economist determines is of historical value only; he is in his statistical work a historian, but not an experimenter. The work of the late lamented Henry Schultz was economic history; what we learn from his research is what happened with some commodities in a limited period of the past in the United States and Canada. It tells us nothing about what happened with the same commodities elsewhere or in another period or what will happen in the future.
But there still has remained the belief that it is different with money. I may cite, for example, Professor Fisher’s book on the Purchasing Power of Money, which is founded on the assumption that the purchasing power of the monetary unit changes in inverse proportion to the quantity of money. I think that this assumption is arbitrary and fallacious.
The second conclusion which we have to draw is the futility of all endeavors to make money stable in purchasing power. It is beyond the scope of my short address to explain the advantages of a sound money policy and the disadvantages of both inflation and deflation. But we should not confuse the political concept of sound money with the theoretical concept of stable money. I do not wish to discuss the inner contradictions of this stability concept. From the point of view of the present subject it is more important to emphasize that all proposals for stabilization, apart from other deficiencies, are based on the idea of money’s neutrality. They all suggest methods to undo changes in purchasing power already effected if there has been an inflation they wish to deflate to the same extent and vice versa. They do not realize that by this procedure they do not undo the social consequences of the first change, but simply add to it the social consequences of a new change. If a man has been hurt by being run over by an automobile, it is no remedy to let the car go back over him in the opposition direction.
The popularity of all schemes for stabilization invites us to a philosophical consideration. It is a general weakness of the human mind to regard the state of rest and absence of change as more perfect than the state of motion. The absolute, that old phantom of misguided philosophical speculation, is still with us; its modern name is stability. But stability, e.g., absence of change, is, we have to repeat, absence of life.
The third conclusion which we may draw is the futility of the distinction between statics and dynamics and between short-run and long-run economics. The way in which we have to study monetary changes provides us with the best evidence that every correct economic consideration has to be dynamic and that static concepts are only instrumental. And at the same time we have to realize that all correct economic theorizing is a gradual progress from short-run to long-run effects.
But the most important value of the theory of money’s dynamism is its use for the development of the monetary theory of the trade cycle. The old British Currency-Theory was already in a restricted sense a monetary explanation of the cycle. It studied the consequences of credit expansion on the assumption only that there is credit expansion in one country whereas in the rest of the world things are left unchanged. This seemed to be enough for the explanation of the business cycle in Great Britain in the first half of the nineteenth century. But the explanation of an external drain does not provide an answer to the question what may happen in a completely isolated country or in the case of a simultaneous credit expansion all over the world. But only the answer to this second question could be considered satisfactory under the conditions prevailing in the twentieth century. Only the answer to this second question is important, if we have to consider the proposals for eliminating the cyclical changes either by loosening the international ties of the national economy or by making credit expansion international in the way the Bretton Woods Agreements provide. It is the boast of the monetary theory of the trade cycle that it provides us with a satisfactory answer to these and to some other serious problems.
I do not wish to infringe more upon your time and so I wish only to add some remarks on the treatment of the problem by certain younger economists. I myself am not responsible for the term “neutral money.” I have developed a theory of the changes in purchasing power and its social consequences. I have demonstrated that money acts as a dynamic agent and that the assumption that the changes in purchasing power are inversely proportional to the changes in the relation of demand for to the supply of money is fallacious. The term “neutral money” was coined by later authors. I do not wish to consider the question of whether it was a happy choice. But in any case I must protest against the belief that it has to be a goal of monetary policy to make money neutral and that it is the duty of the economists to determine a method of doing so. I wish to emphasize that in a living and changing world, in a world of action, there is no room left for a neutral money. Money is non-neutral or it does not exist.
Economic Policy: Thoughts for Tomorrow and Today[Ludwig von Mises, Economic Policy: Thoughts for Tomorrow and Today (1979; Washington, D.C.: Regnery Gateway, 2006), Lecture 4, pp. 55–73.]“Inflation”If the supply of caviar were as plentiful as the supply of potatoes, the price of caviar — that is, the exchange ratio between caviar and money or caviar and other commodities — would change considerably. In that case, one could obtain caviar at a much smaller sacrifice than is required today. Likewise, if the quantity of money is increased, the purchasing power of the monetary unit decreases, and the quantity of goods that can be obtained for one unit of this money decreases also.
When, in the sixteenth century, American resources of gold and silver were discovered and exploited, enormous quantities of the precious metals were transported to Europe. The result of this increase in the quantity of money was a general tendency toward an upward movement of prices in Europe. In the same way, today, when a government increases the quantity of paper money, the result is that the purchasing power of the monetary unit begins to drop, and so prices rise. This is called inflation.
Unfortunately, in the United States, as well as in other countries, some people prefer to attribute the cause of inflation not to an increase in the quantity of money but, rather, to the rise in prices.
However, there has never been any serious argument against the economic interpretation of the relationship between prices and the quantity of money, or the exchange ratio between money and other goods, commodities, and services. Under present day technological conditions there is nothing easier than to manufacture pieces of paper upon which certain monetary amounts are printed. In the United States, where all the notes are of the same size, it does not cost the government more to print a bill of a thousand dollars than it does to print a bill of one dollar. It is purely a printing procedure that requires the same quantity of paper and ink.
In the eighteenth century, when the first attempts were made to issue bank notes and to give these bank notes the quality of legal tender — that is, the right to be honored in exchange transactions in the same way that gold and silver pieces were honored — the governments and nations believed that bankers had some secret knowledge enabling them to produce wealth out of nothing. When the governments of the eighteenth century were in financial difficulties, they thought all they needed was a clever banker at the head of their financial management in order to get rid of all their difficulties.
Some years before the French Revolution, when the royalty of France was in financial trouble, the king of France sought out such a clever banker, and appointed him to a high position. This man was, in every regard, the opposite of the people who, up to that time, had ruled France. First of all he was not a Frenchman, he was a foreigner — a Swiss from Geneva, Jacques Necker. Secondly, he was not a member of the aristocracy, he was a simple commoner. And what counted even more in eighteenth century France, he was not a Catholic, but a Protestant. And so Monsieur Necker, the father of the famous Madame de Staël, became the minister of finance, and everyone expected him to solve the financial problems of France. But in spite of the high degree of confidence Monsieur Necker enjoyed, the royal cashbox remained empty — Necker’s greatest mistake having been his attempt to finance aid to the American colonists in their war of independence against England without raising taxes. That was certainly the wrong way to go about solving France’s financial troubles.
There can be no secret way to the solution of the financial problems of a government; if it needs money, it has to obtain the money by taxing its citizens (or, under special conditions, by borrowing it from people who have the money). But many governments, we can even say most governments, think there is another method for getting the needed money; simply to print it.
If the government wants to do something beneficial — if, for example, it wants to build a hospital — the way to find the needed money for this project is to tax the citizens and build the hospital out of tax revenues. Then no special “price revolution” will occur, because when the government collects money for the construction of the hospital, the citizens — having paid the taxes — are forced to reduce their spending. The individual taxpayer is forced to restrict either his consumption, his investments or his savings. The government, appearing on the market as a buyer, replaces the individual citizen: the citizen buys less, but the government buys more. The government, of course, does not always buy the same goods which the citizens would have bought; but on the average there occurs no rise in prices due to the government’s construction of a hospital.
I choose this example of a hospital precisely because people sometimes say: “It makes a difference whether the government uses its money for good or for bad purposes.” I want to assume that the government always uses the money which it has printed for the best possible purposes-purposes with which we all agree. For it is not the way in which the money is spent, it is the way in which the government obtains this money that brings about those consequences we call inflation and which most people in the world today do not consider as beneficial.
For example, without inflating, the government could use the tax-collected money for hiring new employees or for raising the salaries of those who are already in government service. Then these people, whose salaries have been increased, are in a position to buy more. When the government taxes the citizens and uses this money to increase the salaries of government employees, the taxpayers have less to spend, but the government employees have more. Prices in general will not increase.
But if the government does not use tax money for this purpose, if it uses freshly printed money instead, it means that there will be people who now have more money while all other people still have as much as they had before. So those who received the newly-printed money will be competing with those people who were buyers before. And since there are no more commodities than there were previously, but there is more money on the market — and since there are now people who can buy more today than they could have bought yesterday — there will be an additional demand for that same quantity of goods. Therefore prices will tend to go up. This cannot be avoided, no matter what the use of this newly-issued money will be.
And more importantly, this tendency for prices to go up will develop step by step; it is not a general upward movement of what has been called the “price level.” The metaphorical expression “price level” must never be used.
When people talk of a “price level,” they have in mind the image of a level of a liquid which goes up or down according to the increase or decrease in its quantity, but which, like a liquid in a tank, always rises evenly. But with prices, there is no such thing as a “level.” Prices do not change to the same extent at the same time. There are always prices that are changing more rapidly, rising or falling more rapidly than other prices. There is a reason for this.
Consider the case of the government employee who received the new money added to the money supply. People do not buy today precisely the same commodities and in the same quantities as they did yesterday. The additional money which the government has printed and introduced into the market is not used for the purchase of all commodities and services. It is used for the purchase of certain commodities, the prices of which will rise, while other commodities will still remain at the prices that prevailed before the new money was put on the market. Therefore, when inflation starts, different groups within the population are affected by this inflation in different ways. Those groups who get the new money first gain a temporary benefit.
When the government inflates in order to wage a war, it has to buy munitions, and the first to get the additional money are the munitions industries and the workers within these industries. These groups are now in a very favorable position. They have higher profits and higher wages; their business is moving. Why? Because they were the first to receive the additional money. And having now more money at their disposal, they are buying. And they are buying from other people who are manufacturing and selling the commodities that these munitions makers want.
These other people form a second group. And this second group considers inflation to be very good for business. Why not? Isn’t it wonderful to sell more? For example, the owner of a restaurant in the neighborhood of a munitions factory says: “It is really marvelous! The munitions workers have more money; there are many more of them now than before; they are all patronizing my restaurant; I am very happy about it.” He does not see any reason to feel otherwise.
The situation is this: those people to whom the money comes first now have a higher income, and they can still buy many commodities and services at prices which correspond to the previous state of the market, to the condition that existed on the eve of inflation. Therefore, they are in a very favorable position. And thus inflation continues step by step, from one group of the population to another. And all those to whom the additional money comes at the early state of inflation are benefited because they are buying some things at prices still corresponding to the previous stage of the exchange ratio between money and commodities.
But there are other groups in the population to whom this additional money comes much, much later. These people are in an unfavorable position. Before the additional money comes to them they are forced to pay higher prices than they paid before for some — or for practically all — of the commodities they wanted to purchase, while their income has remained the same, or has not increased proportionately with prices.
Consider for instance a country like the United States during the Second World War; on the one hand, inflation at that time favored the munitions workers, the munitions industries, the manufacturers of guns, while on the other hand it worked against other groups of the population. And the ones who suffered the greatest disadvantages from inflation were the teachers and the ministers.
As you know, a minister is a very modest person who serves God and must not talk too much about money. Teachers, likewise, are dedicated persons who are supposed to think more about educating the young than about their salaries. Consequently, the teachers and ministers were among those who were most penalized by inflation, for the various schools and churches were the last to realize that they must raise salaries. When the church elders and the school corporations finally discovered that after all, one should also raise the salaries of those dedicated people, the earlier losses they had suffered still remained.
For a long time, they had to buy less than they did before, to cut down their consumption of better and more expensive foods, and to restrict their purchase of clothing — because prices had already adjusted upward, while their incomes, their salaries, had not yet been raised. (This situation has changed considerably today, at least for teachers.)
There are therefore always different groups in the population being affected differently by inflation. For some of them, inflation is not so bad; they even ask for a continuation of it because they are the first to profit from it. We will see, in the next lecture, how this unevenness in the consequences of inflation vitally affects the politics that lead toward inflation.
Under these changes brought about by inflation, we have groups who are favored and groups who are directly profiteering. I do not use the term “profiteering” as a reproach to these people, for if there is someone to blame, it is the government that established the inflation. And there are always people who favor inflation, because they realize what is going on sooner than other people do. Their special profits are due to the fact that there will necessarily be unevenness in the process of inflation.
The government may think that inflation — as a method of raising funds — is better than taxation, which is always unpopular and difficult. In many rich and great nations, legislators have often discussed, for months and months, the various forms of new taxes that were necessary because the parliament had decided to increase expenditures. Having discussed various methods of getting the money by taxation, they finally decided that perhaps it was better to do it by inflation.
But of course, the word “inflation” was not used. The politician in power who proceeds toward inflation does not announce: “I am proceeding toward inflation.” The technical methods employed to achieve the inflation are so complicated that the average citizen does not realize inflation has begun.
One of the biggest inflations in history was in the German Reich after the First World War. The inflation was not so momentous during the war; it was the inflation after the war that brought about the catastrophe. The government did not say: “We are proceeding toward inflation.” The government simply borrowed money very indirectly from the central bank. The government did not have to ask how the central bank would find and deliver the money. The central bank simply printed it.
Today the techniques for inflation are complicated by the fact that there is checkbook money. It involves another technique, but the result is the same. With the stroke of a pen, the government creates fiat money, thus increasing the quantity of money and credit. The government simply issues the order, and the fiat money is there.
The government does not care, at first, that some people will be losers, it does not care that prices will go up. The legislators say: “This is a wonderful system!” But this wonderful system has one fundamental weakness: it cannot last. If inflation could go on forever, there would be no point in telling governments they should not inflate. But the certain fact about inflation is that, sooner or later, it must come to an end. It is a policy that cannot last.
In the long run, inflation comes to an end with the breakdown of the currency; it comes to a catastrophe, to a situation like the one in Germany in 1923. On August 1, 1914, the value of the dollar was four marks and twenty pfennigs. Nine years and three months later, in November 1923, the dollar was pegged at 4.2 trillion marks. In other words, the mark was worth nothing. It no longer had any value.
Some years ago, a famous author, John Maynard Keynes, wrote: “In the long run we are all dead.” This is certainly true, I am sorry to say. But the question is, how short or long will the short run be? In the eighteenth century there was a famous lady, Madame de Pompadour, who is credited with the dictum: “Après nous le déluge” (“After us will come the flood”). Madame de Pompadour was happy enough to die in the short run. But her successor in office, Madame du Barry, outlived the short run and was beheaded in the long run. For many people the “long run” quickly becomes the “short run” — and the longer inflation goes on the sooner the “short run.”
How long can the short run last? How long can a central bank continue an inflation? Probably as long as people are convinced that the government, sooner or later, but certainly not too late, will stop printing money and thereby stop decreasing the value of each unit of money.
When people no longer believe this, when they realize that the government will go on and on without any intention of stopping, then they begin to understand that prices tomorrow will be higher than they are today. Then they begin buying at any price, causing prices to go up to such heights that the monetary system breaks down.
I refer to the case of Germany, which the whole world was watching. Many books have described the events of that time. (Although I am not a German, but an Austrian, I saw everything from the inside: in Austria, conditions were not very different from those in Germany; nor were they much different in many other European countries.) For several years, the German people believed that their inflation was just a temporary affair, that it would soon come to an end. They believed it for almost nine years, until the summer of 1923. Then, finally, they began to doubt. As the inflation continued, people thought it wiser to buy anything available, instead of keeping money in their pockets. Furthermore, they reasoned that one should not give loans of money, but on the contrary, that it was a very good idea to be a debtor. Thus inflation continued feeding on itself.
And it went on in Germany until exactly November 20, 1923. The masses had believed inflation money to be real money, but then they found out that conditions had changed. At the end of the German inflation, in the fall of 1923, the German factories paid their workers every morning in advance for the day. And the workingman who came to the factory with his wife, handed his wages — all the millions he got — over to her immediately. And the lady immediately went to a shop to buy something, no matter what. She realized what most people knew at that time-that overnight, from one day to another, the mark lost 50% of its purchasing power. Money, like chocolate in a hot oven, was melting in the pockets of the people. This last phase of German inflation did not last long; after a few days, the whole nightmare was over: the mark was valueless and a new currency had to be established.
Lord Keynes, the same man who said that in the long run we are all dead, was one of a long line of inflationist authors of the twentieth century. They all wrote against the gold standard. When Keynes attacked the gold standard, he called it a “barbarous relic.” And most people today consider it ridiculous to speak of a return to the gold standard. In the United States, for instance, you are considered to be more or less a dreamer if you say: “Sooner or later, the United States will have to return to the gold standard.”
Yet the gold standard has one tremendous virtue: the quantity of money under the gold standard is independent of the policies of governments and political parties. This is its advantage. It is a form of protection against spendthrift governments. If, under the gold standard, a government is asked to spend money for something new, the minister of finance can say: “And where do I get the money? Tell me, first, how I will find the money for this additional expenditure.”
Under an inflationary system, nothing is simpler for the politicians to do than to order the government printing office to provide as much money as they need for their projects. Under a gold standard, sound government has a much better chance; its leaders can say to the people and to the politicians: “We can’t do it unless we increase taxes.”
But under inflationary conditions, people acquire the habit of looking upon the government as an institution with limitless means at its disposal: the state, the government, can do anything. If, for instance, the nation wants a new highway system, the government is expected to build it. But where will the government get the money?
One could say that in the United States today — and even in the past, under McKinley — the Republican party was more or less in favor of sound money and of the gold standard, and the Democratic party was in favor of inflation, of course not a paper inflation, but a silver inflation.
It was, however, a Democratic president of the United States, President Cleveland, who at the end of the 1880s vetoed a decision of Congress, to give a small sum — about $10,000 — to help a community that had suffered some disaster. And President Cleveland justified his veto by writing: “While it is the duty of the citizens to support the government, it is not the duty of the government to support the citizens.” This is something which every statesman should write on the wall of his office to show to people who come asking for money.
I am rather embarrassed by the necessity to simplify these problems. There are so many complex problems in the monetary system, and I would not have written volumes about them if they were as simple as I am describing them here. But the fundamentals are precisely these: if you increase the quantity of money, you bring about the lowering of the purchasing power of the monetary unit. This is what people whose private affairs are unfavorably affected do not like. People who do not benefit from inflation are the ones who complain.
If inflation is bad and if people realize it, why has it become almost a way of life in all countries? Even some of the richest countries suffer from this disease. The United States today is certainly the richest country in the world, with the highest standard of living. But when you travel in the United States, you will discover that there is constant talk about inflation and about the necessity to stop it. But they only talk; they do not act.
To give you some facts: after the First World War, Great Britain returned to the prewar gold parity of the pound. That is, it revalued the pound upward. This increased the purchasing power of every worker’s wages. In an unhampered market the nominal money wage would have fallen to compensate for this and the workers’ real wage would not have suffered. We do not have time here to discuss the reasons for this. But the unions in Great Britain were unwilling to accept an adjustment of money wage rates downward as the purchasing power of the monetary unit rose. Therefore real wages were raised considerably by this monetary measure. This was a serious catastrophe for England, because Great Britain is a predominantly industrial country that has to import its raw materials, half-finished goods, and food stuffs in order to live, and has to export manufactured goods to pay for these imports. With the rise in the international value of the pound, the price of British goods rose on foreign markets and sales and exports declined. Great Britain had, in effect, priced itself out of the world market.
The unions could not be defeated. You know the power of a union today. It has the right, practically the privilege, to resort to violence. And a union order is, therefore, let us say, not less important than a government decree. The government decree is an order for the enforcement of which the enforcement apparatus of the government — the police — is ready. You must obey the government decree, otherwise you will have difficulties with the police.
Unfortunately, we have now, in almost all countries all over the world, a second power that is in a position to exercise force: the labor unions. The labor unions determine wages and then strike to enforce them in the same way in which the government might decree a minimum wage rate. I will not discuss the union question now; I shall deal with it later. I only want to establish that it is the union policy to raise wage rates above the level they would have on an unhampered market. As a result a considerable part of the potential labor force can be employed only by people or industries that are prepared to suffer losses. And, since businesses are not able to keep on suffering losses, they close their doors and people become unemployed. The setting of wage rates above the level they would have on the unhampered market always results in the unemployment of a considerable part of the potential labor force.
In Great Britain, the result of high wage rates enforced by the labor unions was lasting unemployment, prolonged year after year. Millions of workers were unemployed, production figures dropped. Even experts were perplexed. In this situation the British government made a move which it considered an indispensable, emergency measure: it devalued its currency.
The result was that the purchasing power of the money wages, upon which the unions had insisted, was no longer the same. The real wages, the commodity wages, were reduced. Now the worker could not buy as much as he had been able to buy before, even though the nominal wage rates remained the same. In this way, it was thought, real wage rates would return to free market levels and unemployment would disappear.
This measure — devaluation — was adopted by various other countries, by France, the Netherlands, and Belgium. One country even resorted twice to this measure within a period of one year and a half. That country was Czechoslovakia. It was a surreptitious method, let us say, to thwart the power of the unions. You could not call it a real success, however.
After a few years, the people, the workers, even the unions, began to understand what was going on. They came to realize that currency devaluation had reduced their real wages. The unions had the power to oppose this. In many countries they inserted a clause into wage contracts providing that money wages must go up automatically with an increase in prices. This is called indexing. The unions became index conscious. So, this method of reducing unemployment that the government of Great Britain started in 1931 — which was later adopted by almost all important governments — this method of “solving unemployment” no longer works today.
In 1936, in his General Theory of Employment, Interest and Money, Lord Keynes unfortunately elevated this method — the emergency measures of the period between 1929 and 1933 — to a principle, to a fundamental system of policy. And he justified it by saying, in effect: “Unemployment is bad. If you want unemployment to disappear you must inflate the currency.”
He realized very well that wage rates can be too high for the market, that is, too high to make it profitable for an employer to increase his work force, thus too high from the point of view of the total working population, for with wage rates imposed by unions above the market only a part of those anxious to earn wages can obtain jobs.
And Keynes said, in effect: “Certainly mass unemployment prolonged year after year, is a very unsatisfactory condition.” But instead of suggesting that wage rates could and should be adjusted to market conditions, he said, in effect: “If one devalues the currency and the workers are not clever enough to realize it, they will not offer resistance against a drop in real wage rates, as long as nominal wage rates remain the same.” In other words, Lord Keynes was saying that if a man gets the same amount of sterling today as he got before the currency was devalued, he will not realize that he is, in fact, now getting less.
In old fashioned language, Keynes proposed cheating the workers. Instead of declaring openly that wage rates must be adjusted to the conditions of the market — because, if they are not, a part of the labor force will inevitably remain unemployed — he said, in effect: “Full employment can be reached only if you have inflation. Cheat the workers.” The most interesting fact, however, is that when his General Theory was published, it was no longer possible to cheat, because people had already become index conscious. But the goal of full employment remained.
What does “full employment” mean? It has to do with the unhampered labor market, which is not manipulated by the unions or by the government. On this market, wage rates for every type of labor tend to reach a point at which everybody who wants a job can get one and every employer can hire as many workers as he needs. If there is an increase in the demand for labor, the wage rate will tend to be greater, and if fewer workers are needed, the wage rate will tend to fall.
The only method by which a “full employment” situation can be brought about is by the maintenance of an unhampered labor market. This is valid for every kind of labor and for every kind of commodity.
What does a businessman do who wants to sell a commodity for five dollars a unit? When he cannot sell it at that price, the technical business expression in the United States is, “the inventory does not move.” But it must move. He cannot retain things because he must buy something new; fashions are changing. So he sells at a lower price. If he cannot sell the merchandise at five dollars, he must sell it at four. If he cannot sell it at four, he must sell it at three. There is no other choice as long as he stays in business. He may suffer losses, but these losses are due to the fact that his anticipation of the market for his product was wrong.
It is the same with the thousands and thousands of young people who come every day from the agricultural districts into the city trying to earn money. It happens so in every industrial nation. In the United States they come to town with the idea that they should get, say, a hundred dollars a week. This may be impossible. So if a man cannot get a job for a hundred dollars a week, he must try to get a job for ninety or eighty dollars, and perhaps even less. But if he were to say — as the unions do — “one hundred dollars a week or nothing,” then he might have to remain unemployed. (Many do not mind being unemployed, because the government pays unemployment benefits — out of special taxes levied on the employers — which are sometimes nearly as high as the wages the man would receive if he were employed.)
Because a certain group of people believes that full employment can be attained only by inflation, inflation is accepted in the United States. But people are discussing the question: Should we have a sound currency with unemployment, or inflation with full employment? This is in fact a very vicious analysis.
To deal with this problem we must raise the question: How can one improve the condition of the workers and of all other groups of the population? The answer is: by maintaining an unhampered labor market and thus achieving full employment. Our dilemma is, shall the market determine wage rates or shall they be determined by union pressure and compulsion? The dilemma is not “shall we have inflation or unemployment?”
This mistaken analysis of the problem is argued in England, in European industrial countries and even in the United States. And some people say: “Now look, even the United States is inflating. Why should we not do it also.”
To these people one should answer first of all: “One of the privileges of a rich man is that he can afford to be foolish much longer than a poor man.” And this is the situation of the United States. The financial policy of the United States is very bad and is getting worse. Perhaps the United States can afford to be foolish a bit longer than some other countries.
The most important thing to remember is that inflation is not an act of God; inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy — a deliberate policy of people who resort to inflation because they consider it to be a lesser evil than unemployment. But the fact is that, in the not very long run, inflation does not cure unemployment.
Inflation is a policy. And a policy can be changed. Therefore, there is no reason to give in to inflation. If one regards inflation as an evil, then one has to stop inflating. One has to balance the budget of the government. Of course, public opinion must support this; the intellectuals must help the people to understand. Given the support of public opinion, it is certainly possible for the people’s elected representatives to abandon the policy of inflation.
We must remember that, in the long run, we may all be dead and certainly will be dead. But we should arrange our earthly affairs, for the short run in which we have to live, in the best possible way. And one of the measures necessary for this purpose is to abandon inflationary policies.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 18: “Action in the Passing of Time,” pp. 476–85, 496–99.]1. Perspective in the Valuation of Time PeriodsActing man distinguishes the time before satisfaction of a want is attained and the time for which the satisfaction continues.
Action always aims at the removal of future uneasiness, be it only the future of the impending instant. Between the setting in of action and the attainment of the end sought there always elapses a fraction of time, viz., the maturing time in which the seed sown by the action grows to maturity. The most obvious example is provided by agriculture. Between the tilling of the soil and the ripening of the fruit there passes a considerable period of time. Another example is the improvement of the quality of wine by aging. In some cases, however, the maturing time is so short that ordinary speech may assert that the success appears instantly.
As far as action requires the employment of labor, it is concerned with the working time. The performance of every kind of labor absorbs time. In some cases the working time is so short that people say the performance requires no time at all.
Only in rare cases does a simple, indivisible and nonrepeated act suffice to attain the end aimed at. As a rule what separates the actor from the goal of his endeavors is more than one step only. He must make many steps. And every further step to be added to those previously made raises anew the question whether or not he should continue marching toward the goal once chosen. Most goals are so far away that only determined persistence leads to them. Persevering action, unflinchingly directed to the end sought, is needed in order to succeed. The total expenditure of time required, i.e., working time plus maturing time, may be called the period of production. The period of production is long in some cases and short in other cases. It is sometimes so short that it can be entirely neglected in practice.
The increment in want-satisfaction which the attainment of the end brings about is temporally limited. The result produced extends services only over a period of time which we may call the duration of serviceableness. The duration of serviceableness is shorter with some products and longer with other goods which are commonly called durable goods. Hence acting man must always take into account the period of production and the duration of serviceableness of the product. In estimating the disutility of a project considered he is not only concerned with the expenditure of material factors and labor required, but also with the period of production. In estimating the utility of the expected product he is concerned with the duration of its serviceableness. Of course, the more durable a product is, the greater is the amount of services it renders. But if these services are not cumulatively available on the same date, but extended piecemeal over a certain period of time, the time element, as will be shown, plays a particular role in their evaluation. It makes a difference whether n units of service are rendered on the same date or whether they are stretched over a period of n days in such a way that only one unit is available daily.
It is important to realize that the period of production as well as the duration of serviceableness are categories of human action and not concepts constructed by philosophers, economists, and historians as mental tools for their interpretation of events. They are essential elements present in every act of reasoning that precedes and directs action. It is necessary to stress this point because Böhm-Bawerk, to whom economics owes the discovery of the role played by the period of production, failed to comprehend the difference.
Acting man does not look at his condition with the eyes of a historian. He is not concerned with how the present situation originated. His only concern is to make the best use of the means available today for the best possible removal of future uneasiness. The past does not count for him. He has at his disposal a definite quantity of material factors of production. He does not ask whether these factors are nature-given or the product of production processes accomplished in the past. It does not matter for him how great a quantity of nature-given, i.e., original material factors of production and labor, was expended in their production and how much time these processes of production have absorbed. He values the available means exclusively from the aspect of the services they can render him in his endeavors to make future conditions more satisfactory. The period of production and the duration of serviceableness are for him categories in planning future action, not concepts of academic retrospection and historical research. They play a role in so far as the actor has to choose between periods of production of different length and between the production of more durable and less durable goods.
Action is not concerned with the future in general, but always with a definite and limited fraction of the future. This fraction is limited, on the one side, by the instant in which the action must take place. Where its other end lies depends on the actor’s decision and choice. There are people who are concerned with only the impending instant. There are other people whose provident care stretches far beyond the prospective length of their own life. We may call the fraction of future time for which the actor in a definite action wants to provide in some way and to some extent, the period of provision. In the same way in which acting man chooses among various kinds of want-satisfaction within the same fraction of future time, he chooses also between want-satisfaction in the nearer and in the remoter future. Every choice implies also a choice of a period of provision. In making up his mind how to employ the various means available for the removal of uneasiness, man also determines implicitly the period of provision. In the market economy the demand of the consumers also determines the length of the period of provision.
There are various methods available for a lengthening of the period of provision:
- The accumulation of larger stocks of consumers’ goods destined for later consumption.2. The production of goods which are more durable.3. The production of goods requiring a longer period of production.4. The choice of methods of production consuming more time for the production of goods which could also be produced within a shorter period of production.
The first two methods do not require any further comment. The third and the fourth methods must be scrutinized more closely.
It is one of the fundamental data of human life and action that the shortest processes of production, i.e., those with the shortest period of production, do not remove felt uneasiness entirely. If all those goods which these shortest processes can provide are produced, unsatisfied wants remain and incentive to further action is still present. As acting man prefers those processes which, other things being equal, produce the products in the shortest time,Why man proceeds in this way, will be shown on the following pages. only such processes are left for further action which consume more time. People embark upon these more time-consuming processes because they value the increment in satisfaction expected more highly than the disadvantage of waiting longer for their fruits. Böhm-Bawerk speaks of the higher productivity of roundabout ways of production requiring more time. It is more appropriate to speak of the higher physical productivity of production processes requiring more time. The higher productivity of these processes does not always consist in the fact that they produce — with the same quantity of factors of production expended — a greater quantity of products. More often it consists in the fact that they produce products which could not be produced at all in shorter periods of production. These processes are not roundabout processes. They are the shortest and quickest way to the goal chosen. If one wants to catch more fish, there is no other method available than the substitution of fishing with the aid of nets and canoes for fishing without the aid of this equipment. There is no better, shorter, and cheaper method for the production of aspirin known than that adopted by the chemical plants. If one disregards error and ignorance, there cannot be any doubt about the highest productivity and expediency of the processes chosen. If people had not considered them the most direct processes, viz., those leading by the shortest way to the end sought, they would not have adopted them.
The lengthening of the period of provision through the mere accumulation of stocks of consumers’ goods is the outcome of the desire to provide in advance for a longer period of time. The same is valid for the production of goods the durability of which is greater in proportion to the greater expenditure of factors of production required.If the lengthening of durability were not at least proportionate to the increment in expenditure needed, it would be more advantageous to increase the quantity of units of a shorter durability. But if temporally remoter goals are aimed at, lengthening of the period of production is a necessary corollary of the venture. The end sought cannot be attained in a shorter period of production.
The postponement of an act of consumption means that the individual prefers the satisfaction which later consumption will provide to the satisfaction which immediate consumption could provide. The choice of a longer period of production means that the actor values the product of the process bearing fruit only at a later date more highly than the products which a process consuming less time could provide. In such deliberations and the resulting choices the period of production appears as waiting time. It was the great contribution of Jevons and Böhm-Bawerk to have shown the role played by taking account of waiting time.
If acting men were not to pay heed to the length of the waiting time, they would never say that a goal is temporally so distant that one cannot consider aiming at it. Faced with the alternative of choosing between two processes of production which render different output with the same input, they would always prefer that process which renders the greater quantity of the same products or better products in the same quantity, even if this result could be attained only by lengthening the period of production. Increments in input which result in a more than proportionate increase in the products’ duration of serviceableness would unconditionally be deemed advantageous. The fact that men do not act in this way evidences that they value fractions of time of the same length in a different way according as they are nearer or remoter from the instant of the actor’s decision. Other things being equal, satisfaction in a nearer period of the future is preferred to satisfaction in a more distant period; disutility is seen in waiting.
This fact is already implied in the statement stressed in the opening of this chapter that man distinguishes the time before satisfaction is attained and the time for the duration of which there is satisfaction. If any role at all is played by the time element in human life, there cannot be any question of equal valuation of nearer and remoter periods of the same length. Such an equal valuation would mean that people do not care whether success is attained sooner or later. It would be tantamount to a complete elimination of the time element from the process of valuation.
The mere fact that goods with a longer duration of serviceableness are valued more highly than those with a shorter duration does not yet in itself imply a consideration of time. A roof that can protect a house against the weather during a period of ten years is more valuable than a roof which renders this service only for a period of five years. The quantity of service rendered is different in both cases. But the question which we have to deal with is whether or not an actor in making his choices attaches to a service to be available in a later period of the future the same value he attaches to a service available at an earlier period.
- Time Preference as an Essential Requisite of ActionThe answer to this question is that acting man does not appraise time periods merely with regard to their dimension. His choices regarding the removal of future uneasiness are directed by the categories sooner and later. Time for man is not a homogeneous substance of which only length counts. It is not a more or a less in dimension. It is an irreversible flux the fractions of which appear in different perspective according to whether they are nearer to or remoter from the instant of valuation and decision. Satisfaction of a want in the nearer future is, other things being equal, preferred to that in the farther distant future. Present goods are more valuable than future goods.
Time preference is a categorial requisite of human action. No mode of action can be thought of in which satisfaction within a nearer period of the future is not — other things being equal — preferred to that in a later period. The very act of gratifying a desire implies that gratification at the present instant is preferred to that at a later instant. He who consumes a nonperishable good instead of postponing consumption for an indefinite later moment thereby reveals a higher valuation of present satisfaction as compared with later satisfaction. If he were not to prefer satisfaction in a nearer period of the future to that in a remoter period, he would never consume and so satisfy wants. He would always accumulate, he would never consume and enjoy. He would not consume today, but he would not consume tomorrow either, as the morrow would confront him with the same alternative.
Not only the first step toward want-satisfaction, but also any further step is guided by time preference. Once the desire a to which the scale of values assigns the rank 1 is satisfied, one must choose between the desire b to which the rank 2 is assigned and c that desire of tomorrow to which — in the absence of time preference — the rank 1 would have been assigned. If b is preferred to c, the choice clearly involves time preference. Purposive striving after want-satisfaction must needs be guided by a preference for satisfaction in the nearer future over that in a remoter future.
The conditions under which modern man of the capitalist West must act are different from those under which his primitive ancestors lived and acted. As a result of the providential care of our forebears we have at our disposal an ample stock of intermediate products (capital goods or produced factors of production) and of consumers’ goods. Our activities are designed for a longer period of provision because we are the lucky heirs of a past which has lengthened, step by step, the period of provision and has bequeathed to us the means to expand the waiting period. In acting we are concerned with longer periods and are aiming at an even satisfaction in all parts of the period chosen as the period of provision. We are in a position to rely upon a continuing influx of consumers’ goods and have at our disposal not only stocks of goods ready for consumption but also stocks of producers’ goods out of which our continuous efforts again and again make new consumers’ goods mature. In our dealing with this increasing “stream of income,” says the superficial observer, there is no heed paid to any considerations related to a different valuation of present and of future goods. We synchronize, he asserts, and thus the time element loses any importance for the conduct of affairs. It is, therefore, pointless, he continues, in the interpretation of modern conditions to resort to time preference.
The fundamental error involved in this popular objection is caused, like so many other errors, by a lamentable misapprehension of the imaginary construction of the evenly rotating economy. In the frame of this imaginary construction no change occurs; there prevails an unvarying course of all affairs. In the evenly rotating economy consequently nothing is altered in the allocation of goods for the satisfaction of wants in nearer and in remoter periods of the future. No one plans any change because — according to our assumptions — the prevailing allocation best serves him and because he does not believe that any possible rearrangement could improve his condition. No one wants to increase his consumption in a nearer period of the future at the expense of his consumption in a more distant period or vice versa because the existing mode of allocation pleases him better than any other thinkable and feasible mode.
The praxeological distinction between capital and income is a category of thought based on a different valuation of want-satisfaction in various periods of the future. In the imaginary construction of the evenly rotating economy it is implied that the whole income but not more than the income is consumed and that therefore the capital remains unchanged. An equilibrium is reached in the allocation of goods for want-satisfaction in different periods of the future. It is permissible to describe this state of affairs by asserting that nobody wants to consume tomorrow’s income today. We have precisely designed the imaginary construction of the evenly rotating economy in such a way as to make it fit just this condition. But it is necessary to realize that we can assert with the same apodictic assurance that, in the evenly rotating economy, nobody wants to have more of any commodity than he really has. These statements are true with regard to the evenly rotating economy because they are implied in our definition of this imaginary construction. They are nonsensical when asserted with regard to a changing economy which alone is real. As soon as a change in the data occurs, the individuals are faced anew with the necessity of choosing both between various modes of want-satisfaction in the same period and between want-satisfaction in different periods. An increment can be either employed for immediate consumption or invested for further production. No matter how the actors employ it, their choice must needs be the result of a weighing of the advantages expected from want-satisfaction in different periods of the future. In the world of reality, in the living and changing universe, each individual in each of his actions is forced to choose between satisfaction in various periods of time. Some people consume all that they earn, others consume a part of their capital, others save a part of their income.
Those contesting the universal validity of time preference fail to explain why a man does not always invest a sum of 100 dollars available today, although these 100 dollars would increase to 104 dollars within a year’s time. It is obvious that this man in consuming this sum today is determined by a judgment of value which values 100 present dollars higher than 104 dollars available a year later. But even in case he chooses to invest these 100 dollars, the meaning is not that he prefers satisfaction in a later period to that of today. It means that he values 100 dollars today less than 104 dollars a year later. Every penny spent today is, precisely under the conditions of a capitalist economy in which institutions make it possible to invest even the smallest sums, a proof of the higher valuation of present satisfaction as compared with later satisfaction.
The theorem of time preference must be demonstrated in a double way. First for the case of plain saving in which people must choose between the immediate consumption of a quantity of goods and the later consumption of the same quantity. Second for the case of capitalist saving in which the choice is to be made between the immediate consumption of a quantity of goods and the later consumption either of a greater quantity or of goods which are fit to provide a satisfaction which — except for the difference in time — is valued more highly. The proof has been given for both cases. No other case is thinkable.
It is possible to search for a psychological understanding of the problem of time preference. Impatience and the pains caused by waiting are certainly psychological phenomena. One may approach their elucidation by referring to the temporal limitations of human life, to the individual’s coming into existence, his growth and maturing, and his inevitable decay and passing away. There is in the course of man’s life a right moment for everything as well as a too early and a too late. However, the praxeological problem is in no way related to psychological issues. We must conceive, not merely understand. We must conceive that a man who does not prefer satisfaction within a nearer period of the future to that in a remoter period would never achieve consumption and enjoyment at all.
Neither must the praxeological problem be confused with the physiological. He who wants to live to see the later day, must first of all care for the preservation of his life in the intermediate period. Survival and appeasement of vital needs are thus requirements for the satisfaction of any wants in the remoter future. This makes us understand why in all those situations in which bare life in the strict sense of the term is at stake satisfaction in the nearer future is preferred to that in later periods. But we are dealing with action as such, not with the motives directing its course. In the same way in which as economists we do not ask why albumin, carbohydrates, and fat are demanded by man, we do not inquire why the satisfaction of vital needs appears imperative and does not brook any delay. We must conceive that consumption and enjoyment of any kind presuppose a preference for present satisfaction to later satisfaction. The knowledge provided by this insight far exceeds the orbit for which the physiological facts concerned provide explanation. It refers to every kind of want-satisfaction, not only to the satisfaction of the vital necessities of mere survival.
It is important to stress this point because the term “supply of subsistence, available for advances of subsistence,” as used by Böhm-Bawerk, can easily be misinterpreted. It is certainly one of the tasks of this stock to provide the means for a satisfaction of the bare necessities of life and thus to secure survival. But besides it must be large enough to satisfy, beyond the requirements of necessary maintenance for the waiting time, all those wants and desires which — apart from mere survival — are considered more urgent than the harvesting of the physically more abundant fruits of production processes consuming more time.
Böhm-Bawerk declared that every lengthening of the period of production depends on the condition that “a sufficient quantity of present goods is available to make it possible to overbridge the lengthened average interval between the starting of preparatory work and the harvesting of its product.”Cf. [Eugen von] Böhm-Bawerk, Kleinere Abhandlungen über Kapital und Zins, vol. 2 in Gesammelte Schriften, ed. F.X. Weiss (Vienna, 1926), p. 169. The expression “sufficient quantity” needs elucidation. It does not mean a quantity sufficient for necessary sustenance. The quantity in question must be large enough to secure the satisfaction of all those wants the satisfaction of which during the waiting time is considered more urgent than the advantages which a still greater lengthening of the period of production would provide. If the quantity in question were smaller, a shortening of the period of production would appear advantageous; the increase in the quantity of products or the improvement of their quality to be expected from the preservation of the longer period of production would no longer be considered a sufficient remuneration for the restriction of consumption enjoined during the waiting time. Whether or not the supply of subsistence is sufficient, does not depend on any physiological or other facts open to objective determination by the methods of technology and physiology. The metaphorical term “overbridge,” suggesting a body of water the breadth of which poses to the bridge builder an objectively determined task, is misleading. The quantity in question is valued by men, and their subjective judgments decide whether or not it is sufficient.
Even in a hypothetical world in which nature provides every man with the means for the preservation of biological survival (in the strict sense of the term), in which the most important foodstuffs are not scarce and action is not concerned with the provision for bare life, the phenomenon of time preference would be present and direct all actions.Time preference is not specifically human. It is an inherent feature of the behavior of all living beings. The distinction of man consists in preference is not inexorable and the lengthening of the period of provision not merely instinctive as with certain animals that store food, but the result of a process of valuation.
Money, Method, and the Market Process[Ludwig von Mises, Money, Method, and the Market Process: Essays by Ludwig von Mises,ed. Richard M. Ebeling (1933; Norwell, Mass. and Auburn, Ala.: Kluwer Academic Publishersand Mises Institute, 1990), chap. 4, pp. 55–64.]“The Position of Money among Economic Goods”
Karl Knies has recommended to replace the traditional division of economic goods into consumer goods and producer goods with a threefold classification: producer goods, consumer goods, and means of exchange.Karl Knies, Geld und Kredit, 2d. (Berlin: Weidmann, 1885), pp. 20 ff. Terminological questions of this kind, however, should be decided solely on the basis of their usefulness for furthering scientific work; definitions, concepts, and the taxonomy of phenomena have to prove their usefulness in the results of the research which makes use of them. When these criteria are applied to the classification and terminology suggested by Knies, it becomes apparent that they are extremely appropriate. Indeed, there is no theory of catallactics which does not make use of them. The theory of the value of money is always reserved for special treatment and separated for the explanation of the price formation of producer goods as well as consumer goods, although it is obviously part of a uniform theory of value and price. Even if we do not use the Kniesian terminology and classification consciously, in all significant discussions we act as if we had adopted them completely.
But it is also necessary to note that the special role of money among economic goods has, if anything, been over-emphasized. The problems of the determination of the purchasing power of money have mostly been treated as if they had nothing or very little in common with the problems of non-monetary exchange. This led to a special status of monetary theory and has been detrimental to the development of economic understanding. Even today, we continually encounter attempts to defend certain unjustified peculiarities of monetary theory.
Roscher’s often quoted remark, “[that] the wrong definitions of money can be divided into two main groups: Those which think of it as more and those which think of it as less than the most saleable good,”Wilhelm Roscher, Gundlagen der Nationalökonomie, 25th ed. (Stuttgart and Berlin: J.G. Cotta’sche Buchhandlung Nachtfolger, 1918), p. 340. applies not only to the question of the definition of money. Even a number of those who consider the theory of money a part of catallactics go too far in emphasizing its special position. This branch of our science offers plenty of difficulties and it is not necessary to construct artificial problems; the existing ones provide enough challenge.
- Monetary Services and the Value of MoneyIt is clear that the naive conception of the layman that things have value in themselves, i.e., intrinsic value, necessarily leads to a position which draws the dividing line between money and money substitutes differently from the position according to which the value of a thing is derived from its usefulness. Those who conceive of value as the result of properties inherent in things must necessarily make a distinction between physically valuable money and means of exchange which provide monetary services but are without material value. This approach inescapably leads to a contrasting of normal money with bad and abnormal money, which, in reality, is not money at all.
Today there is no need to deal with this theory. For the modern subjective theory of value, the question has long been decided. No one would still openly defend a concept according to which the whole or a portion of value and price theory was based upon intrinsic exchange value, i.e., independent of the valuations of acting men. Once this is admitted, one has already adopted the fundamental principle of subjective value theory, i.e., the theory of marginal utility.
For prescientific economists — the predecessors of the Physiocrats and the Classical Economists — it was a significant problem to integrate the theory of the value of money with that of the value of other goods. Holding a crudely materialistic bias, they saw the source of value in the “objective” usefulness of goods. From this point of view, it is obvious why bread, which can still hunger, and cloth, which can protect from the cold, will have value. But from where does money, which can neither nourish people nor keep them warm, derive its value? Some responded that it arose “from convention” and others maintained that the value of money was “imaginary.”
The error in this view was discovered early. John Law had put it most succinctly. If all value is derived from usefulness, then it must be true that the adoption of the precious metals as means of exchange must generate a value for it. If one wishes to call the value of the metal used as money, insofar as it is derived from its monetary services, imaginary, one has to regard all value as imaginary,
Car aucune chose n’a de valeur que par l’usage auquel on l’applique, et a raison des demandes qu’on en fait, proportionellement a sa quantite.John Law, Considerations sur le Numeraire et le Commerce (Paris: Buisson, 1851), pp. 447 ff. The passage translates as: The value of a thing is only in the use we make of it and the expectations we put into it, proportional to its quantity.
With these words, Law anticipated the subjective theory of value; he should not be denied the place he deserves in the history of our science. The importance of his accomplishment is not reduced by his inability to develop all the implications from his fundamental idea or that he got lost in the impenetrable thicket of error or, perhaps, even of guilt.
Researchers who came after him were also unable to make full use of the content of the clearly developed fundamental idea advanced by Law. In three respects we still encounter misconceptions.
First, some writers categorically deny that the service provided by money can generate value. Unfortunately, they do not provide a justification why monetary services should be different from the services provided by food and clothing. The difficulty posed by “paper money” is circumvented by viewing “paper money” as a claim on genuine, i.e., “materially” valuable, metallic money. Fluctuations in the rate of exchange of “paper money” are explained by changes in the probability of payment in species. In view of the development of monetary theory during the last decades, I consider it superfluous to challenge this theory. I have attempted an empirical refutation and have not encountered adequate opposition.See [Ludwig von] Mises, The Theory of Money and Credit, pp. 146–53.
In a way, the second error is connected with the first: the denial of the possibility of there being a money whose “substance” only produces monetary services and nothing else. It is usually granted that monetary services can generate value, just as every other service, in general. Without reservation, we have to agree with Knies when he argues, “[that] gold and silver would have been as unsuitable for the purpose of performing the functions of money as any other commodity, if they had not previously — before their adoption for monetary services — served as economic goods for the satisfaction of human wants, a ‘general’ economic need, a need that was widely felt and persistent.”Knies, Geld und Kredit, p. 322. But Knies is in error when he continues, “it is not sufficient that this primary use of the precious metals has preceded their use for monetary services; it is necessary that this use continues, lest the pieces of precious metal lose their usefulness as money. ... If people ceased to use gold and silver to satisfy their desire for jewelry or ornamentation, etc., then the other use of the precious metals, their use as a means of exchange, would be eliminated, also.”Ibid., pp. 322 ff. Knies did not succeed in proving the validity of this assertion. It is by no means evident why an economic good, which performs the services of a commonly used means of exchange, should lose its ability to serve as money simply because its use for other purposes are gradually discontinued.
That the adoption of a good as a medium of exchange requires the goods’ previous use or consumption for other purposes results from the fact that the specific demand for its services as a means of exchange presupposes an already existing objective exchange value. This objective exchange value, which subsequently will be modified by the demand for the good as a medium of exchange in addition to the demand for it in its “other” use, will be based exclusively upon its “other” use when it begins to be used as a means of exchange. But once an economic good has become money, then the specific demand for money can tie into an already existing exchange relationship between money and goods in the market, even if the demand for the money-good, as motivated by the other use, disappears.
Only very slowly and with difficulty has the human spirit freed itself from the crude materialistic mode of thought that has resulted in a prolonged resistance to the idea that the use of a good as a medium of exchange, like any other possible use for the good, generates a demand that establishes a price and is capable of changing that price. If the ability of a thing to satisfy a human need, as well as the recognition of this ability, are made the prerequisites for establishing the goods-quality of a thing,This is even done by [Carl] Menger; see, his Principles of Economics (1871) (New York: New York University Press, 1981), pp. 52–53. then one comes close to distinguishing between “real” and “unreal” goods among the objects of economic action. As soon as the economist steps upon this ground, he loses his footing and slides unintentionally out of the domain of scientific objectivity; he enters the realm of ethical valuations, morality, and policy. There, he will compare the “objectively useful” things to those which are merely “thought to be useful.” He will examine whether and to what extent the things which are thought to be useful (and therefore are treated accordingly) are indeed so in an “objective” sense. As soon as one has come this far, it is only logical to ask whether the usefulness provided by a good satisfies a genuine need or merely a fictitious one. This way of thinking may subsequently lead to the view that the value of precious metals (which serve “only” the desire for jewelry and do not satisfy a physiological need as, e.g., food and clothing undeniably do from a crude materialistic point-of-view) is entirely imaginary, a result of inappropriate social institutions and human vanity. On the other hand, the result can be that the value of precious metals is admitted as legitimate since even the desire for jewelry is “genuine” and “justified.” The objective utility of the precious metals is not denied; rather, the general validity of the requirement for the services of money is questioned since society had once existed without money and, in any case, such a society is imaginable. It is an untenable assumption that the “goods-quality” requires a “natural” utility not limited to the particular requirements of any presupposed social order.
But an even cruder materialism was the view which wanted to deny monetary services their value-creating power because money in its performance of this service did not lose its ability to serve other purposes; in other words, because its “substance” was not used up in its services as money.
All of those who denied the ability of the services of money to determine its exchange value failed to recognize that the only decisive element is demand. The fact that there exists a demand for money — the most marketable (most saleable) good, for which the owners of other goods are prepared to exchange — means that the monetary function is capable of creating value.
- Money Supply and Money Demand: The “Velocity of Circulation” of MoneyThe most disastrous of the unjustified deviations of monetary theory from the theory of direct exchange was the failure to base the analysis of the fundamental problem of the theory of the value of money on the relation between the stock of money and the demand for it by the individual economic units, or between the demand for money and the supply of money on the market. Rather, the analysis began with the objective usefulness of the monetary unit for the aggregate economy, which was expressed as the velocity of money relative to the money stock and which was then compared to the sum of transactions.
The old tendency, taken over from the Cameralists, to base the analysis of economic problems of the “national economy,” on the “totality” and not on the acting human subjects, seems hard to eradicate. In spite of all the warnings of the subjective economists, we continue to observe relapses. It is one of the lesser evils that ethical judgments regarding phenomena are presented under the guise of scientific objectivity. For example, productive activity (i.e., activity carried out in an imagined socialist community led by the critic) is contrasted with profit-seeking activity (i.e., the activity of individuals in a society based on private property in the means of production). The former will be viewed as the “just” and the latter as the “unjust” mode of production. Much more important is the fact that if one thinks in terms of the totality of a society’s economy, one can never understand the operation of a society based on private property in the means of production. It is erroneous to maintain that the necessity for the collectivist method can be proved by showing that actions of the individuals can only be understood within the framework of that individual’s environment. This is so because economic analysis does not depend on the psychological understanding of the motives of action, but only an understanding of action itself. It is unimportant for catallactics why bread, clothes, books, cannons or religious items are desired on the market; it is only important that a certain demand does exist. The mechanism of the market and, therefore, the laws of the capitalistic economy can only be grasped if one begins with the forces operating on the market. But on the market there are only individuals acting as buyers and sellers, never the “totality.” In economic theory, the totality can be taken only in the sense of an economic collective where the means of production are entirely outside the orbit of exchange and, therefore, cannot be sold for money. Here there is neither room for price theory nor a theory of money. But if we wish to grasp the value problems of a collective economy, we can — ironically — only use that method of analysis which has come to be known as the “individualistic method.”
The attempts to solve the problem of the value of money with reference to the aggregate economy, rather than through market factors, culminated in a tautological equation without any epistemological value. Only a theory which shows how subjective value judgments of buyers and sellers are influenced by changes in the different elements of the equation of exchange can legitimately be called a theory of the value of money.
Buyers and sellers on the market never concern themselves with the elements in the equation of exchange, of which two — velocity of circulation and the price level — do not even exist before market parties act and the other two — the quantity of money (in the whole economy) and the sum of transactions — could not possibly be known to the parties in the market. Only the importance which the various actors in the market attach, on the one hand, to the maintenance of a cash balance of a certain magnitude and, on the other hand, to the ownership of the various goods in question determines the formation of the exchange relationship between money and goods.
Connected with the concept of the velocity of circulation of money is the mental image that money generates its usefulness only at the instant of transaction, but is “idle” and useless at other times. A distinction between active and idle money is also made when one speaks of money hoarding and proceeds to a comparison between the “hoarded” quantity of money and the quantity of money that would be necessary to perform the monetary services; what distinguishes this from the previous case is the way in which the boundary between active and idle money is drawn. Both distinctions must be rejected.
The service of money is not confined to transactions. It fulfills its task not only at the moment it passes from one hand to the next. It also performs services when it rests in the till, as the most marketable good, in anticipation of its future use in trade as a generally used means of exchange. The demand for money of individuals, as well as the entire economy, is determined by the desire to maintain a cash balance and not by the aggregate of transactions to be carried out during a certain time period.Also see, Edwin Cannan, Money, 4th ed. (Westminster: P.S. King and Son, 1932), pp. 72 ff.
It is an arbitrary procedure to divide the money stock into two parts: that which is designated to perform money services proper and that which serves as a money hoard. Of course, no damage will be done if, on the one hand, the demand for money is separated into a demand for hoarding and a demand to perform the monetary service proper. But a formula which portrays and solves only an arbitrarily delineated part of the problem must be rejected if we are able to show another one which will deal with and solve the whole problem in a uniform fashion.
- Fluctuations in the Value of MoneyOne of the most peculiar phenomena in the history of monetary theory is the stubborn resistance encountered by the quantity theory. The imperfect formulation given to it by many of its advocates inevitably ran into opposition, with many — as, for example, Benjamin AndersonBenjamin Anderson, The Value of Money (New York: Macmillan, 1917). — ascribing to the concept a meaning quite different from that commonly accepted. As a result, what they call the quantity theory, and oppose as such, is not the theory itself but only a variation of it. This is not particularly astonishing. But what is quite surprising is that an attempt was made and sometimes is still made today to deny that changes in the relation between money supply and money demand will modify the purchasing power of the monetary unit. It is not sufficient to base an explanation on the special interests of inflationists, statists and socialists, of civil servants and politicians who would be harmed by a spreading of knowledge concerning monetary policy. We will never arrive at an answer by following the path of the Historical-Realistic School, which (following the Marxian example) explains all ideas by ideologies. It had never been a problem to explain why a particular ideology is developed and advocated by certain classes who believe they can benefit from it directly (even if this direct advantage is more than outweighed by indirect disadvantages). What has to be explained, however, is rather how incorrect theories come about and find followers. How does it come about that many people, without justification, come to assume that a certain policy benefits either the entire society or many groups in that society?
However, the theory of money as such is not interested in these psychological aspects which explain the reasons for the unpopularity of the quantity theory and the tendency to adopt other explanations for the value of money. Rather, it is interested in the question: which elements of the doctrines opposing the quantity theory could be useful? Since it was equally inadmissible to deny the importance of changes in supply for the formation of exchange relations in the area of indirect exchange as it was in the area of direct exchange, one could oppose the quantity theory only by admitting its correctness in principle, but arguing that notwithstanding its general validity another principle would regularly eliminate its effectiveness. This attempt was made by the Banking School with its famous theory of hoarding, and its offshoot, the theory of the automatic adjustment of the circulation of money substitutes to the demand for money in the broader sense. Today, both theories are overthrown.
As is the case with so many theories, the advocates of the quantity theory have harmed it more than its enemies. We have already mentioned the inadequacy of those theories based on the concept of the velocity of circulation of money. It was not any less erroneous to interpret the quantity theory as saying that the changes in the quantity of money resulted in proportional changes in the prices of goods. It was overlooked that every change in the relationship between the supply of money and the demand for money would necessarily bring about a shift in the distribution of wealth and income and that, therefore, the prices of the different goods and services could not be effected proportionally and simultaneously.
Nowhere has the practice of working with formulas modeled after mechanics, instead of paying attention to the problem of the influence of market factors, taken a greater toll than in this case. Economists wanted to operate with the equation of exchange without noticing that the changes in the volume of money and the demand for money can come about in only one way: at first, the evaluations and with them the actions of only a few economic subjects will be influenced, with the resulting changes in the purchasing power of the monetary unit only spreading through the economy in a step-by-step pattern. In other words, the problem of changes in the value of money have been treated with the method of “statics,” although there should never have been any doubt concerning the dynamic character of the problem.
- Money SubstitutesThe most difficult and most important special problem of monetary theory is that of money substitutes. The fact that money services can also be rendered by secure money claims redeemable on demand, presents considerable difficulties to the monetary theorists’ attempt to define the supply of money and the demand for money. This difficulty could not be overcome as long as money substitutes were not clearly defined and separated into money certificates and fiduciary media, in order to treat the granting of credit through the issue of fiduciary media separately from all other types of credit.
Loans which do not involve the issuing of fiduciary media (i.e., bank notes or deposits which are not backed by money) is of no consequence for the volume of money. The demand for money can be influenced by lending as much as by any other institution of the economic order. Without knowledge of the data of the specific case, we cannot say in which direction this influence will operate. The widely-held opinion that an expansion of credit will always lead to a reduction in the demand for money is not correct. If many of the loan contracts provide for large repayments on certain days (for example, at the end of the month or quarter), the result will be an increase and not a reduction in the demand for money. The consequences of this increase in the demand for money will be expressed in prices, if it were not for clearing arrangements, on the one hand, and the practice of banks to increase the volume of fiduciary media on critical days, on the other hand.
Everything depends on the clear separation of money from money substitutes and within the category of money substitutes a distinction between money certificates (a money substitute fully backed by money) and the fiduciary medium (the money substitute not backed by money). But this is above all a question of terminological appropriateness. However, this question gains in importance in view of the difficulty and complexity of the problems. It is not — as so often is still maintained — the “granting of credit” but the issuing of fiduciary media which causes those effects on prices, wages, and interest rates, which banking theory has to deal with. It is, therefore, not inappropriate to refer to banking theory as the theory of fiduciary media.
Economic Calculation in the Socialist Commonwealth[Ludwig von Mises, Economic Calculation in the Socialist Commonwealth (1920; Auburn, Ala.: Mises Institute, 1990), pp. 10–26.]2. The Nature of Economic CalculationEvery man who, in the course of economic life, takes a choice between the satisfaction of one need as against another, eo ipso makes a judgment of value. Such judgments of value at once include only the very satisfaction of the need itself; and from this they reflect back upon the goods of a lower, and then further upon goods of a higher order. As a rule, the man who knows his own mind is in a position to value goods of a lower order. Under simple conditions it is also possible for him without much ado to form some judgment of the significance to him of goods of a higher order. But where the state of affairs is more involved and their interconnections not so easily discernible, subtler means must be employed to accomplish a correctUsing that term, of course, in the sense only of the valuating subject, and not in an objective and universally applicable sense. valuation of the means of production. It would not be difficult for a farmer in economic isolation to come by a distinction between the expansion of pasture-farming and the development of activity in the hunting field. In such a case the processes of production involved are relatively short and the expense and income entailed can be easily gauged. But it is quite a different matter when the choice lies between the utilization of a water-course for the manufacture of electricity or the extension of a coal mine or the drawing up of plans for the better employment of the energies latent in raw coal. Here the roundabout processes of production are many and each is very lengthy; here the conditions necessary for the success of the enterprises which are to be initiated are diverse, so that one cannot apply merely vague valuations, but requires rather more exact estimates and some judgment of the economic issues actually involved.
Valuation can only take place in terms of units, yet it is impossible that there should ever be a unit of subjective use value for goods. Marginal utility does not posit any unit of value, since it is obvious that the value of two units of a given stock is necessarily greater than, but less than double, the value of a single unit. Judgments of value do not measure; they merely establish grades and scales.Franz Cuhel, Zur Lehre von den Bedürfnissen (Innsbruck: Wagner’sche Universität-Buchhandlung, 1907), pp. 198 f. Even Robinson Crusoe, when he has to make a decision where no ready judgment of value appears and where he has to construct one upon the basis of a more or less exact estimate, cannot operate solely with subjective use value, but must take into consideration the intersubstitutability of goods on the basis of which he can then form his estimates. In such circumstances it will be impossible for him to refer all things back to one unit. Rather will he, so far as he can, refer all the elements which have to be taken into account in forming his estimate to those economic goods which can be apprehended by an obvious judgment of value — that is to say, to goods of a lower order and to pain-cost. That this is only possible in very simple conditions is obvious. In the case of more complicated and more lengthy processes of production it will, plainly, not answer.
In an exchange economy the objective exchange value of commodities enters as the unit of economic calculation. This entails a threefold advantage. In the first place, it renders it possible to base the calculation upon the valuations of all participants in trade. The subjective use value of each is not immediately comparable as a purely individual phenomenon with the subjective use value of other men. It only becomes so in exchange value, which arises out of the interplay of the subjective valuations of all who take part in exchange. But in that case calculation by exchange value furnishes a control over the appropriate employment of goods. Anyone who wishes to make calculations in regard to a complicated process of production will immediately notice whether he has worked more economically than others or not; if he finds, from reference to the exchange relations obtaining in the market, that he will not be able to produce profitably, this shows that others understand how to make a better use of the goods of higher order in question. Lastly, calculation by exchange value makes it possible to refer values back to a unit. For this purpose, since goods are mutually substitutable in accordance with the exchange relations obtaining in the market, any possible good can be chosen. In a monetary economy it is money that is so chosen.
Monetary calculation has its limits. Money is no yardstick of value, nor yet of price. Value is not indeed measured in money, nor is price. They merely consist in money. Money as an economic good is not of stable value as has been naïvely, but wrongly, assumed in using it as a “standard of deferred payments.” The exchange-relationship which obtains between money and goods is subjected to constant, if (as a rule) not too violent, fluctuations originating not only from the side of other economic goods, but also from the side of money. However, these fluctuations disturb value calculations only in the slightest degree, since usually, in view of the ceaseless alternations in other economic data — these calculations will refer only to comparatively short periods of time — periods in which “good” money, at least normally, undergoes comparatively trivial fluctuations in regard to its exchange relations. The inadequacy of the monetary calculation of value does not have its mainspring in the fact that value is then calculated in terms of a universal medium of exchange, namely money, but rather in the fact that in this system it is exchange value and not subjective use value on which the calculation is based. It can never obtain as a measure for the calculation of those value determining elements which stand outside the domain of exchange transactions. If, for example, a man were to calculate the profitability of erecting a waterworks, he would not be able to include in his calculation the beauty of the waterfall which the scheme might impair, except that he may pay attention to the diminution of tourist traffic or similar changes, which may be valued in terms of money. Yet these considerations might well prove one of the factors in deciding whether or not the building is to go up at all.
It is customary to term such elements “extra-economic.” This perhaps is appropriate; we are not concerned with disputes over terminology; yet the considerations themselves can scarcely be termed irrational. In any place where men regard as significant the beauty of a neighborhood or of a building, the health, happiness and contentment of mankind, the honor of individuals or nations, they are just as much motive forces of rational conduct as are economic factors in the proper sense of the word, even where they are not substitutable against each other on the market and therefore do not enter into exchange relationships.
That monetary calculation cannot embrace these factors lies in its very nature; but for the purposes of our everyday economic life this does not detract from the significance of monetary calculation. For all those ideal goods are goods of a lower order, and can hence be embraced straightway within the ambit of our judgment of values. There is therefore no difficulty in taking them into account, even though they must remain outside the sphere of monetary value. That they do not admit of such computation renders their consideration in the affairs of life easier and not harder. Once we see clearly how highly we value beauty, health, honor and pride, surely nothing can prevent us from paying a corresponding regard to them. It may seem painful to any sensitive spirit to have to balance spiritual goods against material. But that is not the fault of monetary calculation; it lies in the very nature of things themselves. Even where judgments of value can be established directly without computation in value or in money, the necessity of choosing between material and spiritual satisfaction cannot be evaded. Robinson Crusoe and the socialist state have an equal obligation to make the choice.
Anyone with a genuine sense of moral values experiences no hardship in deciding between honor and livelihood. He knows his plain duty. If a man cannot make honor his bread, yet can he renounce his bread for honor’s sake. Only they who prefer to be relieved of the agony of this decision, because they cannot bring themselves to renounce material comfort for the sake of spiritual advantage, see in the choice a profanation of true values.
Monetary calculation only has meaning within the sphere of economic organization. It is a system whereby the rules of economics may be applied in the disposition of economic goods. Economic goods only have part in this system in proportion to the extent to which they may be exchanged for money. Any extension of the sphere of monetary calculation causes misunderstanding. It cannot be regarded as constituting a kind of yardstick for the valuation of goods, and cannot be so treated in historical investigations into the development of social relationships; it cannot be used as a criterion of national wealth and income, nor as a means of gauging the value of goods which stand outside the sphere of exchange, as who should seek to estimate the extent of human losses through emigrations or wars in terms of money?Cf. Friedrich von Wieser, Über den Ursprung und die Hauptgesetze des wirtschaftlichen Eertes (Vienna: A. Hölder, 1884), pp. 185 f. This is mere sciolistic tomfoolery, however much it may be indulged in by otherwise perspicacious economists.
Nevertheless within these limits, which in economic life it never oversteps, monetary calculation fulfils all the requirements of economic calculation. It affords us a guide through the oppressive plenitude of economic potentialities. It enables us to extend to all goods of a higher order the judgment of value, which is bound up with and clearly evident in, the case of goods ready for consumption, or at best of production goods of the lowest order. It renders their value capable of computation and thereby gives us the primary basis for all economic operations with goods of a higher order. Without it, all production involving processes stretching well back in time and all the longer roundabout processes of capitalistic production would be gropings in the dark.
There are two conditions governing the possibility of calculating value in terms of money. Firstly, not only must goods of a lower, but also those of a higher order, come within the ambit of exchange, if they are to be included. If they do not do so, exchange relationships would not arise. True enough, the considerations which must obtain in the case of Robinson Crusoe prepared, within the range of his own hearth, to exchange, by production, labor and flour for bread, are indistinguishable from those which obtain when he is prepared to exchange bread for clothes in the open market, and, therefore, it is to some extent true to say that every economic action, including Robinson Crusoe’s own production, can be termed exchange.Cf. [Ludwig von] Mises, Theorie des Geldes und der Umlaufsmittel (Munich and Leipzig: Duncker & Humblot, 1912), p. 16, with the references there given. [See the English translation by H.E. Batson, The Theory of Money and Credit (Indianapolis: Liberty Classics, 1980), p. 52.] Moreover, the mind of one man alone — be it ever so cunning, is too weak to grasp the importance of any single one among the countlessly many goods of a higher order. No single man can ever master all the possibilities of production, innumerable as they are, as to be in a position to make straightway evident judgments of value without the aid of some system of computation. The distribution among a number of individuals of administrative control over economic goods in a community of men who take part in the labor of producing them, and who are economically interested in them, entails a kind of intellectual division of labor, which would not be possible without some system of calculating production and without economy.
The second condition is that there exists in fact a universally employed medium of exchange — namely, money — which plays the same part as a medium in the exchange of production goods also. If this were not the case, it would not be possible to reduce all exchange-relationships to a common denominator.
Only under simple conditions can economics dispense with monetary calculation. Within the narrow confines of household economy, for instance, where the father can supervise the entire economic management, it is possible to determine the significance of changes in the processes of production, without such aids to the mind, and yet with more or less of accuracy. In such a case the process develops under a relatively limited use of capital. Few of the capitalistic roundabout processes of production are here introduced: what is manufactured is, as a rule, consumption goods or at least such goods of a higher order as stand very near to consumption-goods. The division of labor is in its rudimentary stages: one and the same laborer controls the labor of what is in effect, a complete process of production of goods ready for consumption, from beginning to end. All this is different, however, in developed communal production. The experiences of a remote and bygone period of simple production do not provide any sort of argument for establishing the possibility of an economic system without monetary calculation.
In the narrow confines of a closed household economy, it is possible throughout to review the process of production from beginning to end, and to judge all the time whether one or another mode of procedure yields more consumable goods. This, however, is no longer possible in the incomparably more involved circumstances of our own social economy. It will be evident, even in the socialist society, that 1,000 hectolitres of wine are better than 800, and it is not difficult to decide whether it desires 1,000 hectolitres of wine rather than 500 of oil. There is no need for any system of calculation to establish this fact: the deciding element is the will of the economic subjects involved. But once this decision has been taken, the real task of rational economic direction only commences, i.e., economically, to place the means at the service of the end. That can only be done with some kind of economic calculation. The human mind cannot orientate itself properly among the bewildering mass of intermediate products and potentialities of production without such aid. It would simply stand perplexed before the problems of management and location.Friedrich von Gottl-Ottlilienfeld, Wirtschaft und technik (Grundriss der Sozialökonomik, Section 2; Tübingen: J.C.B. Mohr, 1914), p. 216.
It is an illusion to imagine that in a socialist state calculation in natura can take the place of monetary calculation. Calculation in natura, in an economy without exchange, can embrace consumption goods only; it completely fails when it comes to dealing with goods of a higher order. And as soon as one gives up the conception of a freely established monetary price for goods of a higher order, rational production becomes completely impossible. Every step that takes us away from private ownership of the means of production and from the use of money also takes us away from rational economics.
It is easy to overlook this fact, considering that the extent to which socialism is in evidence among us constitutes only a socialistic oasis in a society with monetary exchange, which is still a free society to a certain degree. In one sense we may agree with the socialists’ assertion which is otherwise entirely untenable and advanced only as a demagogic point, to the effect that the nationalization and municipalization of enterprise is not really socialism, since these concerns in their business organizations are so much dependent upon the environing economic system with its free commerce that they cannot be said to partake today of the really essential nature of a socialist economy. In state and municipal undertakings technical improvements are introduced because their effect in similar private enterprises, domestic or foreign, can be noticed, and because those private industries which produce the materials for these improvements give the impulse for their introduction. In these concerns the advantages of reorganization can be established, because they operate within the sphere of a society based upon private ownership of the means of production and upon the system of monetary exchange, being thus capable of computation and account. This state of affairs, however, could not obtain in the case of socialist concerns operating in a purely socialistic environment.
Without economic calculation there can be no economy. Hence, in a socialist state wherein the pursuit of economic calculation is impossible, there can be — in our sense of the term — no economy whatsoever. In trivial and secondary matters rational conduct might still be possible, but in general it would be impossible to speak of rational production any more. There would be no means of determining what was rational, and hence it is obvious that production could never be directed by economic considerations. What this means is clear enough, apart from its effects on the supply of commodities. Rational conduct would be divorced from the very ground which is its proper domain. Would there, in fact, be any such thing as rational conduct at all, or, indeed, such a thing as rationality and logic in thought itself? Historically, human rationality is a development of economic life. Could it then obtain when divorced therefrom?
For a time the remembrance of the experiences gained in a competitive economy, which has obtained for some thousands of years, may provide a check to the complete collapse of the art of economy. The older methods of procedure might be retained not because of their rationality but because they appear to be hallowed by tradition. Actually, they would meanwhile have become irrational, as no longer comporting with the new conditions. Eventually, through the general reconstruction of economic thought, they will experience alterations which will render them in fact uneconomic. The supply of goods will no longer proceed anarchically of its own accord; that is true. All transactions which serve the purpose of meeting requirements will be subject to the control of a supreme authority. Yet in place of the economy of the “anarchic” method of production, recourse will be had to the senseless output of an absurd apparatus. The wheels will turn, but will run to no effect.
One may anticipate the nature of the future socialist society. There will be hundreds and thousands of factories in operation. Very few of these will be producing wares ready for use; in the majority of cases what will be manufactured will be unfinished goods and production goods. All these concerns will be interrelated. Every good will go through a whole series of stages before it is ready for use. In the ceaseless toil and moil of this process, however, the administration will be without any means of testing their bearings. It will never be able to determine whether a given good has not been kept for a superfluous length of time in the necessary processes of production, or whether work and material have not been wasted in its completion. How will it be able to decide whether this or that method of production is the more profitable? At best it will only be able to compare the quality and quantity of the consumable end product produced, but will in the rarest cases be in a position to compare the expenses entailed in production. It will know, or think it knows, the ends to be achieved by economic organization, and will have to regulate its activities accordingly, i.e., it will have to attain those ends with the least expense. It will have to make its computations with a view to finding the cheapest way. This computation will naturally have to be a value computation. It is eminently clear, and requires no further proof, that it cannot be of a technical character, and that it cannot be based upon the objective use value of goods and services.
Now, in the economic system of private ownership of the means of production, the system of computation by value is necessarily employed by each independent member of society. Everybody participates in its emergence in a double way: on the one hand as a consumer and on the other as a producer. As a consumer he establishes a scale of valuation for goods ready for use in consumption. As a producer he puts goods of a higher order into such use as produces the greatest return. In this way all goods of a higher order receive a position in the scale of valuations in accordance with the immediate state of social conditions of production and of social needs. Through the interplay of these two processes of valuation, means will be afforded for governing both consumption and production by the economic principle throughout. Every graded system of pricing proceeds from the fact that men always and ever harmonized their own requirements with their estimation of economic facts.
All this is necessarily absent from a socialist state. The administration may know exactly what goods are most urgently needed. But in so doing, it has only found what is, in fact, but one of the two necessary prerequisites for economic calculation. In the nature of the case it must, however, dispense with the other — the valuation of the means of production. It may establish the value attained by the totality of the means of production; this is obviously identical with that of all the needs thereby satisfied. It may also be able to calculate the value of any means of production by calculating the consequence of its withdrawal in relation to the satisfaction of needs. Yet it cannot reduce this value to the uniform expression of a money price, as can a competitive economy, wherein all prices can be referred back to a common expression in terms of money. In a socialist commonwealth which, whilst it need not of necessity dispense with money altogether, yet finds it impossible to use money as an expression of the price of the factors of production (including labor), money can play no role in economic calculation.This fact is also recognized by Otto Neurath (Durch die Kriegswirtschaft zur Naturalwirtschaft [Munich: G.D.W. Callwey, 1919], pp. 216 f.). He advances the view that every complete administrative economy is, in the final analysis, a natural economy. “Socialization,” he says, “is thus the pursuit of natural economy.” Neurath merely overlooks the insuperable difficulties that would have to develop with economic calculation in the socialist commonwealth.
Picture the building of a new railroad. Should it be built at all, and if so, which out of a number of conceivable roads should be built? In a competitive and monetary economy, this question would be answered by monetary calculation. The new road will render less expensive the transport of some goods, and it may be possible to calculate whether this reduction of expense transcends that involved in the building and upkeep of the next line. That can only be calculated in money. It is not possible to attain the desired end merely by counterbalancing the various physical expenses and physical savings. Where one cannot express hours of labor, iron, coal, all kinds of building material, machines and other things necessary for the construction and upkeep of the railroad in a common unit it is not possible to make calculations at all. The drawing up of bills on an economic basis is only possible where all the goods concerned can be referred back to money. Admittedly, monetary calculation has its inconveniences and serious defects, but we have certainly nothing better to put in its place, and for the practical purposes of life monetary calculation as it exists under a sound monetary system always suffices. Were we to dispense with it, any economic system of calculation would become absolutely impossible.
The socialist society would know how to look after itself. It would issue an edict and decide for or against the projected building. Yet this decision would depend at best upon vague estimates; it would never be based upon the foundation of an exact calculation of value.
The static state can dispense with economic calculation. For here the same events in economic life are ever recurring; and if we assume that the first disposition of the static socialist economy follows on the basis of the final state of the competitive economy, we might at all events conceive of a socialist production system which is rationally controlled from an economic point of view. But this is only conceptually possible. For the moment, we leave aside the fact that a static state is impossible in real life, as our economic data are forever changing, so that the static nature of economic activity is only a theoretical assumption corresponding to no real state of affairs, however necessary it may be for our thinking and for the perfection of our knowledge of economics. Even so, we must assume that the transition to socialism must, as a consequence of the levelling out of the differences in income and the resultant readjustments in consumption, and therefore production, change all economic data in such a way that a connecting link with the final state of affairs in the previously existing competitive economy becomes impossible. But then we have the spectacle of a socialist economic order floundering in the ocean of possible and conceivable economic combinations without the compass of economic calculation.
Thus in the socialist commonwealth every economic change becomes an undertaking whose success can be neither appraised in advance nor later retrospectively determined. There is only groping in the dark. Socialism is the abolition of rational economy.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 13: “Monetary Calculation as a Tool of Action,” pp. 230–32.]1. Monetary Calculation as a Method of ThinkingMonetary calculation is the guiding star of action under the social system of division of labor. It is the compass of the man embarking upon production. He calculates in order to distinguish the remunerative lines of production from the unprofitable ones, those of which the sovereign consumers are likely to approve from those of which they are likely to disapprove. Every single step of entrepreneurial activities is subject to scrutiny by monetary calculation. The premeditation of planned action becomes commercial precalculation of expected costs and expected proceeds. The retrospective establishment of the outcome of past action becomes accounting of profit and loss.
The system of economic calculation in monetary terms is conditioned by certain social institutions. It can operate only in an institutional setting of the division of labor and private ownership of the means of production in which goods and services of all orders are bought and sold against a generally used medium of exchange, i.e., money.
Monetary calculation is the method of calculating employed by people acting within the frame of society based on private control of the means of production. It is a device of acting individuals; it is a mode of computation designed for ascertaining private wealth and income and private profits and losses of individuals acting on their own behalf within a free enterprise society.In partnerships and corporations it is always individuals who act, although not only one individual. All its results refer to the actions of individuals only. When statisticians summarize these results, the outcome shows the sum of the autonomous actions of a plurality of self-directing individuals, but not the effect of the action of a collective body, of a whole, or of a totality. Monetary calculation is entirely inapplicable and useless for any consideration which does not look at things from the point of view of individuals. It involves calculating the individuals’ profits, not imaginary “social” values and “social” welfare.
Monetary calculation is the main vehicle of planning and acting in the social setting of a society of free enterprise directed and controlled by the market and its prices. It developed in this frame and was gradually perfected with the improvement of the market mechanism and with the expansion of the scope of things which are negotiated on markets against money. It was economic calculation that assigned to measurement, number, and reckoning the role they play in our quantitative and computing civilization. The measurements of physics and chemistry make sense for practical action only because there is economic calculation. It is monetary calculation that made arithmetic a tool in the struggle for a better life. It provides a mode of using the achievements of laboratory experiments for the most efficacious removal of uneasiness.
Monetary calculation reaches its full perfection in capital accounting. It establishes the money prices of the available means and confronts this total with the changes brought about by action and by the operation of other factors. This confrontation shows what changes occurred in the state of the acting men’s affairs, and the magnitude of those changes; it makes success and failure, profit and loss ascertainable. The system of free enterprise has been dubbed capitalism in order to deprecate and to smear it. However, this term can be considered very pertinent. It refers to the most characteristic feature of the system, its main eminence, viz. the role the notion of capital plays in its conduct.
There are people to whom monetary calculation is repulsive. They do not want to be roused from their daydreams by the voice of critical reason. Reality sickens them, they long for a realm of unlimited opportunity. They are disgusted by the meanness of a social order in which everything is nicely reckoned in dollars and pennies. They call their grumbling the noble deportment worthy of the friends of the spirit, of beauty, and virtue as opposed to the ignoble baseness and villainy of Babbittry. However, the cult of beauty and virtue, wisdom and the search for truth are not hindered by the rationality of the calculating and computing mind. It is only romantic reverie that cannot thrive in a milieu of sober criticism. The cool-headed reckoner is the stern chastiser of the ecstatic visionary.
Our civilization is inseparably linked with our methods of economic calculation. It would perish if we were to abandon this most precious intellectual tool of acting. Goethe was right in calling bookkeeping by double entry “one of the finest inventions of the human mind.”Cf. [Johann Wolfgang von] Goethe, Wilhelm Meister’s Apprenticeship (1795), Bk. 1, chap. 10.
- Economic Calculation and the Science of Human ActionThe evolution of capitalist economic calculation was the necessary condition for the establishment of a systematic and logically coherent science of human action. Praxeology and economics have a definite place in the evolution of human history and in the process of scientific research. They could only emerge when acting man had succeeded in creating methods of thinking that made it possible to calculate his actions. The science of human action was at the beginning merely a discipline dealing with those actions which can be tested by monetary calculation. It dealt exclusively with what we may call the orbit of economics in the narrower sense, that is, with those actions which within a market society are transacted by the intermediary of money. The first steps on the way to its elaboration were odd investigations concerning currency, moneylending, and the prices of various goods. The knowledge conveyed by Gresham’s Law, the first crude formulations of the quantity theory of money — such as those of Bodin and Davanzati — and the Law of Gregory King mark the first dawn of the cognition that regularity of phenomena and inevitable necessity prevail in the field of action. The first comprehensive system of economic theory, that brilliant achievement of the classical economists, was essentially a theory of calculated action. It drew implicitly the borderline between what is to be considered economic and what extra-economic along the line which separates action calculated in monetary terms from other action. Starting from this basis the economists were bound to widen step by step the field of their studies until they finally developed a system dealing with all human choices, a general theory of action.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 10: “Exchange within Society,” pp. 195–98.]1. Autistic Exchange and Interpersonal ExchangeAction always is essentially the exchange of one state of affairs for another state of affairs. If the action is performed by an individual without any reference to cooperation with other individuals, we may call it autistic exchange. An instance: the isolated hunter who kills an animal for his own consumption; he exchanges leisure and a cartridge for food.
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. Where there is no intentional mutuality, where an action is performed without any design of being benefited by a concomitant action of other men, there is no interpersonal exchange, but autistic exchange. It does not matter whether the autistic action is beneficial or detrimental to other people or whether it does not concern them at all. A genius may perform his task for himself, not for the crowd; however, he is an outstanding benefactor of mankind. The robber kills the victim for his own advantage; the murdered man is by no means a partner in this crime, he is merely its object; what is done, is done against him.
Hostile aggression was a practice common to man’s nonhuman forebears. Conscious and purposeful cooperation is the outcome of a long evolutionary process. Ethnology and history have provided us with interesting information concerning the beginning and the primitive patterns of interpersonal exchange. Some consider the custom of mutual giving and returning of presents and stipulating a certain return present in advance as a precursory pattern of interpersonal exchange.Gustav Cassel, The Theory of Social Economy, trans. S.L. Banon (new ed; London, 1932), p. 371. Others consider dumb barter as the primitive mode of trade. However, to make presents in the expectation of being rewarded by the receiver’s return present or in order to acquire the favor of a man whose animosity could be disastrous, is already tantamount to interpersonal exchange. The same applies to dumb barter which is distinguished from other modes of bartering and trading only through the absence of oral discussion.
It is the essential characteristic of the categories of human action that they are apodictic and absolute and do not admit of any gradation. There is action or nonaction, there is exchange or nonexchange; everything which applies to action and exchange as such is given or not given in every individual instance according to whether there is or there is not action and exchange. In the same way the boundaries between autistic exchange and interpersonal exchange are sharply distinct. Making one-sided presents without the aim of being rewarded by any conduct on the part of the receiver or of third persons is autistic exchange. The donor acquires the satisfaction which the better condition of the receiver gives to him. The receiver gets the present as a God-sent gift. But if presents are given in order to influence some people’s conduct, they are no longer one-sided, but a variety of interpersonal exchange between the donor and the man whose conduct they are designed to influence. Although the emergence of interpersonal exchange was the result of a long evolution, no gradual transition is conceivable between autistic and interpersonal exchange. There were no intermediary modes of exchange between them. The step which leads from autistic to interpersonal exchange was no less a jump into something entirely new and essentially different than was the step from automatic reaction of the cells and nerves to conscious and purposeful behavior, to action.
- Contractual Bonds and Hegemonic BondsThere are two different kinds of social cooperation: cooperation by virtue of contract and coordination, and cooperation by virtue of command and subordination or hegemony.
Where and as far as cooperation is based on contract, the logical relation between the cooperating individuals is symmetrical. They are all parties to interpersonal exchange contracts. John has the same relation to Tom as Tom has to John. Where and as far as cooperation is based on command and subordination, there is the man who commands and there are those who obey his orders. The logical relation between these two classes of men is asymmetrical. There is a director and there are people under his care. The director alone chooses and directs; the others — the wards — are mere pawns in his actions.
The power that calls into life and animates any social body is always ideological might, and the fact that makes an individual a member of any social compound is always his own conduct. This is no less valid with regard to a hegemonic societal bond. It is true, people are as a rule born into the most important hegemonic bonds, into the family and into the state, and this was also the case with the hegemonic bonds of older days, slavery and serfdom, which disappeared in the realm of Western civilization. But no physical violence and compulsion can possibly force a man against his will to remain in the status of the ward of a hegemonic order. What violence or the threat of violence brings about is a state of affairs in which subjection as a rule is considered more desirable than rebellion. Faced with the choice between the consequences of obedience and of disobedience, the ward prefers the former and thus integrates himself into the hegemonic bond. Every new command places this choice before him again. In yielding again and again he himself contributes his share to the continuous existence of the hegemonic societal body. Even as a ward in such a system he is an acting human being, i.e., a being not simply yielding to blind impulses, but using his reason in choosing between alternatives.
What differentiates the hegemonic bond from the contractual bond is the scope in which the choices of the individuals determine the course of events. As soon as a man has decided in favor of his subjection to a hegemonic system, he becomes, within the margin of this system’s activities and for the time of his subjection, a pawn of the director’s actions. Within the hegemonic societal body and as far as it directs its subordinates’ conduct, only the director acts. The wards act only in choosing subordination; having once chosen subordination they no longer act for themselves, they are taken care of.In the frame of a contractual society the individual members exchange definite quantities of goods and services of a definite quality. In choosing subjection in a hegemonic body a man neither gives nor receives anything that is definite. He integrates himself into a system in which he has to render indefinite services and will receive what the director is willing to assign to him. He is at the mercy of the director. The director alone is free to choose. Whether the director is an individual or an organized group of individuals, a directorate, and whether the director is a selfish maniacal tyrant or a benevolent paternal despot is of no relevance for the structure of the whole system.
The distinction between these two kinds of social cooperation is common to all theories of society. Ferguson described it as the contrast between warlike nations and commercial nation; Saint Simon as the contrast between pugnacious nations and peaceful or industrial nations;Cf. Adam Ferguson, An Essay on the History of Civil Society (new ed; Basel, 1789), p. 208. Herbert Spencer as the contrast between societies of individual freedom and those of a militant structure;Cf. Herbert Spencer, The Principles of Sociology (New York, 1914), vol. 3, pp. 575–611. Sombart as the contrast between heroes and peddlers.Cf. Werner Sombart, Haendler und Helden (Munich, 1915). The Marxians distinguish between the “gentile organization” of a fabulous state of primitive society and the eternal bliss of socialism on the one hand and the unspeakable degradation of capitalism on the other hand.Cf. Frederick Engels, The Origin of the Family, Private Property and the State (New York, 1942), p. 144. The Nazi philosophers distinguish the counterfeit system of bourgeois security from the heroic system of authoritarian Führertum. The valuation of both systems is different with the various sociologists. But they fully agree in the establishment of the contrast and no less in recognizing that no third principle is thinkable and feasible.
Western civilization as well as the civilization of the more advanced Eastern peoples are achievements of men who have cooperated according to the pattern of contractual coordination. These civilizations, it is true, have adopted in some respects bonds of hegemonic structure. The state as an apparatus of compulsion and coercion is by necessity a hegemonic organization. So is the family and its household community. However, the characteristic feature of these civilizations is the contractual structure proper to the cooperation of the individual families. There once prevailed almost complete autarky and economic isolation of the individual household units. When interfamilial exchange of goods and services was substituted for each family’s economic self-sufficiency, it was, in all nations commonly considered civilized, a cooperation based on contract. Human civilization as it has been hitherto known to historical experience is preponderantly a product of contractual relations.
Any kind of human cooperation and social mutuality is essentially an order of peace and conciliatory settlement of disputes. In the domestic relations of any societal unit, be it a contractual or a hegemonic bond, there must be peace. Where there are violent conflicts and as far as there are such conflicts, there is neither cooperation nor societal bonds. Those political parties which in their eagerness to substitute the hegemonic system for the contractual system point at the rottenness of peace and of bourgeois security, extol the moral nobility of violence and bloodshed and praise war and revolution as the eminently natural methods of interhuman relations, contradict themselves. For their own utopias are designed as realms of peace. The Reich of the Nazis and the commonwealth of the Marxians are planned as societies of undisturbed peace. They are to be created by pacification, i.e., the violent subjection of all those not ready to yield without resistance. In a contractual world various states can quietly coexist. In a hegemonic world there can only be one Reich or commonwealth and only one dictator. Socialism must choose between a renunciation of the advantages of division of labor encompassing the whole earth and all peoples and the establishment of a world-embracing hegemonic order. It is this fact that made Russian Bolshevism, German Nazism, and Italian Fascism “dynamic,” i.e., aggressive. Under contractual conditions empires are dissolved into a loose league of autonomous member nations. The hegemonic system is bound to strive after the annexation of all independent states.
The contractual order of society is an order of right and law. It is a government under the rule of law (Rechtsstaat) as differentiated from the welfare state (Wohlfahrtsstaat) or paternal state. Right or law is the complex of rules determining the orbit in which individuals are free to act. No such orbit is left to wards of a hegemonic society. In the hegemonic state there is neither right nor law; there are only directives and regulations which the director may change daily and apply with what discrimination he pleases and which the wards must obey. The wards have one freedom only: to obey without asking questions.
Socialism[Ludwig von Mises, Socialism (1922; Indianapolis, Ind.: Liberty Classics, 1981), chap. 18: “Society,” pp. 256–78.]1. The Nature of SocietyThe idea of human destiny dominates all the more ancient views of social existence. Society progresses towards a goal fore-ordained by the deity. Whoever thinks in this way is logically correct if, in speaking of progress and retrogression, of revolution and counterrevolution, of action and reaction he lays on these concepts the emphasis adopted by so many historians and politicians. History is judged according as it brings mankind nearer to the goal or carries it farther away.
Social science, however, begins at the point where one frees oneself from such habits, and indeed from all valuation. Social science is indeed teleological in the sense in which every causal study of the will must be. But its concept of purpose is wholly comprised in the causal explanation. For social science causality remains the fundamental principle of cognition, the maintenance of which must not be impaired even by teleology.[Hermann] Cohen, Logik der reinen Erkenntnis, 2nd ed. (Berlin, 1914), p. 359. Since it does not evaluate purposes, it cannot speak of evolution to a higher plane, in the sense let us say, of Hegel and Marx. For it is by no means proved that all evolution leads upwards, or that every later stage is a higher one. No more, of course, can it agree with the pessimistic philosophers of history, who see in the historical process a decline, a progressive approach to a bad end. To ask what are the driving forces of historical evolution is to ask what is the nature of society and the origin and causes of the changes in social conditions. What society is, how it originates, how it changes — these alone can be the problems which scientific sociology sets itself.
That the social life of men resembles the biological process is an observation of ancient date. It lies at the basis of the famous legend of Menenius Agrippa, handed down to us by Livy. Social science did itself little good when, inspired by the triumph of Biology in the nineteenth century, voluminous works developed this analogy to the point of absurdity. What is the use of calling the products of human activity “social intercellular substance”?As is done by [Paul von] Lilienfeld, La pathologie sociale (Paris, 1896), p. 95. When a government takes a loan from the House of Rothschild organic sociology conceives the process as follows: “La maison Rothschild agit, dans cette occasion, parfaitement en analogie avec l’action d’un groupe de cellules qui, dans le corps humain, coopèrent à la production du sang nécessaire à l’alimentation du cerveau dans l’espoir d’en être indemnisées par une réaction des cellules de la substance grise dont ils ont besoin pour s’activer de nouveau et accumuler de nouvelles énergies.” (“The House of Rothschild’s operation, on such an occasion, is precisely similar to the action of a group of human body cells which cooperate in the production of the blood necessary for nourishing the brain, in the hope of being compensated by a reaction of the gray matter cells which they need to reactivate and to accumulate new energies.”) (Ibid., p. 104.) This is the method which claims that it stands on “firm ground” and explores “the Becoming of Phenomena step by step, proceeding from the simpler to the more complex.” See Lilienfeld, Zur Verteidigung der organischen Methode in der Soziologie (Berlin, 1898), p. 75. Who was enlightened when scholars disputed which organ of the social body corresponded to the central nervous system? The best comment on this form of sociological study was the remark of an economist, to the effect that anyone who compared money with blood and the circulation of money with the circulation of blood would be making the same contribution to economics as would be made to biology by a man who compared blood with money and the blood-circulation with the circulation of money. Modern biology has borrowed from social science some of its most important concepts — that of evolution, of the division of labour, and of the struggle for existence. But it has not stopped short at metaphorical phrases and conclusions by analogy; rather has it proceeded to make profitable use of what it had gained. On the other hand biological-sociology did nothing but play a futile word-spinning game with the ideas it borrowed back. The romantic movement, with its “organic” theory of the state has done even less to clear up our knowledge of social interrelations. Because it deliberately cold-shouldered the most important achievement of social science up to that date — the system of classical Political Economy — it was unable to utilize the doctrine of the division of labour, that part of the classical system which must be the starting point of all sociology, as it is of modern biology.It is characteristic that just the romantics stress excessively society’s organic character, whereas liberal social philosophy has never done so. Quite understandably. A social theory which was genuinely organic did not need to stress obtrusively this attribute of its system.
Comparison with the biological organism should have taught sociology one thing: that the organism can only be conceived as a system of organs. This, however, merely means that the essence of the organism is the division of labour. Only division of labour makes the parts become members; it is in the collaboration of the members that we recognize the unity of the system, the organism.Cohen, Logik der reinen Erkenntnis, p. 349. This is true of the life of plants and animals as well as of society. As far as the principle of the division of labour is concerned, the social body may be compared with the biological. The division of labour is the tertium comparationis (basis for comparison) of the old simile.
The division of labour is a fundamental principle of all forms of life.[Oscar] Hertwig, Allgemeine Biologie, 4th ed. (Jena, 1912), pp. 500 ff; Hertwig, Zur Abwehr des ethischen, des sozialen und des politischen Darwinismus (Jena, 1918), pp. 69 ff. It was first detected in the sphere of social life when political economists emphasized the meaning of the division of labour in the social economy. Biology then adopted it, at the instigation in the first place of Milne Edwards in 1827. The fact that we can regard the division of labour as a general law must not, however, prevent us from recognizing the fundamental differences between division of labour in the animal and vegetable organism on the one hand and division of labour in the social life of human beings on the other. Whatever we imagine to be the origin, evolution, and meaning of the physiological division of labour, it clearly does not shed any light on the nature of the sociological division of labour. The process that differentiates and integrates homogeneous cells is completely different from that which led to the growth of human society out of self-sufficient individuals. In the second process, reason and will play their part in the coalescence, by which the previously independent units form a larger unit and become parts of a whole, whereas the intervention of such forces in the first process is inconceivable.
Even where creatures such as ants and bees come together in “animal communities,” all movements and changes take place instinctively and unconsciously. Instinct may very well have operated at the beginning and in the earliest stages of social formation also. Man is already a member of a social body when he appears as a thinking, willing creature, for the thinking man is inconceivable as a solitary individual. “Only amongst men does man become a man” (Fichte). The development of human reason and the development of human society are one and the same process. All further growth of social relations is entirely a matter of will. Society is the product of thought and will. It does not exist outside thought and will. Its being lies within man, not in the outer world. It is projected from within outwards.
Society is co-operation; it is community in action.
To say that Society is an organism, means that society is division of labour.[Jean] Izoulet, La cité moderne (Paris, 1894), pp. 35 ff. To do justice to this idea we must take into account all the aims which men set themselves and the means by which these are to be attained. It includes every inter-relation of thinking and willing man. Modern man is a social being, not only as one whose material needs could not be supplied in isolation, but also as one who has achieved a development of reason and of the perceptive faculty that would have been impossible except within society. Man is inconceivable as an isolated being, for humanity exists only as a social phenomenon and mankind transcended the stage of animality only in so far as co-operation evolved the social relationships between the individuals. Evolution from the human animal to the human being was made possible by and achieved by means of social cooperation and by that alone. And therein lies the interpretation of Aristotle’s dictum that man is the ζvονπsλιτιχον (the living body politic).
- The Division of Labour as the Principle of Social DevelopmentWe are still far from understanding the ultimate and most profound secret of life, the principle of the origin of organisms. Who knows whether we shall ever discover it? All we know today is that when organisms are formed, something which did not exist before is created out of individuals. Vegetable and animal organisms are more than conglomerations of single cells, and society is more than the sum of the individuals of which it is composed. We have not yet grasped the whole significance of this fact. Our thoughts are still limited by the mechanical theory of the conservation of energy and of matter, which is never able to tell us how one can become two. Here again, if we are to extend our knowledge of the nature of life, understanding of the social organization will have to precede that of the biological.
Historically division of labour originates in two facts of nature: the inequality of human abilities and the variety of the external conditions of human life on the earth. These two facts are really one: the diversity of Nature, which does not repeat itself but creates the universe in infinite, inexhaustible variety. The special nature of our inquiry, however, which is directed towards sociological knowledge, justifies us in treating these two aspects separately.
It is obvious that as soon as human action becomes conscious and logical it must be influenced by these two conditions. They are indeed such as almost to force the division of labour on mankind.[Émile] Durkheim, De la division du travail social (Paris, 1893), pp. 294 ff. endeavours (following Comte and against Spencer) to prove that the division of labour prevails not because, as the economists think, it increases output but as a result of the struggle for existence. The denser the social mass the sharper the struggle for existence. This forces individuals to specialize in their work, as otherwise they would not be able to maintain themselves. But Durkheim overlooks the fact that the division of labour makes this possible only because it makes labour more productive. Durkheim comes to reject the theory of the importance of the greater productivity in the division of labour through a false conception of the fundamental idea of utilitarianism and of the law of the satiation of wants (ibid., 218 ff., 257 ff.). His view that civilization is called forth by changes in the volume and density of society is untenable. Population grows because labour becomes more productive and is able to nourish more people, not vice versa. Old and young, men and women co-operate by making appropriate use of their various abilities. Here also is the germ of the geographical division of labour; man goes to the hunt and woman to the spring to fetch water. Had the strength and abilities of all individuals and the external conditions of production been everywhere equal the idea of division of labour could never have arisen. Man would never of himself have hit upon the idea of making the struggle for existence easier by co-operation in the division of labour. No social life could have arisen among men of equal natural capacity in a world which was geographically uniform.On the important part played by the local variety of productive conditions in the origin of the division of labour see [Karl] von den Steinen, Unter den Naturvölkern Zentralbrasiliens, 2nd ed. (Berlin, 1897), pp. 196 ff. Perhaps men would have joined together to cope with tasks which were beyond the strength of individuals, but such alliances do not make a society. The relations they create are transient, and endure only for the occasion that brings them about. Their only importance in the origin of social life is that they create a rapprochement between men which brings with it mutual recognition of the difference in the natural capacities of individuals and thus in turn gives rise to the division of labour.
Once labour has been divided, the division itself exercises a differentiating influence. The fact that labour is divided makes possible further cultivation of individual talent and thus co-operation becomes more and more productive. Through co-operation men are able to achieve what would have been beyond them as individuals, and even the work which individuals are capable of doing alone is made more productive. But all this can only be grasped fully when the conditions which govern increase of productivity under co-operation are set out with analytical precision.
The theory of the international division of labour is one of the most important contributions of Classical Political Economy. It shows that as long as — for any reasons — movements of capital and labour between countries are prevented, it is the comparative, not the absolute, costs of production which govern the geographical division of labour.[David] Ricardo, Principles of Political Economy and Taxation, in Works, ed. John Ramsay MacCulloch, 2nd. (London, 1852), pp. 76 ff.; [John Stuart] Mill, Principles of Political Economy (People’s ed.; London, 1867), pp. 348 ff.; [C.F.] Bastable, The Theory of International Trade, 3rd ed. (London, 1900), pp. 16 ff. When the same principle is applied to the personal division of labour it is found that the individual enjoys an advantage in co-operating not only with people superior to himself in this or that capacity but also with those who are inferior to himself in every relevant way. If, through his superiority to B, A needs three hours’ labour for the production of one unit of commodity p compared with B’s five, and for the production of commodity q two hours against B’s four, then A will gain if he confines his labour to producing q and leaves B to produce p. If each gives sixty hours to producing both p and q, the result of A’s labour is 20p + 30q, of B’s 12p + 15q, and for both together 32p + 45q. If however, A confines himself to producing q alone he produces sixty units in 120 hours, whilst B, if he confines himself to producing p, produces in the same time twenty-four units. The result of the activity is then 24p + 60q, which, as p has for A a substitution value of 3:2q and for B one of 5:4q, signifies a larger production than 32p + 45q. Therefore it is obvious that every expansion of the personal division of labour brings advantages to all who take part in it. He who collaborates with the less talented, less able, and less industrious individuals gains an advantage equally as the man who associated with the more talented, more able, and more industrious. The advantage of the division of labour is mutual; it is not limited to the case where work is done which the solitary individual could never have carried out.
The greater productivity of work under the division of labour is a unifying influence. It leads men to regard each other as comrades in a joint struggle for welfare, rather than as competitors in a struggle for existence. It makes friends out of enemies, peace out of war, society out of individuals.“Trade makes the human race, which originally has only the unity of the species, into a really unitary society.” See Heymann Steinthal, Allgemeine Ethik (Berlin, 1885), p. 208. Trade, however, is nothing more than a technical aid of the division of labour. On the division of labour in the sociology of Thomas Aquinas see Edmund Schreiber, Die volkswirtschaftlichen Anschauungen der Scholastik seit Thomas von Aquin (Jena, 1913), pp. 19 ff.
- Organism and OrganizationOrganism and organization are as different from each other as life is from a machine, as a flower which is natural from one which is artificial. In the natural plant each cell lives its own life for itself while functioning reciprocally with the others. What we call living is just this self-existence and self-maintenance. In the artificial plant the separate parts are members of the whole only as far as the will of him, who united them, has been effective. Only to the extent to which this will is effective are the parts within the organization inter-related. Each part occupies only the place given to it, and leaves that place, so to speak, only on instructions. Within this framework the parts can live, that is, exist for themselves, only in so far as the creator has put them alive into his creation. The horse which the driver has harnessed to the cart lives as a horse. In the organization, the “team,” the horse is just as foreign to the vehicle as is an engine to the car it drives. The parts may use their life in opposition to the organization, as, for instance, when the horse runs away with the carriage or the tissue out of which the artificial flower is made disintegrates under chemical action. Human organization is no different. Like society it is a result of will. But in this case the will no more produces a living social organism than the flower-maker produces a living rose. The organization holds together as long as the creating will is effective, no longer. The parts which compose the organization merge into the whole only so far as the will of the creator can impose itself upon them and their life can be fixed in the organization. In the battalion on parade there is one will, the will of the commander. Everything else so far as it functions within the organization is lifeless machinery. In this destruction of the will, or that portion of it which does not serve the purpose of the body of troops, lies the essence of military drill. The soldier in the phalangial order, fighting in line, in which the body of troops must be nothing more than an organization — is drilled. Within the mass there is no life. Whatever life the individual lives is by the side of, or outside the body of troops — against it perhaps, but never in it. Modern warfare, based on the skirmisher’s personal enterprise, has to make use of the individual soldier, of his thought and his will. So the army no longer simply drills the soldier. It seeks to educate him.
Organization is an association based on authority, organism is mutuality. The primitive thinker always sees things as having been organized from outside, never as having grown themselves, organically. He sees the arrow which he has carved, he knows how it came into existence and how it was set in motion. So he asks of everything he sees, who made it and who sets it in motion. He inquires after the creation of every form of life, the authors of every change in nature, and discovers an animistic explanation. Thus the Gods are born. Man sees the organized community with its contrast of rulers and ruled, and, accordingly, he tries to understand life as an organization, not as an organism. Hence the ancient conception of the head as the master of the body, and the use of the same term “head” for the chief of the organization.
In recognizing the nature of the organism and sweeping away the exclusiveness of the concept of organization, science made one of its great steps forward. With all deference to earlier thinkers one may say that in the domain of Social Science this was achieved mainly in the eighteenth century, and that Classical Political Economy and its immediate precursors played the chief part. Biology took up the good work, flinging off all animistic and vitalistic beliefs. For modern biology the head is no longer the crown, the ruler of the body. In the living body there is no longer leader and followers, a contrast of sovereign and subjects, of means and purpose. There are only members, organs.
To seek to organize society is just as crazy as it would be to tear a living plant to bits in order to make a new one out of the dead parts. An organization of mankind can only be conceived after the living social organism has been killed. The collectivist movements are therefore fore-doomed to failure. It may be possible to create an organization embracing all mankind. But this would always be merely an organization, side by side with which social life would continue. It could be altered and destroyed by the forces of social life, and it certainly would be destroyed from the moment it tried to rebel against these forces. To make Collectivism a fact one must first kill all social life, then build up the collectivist state. The Bolshevists are thus quite logical in wishing to dissolve all traditional social ties, to destroy the social edifice built up through countless centuries, in order to erect a new structure on the ruins. Only they overlook the fact that isolated individuals, between whom no kind of social relations exist, can no longer be organized.
Organizations are possible only as long as they are not directed against the organic or do it any injury. All attempts to coerce the living will of human beings into the service of something they do not want must fail. An organization cannot flourish unless it is founded on the will of those organized and serves their purposes.
- The Individual and SocietySociety is not mere reciprocity. There is reciprocity amongst animals, for example when the wolf eats the lamb or when the wolf and she-wolf mate. Yet we do not speak of animal societies or of a society of wolves. Wolf and lamb, wolf and she-wolf, are indeed members of an organism — the organism of Nature. But this organism lacks the specific characteristic of the social organism: it is beyond the reach of will and action. For the same reason, the relation between the sexes is not, as such, a social relation. When a man and a woman come together they follow the law which assigns to them their place in Nature. Thus far they are ruled by instinct. Society exists only where willing becomes a co-willing and action co-action. To strive jointly towards aims which alone individuals could not reach at all, or not with equal effectiveness — that is society.Therefore, too, one must reject the idea of Guyau, which derives the social bond directly from bi-sexuality. See [Jean-Marie] Guyau, Sittlichkeit ohne Pflicht, trans. [Elisabeth] Schwarz (Leipzig, 1909), pp. 113 ff.
Therefore, Society is not an end but a means, the means by which each individual member seeks to attain his own ends. That society is possible at all is due to the fact that the will of one person and the will of another find themselves linked in a joint endeavour. Community of work springs from community of will. Because I can get what I want only if my fellow citizen gets what he wants, his will and action become the means by which I can attain my own end. Because my willing necessarily includes his willing, my intention cannot be to frustrate his will. On this fundamental fact all social life is built up.Fouillée argues as follows against the utilitarian theory of society, which calls society a “moyen universal” (“universal means”) (Belot): “Tout moyen n’a qu’une valeur provisoire; le jour où un instrument dont je me servais me devient inutile ou nuisible, je le mets de côté. Si la société n’ est qu’un moyen, le jour où, exceptionellement, elle se trouvera contraire à mes fins, je me delivrerai des lois sociales et moyens. sociaux. ... Aucune considération sociale ne pourra empêcher la révolte de l’individu tant qu’on ne lui aura pas montré que la société est établie pour des fins qui sont d’abord et avant tout ses vraies fins à lui-même et qui, de plus, ne sont pas simplement des fins de plaisir ou d’intérêt, l’intérêt n’étant que le plaisir différé et attendu pour l’avenir ... L’idée d’intérét est précisément ce qui divise les hommes, malgré les rapprochements qu’elle peut produire lorsqu’il y a convergence d’intérêts sur certains points.” (“Every means has only a temporary value; the day when a means ceases to serve me or becomes harmful to me, I cast it aside. If society is only a means, the day when, by some special circumstances, it is found to act contrary to my ends, I will free myself from its social laws and social means. ... No social consideration can prevent an individual from rebelling when it has not been demonstrated to him that society exists for ends which are primarily and above all his own true ends and, further, which are not simply for the ends of pleasure or self-interest, self-interest being only pleasure postponed and expected in the future. ... The idea of self-interest is precisely what divides men, in spite of the cooperation it can produce when self-interests coincide in certain instances.”) [Alfred] Fouillée, Humanitaires et libertaires au point de vue Sociologique et moral (Paris, 1914), pp. 146 ff.; see also [Jean-Marie] Guyau, Die englische Ethik der Gegenwart, trans. Peusner (Leipzig, 1914), pp. 372 ff. Fouillée does not see that the provisional value which society gets as a means, lasts as long as the conditions of human life, given by nature, continue unchanged and as long as man continues to recognize the advantages of human co-operation. The “eternal,” not merely provisional, existence of society follows from the eternity of the conditions on which it is built up. Those in power may demand of social theory that it should serve them by preventing the individual from revolting against society, but this is by no means a scientific demand. Besides no social theory could, as easily as the utilitarian, induce the social individual to enrol himself voluntarily in the social union. But when an individual shows that he is an enemy of society there is nothing left for society to do but make him harmless.
The principle of the division of labour revealed the nature of the growth of society. Once the significance of the division of labour had been grasped, social knowledge developed at an extraordinary pace, as we see from a comparison between Kant and those who came after him. The doctrine of the division of labour as put forward by eighteenth-century economists, was far from fully developed when Kant wrote. It had yet to be made precise by the Ricardian Theory of International Trade. But the Doctrine of the Harmony of Interests had already anticipated its far-reaching application to social theory. Kant was untouched by these ideas. His only explanation of society, therefore, is that there is an impulse in human beings to form a society, and a second contrary impulse that seeks to split up society. The antagonism of these two tendencies is used by Nature to lead men towards the ultimate goal to which it wishes to lead them.[Immanuel] Kant, “Idee zu einer allgemeinen Geschichte in weltbürgerlicher Absicht” (Collected Works), vol. 1, pp. 227 ff. It is difficult to imagine a more threadbare idea than such an attempt to explain society by the interplay of two impulses, the impulse “to socialize oneself” and the impulse “to isolate oneself.” Obviously it goes no farther than the attempt to explain the effects of opium from the virtus dormitiva, cuius est natura sensus assupire (the sleep-inducing property whose nature is to dull the senses).
Once it has been perceived that the division of labour is the essence of society, nothing remains of the antithesis between individual and society. The contradiction between individual principle and social principle disappears.
- The Development of the Division of LabourIn so far as the individual becomes a social being under the influence of blind instinct, before thought and will are fully conscious, the formation of society cannot be the subject of sociological inquiry. But this does not mean that Sociology must shift the task of explaining the origins of society on to another science, accepting the social web of mankind as a given fact. For if we decide — and this is the immediate consequence of equating society and division of labour — that the structure of society was incomplete at the appearance of the thinking and willing human being and that the constructive process is continuous throughout history, then we must seek a principle which makes this evolution intelligible to us. The economic theory of the division of labour gives us this principle. It has been said that the happy accident which made possible the birth of civilization was the fact that divided labour is more productive than labour without division. The division of labour extends by the spread of the realization that the more labour is divided the more productive it is. In this sense the extension of the division of labour is economic progress: it brings production nearer to its goal — the greatest possible satisfaction of wants, and this progress is sociological progress also, for it involves the intensification of the social relation.
It is only in this sense, and if all teleological or ethical valuation is excluded, that it is legitimate to use the expression “progress” sociologically in historical inquiry. We believe that we can observe a certain tendency in the changes of social conditions and we examine each single change separately, to see whether and how far this assumption is compatible with it. It may be that we make various assumptions of this kind, each of which corresponds in like measure to experience. The problem next arises of the relations between these assumptions, whether they are independent of each other or whether they are connected internally. We should then have to go further, and define the nature of the connection. But all that this amounts to is a study, free from valuation and based on a hypothesis, of the course of successive changes.
If we disregard those theories of evolution that are naively built up on value judgments, we shall find, in the majority of the theories claiming to interpret social evolution, two outstanding defects which render them unsatisfactory. The first is that their evolutionary principle is not connected with society as such. Neither Comte’s law of the three stages of the human mind nor Lamprecht’s five stages of social-psychical development gives any clue to the inner and necessary connection between evolution of the mind and evolution of society. We are shown how society behaves when it has entered a new stage, but we want to know more, namely by what law society originates and transforms itself. The changes which we see as social changes are treated by such theories as facts acting on society from outside; but we need to understand them as the workings of a constant law. The second defeat is that all these theories are “stage” theories (Stufentheorien). For the stage-theories there is really no such thing as evolution, that is, no continuous change in which we can recognize a definite trend. The statements of these theories do not go beyond establishing a definite sequence of events; they give no proof of the causal connection between the stages constituting the sequence. At best they succeed in establishing parallels between the sequence of events in different nations. But it is one thing to divide human life into childhood, youth, maturity, and old age, it is another to reveal the law which governs the growth and decay of the organism. A certain arbitrariness attaches to every theory of stages. The delimitation of the stages always fluctuates.
Modern German economic history has undoubtedly done right in making the division of labour the basis of its theory of evolution. But it has not been able to free itself from the old traditional scheme of development by stages. Its theory is still a stage-theory. Thus Bücher distinguishes the stage of the closed domestic economy (pure production for one’s own use, barterless economy), the stage of town economy (production for clients, the stage of direct exchange), and the stage of national economy (production for markets, the stage of the circulation of goods).[Karl] Bücher, Die Entstehung der Volkswirtschaft, First collection, 10th ed. (Tübingen, 1917), p. 91. Schmoller differentiates the periods of village economy, town economy, territorial economy, and state economy.[Gustav] Schmoller, Grundriss der allgemeinen Volkswirtschaftslehre (Munich, 1920), vol. 2, pp. 760 ff. Philippovich distinguishes closed domestic economy and trade economy, and within trade economy he finds the period of the locally limited trade, the period of trade controlled by the state and limited to the state area, and the period of free trade (developed national economy, Capitalism).[Eugen von] Philippovich, Grundriss der politischen Ökonomie, 11th ed. (Tübingen, 1916), vol. 1, pp. 11 ff. Against these attempts to force evolution into a general scheme many grave objections have been raised. We need not discuss what value such classification may have in revealing the characteristics of clearly defined historical epochs and how far they may be admitted as aids to description. At any rate they should be used with great discretion. The barren dispute over the economic life of the nations of antiquity shows how easily such classifying may lead to our mistaking the shadow of scholastic word-splitting for the substance of historical reality. For sociological study the stage theories are useless.On the stages theory see also my Grundprobleme der Nationalökonomie (Jena, 1933), pp. 106 ff. They mislead us in regard to one of the most important problems of history — that of deciding how far historical evolution is continuous. The solution of this problem usually takes the form either of an assumption, that social evolution — which it should be remembered is the development of the division of labour — has moved in an uninterrupted line, or by the assumption that each nation has progressed step-by-step over the same ground. Both assumptions are beside the point. It is absurd to say that evolution is uninterrupted when we can clearly discern periods of decay in history, periods when the division of labour has retrogressed. On the other hand, the progress achieved by individual nations by reaching a higher stage of the division of labour is never completely lost. It spreads to other nations and hastens their evolution. The fall of the ancient world undoubtedly put back economic evolution for centuries. But more recent historical research has shown that the ties connecting the economic civilization of antiquity with that of the Middle Ages were much stronger than people used to assume. The Exchange Economy certainly suffered badly under the storm of the great migration of peoples, but it survived them. The towns on which it depended, were not entirely ruined, and a link was soon made between the remnants of town-life and the new development of traffic by barter.[Alphons] Dopsch, Wirtschaftliche und soziale Grundlagen der europäischen Kulturentwicklung (Vienna, 1918), vol. 1, pp. 91 ff. In the civilization of the towns a fragment of the social achievements of antiquity was preserved and carried over into the life of the Middle Ages.
Progress in the division of labour depends entirely on a realization of its advantages, that is, of its higher productivity. The truth of this first became fully evident through the free-trade doctrines of the physiocrats and the classical eighteenth-century political economy. But in rudiments it is found in all arguments favouring peace, wherever peace is praised, or war condemned. History is a struggle between two principles, the peaceful principle, which advances the development of trade, and the militarist-imperialist principle, which interprets human society not as a friendly division of labour but as the forcible repression of some of its members by others. The imperialistic principle continually regains the upper hand. The liberal principle cannot maintain itself against it until the inclination for peaceful labour inherent in the masses shall have struggled through to full recognition of its own importance as a principle of social evolution. Wherever the imperialistic principle is in force peace can only be local and temporary: it never lasts longer than the facts which created it. The mental atmosphere with which Imperialism surrounds itself is little suited to the promotion of the growth of the division of labour within state frontiers; it practically prohibits the extension of the division of labour beyond the political-military barriers which separate the states. The division of labour needs liberty and peace. Only when the modern liberal thought of the eighteenth century had supplied a philosophy of peace and social collaboration was the basis laid for the astonishing development of the economic civilization of that age — an age branded by the latest imperialistic and socialistic doctrines as the age of crass materialism, egotism and capitalism.
Nothing could be more perverted than the conclusions drawn in this connection by the materialistic conception of history, which represents the development of social ideology as dependent on the stage of technical evolution which has been attained. Nothing is more erroneous than Marx’s well-known saying: “The handmill produces a society with feudal lords, the steam-mill a society with industrial capitalists.”[Karl] Marx, Das Elend der Philosophie, p. 92. In the formulations which Marx later on gave to his conception of history he avoided the rigidity of this earliest version. Behind such indefinite expressions as “productive forces” and “conditions of production” are hidden the critical doubts which Marx may meanwhile have experienced. But obscurity, opening the way to multitudinous interpretations, does not make an untenable theory tenable. It is not even formally correct. To try and explain social evolution through the evolution of technique is merely to side-track the problem without in any way solving it. For on such a conception, how are we to explain technical evolution itself?
Ferguson showed that the development of technique depends on social conditions, and that each age gets as far in technique as is permitted by the stages it has reached in the social division of labour.[Adam] Ferguson, Abhandlung über die Geschichte der bürgerlichen Gesellschaft, trans. Dorn (Jena, 1904), pp. 237 ff.; also [Paul] Barth, Die Philosophie der Geschichte als Soziologie, 2nd ed. (Leipzig, 1915), Part 1, pp. 578 ff. Technical advances are possible only where the division of labour has prepared the way for their application. The mass manufacturing of shoes presupposes a society in which the production of shoes for hundreds of thousands or millions of human beings can be united in a few enterprises. In a society of self-sufficing peasants there is no possible use for the steam mill. Only the division of labour could inspire the idea of placing mechanical forces at the service of manufacture.All that remains of the materialist conception of history, which appeared with the widest possible claims, is the discovery that all human and social action is decisively influenced by the scarcity of goods and the disutility of labour. But the Marxists can least admit just this, for all they say about the future socialist order of society disregards these two economic conditions.
To trace the origin of everything concerned with society in the development of the division of labour has nothing in common with the gross and naive materialism of the technological and other materialistic theories of history. Nor does it by any means signify, as disciples of the idealistic philosophy are apt to maintain, an inadmissible limitation of the concept of social relations. Neither does it restrict society to the specifically material. That part of social life which lies beyond the economic is indeed the ultimate aim, but the ways which lead to it are governed by the law of all rational action; wherever they come into question there is economic action.
- Changes in the Individual in SocietyThe most important effect of the division of labour is that it turns the independent individual into a dependent social being. Under the division of labour social man changes, like the cell which adapts itself to be part of an organism. He adapts himself to new ways of life, permits some energies and organs to atrophy and develops others. He becomes one-sided. The whole tribe of romantics, the unbending laudatores temporis acti (praisers of time past), have deplored this fact. For them the man of the past who developed his powers “harmoniously” is the ideal: an ideal which alas no longer inspires our degenerate age. They recommend retrogression in the division of labour, hence their praise of agricultural labour, by which they always mean the almost self-sufficing peasant.Adam Müller says about “the vicious tendency to divide labour in all branches of private industry and in government business too,” that man needs “an all round, I might say a sphere-round field of activity.” If the “division of labour in large cities or industrial or mining provinces cuts up man, the completely free man, into wheels, rollers, spokes, shafts, etc., forces on him an utterly one-sided scope in the already one-sided field of the provisioning of one single want, how can one then demand that this fragment should accord with the whole complete life and with its law, or with legality; how should the rhombuses, triangles, and figures of all kinds accord separately with the great sphere of political life and its law?” See Adam Müller, Ausgewählte Abhandlungen, ed. Baxa (Jena, 1921), p. 46.
Here, again the modern socialist outdoes the rest. Marx promises that in the higher phase of the communist society “the enslaving subjection of individuals under the division of labour, and with this also the contrast between mental and bodily labour, shall have disappeared.”[Karl] Marx, Zur Kritik des sozialdemokratischen Parteiprogramms von Gotha (New York, 1920), p. 17. Innumerable passages in his writings show how falsely Marx conceived the nature of labour in industry. Thus he thought also that “the division of labour in the mechanical factory” is characterized by “having lost every specialized character. ... The automatic factory abolishes the specialist and the one-track mind.” And he blames Proudhon, “who did not understand even this one revolutionary side of the automatic factory.” Marx, Das Elend der Philosophie, p. 129. Account will be taken of the human “need for change.” “Alternation of mental and bodily labour” will “safeguard man’s harmonious development.”[August] Bebel, Die Frau und der Sozialismus, pp. 283 ff.
We have already dealt with this illusion. Were it possible to achieve all human aims with only that amount of labour which does not itself cause any discomfort but at the same time relieves the sensation of displeasure that arises from doing nothing, then labour would not be an economic object at all. To satisfy needs would not be work but play. This, however, is not possible. Even the self-sufficient worker, for the most part, must labour far beyond the point where the effort is agreeable. One may assume that work is less unpleasant to him than to the worker who is tied to a definite task, as he finds at the beginning of each job he tackles fresh sensations of pleasure in the activity itself. If, nevertheless, man has given himself up more and more to the division of labour, it is because he has recognized that the higher productivity of labour thus specialized more than repays him for the loss of pleasure. The extent of the division of labour cannot be curtailed without reducing the productivity of labour. This is true of all kinds of labour. It is an illusion to believe that one can maintain productivity and reduce the division of labour.
Abolition of the division of labour would be no remedy for the injuries inflicted on the individual, body and soul, by specialized labour, unless we are prepared to set back social development. It is for the individual himself to set about becoming a complete human being. The remedy lies in reforming consumption, not in “reforming” labour. Play and sport, the pleasure of art, reading are the obvious way of escape.
It is futile to look for the harmoniously developed man at the outset of economic evolution. The almost self-sufficient economic subject as we know him in the solitary peasant of remote valleys shows none of that noble, harmonious development of body, mind, and feeling which the romantics ascribe to him. Civilization is a product of leisure and the peace of mind that only the division of labour can make possible. Nothing is more false than to assume that man first appeared in history with an independent individuality and that only during the evolution which led to the Great Society did he lose, together with material freedom, his spiritual independence. All history, evidence and observation of the lives of primitive peoples is directly contrary to this view. Primitive man lacks all individuality in our sense. Two South Sea Islanders resemble each other far more closely than two twentieth-century Londoners. Personality was not bestowed upon man at the outset. It has been acquired in the course of evolution of society.Durkheim, De la division du travail social, pp. 452 ff.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 4: “A First Analysis of the Category of Analysis,” pp. 92–98.]1. Ends and MeansThe result sought by an action is called its end, goal, or aim. One uses these terms in ordinary speech also to signify intermediate ends, goals, or aims; these are points which acting man wants to attain only because he believes that he will reach his ultimate end, goal, or aim in passing beyond them. Strictly speaking the end, goal, or aim of any action is always the relief from a felt uneasiness.
A means is what serves to the attainment of any end, goal, or aim. Means are not in the given universe; in this universe there exist only things. A thing becomes a means when human reason plans to employ it for the attainment of some end and human action really employs it for this purpose. Thinking man sees the serviceableness of things, i.e., their ability to minister to his ends, and acting man makes them means. It is of primary importance to realize that parts of the external world become means only through the operation of the human mind and its offshoot, human action. External objects are as such only phenomena of the physical universe and the subject matter of the natural sciences. It is human meaning and action which transform them into means. Praxeology does not deal with the external world, but with man’s conduct with regard to it. Praxeological reality is not the physical universe, but man’s conscious reaction to the given state of this universe. Economics is not about things and tangible material objects; it is about men, their meanings and actions. Goods, commodities, and wealth and all the other notions of conduct are not elements of nature; they are elements of human meaning and conduct. He who wants to deal with them must not look at the external world; he must search for them in the meaning of acting men.
Praxeology and economics do not deal with human meaning and action as they should be or would be if all men were inspired by an absolutely valid philosophy and equipped with a perfect knowledge of technology. For such notions as absolute validity and omniscience there is no room in the frame of a science whose subject matter is erring man. An end is everything which men aim at. A means is everything which acting men consider as such.
It is the task of scientific technology and therapeutics to explode errors in their respective fields. It is the task of economics to expose erroneous doctrines in the field of social action. But if men do not follow the advice of science, but cling to their fallacious prejudices, these errors are reality and must be dealt with as such. Economists consider foreign exchange control as inappropriate to attain the ends aimed at by those who take recourse to it. However, if public opinion does not abandon its delusions and governments consequently resort to foreign exchange control, the course of events is determined by this attitude. Present-day medicine considers the doctrine of the therapeutic effects of mandrake as a fable. But as long as people took this fable as truth, mandrake was an economic good and prices were paid for its acquisition. In dealing with prices economics does not ask what things are in the eyes of other people, but only what they are in the meaning of those intent upon getting them. For it deals with real prices, paid and received in real transactions, not with prices as they would be if men were different from what they really are.
Means are necessarily always limited, i.e., scarce with regard to the services for which man wants to use them. If this were not the case, there would not be any action with regard to them. Where man is not restrained by the insufficient quantity of things available, there is no need for any action.
It is customary to call the end the ultimate good and the means goods. In applying this terminology economists mainly used to think as technologists and not as praxeologists. They differentiated between free goods and economic goods. They called free goods things available in superfluous abundance which man does not need to be economize. Such goods are, however, not the object of any action. They are general conditions of human welfare; they are parts of the natural environment in which man lives and acts. Only the economic goods are the substratum of action. They alone are dealt with in economics.
Economic goods which in themselves are fitted to satisfy human wants directly and whose serviceableness does not depend on the cooperation of other economic goods, are called consumers’ goods or goods of the first order. Means which can satisfy wants only indirectly when complemented by cooperation of other goods are called producers’ goods or factors of production or goods of a remoter or higher order. The services rendered by a producers’ good consist in bringing about, by the cooperation of complementary producers’ goods, a product. This product may be a consumers’ good; it may be a producers’ good which when combined with other producers’ goods will finally bring about a consumers’ good. It is possible to think of the producers’ goods as arranged in orders according to their proximity to the consumers’ good for whose production they can be used. Those producers’ goods which are nearest to the production of a consumers’ good are ranged in the second order, and accordingly those which are used for the production of goods of the second order in the third order and so on.
The purpose of such an arrangement of goods in orders is to provide a basis for the theory of value and prices of the factors of production. It will be shown later how the valuation and the prices of the goods of higher orders are dependent on the valuation and the prices of the goods of lower orders produced by their expenditure. The first and ultimate valuation of external things refers only to consumers’ goods. All other things are valued according to the part they play in the production of consumers’ goods.
It is therefore not necessary actually to arrange producers’ goods in various orders from the second to the nth. It is no less superfluous to enter into pedantic discussions of whether a concrete good has to be called a good of the lowest order or should rather be attributed to one of the higher orders. Whether raw coffee beans or roast coffee beans or ground coffee or coffee prepared for drinking or only coffee prepared and mixed with cream and sugar are to be called a consumers’ good ready for consumption is of no importance. It is immaterial which manner of speech we adopt. For with regard to the problem of valuation, all that we say about a consumers’ good can be applied to any good of a higher order (except those of the highest order) if we consider it as a product.
An economic good does not necessarily have to be embodied in a tangible thing. Nonmaterial economic goods are called services.
- The Scale of ValueActing man chooses between various opportunities offered for choice. He prefers one alternative to others.
It is customary to say that acting man has a scale of wants or values in his mind when he arranges his actions. On the basis of such a scale he satisfies what is of higher value, i.e., his more urgent wants, and leaves unsatisfied what is of lower value, i.e., what is a less urgent want. There is no objection to such a presentation of the state of affairs. However, one must not forget that the scale of values or wants manifests itself only in the reality of action. These scales have no independent existence apart from the actual behavior of individuals. The only source from which our knowledge concerning these scales is derived is the observation of a man’s actions. Every action is always in perfect agreement with the scale of values or wants because these scales are nothing but an instrument for the interpretation of a man’s acting.
Ethical doctrines are intent upon establishing scales of value according to which man should act but does not necessarily always act. They claim for themselves the vocation of telling right from wrong and of advising man concerning what he should aim at as the supreme good. They are normative disciplines aiming at the cognition of what ought to be. They are not neutral with regard to facts; they judge them from the point of view of freely adopted standards.
This is not the attitude of praxeology and economics. They are fully aware of the fact that the ultimate ends of human action are not open to examination from any absolute standard. Ultimate ends are ultimately given, they are purely subjective, they differ with various people and with the same people at various moments in their lives. Praxeology and economics deal with the means for the attainment of ends chosen by the acting individuals. They do not express any opinion with regard to such problems as whether or not sybaritism is better than asceticism. They apply to the means only one yardstick, viz., whether or not they are suitable to attain the ends at which the acting individuals aim.
The notions of abnormality and perversity therefore have no place in economics. It does not say that a man is perverse because he prefers the disagreeable, the detrimental, and the painful to the agreeable, the beneficial, and the pleasant. It says only that he is different from other people; that he likes what others detest; that he considers useful what others want to avoid; that he takes pleasure in enduring pain which others avoid because it hurts them. The polar notions normal and perverse can be used anthropologically for the distinction between those who behave as most people do and outsiders and atypical exceptions; they can be applied biologically for the distinction between those whose behavior preserves the vital forces and those whose behavior is self-destructive; they can be applied in an ethical sense for the distinction between those who behave correctly and those who act otherwise than they should. However, in the frame of a theoretical science of human action, there is no room for such a distinction. Any examination of ultimate ends turns out to be purely subjective and therefore arbitrary.
Value is the importance that acting man attaches to ultimate ends. Only to ultimate ends is primary and original value assigned. Means are valued derivatively according to their serviceableness in contributing to the attainment of ultimate ends. Their valuation is derived from the valuation of the respective ends. They are important for man only as far as they make it possible for him to attain some ends.
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.
Neither is value in words and in doctrines. It is reflected in human conduct. It is not what a man or groups of men say about value that counts, but how they act. The bombastic oratory of moralists and the inflated pompousness of party programs are significant as such. But they influence the course of human events only as far as they really determine the actions of men.
- The Scale of NeedsNotwithstanding all declarations to the contrary, the immense majority of men aim first of all at an improvement of the material conditions of well-being. They want more and better food, better homes and clothes, and a thousand other amenities. They strive after abundance and health. Taking these goals as given, applied physiology tries to determine what means are best suited to provide as much satisfaction as possible. It distinguishes, from this point of view, between man’s “real” needs and imaginary and spurious appetites. It teaches people how they should act and what they should aim at as a means.
The importance of such doctrines is obvious. From his point of view the physiologist is right in distinguishing between sensible action and action contrary to purpose. He is right in contrasting judicious methods of nourishment from unwise methods. He may condemn certain modes of behavior as absurd and opposed to “real” needs. However, such judgments are beside the point for a science dealing with the reality of human action. Not what a man should do, but what he does, counts for praxeology and economics. Hygiene may be right or wrong in calling alcohol and nicotine poisons. But economics must explain the prices of tobacco and liquor as they are, not as they would be under different conditions.
There is no room left in the field of economics for a scale of needs different from the scale of values as reflected in man’s actual behavior. Economics deals with real man, weak and subject to error as he is, not with ideal beings, omniscient and perfect as only gods could be.
Theory and History[Ludwig von Mises, Theory and History (1957; Auburn, Ala.: Mises Institute, 1985), chap. 1: “Judgments of Value,” pp. 19–25.]
- Judgments of Value and Propositions of ExistencePropositions asserting existence (affirmative existential propositions) or nonexistence (negative existential propositions) are descriptive. They assert something about the state of the whole universe or of parts of the universe. With regard to them questions of truth and falsity are significant. They must not be confounded with judgments of value.
Judgments of value are voluntaristic. They express feelings, tastes, or preferences of the individual who utters them. With regard to them there cannot be any question of truth and falsity. They are ultimate and not subject to any proof or evidence.
Judgments of value are mental acts of the individual concerned. As such they must be sharply distinguished from the sentences by means of which an individual tries to inform other people about the content of his judgments of value. A man may have some reason to lie about his valuations. We may describe this state of affairs in the following way: Every judgment of value is in itself also a fact of the actual state of the universe and as such may be the topic of existential propositions. The sentence “I prefer Beethoven to Lehar” refers to a judgment of value. If looked upon as an existential proposition, it is true if I really prefer Beethoven and act accordingly and false if I in fact prefer Lehar and for some reasons lie about my real feelings, taste, or preferences. In an analogous way the existential proposition “Paul prefers Beethoven to Lehar” may be true or false. In declaring that with regard to a judgment of value there cannot be any question of truth or falsity, we refer to the judgment as such and not to the sentences communicating the content of such a judgment of value to other people.
- Valuation and ActionA judgment of value is purely academic if it does not impel the man who utters it to any action. There are judgments which must remain academic because it is beyond the power of the individual to embark upon any action directed by them. A man may prefer a starry sky to the starless sky, but he cannot attempt to substitute the former state which he likes better for the latter he likes less.
The significance of value judgments consists precisely in the fact that they are the springs of human action. Guided by his valuations, man is intent upon substituting conditions that please him better for conditions which he deems less satisfactory. He employs means in order to attain ends sought.
Hence the history of human affairs has to deal with the judgments of value that impelled men to act and directed their conduct. What happened in history cannot be discovered and narrated without referring to the various valuations of the acting individuals. It is not the task of the historian qua historian to pass judgments of value on the individuals whose conduct is the theme of his inquiries. As a branch of knowledge history utters existential propositions only. But these existential propositions often refer to the presence or absence of definite judgments of value in the minds of the acting individuals. It is one of the tasks of the specific understanding of the historical sciences to establish what content the value judgments of the acting individuals had.
It is a task of history, for example, to trace back the origin of India’s caste system to the values which prompted the conduct of the generations who developed, perfected, and preserved it. It is its further task to discover what the consequences of this system were and how these effects influenced the value judgments of later generations. But it is not the business of the historian to pass judgments of value on the system as such, to praise or to condemn it. He has to deal with its relevance for the course of affairs, he has to compare it with the designs and intentions of its authors and supporters and to depict its effects and consequences. He has to ask whether or not the means employed were fit to attain the ends the acting individuals sought.
It is a fact that hardly any historian has fully avoided passing judgments of value. But such judgments are always merely incidental to the genuine tasks of history. In uttering them the author speaks as an individual judging from the point of view of his personal valuations, not as a historian.
- The Subjectivity of ValuationAll judgments of value are personal and subjective. There are no judgments of value other than those asserting I prefer, I like better, I wish.
It cannot be denied by anybody that various individuals disagree widely with regard to their feelings, tastes, and preferences and that even the same individuals at various instants of their lives value the same things in a different way. In view of this fact it is useless to talk about absolute and eternal values.
This does not mean that every individual draws his valuations from his own mind. The immense majority of people take their valuations from the social environment into which they were born, in which they grew up, that moulded their personality and educated them. Few men have the power to deviate from the traditional set of values and to establish their own scale of what appears to be better and what appears to be worse.
What the theorem of the subjectivity of valuation means is that there is no standard available which would enable us to reject any ultimate judgment of value as wrong, false, or erroneous in the way we can reject an existential proposition as manifestly false. It is vain to argue about ultimate judgments of value as we argue about the truth or falsity of an existential proposition. As soon as we start to refute by arguments an ultimate judgment of value, we look upon it as a means to attain definite ends. But then we merely shift the discussion to another plane. We no longer view the principle concerned as an ultimate value but as a means to attain an ultimate value, and we are again faced with the same problem. We may, for instance, try to show a Buddhist that to act in conformity with the teachings of his creed results in effects which we consider disastrous. But we are silenced if he replies that these effects are in his opinion lesser evils or no evils at all compared to what would result from nonobservance of his rules of conduct. His ideas about the supreme good, happiness, and eternal bliss are different from ours. He does not care for those values his critics are concerned with, and seeks for satisfaction in other things than they do.
- The Logical and Syntactical Structure of Judgments of ValueA judgment of value looks upon things from the point of view of the man who utters it. It does not assert anything about things as they are. It manifests a man’s affective response to definite conditions of the universe as compared with other definite conditions.
Value is not intrinsic. It is not in things and conditions but in the valuing subject. It is impossible to ascribe value to one thing or state of affairs only. Valuation invariably compares one thing or condition with another thing or condition. It grades various states of the external world. It contrasts one thing or state, whether real or imagined, with another thing or state, whether real or imagined, and arranges both in a scale of what the author of the judgment likes better and what less.
It may happen that the judging individual considers both things or conditions envisaged as equal. He is not concerned whether there is A or B. Then his judgment of value expresses indifference. No action can result from such a neutral disposition.
Sometimes the utterance of a judgment of value is elliptical and makes sense only if appropriately completed by the hearer. “I don’t like measles” means “I prefer the absence of measles to its presence.” Such incompleteness is the mark of all references to freedom. Freedom invariably means freedom from (absence of) something referred to expressly or implicitly. The grammatical form of such judgments may be qualified as negative. But it is vain to deduce from this idiomatic attire of a class of judgments of value any statements about their content and to blame them for an alleged negativism. Every judgment of value allows of a formulation in which the more highly valued thing or state is logically expressed in both a positive and a negative way, although sometimes a language may not have developed the appropriate term. Freedom of the press implies the rejection or negation of censorship. But, stated explicitly, it means a state of affairs in which the author alone determines the content of his publication as distinct from a state in which the police has a right to interfere in the matter.
Action necessarily involves the renunciation of something to which a lower value is assigned in order to attain or to preserve something to which a higher value is assigned. Thus, for instance, a definite amount of leisure is renounced in order to reap the product of a definite amount of labor. The renunciation of leisure is the means to attain a more highly valued thing or state.
There are men whose nerves are so sensitive that they cannot endure an unvarnished account of many facts about the physiological nature of the human body and the praxeological character of human action. Such people take offense at the statement that man must choose between the most sublime things, the loftiest human ideals, on the one hand, and the wants of his body on the other. They feel that such statements detract from the nobility of the higher things. They refuse to notice the fact that there arise in the life of man situations in which he is forced to choose between fidelity to lofty ideals and such animal urges as feeding.
Whenever man is faced with the necessity of choosing between two things or states, his decision is a judgment of value no matter whether or not it is uttered in the grammatical form commonly employed in expressing such judgments.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 5: “Time,” pp. 99–104.]1. The Temporal Character of PraxeologyThe notion of change implies the notion of temporal sequence. A rigid, eternally immutable universe would be out of time, but it would be dead. The concepts of change and of time are inseparably linked together. Action aims at change and is therefore in the temporal order. Human reason is even incapable of conceiving the ideas of timeless existence and of timeless action.
He who acts distinguishes between the time before the action, the time absorbed by the action, and the time after the action has been finished. He cannot be neutral with regard to the lapse of time.
Logic and mathematics deal with an ideal system of thought. The relations and implications of their system are coexistent and interdependent. We may say as well that they are synchronous or that they are out of time. A perfect mind could grasp them all in one thought. Man’s inability to accomplish this makes thinking itself an action, proceeding step by step from the less satisfactory state of insufficient cognition to the more satisfactory state of better insight. But the temporal order in which knowledge is acquired must not be confused with the logical simultaneity of all parts of this aprioristic deductive system. Within this system the notions of anteriority and consequence are metaphorical only. They do not refer to the system, but to our action in grasping it. The system itself implies neither the category of time nor that of causality. There is functional correspondence between elements, but there is neither cause nor effect.
What distinguishes epistemologically the praxeological system from the logical system epistemologically is precisely that it implies the categories both of time and of causality. The praxeological system too is aprioristic and deductive. As a system it is out of time. But change is one of its elements. The notions of sooner and later and of cause and effect are among its constituents. Anteriority and consequence are essential concepts of praxeological reasoning. So is the irreversibility of events. In the frame of the praxeological system any reference to functional correspondence is no less metaphorical and misleading than is the reference to anteriority and consequence in the frame of the logical system.In a treatise on economics there is no need to enter into a discussion of the endeavors to construct mechanics as an axiomatic system in which the concept of function is substituted for that of cause and effect. It will be shown later that axiomatic mechanics cannot serve as a model for the treatment of the economic system.
- Past, Present, and FutureIt is acting that provides man with the notion of time and makes him aware of the flux of time. The idea of time is a praxeological category.Action is always directed toward the future; it is essentially and necessarily always a planning and acting for a better future. Its aim is always to render future conditions more satisfactory than they would be without the interference of action. The uneasiness that impels a man to act is caused by a dissatisfaction with expected future conditions as they would probably develop if nothing were done to alter them. In any case action can influence only the future, never the present that with every infinitesimal fraction of a second sinks down into the past. Man becomes conscious of time when he plans to convert a less satisfactory present state into a more satisfactory future state.
For contemplative meditation time is merely duration, “la durée pure, dont l’écoulement est continu, et où l’on passe, par gradations insensibles, d’un état à l’autre: Continuité réellement vécue.”Henri Bergson, Matière et mémoire (7th ed. Paris, 1911), p. 205. The “now” of the present is continually shifted to the past and is retained in the memory only. Reflecting about the past, say the philosophers, man becomes aware of time.Edmund Husserl, “Vorlesungen zur Phänomenologie des inneren Zeitbewusstseins,” Jahrbuch für Philosophie und Phänomenologische Forschung (1928), vol. 9, pp. 391ff.; Alfred Schütz, Der sinnhafte Aufbau der sozialen Welt (Vienna, 1932), pp. 45 ff. However, it is not recollection that conveys to man the categories of change and of time, but the will to improve the conditions of his life.
Time as we measure it by various mechanical devices is always past, and time as the philosophers use this concept is always either past or future. The present is, from these aspects, nothing but an ideal boundary line separating the past from the future. But from the praxeological aspect there is between the past and the future a real extended present. Action is as such in the real present because it utilizes the instant and thus embodies its reality.“Ce que j’appelle mon présent, c’est mon attitude vis-à-vis de l’avenir immédiat, c’est nom action imminente.” Bergson, Matière et mémoire, p. 152. Later retrospective reflection discerns in the instant passed away first of all the action and the conditions which it offered to action. That which can no longer be done or consumed because the opportunity for it has passed away, contrasts the past with the present. That which cannot yet be done or consumed, because the conditions for undertaking it or the time for its ripening have not yet come, contrasts the future with the past. The present offers to acting opportunities and tasks for which it was hitherto too early and for which it will be hereafter too late.
The present qua duration is the continuation of the conditions and opportunities given for acting. Every kind of action requires special conditions to which it must be adjusted with regard to the aims sought. The concept of the present is therefore different for various fields of action. It has no reference whatever to the various methods of measuring the passing of time by spatial movements. The present encloses as much of the time passed away as still is actual, i.e., of importance for acting. The present contrasts itself, according to the various actions one has in view, with the Middle Ages, with the nineteenth century, with the past year, month, or day, but no less with the hour, minute, or second just passed away. If a man says: Nowadays Zeus is no longer worshiped, he has a present in mind other than that the motorcar driver who thinks: Now it is still too early to turn.
As the future is uncertain it always remains undecided and vague how much of it we can consider as now and present. If a man had said in 1913: At present — now — in Europe freedom of thought is undisputed, he would have not foreseen that this present would very soon be a past.
- The Economization of TimeMan is subject to the passing of time. He comes into existence, grows, becomes old, and passes away. His time is scarce. He must economize it as he does other scarce factors.
The economization of time has a peculiar character because of the uniqueness and irreversibility of the temporal order. The importance of these facts manifests itself in every part of the theory of action.
Only one fact must be stressed at this point. The economization of time is independent of the economization of economic goods and services. Even in the land of Cockaigne man would be forced to economize time, provided he were not immortal and not endowed with eternal youth and indestructible health and vigor. Although all his appetites could be satisfied immediately without any expenditure of labor, he would have to arrange his time schedule, as there are states of satisfaction which are incompatible and cannot be consummated at the same time. For this man, too, time would be scarce and subject to the aspect of sooner and later.
- The Temporal Relation Between ActionsTwo actions of an individual are never synchronous; their temporal relation is that of sooner and later. Actions of various individuals can be considered as synchronous only in the light of the physical methods for the measurement of time. Synchronism is a praxeological notion only with regard to the concerted efforts of various acting men.In order to avoid any possible misunderstanding it may well be expedient to emphasize that this theorem has nothing at all to do with Einstein’s theorem concerning the temporal relation of spatially distant events.
A man’s individual actions succeed one another. They can never be effected at the same instant; they can only follow one another in more or less rapid succession. There are actions which serve several purposes at one blow. It would be misleading to refer to them as a coincidence of various actions.
People have often failed to recognize the meaning of the term “scale of value” and have disregarded the obstacles preventing the assumption of synchronism in the various actions of an individual. They have interpreted a man’s various acts as the outcome of a scale of value, independent of these acts and preceding them, and of a previously devised plan whose realization they aim at. The scale of value and the plan to which duration and immutability for a certain period of time were attributed, were hypostasized into the cause and motive of the various individual actions. Synchronism which could not be asserted with regard to various acts was then easily discovered in the scale of value and in the plan. But this overlooks the fact that the scale of value is nothing but a constructed tool of thought. The scale of value manifests itself only in real acting; it can be discerned only from the observation of real acting. It is therefore impermissible to contrast it with real acting and to use it as a yardstick for the appraisal of real actions.
It is no less impermissible to differentiate between rational and allegedly irrational acting on the basis of a comparison of real acting with earlier drafts and plans for future actions. It may be very interesting that yesterday goals were set for today’s acting other than those really aimed at today. But yesterday’s plans do not provide us with any more objective and nonarbitrary standard for the appraisal of today’s real acting than any other ideas and norms.
The attempt has been made to attain the notion of a nonrational action by this reasoning: If a is preferred to b and b to c, logically a should be preferred to c. But if actually c is preferred to a, we are faced with a mode of acting to which we cannot ascribe consistency and rationality.Cf. Felix Kaufmann, “On the Subject-Matter of Economic Science,” Economica 13: 390. This reasoning disregards the fact that two acts of an individual can never be synchronous. If in one action a is preferred to b and in another action b to c, it is, however short the interval between the two actions may be, not permissible to construct a uniform scale of value in which a precedes b and b precedes c. Nor is it permissible to consider a later third action as coincident with the two previous actions. All that the example proves is that value judgments are not immutable and that therefore a scale of value, which is abstracted from various, necessarily nonsynchronous actions of an individual, may be self-contradictory.Cf. [Philip H.] Wicksteed, The Common Sense of Political Economy, ed. Robbins (London, 1933), vol. 1, pp. 32 ff.; [Lionel] Robbins, An Essay on the Nature and Significance of Economic Science, 2d ed. (London, 1935), pp. 91 ff.
One must not confuse the logical concept of consistency (viz., absence of contradiction) and the praxeological concept of consistency (viz., constancy or clinging to the same principles). Logical consistency has its place only in thinking, constancy has its place only in acting.
Constancy and rationality are entirely different notions. If one’s valuations have changed, unremitting faithfulness to the once espoused principles of action merely for the sake of constancy would not be rational but simply stubborn. Only in one respect can acting be constant: in preferring the more valuable to the less valuable. If the valuations change, acting must change also. Faithfulness, under changed conditions, to an old plan would be nonsensical. A logical system must be consistent and free of contradictions because it implies the coexistence of all its parts and theorems. In acting, which is necessarily in the temporal order, there cannot be any question of such consistency. Acting must be suited to purpose, and purposefulness requires adjustment to changing conditions.
Presence of mind is considered a virtue in acting man. A man has presence of mind if he has the ability to think and to adjust his acting so quickly that the interval between the emergence of new conditions and the adaptation of his actions to them becomes as short as possible. If constancy is viewed as faithfulness to a plan once designed without regard to changes in conditions, then presence of mind and quick reaction are the very opposite of constancy.
When the speculator goes to the stock exchange, he may sketch a definite plan for his operations. Whether or not he clings to this plan, his actions are rational also in the sense which those eager to distinguish rational acting from irrational attribute to the term “rational.” This speculator in the course of the day may embark upon transactions which an observer, not taking into account the changes occurring in market conditions, will not be able to interpret as the outcome of constant behavior. But the speculator is firm in his intention to make profits and to avoid losses. Accordingly he must adjust his conduct to the change in market conditions and in his own judgment concerning the future development of prices.Plans too, of course, may be self-contradictory. Sometimes their contradictions may be the effect of mistaken judgment. But sometimes such contradictions may be intentional and serve a definite purpose. If, for instance, a publicized program of a government or a political party promises high prices to the producers and at the same time low prices to the consumers, the purpose of such an espousal of incompatible goals may be demagogic. Then the program, the publicized plan, is self-contradictory; but the plan of its authors who wanted to attain a definite end through the endorsement of incompatible aims and their public announcement is free of any contradiction.
However one twists things, one will never succeed in formulating the notion of “irrational” action whose “irrationality” is not founded upon an arbitrary judgment of value. Let us suppose that somebody has chosen to act inconstantly for no other purpose than for the sake of refuting the praxeological assertion that there is no irrational action. What happens here is that a man aims at a peculiar goal, viz., the refutation of a praxeological theorem, and that he accordingly acts differently from what he would have done otherwise. He has chosen an unsuitable means for the refutation of praxeology, that is all. ...
- Uncertainty and Acting[Mises, Human Action, chap. 6: “Uncertainty,” pp. 105–15.]The uncertainty of the future is already implied in the very notion of action. That man acts and that the future is uncertain are by no means two independent matters. They are only two different modes of establishing one thing.
We may assume that the outcome of all events and changes is uniquely determined by eternal unchangeable laws governing becoming and development in the whole universe. We may consider the necessary connection and interdependence of all phenomena, i.e., their causal concatenation, as the fundamental and ultimate fact. We may entirely discard the notion of undetermined chance. But however that may be, or appear to the mind of a perfect intelligence, the fact remains that to acting man the future is hidden. If man knew the future, he would not have to choose and would not act. He would be like an automaton, reacting to stimuli without any will of his own.
Some philosophers are prepared to explode the notion of man’s will as an illusion and self-deception because man must unwittingly behave according to the inevitable laws of causality. They may be right or wrong from the point of view of the prime mover or the cause of itself. However, from the human point of view action is the ultimate thing. We do not assert that man is “free” in choosing and acting. We merely establish the fact that he chooses and acts and that we are at a loss to use the methods of the natural sciences for answering the question why he acts this way and not otherwise.
Natural science does not render the future predictable. It makes it possible to foretell the results to be obtained by definite actions. But it leaves impredictable two spheres: that of insufficiently known natural phenomena and that of human acts of choice. Our ignorance with regard to these two spheres taints all human actions with uncertainty. Apodictic certainty is only within the orbit of the deductive system of aprioristic theory. The most that can be attained with regard to reality is probability.
It is not the task of praxeology to investigate whether or not it is permissible to consider as certain some of the theorems of the empirical natural sciences. This problem is without practical importance for praxeological considerations. At any rate, the theorems of physics and chemistry have such a high degree of probability that we are entitled to call them certain for all practical purposes. We can practically forecast the working of a machine constructed according to the rules of scientific technology. But the construction of a machine is only a part in a broader program that aims at supplying the consumers with the machine’s products. Whether this was or was not the most appropriate plan depends on the development of future conditions which at the time of the plan’s execution cannot be forecast with certainty. Thus the degree of certainty with regard to the technological outcome of the machine’s construction, whatever it may be, does not remove the uncertainty inherent in the whole action. Future needs and valuations, the reaction of men to changes in conditions, future scientific and technological knowledge, future ideologies and policies can never be foretold with more than a greater or smaller degree of probability. Every action refers to an unknown future. It is in this sense always a risky speculation.
The problems of truth and certainty concern the general theory of human knowledge. The problem of probability, on the other hand, is a primary concern of praxeology.
- The Meaning of ProbabilityThe treatment of probability has been confused by the mathematicians. From the beginning there was an ambiguity in dealing with the calculus of probability. When the Chevalier de Méré consulted Pascal on the problems involved in the games of dice, the great mathematician should have frankly told his friend the truth, namely, that mathematics cannot be of any use to the gambler in a game of pure chance. Instead he wrapped his answer in the symbolic language of mathematics. What could easily be explained in a few sentences of mundane speech was expressed in a terminology which is unfamiliar to the immense majority and therefore regarded with reverential awe. People suspected that the puzzling formulas contain some important revelations, hidden to the uninitiated; they got the impression that a scientific method of gambling exists and that the esoteric teachings of mathematics provide a key for winning. The heavenly mystic Pascal unintentionally became the patron saint of gambling. The textbooks of the calculus of probability gratuitously propagandize for the gambling casinos precisely because they are sealed books to the layman.
No less havoc was spread by the equivocations of the calculus of probability in the field of scientific research. The history of every branch of knowledge records instances of the misapplication of the calculus of probability which, as John Stuart Mill observed, made it “the real opprobrium of mathematics.”John Stuart Mill, A System of Logic Ratiocinative and Inductive (new impression; London, 1936), p. 353. Some of the worst errors have arisen in our day in the interpretation of the methods of physics.
The problem of probable inference is much bigger than those problems which constitute the field of the calculus of probability. Only preoccupation with the mathematical treatment could result in the prejudice that probability always means frequency.
A further error confused the problem of probability with the problem of inductive reasoning as applied by the natural sciences. The attempt to substitute a universal theory of probability for the category of causality characterizes an abortive mode of philosophizing, very fashionable only a few years ago.
A statement is probable if our knowledge concerning its content is deficient. We do not know everything which would be required for a definite decision between true and not true. But, on the other hand, we do know something about it; we are in a position to say more than simply non liquet or ignoramus.
There are two entirely different instances of probability; we may call them class probability (or frequency probability) and case probability (or the specific understanding of the sciences of human action). The field for the application of the former is the field of the natural sciences, entirely ruled by causality; the field for the application of the latter is the field of the sciences of human action, entirely ruled by teleology.
- Class ProbabilityClass probability means: 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.
We know, for instance, that there are ninety tickets in a lottery and that five of them will be drawn. Thus we know all about the behavior of the whole class of tickets. But with regard to the singular tickets we do not know anything but that they are elements of this class of tickets.
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.
For this defective knowledge the calculus of probability provides a presentation in symbols of the mathematical terminology. It neither expands nor deepens nor complements our knowledge. It translates it into mathematical language. Its calculations repeat in algebraic formulas what we knew beforehand. They do not lead to results that would tell us anything about the actual singular events. And, of course, they do not add anything to our knowledge concerning the behavior of the whole class, as this knowledge was already perfect — or was considered perfect — at the very outset of our consideration of the matter.
It is a serious mistake to believe that the calculus of probability provides the gambler with any information which could remove or lessen the risk of gambling. It is, contrary to popular fallacies, quite useless for the gambler, as is any other mode of logical or mathematical reasoning. It is the characteristic mark of gambling that it deals with the unknown, with pure chance. The gambler’s hopes for success are not based on substantial considerations. The nonsuperstitious gambler thinks: “There is a slight chance [or, in other words: ‘it is not impossible’] that I may win; I am ready to put up the stake required. I know very well that in putting it up I am behaving like a fool. But the biggest fools have the most luck. Anyway!”
Cool reasoning must show the gambler that he does not improve his chances by buying two tickets instead of one of a lottery in which the total amount of the winnings is smaller than the proceeds from the sale of all tickets. If he were to buy all the tickets, he would certainly lose a part of his outlay. Yet every lottery customer is firmly convinced that it is better to buy more tickets than less. The habitués of the casinos and slot machines never stop. They do not give a thought to the fact that, because the ruling odds favor the banker over the player, the outcome will the more certainly result in a loss for them the longer they continue to play. The lure of gambling consists precisely in its unpredictability and its adventurous vicissitudes.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. He would substitute himself for the insured. He would collect ten dollars and would get the chance either of keeping it or of losing that ten dollars and ninety dollars more.
If a man promises to pay at the death of another man a definite sum and charges for this promise the amount adequate to the life expectancy as determined by the calculus of probability, he is not an insurer but a gambler. Insurance, whether conducted according to business principles or according to the principle of mutuality, requires the insurance of a whole class or what can reasonably be considered as such. Its basic idea is pooling and distribution of risks, not the calculus of probability. The mathematical operations that it requires are the four elementary operations of arithmetic. The calculus of probability is mere by-play.
This is clearly evidenced by the fact that the elimination of hazardous risk by pooling can also be effected without any recourse to actuarial methods. Everybody practices it in his daily life. Every businessman includes in his normal cost accounting the compensation for losses which regularly occur in the conduct of affairs. “Regularly” means in this context: The amount of these losses is known as far as the whole class of the various items is concerned. The fruit dealer may know, for instance, that one of every fifty apples will rot in this stock; but he does not know to which individual apple this will happen. He deals with such losses as with any other item in the bill of costs.
The definition of the essence of class probability as given above is the only logically satisfactory one. It avoids the crude circularity implied in all definitions referring to the equiprobability of possible events. In stating that we know nothing about actual singular events except that they are elements of a class the behavior of which is fully known, this vicious circle is disposed of. Moreover, it is superfluous to add a further condition called the absence of any regularity in the sequence of the singular events.
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.
- Case ProbabilityCase probability means: We know, with regard to a particular event, some of the factors which determine its outcome; but there are other determining factors about which we know nothing.
Case probability has nothing in common with class probability but the incompleteness of our knowledge. In every other regard the two are entirely different.
There are, of course, many instances in which men try to forecast a particular future event on the basis of their knowledge about the behavior of the class. A doctor may determine the chances for the full recovery of his patient if he knows that 70 per cent of those afflicted with the same disease recover. If he expresses his judgment correctly, he will not say more than that the probability of recovery is 0.7, that is, that out of ten patients not more than three on the average die. All such predictions about external events, i.e., events in the field of the natural sciences, are of this character. They are in fact not forecasts about the issue of the case in question, but statements about the frequency of the various possible outcomes. They are based either on statistical information or simply on the rough estimate of the frequency derived from nonstatistical experience.
So far as such types of probable statements are concerned, we are not faced with case probability. In fact we do not know anything about the case in question except that it is an instance of a class the behavior of which we know or think we know.
A surgeon tells a patient who considers submitting himself to an operation that thirty out of every hundred undergoing such an operation die. If the patient asks whether this number of deaths is already full, he has misunderstood the sense of the doctor’s statement. He has fallen prey to the error known as the “gambler’s fallacy.” Like the roulette player who concludes from a run of ten red in succession that the probability of the next turn being black is now greater than it was before the run, he confuses case probability with class probability.
All medical prognoses, when based only on physiological knowledge, deal with class probability. A doctor who hears that a man he does not know has been seized by a definite illness will, on the basis of his general medical experience, say: His chances for recovery are 7 to 3. If the doctor himself treats the patient, he may have a different opinion. The patient is a young, vigorous man; he was in good health before he was taken with the illness. In such cases, the doctor may think, the mortality figures are lower; the chances for this patient are not 7:3, but 9:1. The logical approach remains the same, although it may be based not on a collection of statistical data, but simply on a more or less exact résumé of the doctor’s own experience with previous cases. What the doctor knows is always only the behavior of classes. In our instance the class is the class of young, vigorous men seized by the illness in question.
Case probability is a particular feature of our dealing with problems of human action. Here any reference to frequency is inappropriate, as our statements always deal with unique events which as such — i.e., with regard to the problem in question — are not members of any class. We can form a class “American presidential elections.” This class concept may prove useful or even necessary for various kinds of reasoning, as, for instance, for a treatment of the matter from the viewpoint of constitutional law. But if we are dealing with the election of 1944 — either, before the election, with its future outcome or, after the election, with an analysis of the factors which determined the outcome — we are grappling with an individual, unique, and nonrepeatable case. The case is characterized by its unique merits, it is a class by itself. All the marks which make it permissible to subsume it under any class are irrelevant for the problem in question.
Two football teams, the Blues and the Yellows, will play tomorrow. In the past the Blues have always defeated the Yellows. This knowledge is not knowledge about a class of events. If we were to consider it as such, we would have to conclude that the Blues are always victorious and that the Yellows are always defeated. We would not be uncertain with regard to the outcome of the game. We would know for certain that the Blues will win again. The mere fact that we consider our forecast about tomorrow’s game as only probable shows that we do not argue this way.
On the other hand, we believe that the fact that the Blues were victorious in the past is not immaterial with regard to the outcome of tomorrow’s game. We consider it as a favorable prognosis for the repeated success of the Blues. If we were to argue correctly according to the reasoning appropriate to class probability, we would not attach any importance to this fact. If we were not to resist the erroneous conclusion of the “gambler’s fallacy,” we would, on the contrary, argue that tomorrow’s game will result in the success of the Yellows.
If we risk some money on the chance of one team’s victory, the lawyers would qualify our action as a bet. They would call it gambling if class probability were involved.
Everything that outside the field of class probability is commonly implied in the term probability refers to the peculiar mode of reasoning involved in dealing with historical uniqueness or individuality, the specific understanding of the historical sciences.
Understanding is always based on incomplete knowledge. We may know the motives of the acting men, the ends they are aiming at, and the means they plan to apply for the attainment of these ends. We have a definite opinion with regard to the effects to be expected from the operation of these factors. But this knowledge is defective. We cannot exclude beforehand the possibility that we have erred in the appraisal of their influence or have failed to take into consideration some factors whose interference we did not foresee at all, or not in a correct way.
Gambling, engineering, and speculating are three different modes of dealing with the future.
The gambler knows nothing about the event on which the outcome of his gambling depends. All that he knows is the frequency of a favorable outcome of a series of such events, knowledge which is useless for his undertaking. He trusts to good luck, that is his only plan.
Life itself is exposed to many risks. At any moment it is endangered by disastrous accidents which cannot be controlled, or at least not sufficiently. Every man banks on good luck. He counts upon not being struck by lightning and not being bitten by a viper. There is an element of gambling in human life. Man can remove some of the chrematistic consequences of such disasters and accidents by taking out insurance policies. In doing so he banks upon the opposite chances. On the part of the insured the insurance is gambling. His premiums were spent in vain if the disaster does not occur.In life insurance the insured’s stake spent in vain consists only in the difference between the amount collected and the amount he could have accumulated by saving. With regard to noncontrollable natural events man is always in the position of a gambler.
The engineer, on the other hand, knows everything that is needed for a technologically satisfactory solution of his problem, the construction of a machine. As far as some fringes of uncertainty are left in his power to control, he tries to eliminate them by taking safety margins. The engineer knows only soluble problems and problems which cannot be solved under the present state of knowledge. He may sometimes discover from adverse experience that his knowledge was less complete than he had assumed and that he failed to recognize the indeterminateness of some issues which he thought he was able to control. Then he will try to render his knowledge more complete. Of course he can never eliminate altogether the element of gambling present in human life. But it is his principle to operate only within an orbit of certainty. He aims at full control of the elements of his action.
It is customary nowadays to speak of “social engineering.” Like planning, this term is a synonym for dictatorship and totalitarian tyranny. The idea is to treat human beings in the same way in which the engineer treats the stuff out of which he builds his bridges, roads, and machines. The social engineer’s will is to be substituted for the will of the various people he plans to use for the construction of his utopia. Mankind is to be divided into two classes: the almighty dictator, on the one hand, and the underlings who are to be reduced to the status of mere pawns in his plans and cogs in his machinery, on the other. If this were feasible, then of course the social engineer would not have to bother about understanding other people’s actions. He would be free to deal with them as technology deals with lumber and iron.
In the real world acting man is faced with the fact that there are fellow men acting on their own behalf as he himself acts. The necessity to adjust his actions to other people’s actions makes him a speculator for whom success and failure depend on his greater or lesser ability to understand the future. Every investment is a form of speculation. There is in the course of human events no stability and consequently no safety.
Knowledge of the principles of the free society is not something that everyone is born with or something that we just catch like the common cold. The principles of liberty must be carefully passed on from one generation to the next if they are to survive, let alone flourish. Each generation must learn anew from their predecessors the virtues of private property and the consequences of statism. It is even more crucial today, in our contemporary intellectual environment, to have something to offer besides empty platitudes about how we can all “just get along.” Today’s citizen who is interested in things economic, can do no better than to turn to Ludwig von Mises. In his life and work Mises provides the intelligent person a vision for the importance of truth, economics, liberty, and scholarship that continually inspires to greatness.For a good and accessible overview of Mises’s thought see The Essential von Mises and Ludwig von Mises: Scholar, Creator, Hero (Auburn, Ala.: Mises Institute, 2009), both by Murray N. Rothbard. They are combined in one volume in Rothbard (2009). A more extensive biography of Mises can be found in Israel Kirzner’s Ludwig von Mises: The Man and His Economics (Wilmington, Del.: ISI Book, 2001). Jörg Guido Hülsmann’s massive Mises: The Last Knight of Liberalism (Auburn, Ala.: Mises Institute, 2007) is the most extensive biography and the standard-bearer on Mises’s life and work.
The reason Mises is so important can be understood by looking at our halls of learning. It is no secret that state-run elementary and secondary schools are failing their charges. Year after year we hear the all-too-familiar reports telling us again and again how test scores are falling. Such dismal performance sows the seeds for a meager harvest reaped by these same students as they enter college. Fewer and fewer of them graduate high school with a basic knowledge about history, literature, science, and math. It should not surprise us that 20 percent of all college freshmen in the United States need remedial classes.A. Lu, States Reform Remedial College Education (2013). Available at: http://www.pewstates.org/projects/stateline/headlines/states-reform-college-remedial-education-85899492704 It is particularly disheartening to observe the decayed condition of modern American higher education. Not so very long ago, the college was seen as a most important institution charged with transmitting Western civilization from one generation to the next. It was here that students had the luxury of critically examining what different voices throughout time have answered when considering the big questions regarding man, life, death, and God. The goal was not an endless pursuit for pursuit’s sake, but was indeed pursuit for true answers to these questions.
Most people, I am sure, recognize that this is no longer the case. Most college faculties are now dominated, especially in the humanities, by one manifestation or another of deconstructionism. Everything is up for grabs and, at worst, the intellectual sees his chief end as the destruction of the foundations of Western civilization so that we can all dance on its ruins.
On the economic front, things are not much better. Several years ago a college near mine was having a political debate of sorts and evidently could not find anyone on their campus to defend the free market position, so they asked some of my students if they would participate. The report back from my students was by turns outrageous and depressing. From their opponents, there were numerous serious calls for stronger anti-trust regulation, energy regulation, increased state funding of education, subsidization of business, increased welfare, socialized health care, state urban planning, increased environmental regulation, an $11/hour living wage, regulations forcing insurance companies to cover abortions, and increased gun ownership restrictions.
This is what happens when intellectuals, teachers, and college professors see themselves as destroyers instead of cultivators. If we want to preserve our noble cultural inheritance, we cannot think that it will happen automatically. It is always easier to destroy than to maintain and build up. If civilization is not to descend into barbarism, we must teach each generation the importance of truth, liberty, and private property. It is not called culture for nothing. We must cultivate civilization. A former colleague of mine reminds me from time to time that as professors we are indeed the thin tweed line separating civilization from barbarism. Recently, however, the barbarians have been winning because the troops charged with manning the thin tweed line have been either absent without leave or actually fighting for the enemy.
What makes the fight more difficult is that to preserve society, it is not enough merely to oppose destructive philosophies, although oppose them we must. We also must offer a positive and real alternative. As Mises warns us at the end of his book, The Anti-capitalist Mentality,
An “anti-something” movement displays a purely negative attitude. It has no chance whatever to succeed. Its passionate diatribes virtually advertise the program they attack. People must fight for something they want to achieve, not simply reject an evil, no matter how bad it may be. They must, without any reservations, endorse the program of the market economy.Ludwig von Mises, The Anti-capitalist Mentality (New York: D. Van Nostrand, 1956), p. 112.
In this, Mises was, perhaps unwittingly, in agreement with the Apostle Paul who told us many years ago to hate indeed that which is evil, but also to cling to that which is good. In order to maintain our cultural inheritance, we must not only oppose statism but also teach our students to cultivate and nurture the roots of civilization: the free society of voluntary exchange built on private property.
In today’s intellectual vacuum, students need someone to whom they can look for an example of sound scholarship that provides true answers to the important economic and political questions of the day. They could do no better than to turn to the writings of Ludwig von Mises. The life and work of Mises provides students with a magnificent example of what an economist, a scholar, and, in many ways, what a person should be.
This is certainly true in my own experience. As a freshman at a Christian liberal arts college in Northwest Iowa, I was instinctively conservative. I thought, for instance, that low taxes were better than high taxes, low inflation was better than high inflation, and communism was a bad economic and political system. However, I could not satisfactorily explain why.
That same year I joined the Conservative Book Club. As a member I agreed to buy four books from the Club over the course of three years. One month the Club was offering this book Human Action by some Austrian economist I had never heard of as its featured alternative. Because of its price, it was allowed to count for two of my required purchases. I thought, “hey, pretty economical,” and upon encouragement from my economics professor, I went ahead and bought it. The book changed my life. In Mises’s own memoirs, he recounts how near Christmas in 1903 he read Carl Menger’s Principles of Economics and that book made him an economist.Ludwig von Mises, Memoirs (Auburn, Ala.: Mises Institute, 2009), p. 25. Well, Human Action did the same for me.
I found the book at once inspiring and intimidating. I plowed into it with an eager mind and immediately was impressed with Mises’s intellect and his rigorous logic. What also impressed me was the density of Mises’s arguments. He did not waste words that did not advance his theories. As such, Human Action can be rather daunting for readers relatively new to economics. On the one hand, I had several eureka! moments as Mises unpacked the logic demonstrating another economic truth. A number of times I also found some of it rather slow-going. Many times I read and re-read pages to gain a sense of understanding. I would start at the top of a page and by the time I had worked my way down to the bottom, I forgot what the main point was, so I had to start again. Some of it is quite technical, so I had to slow way down to grasp material. I would read passages, sections, and chapters and need to set the book aside for a bit while I thought about, puzzled over, evaluated, and, finally, achieved understanding. It took me five years of off-and-on reading in the midst of my other studies and then work to complete reading it the first time through. Now all of this work was definitely worth it. The benefit from reading and re-reading Human Action is incalculable. Still, I began to look for a less taxing way of becoming acquainted with Mises’s ideas.
During my time in college, while I was still working through Human Action, I sought out other more accessible books by Mises. This was years before the advent of the internet and mises.org. I had to turn to that ancient institution called the library and I discovered that our college library had a collection of shorter essays by Mises published by Libertarian Press in a collection entitled Planning for Freedom and Sixteen Other Essays. This book proved to be a more accessible introduction to Mises’s thought. I began reading it during my free time and did not stop until I had come to the end. Planning for Freedom turned out to be the first book by Mises that I read completely. As I read, I began to put together an economic and political philosophy that revolved around private property. It was the writings of Mises that provided me the intellectual foundation to evaluate and integrate what I was being taught in school. Looking back on those years, I have grown to appreciate the wisdom expressed in the sentiment by Mark Thornton that one of the best ways to become introduced to the work of Ludwig von Mises is through some of his shorter, more popular works.Mark Thornton, from a Mises Wire post “How to Read Mises,” October 8, 2013. https://mises.org/blog/how-read-mises While sacrificing nothing in the way of sound economic theory, they are more accessible and in any event are not as intimidating as Mises’s 881-page magnum opus.
In this anthology, I have sought to bring you the best of both worlds. An attempt has been made to acquaint the reader with the broad spectrum of Mises’s ideas and analyses in a way that is more accessible and less daunting. The selections include, therefore, several shorter, more popular works side-by-side with excerpts from longer, more scholarly and technically difficult works. A special feature of this collection is the inclusion of an appreciation of Eugen von Böhm-Bawerk, available for the first time in English, translated from the French by Karl-Friederich Israel. It is my hope that this book will provide a user-friendly gateway into the brilliance of Mises, because we desperately need his wisdom as much now as in any other time in our history.
The work of Ludwig von Mises is an important guide for thoughtful citizens because he strongly, yet matter-of-factly sets forth economics as the pursuit of truth. Not the truth of the passing fancy, nor the so-called “small t-truth” that is always in danger of being refuted by the latest bit of empirical data; but economic truth that will stand for all ages. Misesian economic theory is a triumphant response to the epistemological relativism of today because it is economics developed in light of reality.
Upon reading the works of Mises, one is immediately set forth on the right road, because Mises begins where economics must begin — human action. All of his economic theorems and corollaries are deduced from the non-controversial axiom that people engage in purposeful behavior. This immediately sets his theories on intellectual bedrock.
As I read the opening chapters of Human Action during my sophomore year, I had a sort of epiphany as all of the conclusions I had learned in my economics classes began to fall into logical place. The law of demand was not merely a plausible sounding notion that is true only in an unrealizable ideal world. It was not the necessary implication of arbitrary assumptions that must be tested again and again. Mises showed that economics is logically whole and that demand is rooted in the law of marginal utility which itself is deduced from the premise that human beings act purposefully. Readers of Mises are not left walking on the shifting sand of empiricism, but on the solid ground of true axioms and sound logic.
A former student of mine who received his J.D. at Harvard Law School had a similar reaction. He once told me that while he appreciated the insights that economics in general gives him in the field of law and economics, what sets Mises above all others in his mind is Mises’s focus on individual human action. The modern focus on bell curves and treating people as rats in mazes, he said, makes it difficult to imagine the practical implication of economic theory relating to a contract case between Joe and Bob. Mises’s framework starts with people like Joe and Bob.
In arguing for economic truth, Mises explicitly rejects relativism. A much-too-large segment of our intellectual culture is under the spell of post-modernism. One root of such thinking is what Mises termed polylogism, the idea that different groups of people have different mental categories and systems of logic. Marxists, for instance, argue that there is an inseparable gulf between the proletariat mind and the bourgeois mind. Not that they have different opinions on things, but that they have entirely different laws of logic and ways of thinking. The same notions are found in feminist academic circles and in all brands of multiculturalism. These theories attempt to shield their subscribers from criticism made by those outside of their particular cults. Mises refutes such illogic by stressing that truth is truth no matter who says it. He writes,
A theory is either correct or incorrect. ... But a theory can never be valid for a bourgeois or an American if it is invalid for a proletarian or a Chinese.Ludwig von Mises, Human Action (Auburn, Ala.:Mises Institute [1949] 1998), p. 91.
Mises’s demolition of polylogism provides students a basis from which they can reply to the Marxist, feminist, and racist theories of criticism that have been running amok within the humanities for some time.
The work of Mises is also important for today because Mises provides a clear understanding of why economics is important by asking the right and important questions and providing correct answers. His books and essays are not consumed with inquiries regarding what the stock market will do in the next six months, or will a federal funds rate of 0.25 percent achieve full employment or should it be 0.5 percent.
While Mises does help us speak to such questions, he focuses on the larger, more fundamental issues. A key theme that runs throughout the work of Mises, for instance, is the consideration of the survival of civilization. Mises warns that social progress is not automatic. In Human Action he explains that our
civilization was able to spring into existence because the peoples were dominated by ideas which were the application of the teachings of economics to the problems of economic policy. It will and must perish if the nations continue to pursue the course which they entered upon under the spell of doctrines rejecting economic thinking.Mises, Human Action, p. 10.
The work of Mises is important to the survival of civilization because it helps pass along knowledge to a new generation of students. And this knowledge helps answer one of the most pressing dilemmas of our human existence — a dilemma that has been with us since the beginning of time. How do we deal with the fundamental condition of scarcity? As we are reminded by that eminent modern philosopher and former student of the London School of Economics Mick Jagger, “You can’t always get what you want.” We are presented with the question: How do we go about our business in this world of scarcity without descending into a barbaric struggle for survival?
Because of the relative material comfort we possess in the West, it is natural for this question to never have occurred to most people. The brilliance of Mises, however, lies in the fact that he invites us to ponder this very real question and then sets out the right answer. He explains that in order to escape starvation and a barbaric struggle for survival, it is crucial that we take advantage of social cooperation through the division of labor. Without the division of labor, everyone would have to produce all that he or she consumes. Each person would have to produce his own food, plus his own house, plus his own clothes, plus all the other goods that make his life better. Without the division of labor, no one would be able to specialize in that thing he does relatively better than everyone else. Our total wealth would be greatly reduced and we would be left living largely from hand to mouth.
By reading Mises, however, students clearly see that as the result of our ability to exchange goods with one another, we can specialize in producing only those things at which we are most efficient and then trade the surplus we don’t need for other things we want. As we specialize, our productivity goes up individually and the total wealth of our community increases. The division of labor through voluntary exchange allows us to rise above a barbaric struggle for existence in which we hope that we are one of the fittest that will survive. The division of labor allows us to build civilization.
However the expansion of the division of labor has challenges of its own. And it is here that Mises is really in his element. An economy that has taken advantage of an extensive division of labor is very complex and yet, decentralized. Such an economy features a multitude of different markets in which the participants must coordinate their activities if we want to avoid recessions and depressions. The biggest problem for this decentralized economy to work is that all of the various producers have to know what to produce, how much to produce, and how to produce it.
This can only be done if some method of calculation exists. No other economist of his day stressed this point more than Mises. Indeed in the 1920s Mises demonstrated that the lack of economic calculation is the Achilles heel of socialism. Alternatives must be compared to one another if producers are to know how best to fulfill the desires of consumers for goods and services. Even if they know what consumers want they must be able to compare alternative ways to produce it. Should we build this house with wooden studs or metal? Blown or rolled insulation? Air or coil heating? This can be known only if there is a common denominator we can use to assess the relative value of each alternative. We cannot simply use physical units of goods for the comparison. Saying that ten two-by-fours are worth less than fifty nails because ten is less than fifty is like saying I’m taller than you because I’m 5 foot 8 and you are 98.6 degrees Fahrenheit.
Mises recognizes that what makes such comparisons even harder is that we all value goods subjectively, according to our personal preferences. We cannot, therefore, measure value because there are no objective units of value measurement.
Again it was Mises who demonstrated that voluntary exchange in a monetary economy opens the door to a solution. In a monetary economy, every good is exchanged against money, so every price is expressed in terms of the monetary unit — in our case dollars and cents. Even though value is subjective, in a free market, people manifest their values by voluntarily deciding what they will pay for particular products and services. These objective prices, therefore, are reflections of subjective values. Entrepreneurs are able to use these objective prices to calculate expected profit and loss and act accordingly. In a free market, Mises shows, entrepreneurs are able to plan for the future and consumers will receive what they most want.
Socialism, on the other hand, is doomed because there is no way for the central planner to efficiently allocate factors of production because there is no way to calculate profit and loss. In a completely socialistic economy all of the means of production are owned by the state. There is, therefore, no actual exchange of goods, and hence no actual prices that reflect the actual subjective values of human beings. Producers, then, have no way to calculate whether their actions are productive or wasteful from the point of view of society. What is called a planned economy is, instead, as Mises so eloquently put it, “groping about in the dark.”
I once had a student from China who cited Human Action as the book that finally turned him away from socialism. He had read all of Human Action, praising it for its readability. He told me that reading Human Action helped him realize that Communism was an impossible utopia. Mises’s explanation of the devastating economic consequences of war also attracted this student to read further works by Mises.
The moral of the story is that voluntary exchange in a monetary economy allows us to have the civilization we enjoy. In order to engage in voluntary exchange using money, however, Mises stresses that it is necessary for people to own private property. You cannot exchange what you do not own. If there is no ownership of private property, there is no actual exchange. If there is no exchange, there is no division of labor and there is no money so there are neither money prices, nor economic calculation. We would be left with chaos, not civilization. For civilization to survive, consequently, Mises teaches us that society must be a private property order. If people are able to own and trade their property as they see fit, wealth increases and civilization prospers.
The insights of Mises do not stop with his critique of socialism, however. From his 1929 collection of essays A Critique of Interventionism through the rest of his career, he continually explained to whomever would listen that even if the state does not fully socialize the economy, but intervenes only here and there, this too hinders the workings of the price system. To the extent that the state intervenes and curbs the free actions of individuals through price controls, monetary inflation, product restrictions, taxation, and subsidization, to that extent will prices for goods not accurately reflect the values of the people in that society. Such intervention will make it that much harder for entrepreneurs to do their job and one should expect to see shortages in some industries and surpluses in another.
You can see, then, that Mises builds his economic theory into a massive, logically integrated edifice of truth. More than any other economist of his day, Mises demonstrates that laws of economics are indeed laws every bit as universal and irrevocable as the laws of chemistry and physics, and we violate them at our peril. It is this fact that enables the study of economics to be a noble endeavor for everyone. In Human Action, Mises comments on the role of the economist by likening him to a chemist warning people against poisoning themselves. He writes,
A man who chooses between drinking a glass of milk and a glass of a solution of potassium cyanide does not choose between two beverages; he chooses between life and death. A society that chooses between capitalism and socialism does not choose between two social systems; it chooses between social cooperation and the disintegration of society. Socialism is not an alternative to capitalism; it is an alternative to any system under which men can live as human beings. To stress this point is the task of economics as it is the task of biology and chemistry to teach that potassium cyanide is not a nutriment but a deadly poison.Mises, Human Action, p. 676.
Indeed, one of the most important benefits received from reading Mises is the ability to critically evaluate public policy.
When assigned in a college class long ago to research the viability of the social security system, the first place I turned to was Human Action. The passage I read then I have never forgotten. It is a passage that is as timely as today’s headlines. Mises writes,
One may try to justify [social security] by declaring that the wage earners lack the insight and the moral strength to provide spontaneously for their own future. But then it is not easy to silence the voices of those who ask whether it is not paradoxical to entrust the nation’s welfare to the decisions of voters whom the law itself considers incapable of managing their own affairs.Ibid., p. 613.
This is dynamite for the intelligent person who wants to truly understand the nature of hydra-headed interventionism that pushes a myriad of statist policies including inflationism, the welfare-warfare state, Keynesian fiscal management, socialized medicine, and countless business regulations that serve only to hamper mutually beneficial exchange.
Today people are increasingly urged to support this or that political program advertised as solving a vexing social problem with no understanding of economics and hence no frame of reference from which to evaluate different policies. All that is mustered in justification for interventionism are feelings that make people want to “do something.” The economics of Mises is the crucial antidote for the current interventionist ideology supporting the progressive march to economic fascism. Citizens acquainted with Mises quickly understand that any sort of middle-of-the-road economic policy does indeed lead to socialism.
Ludwig von Mises does not only provide us a vision of economic truth, however. He also inspires us to greatness by presenting the student an example of what an outstanding scholar should be. It does not take the reader of Mises’s work very long to see what a breadth of knowledge Mises had. Murray Rothbard once recounted how, when someone first recommended Human Action to him, he asked, “What is it about?” The response to Rothbard was “Everything.” A student in one of my managerial economics courses was impressed with the same observation. I had assigned from Human Action a brief section about the distinction between the manager and the entrepreneur. He liked what was assigned, so he began to read through the first part of the book. He was greatly impressed and told me, “He doesn’t write just about economics. It’s all there, of course, but he also writes about everything else.” This student now has a standard for real scholarship.
Throughout Mises’s works are insightful discussions about history, philosophy, political science, sociology, and even aesthetics. He makes not only references to, but thoughtful comments on the likes of Aristotle, Bentham, Bismark, Comte, Locke, Kant, Marx, Mill, Napoleon, Tacitus, Saint Francis of Assisi, and Spinoza. As he once explained in his New York University Seminar,
One of the indispensable prerequisites of a master of economics is a perfect knowledge of history, the history of ideas and of civilization, and of social, economic, and political history. To know one field well, one must also know other fields.John Chamberlain, “My Years with Ludwig von Mises,” The Freeman 27, no. 2 (February 1977): 126–27.
In another instance Mises cited a number of authors in French and German. One student spoke up, asking, “Why are you giving these citations, Professor? I can’t read French and German.” Mises replied simply, “Learn it. You are engaged in scholarly activities.”Margit von Mises, My Years with Ludwig von Mises (New Rochelle, New York: Arlington Press, 1976), pp. 135–36. He also encouraged his students not only to read authors with which they agreed, but to read about an issue from all sides. A student who reads Mises is inspired to be such a scholar.
Looking at Mises the scholar, the contemporary student learns a valuable lesson in integrity. His life was a never-ending fight for economic truth, liberty, scholarly excellence, and the principles of the free market. As he notes in his autobiography, at a particularly depressing time in his life when it appeared that he had become merely “an historian of decline,” he remembered his personal motto adopted from a line out of Virgil: “Do not give in to the evil, but proceed ever the more against it.” Throughout his life, he did just that.
His research and logical analysis convinced him of the negative consequences of socialism and interventionism. He never wavered from those convictions and his steadfastness cost him plenty. He did without a salaried academic appointment because he was not willing to be a court intellectual. However, he never grew bitter about this. In his autobiography he writes,
I was sometimes accused of representing my viewpoint in a manner too abrupt and intransigent. It was also claimed that I could have accomplished more had I displayed a greater willingness to compromise. ... When I look back at my work … my only regret is my willingness to compromise, and not my intransigence.Mises, Memoirs, p. 60.
The reason for his uncompromising attitude is that he took his work as a scholar seriously. Mises thought, “In science, compromise is a betrayal of truth.”Ibid., p. 61. Would that more contemporary economists had the same convictions.
Ludwig von Mises truly was an intellectual giant among men and, as Murray RothbardMurray N. Rothbard, “Ludwig von Mises and the Paradigm for our Age,” Modern Age (Fall 1971): 370–79. saw, his thought and causal-realist framework is the best alternative to the economic paradigm of our age. In the contemporary fog of the modern academy, Mises serves as a lighthouse, warning unsuspecting students of the perils of bad economics and statist economic policies, while illuminating students to the principles of the free society.
The book in your hands is intended to give a taste of the many facets of Mises’s thought in a way that accessibly communicates most of his key contributions to the social sciences. It therefore includes excerpts from his larger and more technically demanding works side-by-side with shorter, more introductory articles and lectures. The finished product is sort of an intelligent person’s guide to the work of Ludwig von Mises. It is especially suitable for those with an interest in Mises, but find jumping right into Human Action, Socialism, or The Theory of Money and Credit rather daunting. The hope is to give the reader a survey of Mises’s insights in a format that nourishes his intellectual soul, while also whetting the appetite for his larger corpus of work. Those ready to dive into deeper Misesian waters are encouraged to pick up The Mises Reader Unabridged which contains all of the material in The Mises Reader plus over 125 pages of additional material, primarily from his more scholarly works. It is hoped that together these two volumes will foster a rising generation of citizens more thoroughly acquainted with sound economics and the principles of the free society.
If we want to preserve our civilization from the cultural destroyers, post-modern relativists, and enemies of freedom, we must provide our generation of inquisitive minds with a sound alternative. We must direct our fellow sojourners to a literature that defends truth and property and inspires us to greatness. Fortunately we have such a literature to turn to — a literature of freedom. Those desiring to beat back the barbarians at the gate, would do well to begin with the works of Ludwig von Mises. In him, the reader will find, as Murray Rothbard found, a scholar, creator, and hero.
Shawn RitenourGrove City College
Planning for Freedom and Sixteen Other Essays and Addresses[Ludwig von Mises, Planning for Freedom and Sixteen Other Essays and Addresses (1952; South Holland, Ill.: Libertarian Press, 1980), chap. 10, pp. 150–55.]“Wages, Unemployment and Inflation”
Our economic system — the market economy or capitalism — is a system of consumers’ supremacy. The customer is sovereign; he is, says a popular slogan, “always right.” Businessmen are under the necessity of turning out what the consumers ask for and they must sell their wares at prices which the consumers can afford and are prepared to pay. A business operation is a manifest failure if the proceeds from the sales do not reimburse the businessman for all he has expended in producing the article. Thus the consumers in buying at a definite price determine also the height of the wages that are paid to all those engaged in the industries.
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Wages Ultimately Paid By the ConsumersIt follows that an employer cannot pay more to an employee than the equivalent of the value the latter’s work, according to the judgment of the buying public, adds to the merchandise. (This is the reason why the movie star gets much more than the charwoman.) If he were to pay more, he would not recover his outlays from the purchasers; he would suffer losses and would finally go bankrupt. In paying wages, the employer acts as a mandatory of the consumers, as it were. It is upon the consumers that the incidence of the wage payments falls. As the immense majority of the goods produced are bought and consumed by people who are themselves receiving wages and salaries, it is obvious that in spending their earnings the wage earners and employees themselves are foremost in determining the height of the compensation they and those like them will get.
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What Makes Wages RiseThe buyers do not pay for the toil and trouble the worker took nor for the length of time he spent in working. They pay for the products. The better the tools are which the worker uses in his job, the more he can perform in an hour, the higher is, consequently, his remuneration. What makes wages rise and renders the material conditions of the wage earners more satisfactory is improvement in the technological equipment. American wages are higher than wages in other countries because the capital invested per head of the worker is greater and the plants are thereby in the position to use the most efficient tools and machines. What is called the American way of life is the result of the fact that the United States has put fewer obstacles in the way of saving and capital accumulation than other nations. The economic backwardness of such countries as India consists precisely in the fact that their policies hinder both the accumulation of domestic capital and the investment of foreign capital. As the capital required is lacking, the Indian enterprises are prevented from employing sufficient quantities of modern equipment, are therefore producing much less per man-hour, and can only afford to pay wage rates which, compared with American wage rates, appear as shockingly low.
There is only one way that leads to an improvement of the standard of living for the wage-earning masses, viz., the increase in the amount of capital invested. All other methods, however popular they may be, are not only futile, but are actually detrimental to the well-being of those they allegedly want to benefit.
- What Causes UnemploymentThe fundamental question is: is it possible to raise wage rates for all those eager to find jobs above the height they would have attained on an unhampered labor market?
Public opinion believes that the improvement in the conditions of the wage earners is an achievement of the unions and of various legislative measures. It gives to unionism and to legislation credit for the rise in wage rates, the shortening of hours of work, the disappearance of child labor, and many other changes. The prevalence of this belief made unionism popular and is responsible for the trend in labor legislation of the last two decades. As people think that they owe to unionism their high standard of living, they condone violence, coercion, and intimidation on the part of unionized labor and are indifferent to the curtailment of personal freedom inherent in the union-shop and closed-shop clauses. As long as these fallacies prevail upon the minds of the voters, it is vain to expect a resolute departure from the policies that are mistakenly called progressive.
Yet this popular doctrine misconstrues every aspect of economic reality. The height of wage rates at which all those eager to get jobs can be employed depends on the marginal productivity of labor. The more capital — other things being equal — is invested, the higher wages climb on the free labor market, i.e., on the labor market not manipulated by the government and the unions. At these market wage rates all those eager to employ workers can hire as many as they want. At these market wage rates all those who want to be employed can get a job. There prevails on a free labor market a tendency toward full employment. In fact, the policy of letting the free market determine the height of wage rates is the only reasonable and successful full-employment policy. If wage rates, either by union pressure and compulsion or by government decree, are raised above this height, lasting unemployment of a part of the potential labor force develops.
- Credit Expansion No Substitute for CapitalThese opinions are passionately rejected by the union bosses and their followers among politicians and the self-styled intellectuals. The panacea they recommend to fight unemployment is credit expansion and inflation, euphemistically called “an easy money policy.”
As has been pointed out above, an addition to the available stock of capital previously accumulated makes a further improvement of the industries’ technological equipment possible, thus raises the marginal productivity of labor and consequently also wage rates. But credit expansion, whether it is effected by issuing additional banknotes or by granting additional credits on bank accounts subject to check, does not add anything to the nation’s wealth of capital goods. It merely creates the illusion of an increase in the amount of funds available for an expansion of production. Because they can obtain cheaper credit, people erroneously believe that the country’s wealth has thereby been increased and that therefore certain projects that could not be executed before are now feasible. The inauguration of these projects enhances the demand for labor and for raw materials and makes wage rates and commodity prices rise. An artificial boom is kindled.
Under the conditions of this boom, nominal wage rates which before the credit expansion were too high for the state of the market and therefore created unemployment of a part of the potential labor force are no longer too high and the unemployed can get jobs again. However, this happens only because under the changed monetary and credit conditions prices are rising or, what is the same expressed in other words, the purchasing power of the monetary unit drops. Then the same amount of nominal wages, i.e., wage rates expressed in terms of money, means less in real wages, i.e., in terms of commodities that can be bought by the monetary unit. Inflation can cure unemployment only by curtailing the wage earner’s real wages. But then the unions ask for a new increase in wages in order to keep pace with the rising cost of living and we are back where we were before, i.e., in a situation in which large-scale unemployment can only be prevented by a further expansion of credit.
This is what happened in this country as well as in many other countries in the last years. The unions, supported by the government, forced the enterprises to agree to wage rates that went beyond the potential market rates, i.e., the rates which the public was prepared to refund to the employers in purchasing their products. This would have inevitably resulted in rising unemployment figures. But the government policies tried to prevent the emergence of serious unemployment by credit expansion, i.e., inflation. The outcome was rising prices, renewed demands for higher wages and reiterated credit expansion; in short, protracted inflation.
Human Action[Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 21: “Work and Wages,” pp. 595–98.]4. Catallactic UnemploymentIf a job-seeker cannot obtain the position he prefers, he must look for another kind of job. If he cannot find an employer ready to pay him as much as he would like to earn, he must abate his pretensions. If he refuses, he will not get any job. He remains unemployed.
What causes unemployment is the fact that — contrary to the above-mentioned doctrine of the worker’s inability to wait — those eager to earn wages can and do wait. A job-seeker who does not want to wait will always get a job in the unhampered market economy in which there is always unused capacity of natural resources and very often also unused capacity of produced factors of production. It is only necessary for him either to reduce the amount of pay he is asking for or to alter his occupation or his place of work.
There were and still are people who work only for some time and then live for another period from the savings they have accumulated by working. In countries in which the cultural state of the masses is low, it is often difficult to recruit workers who are ready to stay on the job. The average man there is so callous and inert that he knows of no other use for his earnings than to buy some leisure time. He works only in order to remain unemployed for some time.
It is different in the civilized countries. Here the worker looks upon unemployment as an evil. He would like to avoid it provided the sacrifice required is not too grievous. He chooses between employment and unemployment in the same way in which he proceeds in all other actions and choices: he weighs the pros and cons. If he chooses unemployment, this unemployment is a market phenomenon whose nature is not different from other market phenomena as they appear in a changing market economy. We may call this kind of unemployment market-generated or catallactic unemployment.
The various considerations which may induce a man to decide for unemployment can be classified in this way:
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The individual believes that he will find at a later date a remunerative job in his dwelling place and in an occupation which he likes better and for which he has been trained. He seeks to avoid the expenditure and other disadvantages involved in shifting from one occupation to another and from one geographical point to another. There may be special conditions increasing these costs. A worker who owns a homestead is more firmly linked with the place of his residence than people living in rented apartments. A married woman is less mobile than an unmarried girl. Then there are occupations which impair the worker’s ability to resume his previous job at a later date. A watchmaker who works for some time as a lumberman may lose the dexterity required for his previous job. In all these cases the individual chooses temporary unemployment because he believes that this choice pays better in the long run.
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There are occupations the demand for which is subject to considerable seasonal variations. In some months of the year the demand is very intense, in other months it dwindles or disappears altogether. The structure of wage rates discounts these seasonal fluctuations. The branches of industry subject to them can compete on the labor market only if the wages they pay in the good season are high enough to indemnify the wage earners for the disadvantages resulting from the seasonal irregularity in demand. Then many of the workers, having saved a part of their ample earnings in the good season, remain unemployed in the bad season.
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The individual chooses temporary unemployment for considerations which in popular speech are called noneconomic or even irrational. He does not take jobs which are incompatible with his religious, moral, and political convictions. He shuns occupations the exercise of which would impair his social prestige. He lets himself be guided by traditional standards of what is proper for a gentleman and what is unworthy. He does not want to lose face or caste.
Unemployment in the unhampered market is always voluntary. In the eyes of the unemployed man, unemployment is the minor of two evils between which he has to choose. The structure of the market may sometimes cause wage rates to drop. But, on the unhampered market, there is always for each type of labor a rate at which all those eager to work can get a job. The final wage rate is that rate at which all job-seekers get jobs and all employers as many workers as they want to hire. Its height is determined by the marginal productivity of each type of work.
Wage rate fluctuations are the device by means of which the sovereignty of the consumers manifests itself on the labor market. They are the measure adopted for the allocation of labor to the various branches of production. They penalize disobedience by cutting wage rates in the comparatively overmanned branches and recompense obedience by raising wage rates in the comparatively undermanned branches. They thus submit the individual to a harsh social pressure. It is obvious that they indirectly limit the individual’s freedom to choose his occupation. But this coercion is not rigid. It leaves to the individual a margin in the limits of which he can choose between what suits him better and what less. Within this orbit he is free to act of his own accord. This amount of freedom is the maximum of freedom that an individual can enjoy in the framework of the social division of labor, and this amount of coercion is the minimum of coercion that is indispensable for the preservation of the system of social cooperation. There is only one alternative left to the catallactic pressure exercised by the wages system: the assignment of occupations and jobs to each individual by the peremptory decrees of an authority, a central board planning all production activities. This is tantamount to the suppression of all freedom.
It is true that under the wages system the individual is not free to choose permanent unemployment. But no other imaginable social system could grant him a right to unlimited leisure. That man cannot avoid submitting to the disutility of labor is not an outgrowth of any social institution. It is an inescapable natural condition of human life and conduct.
It is not expedient to call catallactic unemployment in a metaphor borrowed from mechanics “frictional” unemployment. In the imaginary construction of the evenly rotating economy there is no unemployment because we have based this construction on such an assumption. Unemployment is a phenomenon of a changing economy. The fact that a worker discharged on account of changes occurring in the arrangement of production processes does not instantly take advantage of every opportunity to get another job but waits for a more propitious opportunity is not a consequence of the tardiness of the adjustment to the change in conditions, but is one of the factors slowing down the pace of this adjustment. It is not an automatic reaction to the changes which have occurred, independent of the will and the choices of the job-seekers concerned, but the effect of their intentional actions. It is speculative, not frictional.
Catallactic unemployment must not be confused with institutional unemployment. Institutional unemployment is not the outcome of the decisions of the individual job-seekers. It is the effect of interference with the market phenomena intent upon enforcing by coercion and compulsion wage rates higher than those the unhampered market would have determined. The treatment of institutional unemployment belongs to the analysis of the problems of interventionism.
Interventionism: An Economic Analysis[Ludwig von Mises, Interventionism: An Economic Analysis (Irvington-on-Hudson, N.Y.: The Foundation for Economic Education, 1998), chap. 3, “Inflation and Credit Expansion,” pp. 39–44.]2. Credit ExpansionIt is a fundamental fact of human behavior that people value present goods higher than future goods. An apple available for immediate consumption is valued higher than an apple which will be available next year. And an apple which will be available in a year is in turn valued higher than an apple which will become available in five years. This difference in valuation appears in the market economy in the form of the discount, to which future goods are subject as compared to present goods. In money transactions this discount is called interest.
Interest therefore cannot be abolished. In order to do away with interest we would have to prevent people from valuing a house, which today is habitable, more highly than a house which will not be ready for use for ten years. Interest is not peculiar to the capitalistic system only. In a socialist community too the fact will have to be considered that a loaf of bread which will not be ready for consumption for another year does not satisfy present hunger.
Interest does not have its origin in the meeting of supply and demand of money loans in the capital market. It is rather the function of the loan market, which in business terms is called the money market (for short-term credit) and the capital market (for long-term credit), to adjust the interest rates for loans transacted in money to the difference in the valuation of present and future goods. This difference in valuation is the real source of interest. An increase in the quantity of money, no matter how large, cannot in the long run influence the rate of interest.
No other economic law is less popular than this, that interest rates are, in the long run, independent of the quantity of money. Public opinion is reluctant to recognize interest as a market phenomenon. Interest is thought to be an evil, an obstacle to human welfare, and, therefore, it is demanded that it be eliminated or at least considerably reduced. And credit expansion is considered the proper means to bring about “easy money.”
There is no doubt that credit expansion leads to a reduction of the interest rate in the short run. At the beginning, the additional supply of credit forces the interest rate for money loans below the point which it would have in an unmanipulated market. But it is equally clear that even the greatest expansion of credit cannot change the difference in the valuation of future and present goods. The interest rate must ultimately return to the point at which it corresponds to this difference in the valuation of goods. The description of this process of adjustment is the task of that part of economics which is called the theory of the business cycle.
At every constellation of prices, wages, and interest rates, there are projects which will not be carried out because a calculation of their profitability shows that there is no chance for the success of such undertakings. The businessman does not have the courage to start the enterprise because his calculations convince him that he will not gain, but will lose by it.
This unattractiveness of the project is not a consequence of money or credit conditions; it is due to the scarcity of economic goods and labor and to the fact that they have to be devoted to more urgent and therefore more attractive uses.
When the interest rate is artificially lowered by credit expansion the false impression is created that enterprises which previously had been regarded as unprofitable now become profitable. Easy money induces the entrepreneurs to embark upon businesses which they would not have undertaken at a higher interest rate. With the money borrowed from the banks they enter the market with additional demand and cause a rise in wages and in the prices of the means of production. This boom of course would have to collapse immediately in the absence of further credit expansion, because these price increases would make the new enterprises appear unprofitable again. But if the banks continue with the credit expansion this brake fails to work. The boom continues.
But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system.As explained in this section on “Credit Expansion.” Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.
It is obvious that a mere banking process like credit expansion cannot create more goods and wealth. What the credit expansion actually accomplishes is to introduce a source of error in the calculations of the entrepreneurs and thus causes them to misjudge business and investment projects. The entrepreneurs act as if more producers’ goods were available than are actually at hand. They plan expansion of production on a scale for which the available quantities of producers’ goods are not sufficient. These plans are bound to fail because of the deficiency in the available amount of producers’ goods. The result is that there are plants which cannot be used because the complementary facilities are lacking; there are plants which cannot be completed; there are other plants again whose products cannot be sold because consumers desire other products more urgently which cannot be produced in sufficient quantities because the necessary productive facilities are not ready. The boom is not over-investment, it is misdirected investment.
It is frequently argued against this conclusion that it would hold true only if at the beginning of the credit expansion there were neither unused capacity nor unemployment. If there were unemployment and idle capacity, things would be different, they claim. But these assumptions do not affect the argument.
The fact that a part of the productive capacity which cannot be diverted to other uses is unused is the consequence of errors of the past. Investments were made in the past under assumptions which proved to be incorrect; the market now demands something else than what can be produced by these facilities.In the absence of credit expansion there also may be plants which are not fully utilized. But they do not disturb the market any more than does the unused submarginal land. The accumulation of inventories is speculation. The owner does not want to sell the goods at the current market price because he hopes to realize a higher price at a future date. Unemployment of workers is also an aspect of speculation. The worker does not want to change his location or occupation, nor does he want to lower his wage demands because he hopes to find the work he prefers at the place he prefers and at higher wages. Both the owners of merchandise and the unemployed refuse to adjust themselves to market conditions because they hope for new data which would change market conditions to their advantage. Because they do not make the necessary adjustments the economic system cannot reach “equilibrium.”
In the opinion of the advocates of credit expansion, what is necessary fully to utilize the unused capacity, to sell the supply at prices acceptable to the owners, and to enable the unemployed to find work at wages satisfactory to them is merely additional credit which such expansion could provide. This is the view which underlies all plans for “pump priming.” It would be correct for the stocks of goods and for the unemployed under two conditions: (1) if the price rises caused by the additional quantity of money and credit would uniformly and simultaneously affect all other prices and wages, and (2) if the owners of the excessive supplies and the unemployed would not increase their prices and wage demands. This would cause the exchange ratios between these goods and services and other goods and services to change in the same way as they would have to be changed in the absence of credit expansion, by reducing the price and wage demands in order to find buyers and employers.
The course of the boom is not any different because, at its inception, there are unused productive capacity, unsold stocks of goods, and unemployed workers. We might assume, for instance, that we are dealing with copper mines, copper inventories, and copper miners. The price of copper is at a point at which a number of mines cannot profitably continue their production; their workers must remain idle if they do not want to change jobs; and the owners of the copper stocks can only sell part of it if they are unwilling to accept a lower price. What is needed to put the idle mines and miners back to work and to dispose of the copper supply without a price drop is an increase (p) in producers’ goods in general, which would permit an expansion of overall production, so that an increase in the price, sales, and production of copper would follow. If this increase (p) does not occur, but the entrepreneurs are induced by credit expansion to act as if it had occurred, the effects on the copper market will first be the same as if p actually had appeared. But everything that has been said before of the effects of credit expansion develops in this case as well. The sole difference is that misdirected capital investment, as far as copper is concerned, does not necessitate the withdrawal of capital and labor from other branches of production, which under existing conditions are considered more important by the consumers. But this is only due to the fact that, as far as copper is concerned, the credit expansion boom impinges upon previously misdirected capital and labor which have not yet been adjusted by the normal corrective processes of the price mechanism.
The true meaning of the argument of unused capacity, unsold — or, as it is said inaccurately, unsalable — inventories, and idle labor, now becomes apparent. The beginning of every credit expansion encounters such remnants of older, misdirected capital investments and apparently “corrects” them. In actuality, it does nothing but disturb the workings of the adjustment process. The existence of unused means of production does not invalidate the conclusions of the monetary theory of the business cycle. The advocates of credit expansion are mistaken when they believe that, in view of unused means of production, the suppression of all possibilities of credit expansion would perpetuate the depression. The measures they propose would not perpetuate real prosperity, but would constantly interfere with the process of readjustment and the return of normal conditions.
It is impossible to explain the cyclical changes of business on any basis other than the theory which commonly is referred to as the monetary theory of the business cycle. Even those economists who refuse to recognize in the monetary theory the proper explanation of the business cycle have never attempted to deny the validity of its conclusions about the effects of credit expansion. In order to defend their theories about the business cycle, which differ from the monetary theory, they still have to admit that the upswing cannot occur without simultaneous credit expansion, and that the end of the credit expansion also marks the turning point of the cycle. The opponents of the monetary theory actually confine themselves to the assertion that the upswing of the cycle is not caused by credit expansion, but by other factors, and that the credit expansion, without which the upswing would be impossible, is not the result of a policy intended to lower the interest rate and to invite the execution of additional business plans, but that it is released somehow by conditions leading to the upswing without intervention by the banks or by the authorities.
It has been asserted that the credit expansion is released by the rise in the rate of interest through the failure of the banks to raise their interest rates in accordance with the rise in the “natural” rate.[Fritz] Machlup, (The Stock Market, Credit and Capital Formation, London, 1940), p. 248, speaks of “passive inflationism.” This argument too misses the main point of the monetary theory of the cycle. Whether the credit expansion gets under way because the banks ease credit terms, or because they fail to stiffen the terms in accordance with changed market conditions, is of minor importance.If a bank is unable to expand credit it cannot create an upswing even if it lowers its interest rate below the market rate. It would merely make a gift to its debtors. The conclusion to be drawn from the monetary theory of the cycle with regard to stabilizing measures is not the postulate that the banks should not lower the interest rate, but that they should not expand credit. This [Gottfried] Haberler (Prosperity and Depression, League of Nations, Geneva, 1939, pp. 65 ff.) misunderstood and therefore his criticisms are untenable. Decisive only is the fact that there is credit expansion because there exist institutions which consider it their task to influence interest rates by the granting of additional credit. Whoever believes that credit expansion is a necessary factor in the movement which forces the economy into the upswing, which must be followed by a crisis and depression, would have to admit that the surest means to achieve a cycle-proof economic system lies in preventing credit expansion. But despite the general agreement that measures should be taken to smooth the wave-like movements of the cycle, measures to prevent credit expansion do not receive consideration. Business cycle policy is given the task to perpetuate the upswing created by the credit expansion and yet to prevent the breakdown. Proposals to prevent credit expansion are refuted because supposedly they would perpetuate the depression. Nothing could be a more convincing proof of the theory which explains the business cycle as originating from interventions in favor of easy money than the obstinate refusal to abandon credit expansion.
One would have to ignore all facts of recent economic history were one to deny that measures to lower rates are considered desirable and that credit expansion is regarded as the most reliable means to achieve this aim. The fact that the smooth functioning and the development and steady progress of the economy is over and over again disturbed by artificial booms and ensuing depressions is not a necessary characteristic of the market economy. It is rather the inevitable consequence of repeated interventions which intend to create easy money by credit expansion.
The Causes of the Economic Crisis and Other Essays Before and After the Great Depression[Ludwig von Mises, “Monetary Stabilization and Cyclical Policy,” in The Causes of the Economic Crisis and Other Essays Before and After the Great Depression, ed. Percy L. Greaves, Jr. (1928; Auburn, Ala.: Mises Institute, 2006), chap. 2: “Circulation Credit Theory,” pp. 103–15.]“Monetary Stabilization and Cyclical Policy”
- The Banking School FallacyIf notes are issued by the banks, or if bank deposits subject to check or other claim are opened, in excess of the amount of money kept in the vaults as cover, the effect on prices is similar to that obtained by an increase in the quantity of money. Since these fiduciary media, as notes and bank deposits not backed by metal are called, render the service of money as safe and generally accepted, payable on demand monetary claims, they may be used as money in all transactions. On that account, they are genuine money substitutes. Since they are in excess of the given total quantity of money in the narrower sense, they represent an increase in the quantity of money in the broader sense.
The practical significance of these undisputed and indisputable conclusions in the formation of prices is denied by the Banking School with its contention that the issue of such fiduciary media is strictly limited by the demand for money in the economy. The Banking School doctrine maintains that if fiduciary media are issued by the banks only to discount short-term commodity bills, then no more would come into circulation than were “needed” to liquidate the transactions. According to this doctrine, bank management could exert no influence on the volume of the commodity transactions activated. Purchases and sales from which short-term commodity bills originate would, by this very transaction, already have brought into existence paper credit which can be used, through further negotiation, for the exchange of goods and services. If the bank discounts the bill and, let us say, issues notes against it, that is, according to the Banking School, a neutral transaction as far as the market is concerned. Nothing more is involved than replacing one instrument which is technically less suitable for circulation, the bill of exchange, with a more suitable one, the note. Thus, according to this School, the effect of the issue of notes need not be to increase the quantity of money in circulation. If the bill of exchange is retired at maturity, then notes would flow back to the bank and new notes could enter circulation again only when new commodity bills came into being once more as a result of new business.
The weak link in this well-known line of reasoning lies in the assertion that the volume of transactions completed, as sales and purchases from which commodity bills can derive, is independent of the behavior of the banks. If the banks discount at a lower, rather than at a higher, interest rate, then more loans are made. Enterprises which are unprofitable at 5 percent, and hence are not undertaken, may be profitable at 4 percent. Therefore, by lowering the interest rate they charge, banks can intensify the demand for credit. Then, by satisfying this demand, they can increase the quantity of fiduciary media in circulation. Once this is recognized, the Banking Theory’s only argument, that prices are not influenced by the issue of fiduciary media, collapses.
One must be careful not to speak simply of the effects of credit in general on prices, but to specify clearly the effects of “increased credit” or “credit expansion.” A sharp distinction must be made between (1) credit which a bank grants by lending its own funds or funds placed at its disposal by depositors, which we call “commodity credit,” and (2) that which is granted by the creation of fiduciary media, i.e., notes and deposits not covered by money, which we call “circulation credit.” It is only through the granting of circulation credit that the prices of all commodities and services are directly affected.
If the banks grant circulation credit by discounting a three month bill of exchange, they exchange a future good — a claim payable in three months — for a present good that they produce out of nothing. It is not correct, therefore, to maintain that it is immaterial whether the bill of exchange is discounted by a bank of issue or whether it remains in circulation, passing from hand to hand. Whoever takes the bill of exchange in trade can do so only if he has the resources. But the bank of issue discounts by creating the necessary funds and putting them into circulation. To be sure, the fiduciary media flow back again to the bank at expiration of the note. If the bank does not give the fiduciary media out again, precisely the same consequences appear as those which come from a decrease in the quantity of money in its broader sense.
- Early Effects of Credit ExpansionThe fact that in the regular course of banking operations the banks issue fiduciary media only as loans to producers and merchants means that they are not used directly for purposes of consumption. Rather, these fiduciary media are used first of all for production, that is to buy factors of production and pay wages. The first prices to rise, therefore, as a result of an increase of the quantity of money in the broader sense, caused by the issue of such fiduciary media, are those of raw materials, semimanufactured products, other goods of higher orders, and wage rates. Only later do the prices of goods of the first order [consumers’ goods] follow. Changes in the purchasing power of a monetary unit, brought about by the issue of fiduciary media, follow a different path and have different accompanying social side effects from those produced by a new discovery of precious metals or by the issue of paper money. Still in the last analysis, the effect on prices is similar in both instances.
Changes in the purchasing power of the monetary unit do not directly affect the height of the rate of interest. An indirect influence on the height of the interest rate can take place as a result of the fact that shifts in wealth and income relationships, appearing as a result of the change in the value of the monetary unit, influence savings and, thus, the accumulation of capital. If a depreciation of the monetary unit favors the wealthier members of society at the expense of the poorer, its effect will probably be an increase in capital accumulation since the well-to-do are the more important savers. The more they put aside, the more their incomes and fortunes will grow.
If monetary depreciation is brought about by an issue of fiduciary media, and if wage rates do not promptly follow the increase in commodity prices, then the decline in purchasing power will certainly make this effect much more severe. This is the “forced savings” which is quite properly stressed in recent literature.Albert Hahn and Joseph Schumpeter have given me credit for the expression “forced savings” or “compulsory savings.” However, three things should not be forgotten. First, it always depends upon the data of the particular case whether shifts of wealth and income, which lead to increased saving, are actually set in motion. Second, under circumstances which need not be discussed further here, by falsifying economic calculation, based on monetary bookkeeping calculations, a very substantial devaluation can lead to capital consumption (such a situation did take place temporarily during the recent inflationary period). Third, as advocates of inflation through credit expansion should observe, any legislative measure which transfers resources to the “rich” at the expense of the “poor” will also foster capital formation.
Eventually, the issue of fiduciary media in such manner can also lead to increased capital accumulation within narrow limits and, hence, to a further reduction of the interest rate. In the beginning, however, an immediate and direct decrease in the loan rate appears with the issue of fiduciary media, but this immediate decrease in the loan rate is distinct in character and degree from the later reduction. The new funds offered on the money market by the banks must obviously bring pressure to bear on the rate of interest. The supply and demand for loan money were adjusted at the interest rate prevailing before the issue of any additional supply of fiduciary media. Additional loans can be placed only if the interest rate is lowered. Such loans are profitable for the banks because the increase in the supply of fiduciary media calls for no expenditure except for the mechanical costs of banking (i.e., printing the notes and bookkeeping). The banks can, therefore, undercut the interest rates which would otherwise appear on the loan market, in the absence of their intervention. Since competition from them compels other money lenders to lower their interest charges, the market interest rate must therefore decline. But can this reduction be maintained? That is the problem.
- Inevitable Effects of Credit Expansion on Interest RatesIn conformity with Wicksell’s terminology, we shall use “natural interest rate” to describe that interest rate which would be established by supply and demand if real goods were loaned in natura [directly, as in barter] without the intermediary of money. “Money rate of interest” will be used for that interest rate asked on loans made in money or money substitutes. Through continued expansion of fiduciary media, it is possible for the banks to force the money rate down to the actual cost of the banking operations, practically speaking that is almost to zero. As a result, several authors have concluded that interest could be completely abolished in this way. Whole schools of reformers have wanted to use banking policy to make credit gratuitous and thus to solve the “social question.” No reasoning person today, however, believes that interest can ever be abolished, nor doubts but what, if the “money interest rate” is depressed by the expansion of fiduciary media, it must sooner or later revert once again to the “natural interest rate.” The question is only how this inevitable adjustment takes place. The answer to this will explain at the same time the fluctuations of the business cycle.
The Currency Theory limited the problem too much. It only considered the situation that was of practical significance for the England of its time — that is, when the issue of fiduciary media is increased in one country while remaining unchanged in others. Under these assumptions, the situation is quite clear: General price increases at home; hence an increase in imports, a drop in commodity exports; and with this, as notes can circulate only within the country, an outflow of metallic money. To obtain metallic money for export, holders of notes present them for redemption; the metallic reserves of the banks decline; and consideration for their own solvency then forces them to restrict the credit offered.
That is the instant at which the business upswing, brought about by the availability of easy credit, is demonstrated to be illusory prosperity. An abrupt reaction sets in. The “money rate of interest” shoots up; enterprises from which credit is withdrawn collapse and sweep along with them the banks which are their creditors. A long persisting period of business stagnation now follows. The banks, warned by this experience into observing restraint, not only no longer underbid the “natural interest rate” but exercise extreme caution in granting credit.
- The Price PremiumIn order to complete this interpretation, we must, first of all, consider the price premium. As the banks start to expand the circulation credit, the anticipated upward movement of prices results in the appearance of a positive price premium. Even if the banks do not lower the actual interest rate any more, the gap widens between the “money interest rate” and the “natural interest rate” which would prevail in the absence of their intervention. Since loan money is now cheaper to acquire than circumstances warrant, entrepreneurial ambitions expand.
New businesses are started in the expectation that the necessary capital can be secured by obtaining credit. To be sure, in the face of growing demand, the banks now raise the “money interest rate.” Still they do not discontinue granting further credit. They expand the supply of fiduciary media issued, with the result that the purchasing power of the monetary unit must decline still further. Certainly the actual “money interest rate” increases during the boom, but it continues to lag behind the rate which would conform to the market, i.e., the “natural interest rate” augmented by the positive price premium.
So long as this situation prevails, the upswing continues. Inventories of goods are readily sold. Prices and profits rise. Business enterprises are overwhelmed with orders because everyone anticipates further price increases and workers find employment at increasing wage rates. However, this situation cannot last forever!
- Malinvestment of Available Capital GoodsThe “natural interest rate” is established at that height which tends toward equilibrium on the market. The tendency is toward a condition where no capital goods are idle, no opportunities for starting profitable enterprises remain unexploited and the only projects not undertaken are those which no longer yield a profit at the prevailing “natural interest rate.” Assume, however, that the equilibrium, toward which the market is moving, is disturbed by the interference of the banks. Money may be obtained below the “natural interest rate.” As a result businesses may be started which weren’t profitable before, and which become profitable only through the lower than “natural interest rate” which appears with the expansion of circulation credit.
Here again, we see the difference which exists between a drop in purchasing power, caused by the expansion of circulation credit, and a loss of purchasing power, brought about by an increase in the quantity of money. In the latter case [i.e., with an increase in the quantity of money in the narrower sense] the prices first affected are either (1) those of consumers’ goods only or (2) the prices of both consumers’ and producers’ goods. Which it will be depends on whether those first receiving the new quantities of money use this new wealth for consumption or production. However, if the decrease in purchasing power is caused by an increase in bank created fiduciary media, then it is the prices of producers’ goods which are first affected. The prices of consumers’ goods follow only to the extent that wages and profits rise.
Since it always requires some time for the market to reach full “equilibrium,” the “static” or “natural”In the language of Knut Wicksell and the classical economists. prices, wage rates and interest rates never actually appear. The process leading to their establishment is never completed before changes occur which once again indicate a new “equilibrium.” At times, even on the unhampered market, there are some unemployed workers, unsold consumers’ goods and quantities of unused factors of production, which would not exist under “static equilibrium.” With the revival of business and productive activity, these reserves are in demand right away. However, once they are gone, the increase in the supply of fiduciary media necessarily leads to disturbances of a special kind.
In a given economic situation, the opportunities for production, which may actually be carried out, are limited by the supply of capital goods available. Roundabout methods of production can be adopted only so far as the means for subsistence exist to maintain the workers during the entire period of the expanded process. All those projects, for the completion of which means are not available, must be left uncompleted, even though they may appear technically feasible — that is, if one disregards the supply of capital. However, such businesses, because of the lower loan rate offered by the banks, appear for the moment to be profitable and are, therefore, initiated. However, the existing resources are insufficient. Sooner or later this must become evident. Then it will become apparent that production has gone astray, that plans were drawn up in excess of the economic means available, that speculation, i.e., activity aimed at the provision of future goods, was misdirected.
Planning for Freedom and Sixteen Other Essays and Addresses[Ludwig von Mises, Planning for Freedom and Sixteen Other Essays and Addresses (1952; South Holland, Ill.: Libertarian Press, 1980), chap. 2, pp. 18–35.]“Middle-of-the-Road Policy Leads to Socialism”
The fundamental dogma of all brands of socialism and communism is that the market economy or capitalism is a system that hurts the vital interests of the immense majority of people for the sole benefit of a small minority of rugged individualists. It condemns the masses to progressing impoverishment. It brings about misery, slavery, oppression, degradation and exploitation of the working men, while it enriches a class of idle and useless parasites.
This doctrine was not the work of Karl Marx. It had been developed long before Marx entered the scene. Its most successful propagators were not the Marxian authors, but such men as Carlyle and Ruskin, the British Fabians, the German professors and the American Institutionalists. And it is a very significant fact that the correctness of this dogma was contested only by a few economists who were very soon silenced and barred from access to the universities, the press, the leadership of political parties and, first of all, public office. Public opinion by and large accepted the condemnation of capitalism without any reservation.
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SocialismBut, of course, the practical political conclusions which people drew from this dogma were not uniform. One group declared that there is but one way to wipe out these evils, namely to abolish capitalism entirely. They advocate the substitution of public control of the means of production for private control. They aim at the establishment of what is called socialism, communism, planning, or state capitalism. All these terms signify the same thing. No longer should the consumers, by their buying and abstention from buying, determine what should be produced, in what quantity and of what quality. Henceforth a central authority alone should direct all production activities.
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Interventionism, Allegedly a Middle-of-the-Road PolicyA second group seems to be less radical. They reject socialism no less than capitalism. They recommend a third system, which, as they say, is as far from capitalism as it is from socialism, which as a third system of society’s economic organization, stands midway between the two other systems, and while retaining the advantages of both, avoids the disadvantages inherent in each. This third system is known as the system of interventionism. In the terminology of American politics it is often referred to as the middle-of-the-road policy.
What makes this third system popular with many people is the particular way they choose to look upon the problems involved. As they see it, two classes, the capitalists and entrepreneurs on the one hand and the wage earners on the other hand, are arguing about the distribution of the yield of capital and entrepreneurial activities. Both parties are claiming the whole cake for themselves. Now, suggest these mediators, let us make peace by splitting the disputed value equally between the two classes. The State as an impartial arbiter should interfere, and should curb the greed of the capitalists and assign a part of the profits to the working classes. Thus it will be possible to dethrone the moloch capitalism without enthroning the moloch of totalitarian socialism.
Yet this mode of judging the issue is entirely fallacious. The antagonism between capitalism and socialism is not a dispute about the distribution of booty. It is a controversy about which two schemes for society’s economic organization, capitalism or socialism, is conducive to the better attainment of those ends which all people consider as the ultimate aim of activities commonly called economic, viz., the best possible supply of useful commodities and services. Capitalism wants to attain these ends by private enterprise and initiative, subject to the supremacy of the public’s buying and abstention from buying on the market. The socialists want to substitute the unique plan of a central authority for the plans of the various individuals. They want to put in place of what Marx called the “anarchy of production” the exclusive monopoly of the government. The antagonism does not refer to the mode of distributing a fixed amount of amenities. It refers to the mode of producing all those goods which people want to enjoy.
The conflict of the two principles is irreconcilable and does not allow for any compromise. Control is indivisible. Either the consumers’ demand as manifested on the market decides for what purposes and how the factors of production should be employed, or the government takes care of these matters. There is nothing that could mitigate the opposition between these two contradictory principles. They preclude each other. Interventionism is not a golden mean between capitalism and socialism. It is the design of a third system of society’s economic organization and must be appreciated as such.
- How Interventionism WorksIt is not the task of today’s discussion to raise any questions about the merits either of capitalism or of socialism. I am dealing today with interventionism alone. And I do not intend to enter into an arbitrary evaluation of interventionism from any preconceived point of view. My only concern is to show how interventionism works and whether or not it can be considered as a pattern of a permanent system for society’s economic organization.
The interventionists emphasize that they plan to retain private ownership of the means of production, entrepreneurship and market exchange. But, they go on to say, it is peremptory to prevent these capitalist institutions from spreading havoc and unfairly exploiting the majority of people. It is the duty of government to restrain, by orders and prohibitions, the greed of the propertied classes lest their acquisitiveness harm the poorer classes. Unhampered or laissez-faire capitalism is an evil. But in order to eliminate its evils, there is no need to abolish capitalism entirely. It is possible to improve the capitalist system by government interference with the actions of the capitalists and entrepreneurs. Such government regulation and regimentation of business is the only method to keep off totalitarian socialism and to salvage those features of capitalism which are worth preserving. On the ground of this philosophy, the interventionists advocate a galaxy of various measures. Let us pick out one of them, the very popular scheme of price control.
- How Price Control Leads to SocialismThe government believes that the price of a definite commodity, e.g., milk, is too high. It wants to make it possible for the poor to give their children more milk. Thus it resorts to a price ceiling and fixes the price of milk at a lower rate than that prevailing on the free market. The result is that the marginal producers of milk, those producing at the highest cost, now incur losses. As no individual farmer or businessman can go on producing at a loss, these marginal producers stop producing and selling milk on the market. They will use their cows and their skill for other more profitable purposes. They will, for example, produce butter, cheese or meat. There will be less milk available for the consumers, not more. This, or course, is contrary to the intentions of the government. It wanted to make it easier for some people to buy more milk. But, as an outcome of its interference, the supply available drops. The measure proves abortive from the very point of view of the government and the groups it was eager to favor. It brings about a state of affairs, which — again from the point of view of the government — is even less desirable than the previous state of affairs which it was designed to improve.
Now, the government is faced with an alternative. It can abrogate its decree and refrain from any further endeavors to control the price of milk. But if it insists upon its intention to keep the price of milk below the rate the unhampered market would have determined and wants nonetheless to avoid a drop in the supply of milk, it must try to eliminate the causes that render the marginal producers’ business unremunerative. It must add to the first decree concerning only the price of milk a second decree fixing the prices of the factors of production necessary for the production of milk at such a low rate that the marginal producers of milk will no longer suffer losses and will therefore abstain from restricting output. But then the same story repeats itself on a remoter plane. The supply of the factors of production required for the production of milk drops, and again the government is back where it started. If it does not want to admit defeat and to abstain from any meddling with prices, it must push further and fix the prices of those factors of production which are needed for the production of the factors necessary for the production of milk. Thus the government is forced to go further and further, fixing step by step the prices of all consumers’ goods and of all factors of production — both human, i.e., labor, and material — and to order every entrepreneur and every worker to continue work at these prices and wages. No branch of industry can be omitted from this all-around fixing of prices and wages and from this obligation to produce those quantities which the government wants to see produced. If some branches were to be left free out of regard for the fact that they produce only goods qualified as non-vital or even as luxuries, capital and labor would tend to flow into them and the result would be a drop in the supply of those goods, the prices of which government has fixed precisely because it considers them as indispensable for the satisfaction of the needs of the masses.
But when this state of all-around control of business is attained, there can no longer be any question of a market economy. No longer do the citizens by their buying and abstention from buying determine what should be produced and how. The power to decide these matters has devolved upon the government. This is no longer capitalism; it is all-around planning by the government, it is socialism.
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The Zwangswirtschaft Type of SocialismIt is, of course, true that this type of socialism preserves some of the labels and the outward appearance of capitalism. It maintains, seemingly and nominally, private ownership of the means of production, prices, wages, interest rates and profits. In fact, however, nothing counts but the government’s unrestricted autocracy. The government tells the entrepreneurs and capitalists what to produce and in what quantity and quality, at what prices to buy and from whom, at what prices to sell and to whom. It decrees at what wages and where the workers must work. Market exchange is but a sham. All the prices, wages, and interest rates are determined by the authority. They are prices, wages, and interest rates in appearance only; in fact they are merely quantity relations in the government’s orders. The government, not the consumers, directs production. The government determines each citizen’s income, it assigns to everybody the position in which he has to work. This is socialism in the outward guise of capitalism. It is the Zwangswirtschaft of Hitler’s German Reich and the planned economy of Great Britain.
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German and British ExperienceFor the scheme of social transformation which I have depicted is not merely a theoretical construction. It is a realistic portrayal of the succession of events that brought about socialism in Germany, in Great Britain and in some other countries.
The Germans, in the first World War, began with price ceilings for a small group of consumers’ goods considered as vital necessities. It was the inevitable failure of these measures that impelled them to go further and further until, in the second period of the war, they designed the Hindenburg plan. In the context of the Hindenburg plan no room whatever was left for a free choice on the part of the consumers and for initiative action on the part of business. All economic activities were unconditionally subordinated to the exclusive jurisdiction of the authorities. The total defeat of the Kaiser swept the whole imperial apparatus of administration away and with it went also the grandiose plan. But when in 1931 Chancellor Brüning embarked anew on a policy of price control and his successors, first of all Hitler, obstinately clung to it, the same story repeated itself.
Great Britain and all the other countries which in the first World War adopted measures of price control, had to experience the same failure. They too were pushed further and further in their attempts to make the initial decrees work. But they were still at a rudimentary stage of this development when the victory and the opposition of the public brushed away all schemes for controlling prices.
It was different in the second World War. Then Great Britain again resorted to price ceilings for a few vital commodities and had to run the whole gamut proceeding further and further until it had substituted all-around planning of the country’s whole economy for economic freedom. When the war came to an end, Great Britain was a socialist commonwealth.
It is noteworthy to remember that British socialism was not an achievement of Mr. Attlee’s Labor Government, but of the war cabinet of Mr. Winston Churchill. What the Labor Party did was not the establishment of socialism in a free country, but retaining socialism as it had developed during the war and in the post-war period. The fact has been obscured by the great sensation made about the nationalization of the Bank of England, the coal mines and other branches of business. However, Great Britain is to be called a socialist country not because certain enterprises have been formally expropriated and nationalized, but because all the economic activities of all citizens are subject to full control of the government and its agencies. The authorities direct the allocation of capital and of manpower to the various branches of business. They determine what should be produced. Supremacy in all business activities is exclusively vested in the government. The people are reduced to the status of wards, unconditionally bound to obey orders. To the businessmen, the former entrepreneurs, merely ancillary functions are left. All that they are free to do is to carry into effect, within a nearly circumscribed narrow field, the decisions of the government departments.
What we have to realize is that price ceilings affecting only a few commodities fail to attain the ends sought. On the contrary. They produce effects which from the point of view of the government are even worse than the previous state of affairs which the government wanted to alter. If the government, in order to eliminate these inevitable but unwelcome consequences, pursues its course further and further, it finally transforms the system of capitalism and free enterprise into socialism of the Hindenburg pattern.
- Crises and UnemploymentThe same is true of all other types of meddling with the market phenomena. Minimum wage rates, whether decreed and enforced by the government or by labor union pressure and violence, result in mass unemployment prolonged year after year as soon as they try to raise wage rates above the height of the unhampered market. The attempts to lower interest rates by credit expansion generate, it is true, a period of booming business. But the prosperity thus created is only an artificial hot-house product and must inexorably lead to the slump and to the depression. People must pay heavily for the easy-money orgy of a few years of credit expansion and inflation.
The recurrence of periods of depression and mass unemployment has discredited capitalism in the opinion of injudicious people. Yet these events are not the outcome of the operation of the free market. They are on the contrary the result of well-intentioned but ill-advised government interference with the market. There are no means by which the height of wage rates and the general standard of living can be raised other than by accelerating the increase of capital as compared with population. The only means to raise wage rates permanently for all those seeking jobs and eager to earn wages is to raise the productivity of the industrial effort by increasing the per-head quota of capital invested. What makes American wage rates by far exceed the wage rates of Europe and Asia is the fact that the American worker’s toil and trouble is aided by more and better tools. All that good government can do to improve the material well-being of the people is to establish and to preserve an institutional order in which there are no obstacles to the progressing accumulation of new capital required for the improvement of technological methods of production. This is what capitalism did achieve in the past and will achieve in the future too if not sabotaged by a bad policy.
- Two Roads to SocialismInterventionism 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. It is as such different from the endeavors of the communists to bring about socialism at one stroke. The difference does not refer to the ultimate end of the political movement; it refers mainly to the tactics to be resorted to for the attainment of an end that both groups are aiming at.
Karl Marx and Friedrich Engels recommended successively each of these two ways for the realization of socialism. In 1848, in the Communist Manifesto, they outlined a plan for the step-by-step transformation of capitalism into socialism. The proletariat should be raised to the position of the ruling class and use its political supremacy “to wrest, by degrees, all capital from the bourgeoisie.” This, they declare, “cannot be effected except by means of despotic inroads on the rights of property and on the conditions of bourgeois production; by means of measures, therefore, which appear economically insufficient and untenable, but which in the course of the movement outstrip themselves, necessitate further inroads upon the old social order, and are unavoidable as a means of entirely revolutionizing the mode of production.” In this vein they enumerate by way of example ten measures.
In later years Marx and Engels changed their minds. In his main treatise, Das Capital, first published in 1867, Marx saw things in a different way. Socialism is bound to come “with the inexorability of a law of nature.” But it cannot appear before capitalism has reached its full maturity. There is but one road to the collapse of capitalism, namely the progressive evolution of capitalism itself. Then only will the great final revolt of the working class give it the finishing stroke and inaugurate the everlasting age of abundance.
From the point of view of this later doctrine Marx and the school of orthodox Marxism reject all policies that pretend to restrain, to regulate and to improve capitalism. Such policies, they declare, are not only futile, but outright harmful. For they rather delay the coming of age of capitalism, its maturity, and thereby also its collapse. They are therefore not progressive, but reactionary. It was this idea that led the German Social Democratic party to vote against Bismarck’s social security legislation and to frustrate Bismarck’s plan to nationalize the German tobacco industry. From the point of view of the same doctrine, the communists branded the American New Deal as a reactionary plot extremely detrimental to the true interests of the working people.
What we must realize is that the antagonism between the interventionists and the communists is a manifestation of the conflict between the two doctrines of the early Marxism and of the late Marxism. It is the conflict between the Marx of 1848, the author of the Communist Manifesto, and the Marx of 1867, the author of Das Capital. And it is paradoxical indeed that the document in which Marx endorsed the policies of the present-day self-styled anti-communists is called the Communist Manifesto.
There are two methods available for the transformation of capitalism into socialism. One is to expropriate all farms, plants, and shops and to operate them by a bureaucratic apparatus as departments of the government. The whole of society, says Lenin, becomes “one office and one factory, with equal work and equal pay,” the whole economy will be organized “like the postal system.” The second method is the method of the Hindenburg plan, the originally German pattern of the welfare state and of planning. It forces every firm and every individual to comply strictly with the orders issued by the government’s central board of production management. Such was the intention of the National Industrial Recovery Act of 1933 which the resistance of business frustrated and the Supreme Court declared unconstitutional. Such is the idea implied in the endeavors to substitute planning for private enterprise.
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Foreign Exchange ControlThe foremost vehicle for the realization of this second type of socialism in industrial countries like Germany and Great Britain is foreign exchange control. These countries cannot feed and clothe their people out of domestic resources. They must import large quantities of food and raw materials. In order to pay for these badly needed imports, they must export manufactures, most of them produced out of imported raw material. In such countries almost every business transaction directly or indirectly is conditioned either by exporting or importing or by both exporting and importing. Hence the government’s monopoly of buying and selling foreign exchange makes every kind of business activity depend on the discretion of the agency entrusted with foreign exchange control. In this country matters are different. The volume of foreign trade is rather small when compared with the total volume of the nation’s trade. Foreign exchange control would only slightly affect the much greater part of American business. This is the reason why in the schemes of our planners there is hardly any question of foreign exchange control. Their pursuits are directed toward the control of prices, wages, and interest rates, toward the control of investment and the limitation of profits and incomes.
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Progressive TaxationLooking backward on the evolution of income tax rates from the beginning of the Federal income tax in 1913 until the present day, one can hardly expect that the tax will not one day absorb 100 percent of all surplus above the income of the average voter. It is this that Marx and Engels had in mind when in the Communist Manifesto they recommended “a heavy progressive or graduated income tax.”
Another of the suggestions of the Communist Manifesto was “abolition of all right of inheritance.” Now, neither in Great Britain nor in this country have the laws gone up to this point. But again, looking backward upon the past history of the estate taxes, we have to realize that they more and more have approached the goal set by Marx. Estate taxes of the height they have already attained for the upper brackets are no longer to be qualified as taxes. They are measures of expropriation.
The philosophy underlying the system of progressive taxation is that the income and the wealth of the well-to-do classes can be freely tapped. What the advocates of these tax rates fail to realize is that the greater part of the income taxed away would not have been consumed but saved and invested. In fact, this fiscal policy does not only prevent the further accumulation of new capital. It brings about capital decumulation. This is certainly today the state of affairs in Great Britain.
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The Trend Toward SocialismThe course of events in the past thirty years shows a continuous, although sometimes interrupted progress toward the establishment in this country of socialism of the British and German pattern. The United States embarked later than these two other countries upon this decline and is today still farther away from its end. But if the trend of this policy will not change, the final result will only in accidental and negligible points differ from what happened in the England of Attlee and in the Germany of Hitler. The middle-of-the-road policy is not an economic system that can last. It is a method for the realization of socialism by installments.
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Loopholes CapitalismMany people object. They stress the fact that most of the laws which aim at planning or at expropriation by means of progressive taxation have left some loopholes which offer to private enterprise a margin within which it can go on. That such loopholes still exist and that thanks to them this country is still a free country is certainly true. But this “loopholes capitalism” is not a lasting system. It is a respite. Powerful forces are at work to close these loopholes. From day to day the field in which private enterprise is free to operate is narrowed down.
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The Coming of Socialism is Not InevitableOf course, this outcome is not inevitable. The trend can be reversed as was the case with many other trends in history. The Marxian dogma according to which socialism is bound to come “with the inexorability of a law of nature” is just an arbitrary surmise devoid of any proof.
But the prestige which this vain prognostic enjoys not only with the Marxians, but with many self-styled non-Marxians, is the main instrument of the progress of socialism. It spreads defeatism among those who otherwise would gallantly fight the socialist menace. The most powerful ally of Soviet Russia is the doctrine that the “wave of the future” carries us toward socialism and that it is therefore “progressive” to sympathize with all measures that restrict more and more the operation of the market economy.
Even in this country which owes to a century of “rugged individualism” the highest standard of living ever attained by any nation, public opinion condemns laissez-faire. In the last fifty years, thousands of books have been published to indict capitalism and to advocate radical interventionism, the welfare state, and socialism. The few books which tried to explain adequately the working of the free-market economy were hardly noticed by the public. Their authors remained obscure, while such authors as Veblen, Commons, John Dewey, and Laski were exuberantly praised. It is a well-known fact that the legitimate stage as well as the Hollywood industry are no less radically critical of free enterprise than are many novels. There are in this country many periodicals which in every issue furiously attack economic freedom. There is hardly any magazine of opinion that would plead for the system that supplied the immense majority of the people with good food and shelter, with cars, refrigerators, radio sets, and other things which the subjects of other countries call luxuries.
The impact of this state of affairs is that practically very little is done to preserve the system of private enterprise. There are only middle-of-the-roaders who think they have been successful when they have delayed for some time an especially ruinous measure. They are always in retreat. They put up today with measures which only ten or twenty years ago they would have considered as undiscussable. They will in a few years acquiesce in other measures which they today consider as simply out of the question. What can prevent the coming of totalitarian socialism is only a thorough change in ideologies.
What we need is neither anti-socialism nor anti-communism but an open positive endorsement of that system to which we owe all the wealth that distinguishes our age from the comparatively straitened conditions of ages gone by.