Other Schools of Thought: Recent Episodes
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Monopoly and Competition includes the nature of competition, criticism of neoclassical, works on the nature of monopoly, antitrust legislation, unions.
Many conservatives, in trying to steer the USA away from "wokeism," fail to understand that their “national greatness” schemes are just as harmful.
Original Article: ""National Greatness" Is Not the Appropriate Response to "Wokeism""
Peter St. Onge joins Bob to discuss his latest piece at Mises.org on "China's Doom Loop." They cover a wide range of topics, including the contrast in leadership between Xi Jinping and Deng Xiaoping, the dollar as global reserve currency, the Belt and Road Initiative, and Jim Rogers' prediction that the 21st century would belong to the Chinese empire.
Peter's Article on China: Mises.org/HAP410a
Join us in Nashville on September 23rd for a no-holds-barred discussion against the regime. Use Code "HA23" for $45 off admission: Mises.org/Nashville23
Following the collapse of the USSR, many socialists pinned their hopes upon the development of a "market socialism" that would be economically efficient and create equality. Marxist philosopher G.A. Cohen wisely dissented.
Original Article: "What Marxists Say about "Market Socialism""
Social democrats are so desperate to cast off limits on government that they'll embrace anything that justifies their ambitions. So they invent theories of money that are very, very wrong.
Original Article: "Progressives Have Corrupted Not Only Money, but Its History as Well"
Michael Rectenwald talks with Paul Gottfried about Paleoconservatism, the left, Wokism, the identity and ethos of the ruling elite, and decentralization.
Join us in Nashville on September 23rd for a no-holds-barred discussion against the regime. Use code "Rekt23" for $45 off admission: Mises.org/Nashville23
By corrupting the meaning of inflation, mainstream economists have given a false picture of what happens when monetary authorities expand the money supply. Mises and Rothbard understood.
Original Article: "Taking Back the Meaning of "Inflation""
Professor Quinn Slobodian believes that free markets must lead to tyrannical worker exploitation, and socialism is the only solution. In truth, market competition is the answer.
Original Article: "Cracked-Up Slobodian"
David Gordon take a critical look at Markus Gabriel's Moral Progress in Dark Times, and although he finds parts that are disturbing, he also discovers important areas of agreement.
Original Article: "Outside the Universe?"
Michael and guest co-host Ben Ahdoot talk with Ron Unz about RFK, Jr., Ron's American Prava series, the Unz Review, the Great Reset, censorship, the origins of SARS-CoV-2, and more.
Even Marx must dimly recognize that not "material productive forces," not even "classes," act in the real world, but only individual consciousness and individual choice. Even in the Marxian analysis, each class, or the individuals within it, must become conscious of its "true" class interests in order to act upon pursuing or achieving them. To Marx, each individual's thinking, his values and theories, are all determined, not by his personal self-interest, but by the interest of the class to which he supposedly belongs. This is the first fatal flaw in the argument; why in the world should each individual ever hold his class higher than himself? Second, according to Marx, this class interest determines his thoughts and viewpoints, and must do so, because each person is only capable of "ideology" or false consciousness in the interest of his class. He is not capable of a disinterested, objective search for truth, nor of pursuit of his own interest or of that of all mankind. But, as von Mises has pointed out, Marx's doctrine pretends to be pure, non-ideological science, and yet written expressly to advance the class interest of the proletariat. But, while all "bourgeois" economics and all other disciplines of thought were interpreted by Marx as false by definition, as "ideological" rationalizations of bourgeois class interest, the Marxists
were not consistent enough to assign to their own doctrines merely ideological character. The Marxian tenets, they implied, are not ideologies. They are a foretaste of the knowledge of the future classless society which, freed from the fetters of class conflicts, will be in a position to conceive pure knowledge, untainted by ideological blemishes. Ludwig von Mises, Theory and History (1957, Auburn, Ala.: Mises Institute, 1985), p. 126, n3.
David Gordon has aptly summed up this point:
If all thought about social and economic matters is determined by class position, what about the Marxist system itself? If, as Marx proudly proclaimed, he aimed at providing a science for the working class, why should any of his views be accepted as true? Mises rightly notes that Marx's view is self-refuting: if all social thought is ideological, then this proposition is itself ideological and the grounds for believing it have been undercut. In his Theories of Surplus Value, Marx cannot contain his sneering at the "apologetics" of various bourgeois economists. He did not realize that in his constant jibes at the class bias of his fellow economists, he was but digging the grave of his own giant work of propaganda on behalf of the proletariat.David Gordon, "Mises Contra Marx," Free Market, 5 (July 1987), pp. 2–3.
Von Mises also raises the point that it is absurd to believe that the interests of any class, including the capitalists, could ever be served better by a false than by a correct doctrine.For the refutation of another, allied, point in Marx's ideology doctrine, that each economic class has a different logical structure of mind ("polylogism"), see Ludwig von Mises, Human Action (New Haven, Conn.: Yale University Press, 1949), pp. 72–91.To Marx, the point of philosophy was only the achievement of some practical goal. But if, as in pragmatism, truth is only "what works," then surely the interests of the bourgeoisie would not be served by clinging to a false theory of society. If the Marxian answer holds, as it has, that false theory is necessary to justify the existence of capitalist rule, then, as von Mises points out, from the Marxian point of view itself the theory should not be necessary. Since each class ruthlessly pursues its own interest, there is no need for the capitalists to justify their rule and their alleged exploitation to themselves. There is also no need to use these false doctrines to keep the proletariat subservient, since, to Marxists, the rule or the overthrow of a given social system depends on the material productive forces, and there is no way by which consciousness can delay this development or speed it up. Or, if there are such ways, and the Marxists often implicitly concede this fact, then there is a grave and self-defeating flaw in the heart of Marxian theory itself.
It is a well-known irony and another deep flaw in the Marxian system that, for all the Marxian exaltation of the proletariat and the "proletarian mind," all leading Marxists, beginning with Marx and Engels, were emphatically bourgeois themselves. Marx was the son of a wealthy lawyer, his wife was a member of the Prussian nobility, and his brother-in-law Prussian minister of the interior. Friedrich Engels, his lifelong benefactor and collaborator, was the son of a wealthy manufacturer, and himself a manufacturer. Why were not their views and doctrines also determined by bourgeois class interests? What permitted their consciousness to rise above a system so powerful that it determines the views of everyone else?
In this way, every determinist system attempts to provide an escape-hatch for its own believers, who are somehow able to escape the determinist laws that afflict everyone else. Unwittingly, these systems become in that way self-contradictory and self-refuting. In the 20th century, Marxists such as the German sociologist Karl Mannheim attempted to elevate this escape-hatch into High Theory: that somehow, "intellectuals" are able to "float free," to levitate above the laws that determine all other classes.
[This article is excerpted from volume 2, chapter 12 of An Austrian Perspective on the History of Economic Thought (1995). An MP3 audio file of this chapter, narrated by Jeff Riggenbach, is available for download.]
Game theory done the wrong way eliminates individual choice.
Download lecture slides at Mises.org/MU23_PPT_30.
Recorded at the Mises Institute in Auburn, Alabama, on 27 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.
Mercantilism has had a "good press" in recent decades, in contrast to 19th-century opinion. In the days of Adam Smith and the classical economists, mercantilism was properly regarded as a blend of economic fallacy and state creation of special privilege. But in our century, the general view of mercantilism has changed drastically: Keynesians hail mercantilists as prefiguring their own economic insights; Marxists, constitutionally unable to distinguish between free enterprise and special privilege, hail mercantilism as a "progressive" step in the historical development of capitalism; socialists and interventionists salute mercantilism as anticipating modern state building and central planning.
Mercantilism, which reached its height in the Europe of the 17th and 18th centuries, was a system of statism which employed economic fallacy to build up a structure of imperial state power, as well as special subsidy and monopolistic privilege to individuals or groups favored by the state. Thus, mercantilism held that exports should be encouraged by the government and imports discouraged. Economically, this seems to be a tissue of fallacy; for what is the point of exports if not to purchase imports, and what is the point of piling up monetary bullion if the bullion is not used to purchase goods?
But mercantilism cannot be viewed satisfactorily as merely an exercise in economic theory. The mercantilist writers, indeed, did not consider themselves economic theorists, but practical men of affairs who argued and pamphleteered for specific economic policies, generally for policies which would subsidize activities or companies in which those writers were interested. Thus, a policy of favoring exports and penalizing imports had two important practical effects: it subsidized merchants and manufacturers engaged in the export trade, and it threw up a wall of privilege around inefficient manufacturers who formerly had to compete with foreign rivals. At the same time, the network of regulation and its enforcement built up the state bureaucracy as well as national and imperial power.
The famous English Navigation Acts, which played a leading role in provoking the American Revolution, are an excellent example of the structure and purpose of mercantilist regulation. The network of restriction greatly penalized Dutch and other European shippers, as well as American shipping and manufacturing, for the benefit of English merchants and manufacturers, whose competition was either outlawed or severely taxed and crippled. The use of the state to cripple or prohibit one's competition is, in effect, the grant by the state of monopolistic privilege; and such was the effect for Englishmen engaged in the colonial trade.
A further consequence was the increase of tax revenue to build up the power and wealth of the English government, as well as the multiplying of the royal bureaucracy needed to administer and enforce the regulations and tax decrees. Thus, the English government, and certain English merchants and manufacturers, benefited from these mercantilist laws, while the losers included foreign merchants, American merchants and manufacturers, and, above all, the consumers of all lands, including England itself. The consumers lost, not only because of the specific distortions and restrictions on production of the various decrees, but also from the hampering of the international division of labor imposed by all the regulations.
Adam Smith's Refutation Mercantilism, then, was not simply an embodiment of theoretical fallacies; for the laws were only fallacies if we look at them from the point of view of the consumer, or of each individual in society. They are not fallacious if we realize that their aim was to confer special privilege and subsidy on favored groups; since subsidy and privilege can only be conferred by government at the expense of the remainder of its citizens, the fact that the bulk of the consumers lost in the process should occasion little surprise."The laws and proclamations … were the product of conflicting interests of varying degrees of respectability. Each group, economic, social, or religious, pressed constantly for legislation in conformity with its special interest. The fiscal needs of the crown were always an important and generally a determining influence on the course of trade legislation. Diplomatic considerations also played their part in influencing legislation, as did the desire of the crown to award special privileges, con amore, to its favorites, or to sell them, or to be bribed into giving them, to the highest bidders.… The mercantilist literature, on the other hand, consisted in the main of writings by or on behalf of 'merchants' or businessmen … tracts which were partly or wholly, frankly or disguisedly, special pleas for special economic interests. Freedom for themselves, restrictions for others, such was the essence of the usual program of legislation of the mercantilist tracts of merchant authorship." Jacob Viner, Studies in the Theory of International Trade (New York: Harper and Bros., 1937), pp. 58–59.
Contrary to general opinion, the classical economists were not content merely to refute the fallacious economics of such mercantilist theories as bullionism or protectionism; they also were perfectly aware of the drive for special privilege that propelled the "mercantile system." Thus, Adam Smith pointed to the fact that linen yarn could be imported into England duty free, whereas heavy import duties were levied on finished woven linen. The reason, as seen by Smith, was that the numerous English yarn spinners did not constitute a strong pressure group, whereas the master weavers were able to pressure the government to impose high duties on their product, while making sure that their raw material could be bought at as low a price as possible. He concluded that the
motive of all these regulations, is to extend our own manufactures, not by their own improvement, but by the depression of those of all our neighbors, and by putting an end, as much as possible, to the troublesome competition of such odious and disagreeable rivals.
Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer. … But in the mercantile system, the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce.
In the restraints upon the importation of all foreign commodities which can come into competition with those of our own growth, or manufacture, the interest of the home-consumer is evidently sacrificed to that of the producer. It is altogether for the benefit of the latter, that the former is obliged to pay that enhancement of price which this monopoly almost always occasions.
It is altogether for the benefit of the producer that bounties are granted upon the exportation of some of his productions. The home-consumer is obliged to pay, first, the tax which is necessary for paying the bounty, and secondly, the still greater tax which necessarily arises from enhancement of the price of the commodity in the home market.Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (New York: Modern Library, 1937), p. 625.
Before Keynes Mercantilism was not only a policy of intricate government regulations; it was also a pre-Keynesian policy of inflation, of lowering interest rates artificially, and of increasing "effective demand" by heavy government spending and sponsorship of measures to increase the quantity of money. Like the Keynesians, the mercantilists thundered against "hoarding," and urged the rapid circulation of money throughout the economy; furthermore, they habitually pointed to an alleged "scarcity of money" as the cause of depressed trade or unemployment.See the laudatory "Note on Mercantilism" in chap. 23 of John Maynard Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt, Brace, 1936). Thus, in a prefiguration of the Keynesian "multiplier," William Potter, one of the first advocates of paper money in the Western world (1650), wrote:
The greater quantity … of money … the more commodity they sell, that is, the greater is their trade. For whatsoever is taken amongst men … though it were ten times more than now it is, yet if it be one way or other laid out by each man, as fast as he receives it … it doth occasion a quickness in the revolution of commodity from hand to hand … much more than proportional to such increase of money.Quoted in Viner, Studies in the Theory of International Trade, p. 38.
And the German mercantilist F.W. von Schrötter wrote of the importance of money changing hands, for one person's spending is another's income; as money "pass[es] from one hand to another … the more useful it is to the country, for … the sustenance of so many people is multiplied," and employment increased. Thrift, according to von Schrötter, causes unemployment, since saving withdraws money from circulation. And John Cary wrote that if everyone spent more, everyone would obtain larger incomes, and "might then live more plentifully."Quoted in Eli F. Heckscher, Mercantilism, 2nd ed. (New York: Macmillan, 1955), 2, pp. 208–9. Also see Edgar S. Furniss, The Position of the Laborer in a System of Nationalism (New York: Kelley and Millman, 1957), p. 41.
Historians have had an unfortunate tendency to depict the mercantilists as inflationists and therefore as champions of the poor debtors, while the classical economists have been considered hardhearted apologists for the status quo and the established order. The truth was almost precisely the reverse. In the first place, inflation did not benefit the poor; wages habitually lagged behind the rise in prices during inflations, especially behind agricultural prices. Furthermore, the "debtors" were generally not the poor but large merchants and quasi-feudal landlords, and it was the landlords who benefited triply from inflation: from the habitually steep increases in food prices, from the lower interest rates and the lower purchasing power of money in their role as debtors, and from the particularly large increases in land values caused by the fall in interest rates. In fact, the English government and Parliament was heavily landlord dominated, and it is no coincidence that one of the main arguments of the mercantilist writers for inflation was that it would greatly raise the value of land.
Exploitation of Workers Far from being true friends of laborers, the mercantilists were frankly interested in exploiting their labor to the utmost; full employment was urged as a means of maximizing such exploitation. Thus, the mercantilist William Petyt wrote frankly of labor as "capital material … raw and undigested … committed into the hands of supreme authority, in whose prudence and disposition it is to improve, manage, and fashion it to more or less advantage."Quoted in ibid., p. 41. Professor Furniss comments that
it is characteristic of these writers that they should be so readily disposed to trust in the wisdom of the civil power to "improve, manage, and fashion" the economic "raw material" of the nation. Bred of this confidence in statecraft, proposals were multiplied for exploiting the labor of the people as the chief source of national wealth, urging upon the rulers of the nation diverse schemes for directing and creating employment.Ibid.
The mercantilists' attitude toward labor and full employment is also indicated by their dislike of holidays, by which the "nation" was deprived of certain amounts of labor; the desire of the individual worker for leisure was never considered worthy of note.
Compulsory Employment The mercantilist writers realized frankly that corollary to a guarantee of full employment is coerced labor for those who don't wish to work or to work in the employment desired by the guarantors. One writer summed up the typical view: "it is absolutely necessary that employment should be provided for persons of every age that are able and willing to work, and the idle and refractory should be sent to the house of correction, there to be detained and constantly kept to labor." Henry Fielding wrote that "the constitution of a society in this country having a claim on all its members, has a right to insist on the labor of the poor as the only service they can render." And George Berkeley asked rhetorically "whether temporary servitude would not be the best cure for idleness and beggary?… Whether sturdy beggars may not be seized and made slaves to the public for a certain term of years?"See ibid., pp. 79–84. William Temple proposed a scheme to send the children of laborers, from the age of four on, to public workhouses, where they would be kept "fully employed" for at least twelve hours a day, "for by these means we hope that the rising generation will be habituated to constant employment." And another writer expressed his amazement that parents tended to balk at these programs:
Parents … from whom to take for time the idle, mischievous, least useful and most burdensome part of their family to bring them up without any care or expense to themselves in habits of industry and decency is a very great relief; are very much adverse to sending their children … from what cause, it is difficult to tell.Ibid., p. 115.
Perhaps the most misleading legend about the classical economists is that they were apologists for the status quo; on the contrary, they were "radical" libertarian opponents of the established Tory mercantilist order of big government, restrictionism, and special privilege. Thus, Professor Fetter writes that during the first half of the 19th century, the
Quarterly Review and Blackwood's Edinburgh Magazine, staunch supporters of the established order, and opponents of change in virtually all fields, had no sympathy with political economy or with laissez-faire, and were constantly urging maintenance of tariffs, expenditures by government, and suspension of the gold standard in order to stimulate demand and increase employment. On the other hand the Westminster's [journal of the classical liberals] support of the gold standard and free trade, and its opposition to any attempt to stimulate the economy by positive government action, came not from believers in authority or from defenders of the dominant social force behind authority, but from the most articulate intellectual radicals of the time and the severest critics of the established order.Frank W. Fetter, "Economic Articles in the Westminster Review and their Authors, 1824–51," Journal of Political Economy (December 1962): 572.
Southey Favors Nationalization In contrast, let us consider the Quarterly Review, a high Tory journal which always "assumed that the unreformed Parliament, the dominance of a landed aristocracy … the supremacy of the established church, discrimination of some sort against Dissenter, Catholic, and Jew, and the keeping of the lower classes in their place were the foundations of a stable society." Their leading writer on economic problems, the poet Robert Southey, repeatedly urged government expenditure as a stimulant to economic activity and attacked England's resumption of specie payments (return to the gold standard) after the Napoleonic Wars. Indeed, Southey proclaimed that an increase in taxes or in the public debt was never a cause for alarm, since they "give a spur to the national industry, and call forth national energies." And, in 1816, Southey advocated a large public works program for relief of unemployment and depression.See Frank W. Fetter, "Economic Articles in the Quarterly Review and their Authors, 1809–52," Journal of Political Economy (February 1958): 48–51.
The Quarterly Review's desire for stringent government control and even ownership of the railroads was at least frankly linked with its hatred of the benefits that railroads were bringing to the mass of the British population. Thus, where the classical liberals hailed the advent of railroads as bringing cheaper transportation and as thereby increasing the mobility of labor, the Quarterly's John Croker denounced railroads as "rendering travel too cheap and easy — unsettling the habits of the poor, and tempting them to improvident migration."Ibid., p. 62.
The arch-Tory, William Robinson, who often denounced his fellow Tories for compromising even slightly on such principles as high tariffs and no political rights for Catholics, wrote many pre-Keynesian articles, advocating inflation to stimulate production and employment, and denouncing the hard-money effects of the gold standard. And the Tory Sir Archibald Alison, inveterate advocate of inflation, who even ascribed the fall of the Roman Empire to a shortage of money, frankly admitted that it was the "agricultural class" that had suffered from the lack of inflation since resumption of the gold standard.See Frank W. Fetter, "Economic Articles in Blackwood's Edinburgh Magazine, and their Authors, 1817–1853," Scottish Journal of Political Economy (June 1960): 91–96.
Controls Under Elizabeth A few case studies will illustrate the nature of mercantilism, the reasons for mercantilist decrees, and some of the consequences that they brought to the economy.
One important part of mercantilist policy was wage controls. In the 14th century, the Black Death killed one-third of the laboring population of England, and naturally brought sharp advances in wage rates. Wage controls came in as wage ceilings, in desperate attempts by the ruling classes to coerce wage rates below their market rates. And since the vast bulk of employed laborers were agricultural workers, this was clearly legislation for the benefit of the feudal landlords and to the detriment of the workers.
Textiles vs. Agriculture The result was a persistent shortage of agricultural and other unskilled laborers for centuries, a shortage mitigated by the fact that the English government did not try to enforce the laws very rigorously. When Queen Elizabeth tried to enforce the wage controls strictly, the agricultural labor shortage was aggravated, and the landlords found their statutory privileges defeated by the more subtle laws of the market. Consequently, Elizabeth passed, in 1563, the famous Statute of Artificers, imposing comprehensive labor control.
Attempting to circumvent the shortage caused by previous interventions, the statute installed forced labor on the land. It provided that:
whoever had worked on the land until the age of 12 be compelled to remain there and not leave for work at any other trade;
all craftsmen, servants, and apprentices who had no great reputation in their fields be forced to harvest wheat; and
unemployed persons were compelled to work as agricultural laborers.
In addition, the statute prohibited any worker from quitting his job unless he had a license proving that he had already been hired by another employer. And, furthermore, justices of the peace were ordered to set maximum wage rates, geared to changes in the cost of living.
The statute also acted to restrict the growth of the woolen textile industry; this benefited two groups: the landlords, who would no longer lose laborers to industry and suffer the pressure of paying higher wage rates, and the textile industry itself, which received the privilege of keeping out the competition of new firms or new craftsmen. The coerced immobility of labor, however, led to suffering for all workers, including textile craftsmen; and to remedy the latter, Queen Elizabeth imposed a minimum wage law for textile craftsmen, thundering all the while that the wicked clothing manufacturers were responsible for the craftsmen's plight. Fortunately, textile employers and workers persisted in agreeing on terms of employment below the artificially set wage rate, and heavy textile unemployment did not yet arise.
Enforcing Bad Laws The programs of wage controls could not cause undue dislocations until they were stringently enforced, and this came to pass under King James I, the first Stuart king of England. Upon assuming the throne in 1603, James decided to enforce the Elizabethan control program with great stringency, including extremely heavy penalties against employers. Rigorous enforcement was imposed on minimum-wage controls for textile craftsmen, and on maximum-wage decrees for agricultural laborers and servants.
The consequences were the inevitable result of tampering with the laws of the market: chronic severe unemployment throughout the textile industry, coupled with a chronic severe shortage of agricultural labor. Misery and discontent spread throughout the land. Citizens were fined for paying their servants more than ceiling wages, and servants fined for accepting the pay. James, and his son Charles I, decided to stem the tide of unemployment in textiles by compelling employers to remain in business even when they were losing money. But even though many employers were jailed for infractions, such Draconian measures could not keep the textile industry from depression, stagnation, and unemployment. Certainly the consequences of the policy of wage controls were one of the reasons for the overthrow of the Stuart tyranny in the mid-17th century.
Mercantilist Practices in Colonial Massachusetts The young colony of Massachusetts engaged in a great many mercantilist ventures, with invariably unfortunate results. One attempt was a comprehensive program of wage and price controls, which had to be abandoned by the 1640s. Another was a series of subsidies to try to create industries in the colony before they were economically viable, and therefore before they would be created on the free market. One example was iron manufacture. Early iron mines in America were small and located in coastal swamps ("bog iron"); and primarily manufactured, or "wrought," iron was made cheaply in local bloomeries, at an open hearth. The Massachusetts government decided, however, to force the creation of the more imposing — and far more expensive — indirect process of wrought iron manufacture at a blast furnace and forge. The Massachusetts legislature therefore decreed that any new iron mine must have a furnace and forge constructed near it within ten years of its discovery. Not content with this measure, the legislature in 1645 granted a new Company of Undertakers for an Iron Works in New England, a 21-year monopoly of all iron making in the colony. In addition, the legislature granted the company generous subsidies of timberland.
But despite these subsidies and privileges, as well as additional large grants of timberland from the town governments of Boston and Dorchester, the Company's venture failed dismally and almost immediately. The Company did its best to salvage its operations, but to no avail. A few years later, John Winthrop, Jr., the main promoter of the older venture, induced the authorities of New Haven colony to subsidize an iron manufacture of his at Stony River. From the governments of New Haven colony and New Haven township, Winthrop was granted a whole host of special subsidies: land grants, payment of all costs of building the furnace, a dam on the river, and the transportation of fuel. One of Winthrop's partners in the venture was the deputy governor of the colony, Stephen Goodyear, who was thus able to use the power of government to grant himself substantial privileges. But again, economic law was not to be denied, and the ironworks proved to be another rapidly failing concern.
Debtors' Relief: A Scheme to Aid the Rich One of the most vigorously held tenets of the dominant neo-Marxist historians of America has been the view that inflation and debtors' relief were always measures of the "lower classes," the poor farmer-debtors and sometimes urban workers, engaging in a Marxian class struggle against conservative merchant-creditors. But a glance at the origins of debtors' relief and paper money in America easily shows the fallacy of this approach; inflation and debtors' relief were mercantilist measures, pursued for familiar mercantilist ends.
Debtors' relief began in the colonies, in Massachusetts in 1640. Massachusetts had experienced a sharp economic crisis in 1640, and the debtors turned immediately to special privilege from the government. Obediently, the legislature of Massachusetts passed the first of a series of debtors' relief laws in October, including a minimum-appraisal law to force creditors to accept insolvent debtors' property at an arbitrarily inflated assessment, and a legal-tender provision to compel creditors to accept payment in an inflated, fixed rate in the monetary media of the day: corn, cattle, or fish.
Further privileges to debtors were passed in 1642 and 1644, the latter permitting a debtor to escape foreclosure simply by leaving the colony. The most drastic proposal went to the amazing length of providing that the Massachusetts government assume all private debts that could not be paid! This plan was passed by the upper house, but defeated in the house of deputies.
The fact that this astounding bill was passed by the upper house — the council of magistrates — is evidence enough that this was not a proto-Marxian eruption of poor debtors. For this council was the ruling group of the colony, consisting of the wealthiest merchants and landowners. If not for historical myths, it should occasion no surprise that the biggest debtors were the wealthiest men of the colony, and that in the mercantilist era a drive for special privilege should have had typically mercantilist aims. On the other hand, it is also instructive that the more democratic and popularly responsible lower house was the one far more resistant to the debt relief program.
Paper Money Inflation Massachusetts has the dubious distinction of having promulgated the first governmental paper money in the history of the Western world — indeed, in the history of the entire world outside of China. The fateful issue was made in 1690, to pay for a plunder expedition against French Canada that had failed drastically. But even before this, the leading men of the colony were busy proposing paper-money schemes. The Rev. John Woodbridge, greatly influenced by William Potter's proposals for an inflationary land bank, proposed one of his own, as did Governor John Winthrop, Jr., of Connecticut. Captain John Blackwell proposed a land bank in 1686, the notes of which would be legal tender in the colony, and such wealthy leaders of the colony as Joseph Dudley, William Stoughton, and Wait Winthrop were prominently associated with the plan.
The most famous of the inflationary land-bank schemes was the Massachusetts Land Bank of 1740, which has generally been limned in neo-Marxist terms as the creation of the mass of poor farmer-debtors over the opposition of wealthy merchant-creditors of Boston. In actuality, its founder, John Colman, was a prominent Boston merchant and real-estate speculator; and its other supporters had similar interest — as did the leading opponents, who were also Boston businessmen. The difference is that the advocates had generally been receivers of land grants from the Massachusetts government, and desired inflation to raise the value of their speculatively held land claims.See the illuminating study by Dr. George Athan Billias, "The Massachusetts Land Bankers of 1740," University of Maine Bulletin (April 1959). Once again — a typically mercantilist project.
Keynes Wouldn't Learn From just a brief excursion into mercantilist theory and practice, we may conclude that Lord Keynes might have come to regret his enthusiastic welcome to the mercantilists as his forbears. For they were his forbears indeed; and the precursors as well of the interventions, subsidies, regulations, grants of special privilege, and central planning of today. But in no way could they be considered as "progressives" or lovers of the common man; on the contrary, they were frank exponents of the Old Order of statism, hierarchy, landed oligarchy, and special privilege — that entire "Tory" regime against which laissez-faire liberalism and classical economics leveled their liberating "revolution" on behalf of the freedom and prosperity of all productive individuals in society, from the wealthiest to the humblest. Perhaps the modern world will learn the lesson that the contemporary drive for a new mercantilism may be just as profoundly "reactionary," as profoundly opposed to the freedom and prosperity of the individual, as its pre-19th-century ancestor.
This article originally appeared in the Freeman, 1963, Mises Daily, May 12, 2010, and chapter 34 in Economic Controversies, pp. 641 –54.]
Bob walks through a recent interview of MMT champion Warren Mosler, in which he claims that Fed rate hikes lead to larger government interest expenses and hence support economic growth and inflation. Bob presents both theoretical and empirical evidence against Mosler's claims.
Bob's Debate with Warren Mosler: Mises.org/HAP403a Bob's Review of Stephanie Kelton: Mises.org/HAP403b Bob's EconLib Article on Austerity: Mises.org/HAP403c Technical Article on Why the Treasury Can't Overdraft: Mises.org/HAP403d
Join us in Nashville on September 23rd for a no-holds-barred discussion against the regime: Mises.org/Nashville23
Mises Institute Fellow Patrick Newman joins Bob to discuss a recent tweet from Stephanie Kelton, which argued that the government's "red ink makes our black ink possible." Patrick and Bob point out that these MMT tautologies are very misleading at best. Patrick also lays out the argument in his journal article, saying that MMT's debt monetization won't cause a boom-bust cycle, but will still reduce living standards.
University of Rochester economist Steve Landsburg joins Bob to discuss the abysmal performance of ChatGPT on his undergraduate exam. They also discuss the importance of market prices in guiding behavior and the unexpected problems with the government handing out "free" goodies.
Bob's article "Superman Needs an Agent:" Mises.org/HAP400a Steven's Book The Armchair Economist: Mises.org/HAP400b More Economic brainteasers: Mises.org/HAP400c
Per Bylund joins Bob to discuss his new paper at the QJAE, which points out several flaws in the MMT claim that money is valued in order to pay taxes.
Per's QJAE article: Mises.org/HAP398a
Bob originally invited Brian Albrecht (Chief Economist of the International Center for Law & Economics) to discuss the work of Armen Alchian, but on the day of recording, Robert Lucas happened to die.
Bob and Brian discuss rational expectations, real business cycle theory, and how Alchian cracked the military's top secrets.
Brian on Alchian's famous "Costs and Outputs" paper: Mises.org/HAP396a
[In his 20s, Murray Rothbard wrote a newsletter called The Vigil, in which he wrote the following review of William F. Buckley, Jr., "A Young Republican View," The Commonweal, January 25, 1952.]
Buckley's article in the recent issue of this Catholic magazine is significant in its revelation of the full extent of Buckley's views. As a result, we congratulate ourselves for treating the Buckley Boom on the intellectual Right with considerable skepticism. The article is completely deplorable, and reveals the morass into which the individualists of today have sunk.
The brief article begins splendidly, with the affirmation that our enemy is the State, and excellent quotations from such great individualists as Albert Jay Nock, Herbert Spencer, and H.L. Mencken. Buckley declares that the great issue of our time is freedom vs. Statism, and sides with Spencer that the State is "begotten of aggression and by aggression." He goes on to castigate the Republican Party for offering no real alternative to the Statist power-drive. It begins to appear that young Buckley is indeed a welcome newcomer to the libertarian ranks.
But such an illusion is not destined to remain very long. It soon appears that Buckley is really, in 1952 terms, a totalitarian socialist, and what is more, admits it.
He admits that his opposition to Statism, eloquently expressed at the beginning, is merely romantic academicism. For Buckley favors "the extensive and productive tax laws that are needed to support a vigorous anti-Communist foreign policy," and by implication supports ECA aid and 50-billion dollar "defense" budgets. He declares that the "thus far invincible aggressiveness of the Soviet Union imminently threatens U.S. security," and that therefore "we have got to accept Big Government for the duration — for neither an offensive nor a defensive war can be waged … except through the instrumentality of a totalitarian bureaucracy within our shores." Therefore, he concludes, we must all support "large armies and air forces, atomic energy, central intelligence, war production boards and the attendant centralization of power in Washington — even with Truman at the reins of it all."
In the light of this errant nonsense, Buckley, considered by practically everybody (and, saddest to relate, by himself) as an "extreme individualist" must be classified as a defacto totalitarian.
This unhappy incident reveals that individualism is practically non-existent in present-day America, and that the biggest and most important defection stems from the uncritical support given to the wasteful, dictatorial policy of military-socialism that now prevails. It spurs us on to continue our analysis of foreign policy and formulate a program in that field. But it is certainly clear that our foreign policy must not be aimed at holy crusades against Communist infidels. Neither should it be based on a policy of blithely and enthusiastically taxing the American citizen in order to pile up useless armaments. Freedom and peace are inherently intertwined, and the way to preserve peace is to avoid war, not to go out of your way to seek one. The best rule for foreign policy is still the great Richard Cobden's "Peace and Retrenchment."
Karl Marx may have been a philosopher or just someone with an opinion. He was not, however, an economist.
Original Article: "Karl Marx Was Not an Economist"
This Audio Mises Wire is generously sponsored by Christopher Condon.
[This article is excerpted from volume 2, chapter 10 of An Austrian Perspective on the History of Economic Thought (1995).
Another important reason for Marx's failure to publish was his candid depiction of the communist society in the essay "Private Property and Communism." In addition to its being philosophic and not economic, he portrayed a horrifying but allegedly necessary stage of society immediately after the necessary violent world revolution of the proletariat, and before ultimate communism is to be finally achieved. Marx's postrevolutionary society, that of "unthinking" or "raw" communism, was not such as to spur the revolutionary energies of the Marxian faithful.
For Marx took to heart two bitter critiques of communism that had become prominent in Europe. One was by the French mutualist anarchist Pierre-Joseph Proudhon, who denounced communism as "oppression and slavery," and to whom Marx explicitly referred in his essay. The other was a fascinating book by the conservative Hegelian monarchist Lorenz von Stein (1815–1890), who had been assigned by the Prussian government in 1840 to study the unsettling new doctrines of socialism and communism becoming rampant in France. Not only did Marx show a "minute textual familiarity" with Stein's subsequent book of 1842, but he actually based his concept of the proletariat as the foundation and the engine of the world revolution on Stein's insights into the new revolutionary doctrines as rationalizations of the class interests of the proletariat.Stein treated French socialism and communism as ideologies of the propertyless proletariat, aiming to destroy the historical foundations of European society based on the principles of individual personality and private property. The difference of course, is that Marx, in contrast to the other "classless" socialists and communists, embraced this connection to the proletariat, whereas Stein condemned and warned against it. See the excellent and illuminating work by Robert C. Tucker, Philosophy and Myth in Karl Marx (Cambridge: Cambridge University Press, 1961), pp. 114–7. Stein's book, Lorenz von Stein, Der Socialismus und Communismus des Heutigen Frankreichs (Leipzig: 1842), remains untranslated. (Later editions were entitled Geschichte des socialen Bewegung in Frankreich, 1850, 1921). Stein spent his mature years as professor of public finance and public administration at the University of Vienna, 1855–88.
Most remarkably, Marx admittedly agreed with Proudhon's, and particularly Stein's, portrayal of the first stage of the postrevolutionary society, which he agreed with Stein to call "raw communism." Stein forecast that raw communism would be an attempt to enforce egalitarianism by wildly and ferociously expropriating and destroying property, confiscating it, and coercively communizing women as well as material wealth. Indeed, Marx's evaluation of raw communism, the stage of the dictatorship of the proletariat, was even more negative than Stein's:
In the same way as woman is to abandon marriage for general [i.e. universal] prostitution, so the whole world of wealth, that is, the objective being of man, is to abandon the relation of exclusive marriage with the private property owner for the relation of general prostitution with the community.
Not only that, but as Professor Tucker puts it, Marx concedes that
raw communism is not the real transcendence of private property but only the universalizing of it, not the overcoming of greed but only the generalizing of it, and not the abolition of labour but only its extension to all men. It is merely a new form in which the vileness of private property comes to the surface.
In short, in the stage of communalization of private property, what Marx himself considers the worst features of private property will be maximized. Not only that, but Marx concedes the truth of the charge of anticommunists then and now that communism and communization is but the expression in Marx's words, of "envy and a desire to reduce all to a common level." Far from leading to a flowering of human personality as Marx is supposed to claim, he admits that communism will negate it totally. Thus Marx:
In completely negating the personality of men, this type of communism is really nothing but the logical expression of private property. General envy, constituting itself as power, is the disguise in which greed re-establishes itself and satisfies itself, only in another way … In the approach to woman as the spoil and handmaid of communal lust is pressed the infinite degradation in which man exists for himself.Quoted in Tucker, op. cit., note 8, pp. 155. Italics are Marx's.
All in all, Marx's portrayal of raw communism is very like the monstrous regimes imposed by the coercive Anabaptists of the sixteenth century.Indeed, it is no accident that Marxian historians, from Engels to Ernst Bloch, have been great admirers of these regimes and movements, first, because of their communism, and second, because they were certainly "people's movements," bubbling up from the lower classes.
Professor Tucker adds, perhaps underlining the obvious, that "these vivid indications from the Paris manuscripts of the way in which Marx envisaged and evaluated the immediate postrevolutionary period very probably explain the extreme reticence that he always later showed on this topic in his published writings."Tucker, op. cit., note 8, pp. 155–6.
But if this communism is admittedly so monstrous, a regime of "infinite degradation," why should anyone favor it, much less dedicate one's life and fight a bloody revolution to establish it? Here, as so often in Marx's thought and writings, he falls back on the mystique of the "dialectic" — that wondrous magic word by which one social system inevitably gives rise to its victorious transcendence and negation. And, in this case, by which total evil — which interestingly enough, turns out to be the postrevolutionary dictatorship of the proletariat and not preceding capitalism — becomes transformed into total good.
To say the least, Marx cannot and does not attempt to explain how a system of total greed becomes transformed into total greedlessness. He leaves it all to the wizardry of the dialectic, now a dialectic fatally shorn of the alleged motor of the class struggle, which yet somehow transforms the monstrosity of raw communism into the paradise of communism's "higher stage."
Mises Institute scholar and Troy University business school Dean Allen Mendenhall is among the leading critics of woke capital. He leads a new initiative against the perverse investment practices demanded by ESG/DEI commissars, and joins Jeff Deist to discuss both the origins of "stakeholder" capitalism and what we can do to push back against ideological purity tests in capital markets and corporate America.
AllenMendenhall.com
"Troy University tackles 'woke' business practices head-on with new program": Mises.org/HAP382a
Back in January Jeff Deist joined the Austrian Economics Discord Server for a live event concerning trends in 2023. Jeff makes the case for viewing today's economy as quite unlike that of 2007—due to steady increases in CPI, more fiscal stimulus relative to monetary stimulus, and ongoing supply shock issues from COVID.
This is a far-ranging discussion of the landscape for the Fed, persistent inflation, and a looming recession. Includes Q and A from the audience.
Professor Per Bylund of Oklahoma State University, author of How to Think About the Economy joins Jeff and Bob to dissect how economics went so badly wrong. A discipline rooted in theory, axioms, and deduction has devolved into statistics, models, and hard science envy. Is the economics profession doing any good, or active harm?
Per's new book How to Think About the Economy: Mises.org/Primer
Gary North and Walter Block debate "Is it Smart to Get a PhD in Economics": Mises.org/HAP380a
Does 2022 America still have legitimate intellectuals? Professor Paul Gottfried joins Jeff and Bob to consider the state of real and pseudo-intellectualism.
Daniel McCarthy joins Jeff and Bob to consider the deep unseriousness of American politics and electorate.
Willmoore Kendall's The Conservative Affirmation: Mises.org/Kendall
Daniel McCarthy, editor of Modern Age, joins Jeff to consider the state of modern conservatism, modern libertarianism, and whether they can or cannot find common ground.
Watch Daniel's talk at the LSC 2022: Mises.org/LSC22-McCarthy Read The Conservative Affirmation: Mises.org/HAP362-1
Lucas Engelhardt summarizes the basics of Modern Monetary Theory.
Recorded at the Mises Institute in Auburn, Alabama, on 27 July 2022.
Good theory leads to better statistics and better predictions.
Download the slides from this lecture at Mises.org/MU22_PPT_19.
Recorded at the Mises Institute in Auburn, Alabama, on 27 July 2022.
Socialism does not build, it destroys.
Recorded at the Mises Institute in Auburn, Alabama, on 27 July 2026.
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.
We wrap up our look at Murray Rothbard's sprawling two volume An Austrian Perspective on the History of Economic Thought with Dr. Joe Salerno, Rothbard's friend and colleague. This show covers the second volume exclusively, starting with the Frenchman JB Say and working through Ricardo, the British Currency School, John Stuart Mill, and finally Karl Marx. Salerno has penetrating insights about all of these thinkers, from Say's understanding of production to Ricardo's erroneous systemization of Adam Smith. He also has great background regarding Mises and the Currency School vs. Banking School debate, on free banking and full reserve banking, and on Mill's deep misconception of money. The show ends with a thorough look at Rothbard's treatment of Marx over more than 100 pages: Marx's sick view of man as a collective, his hatred for the division of labor, his absurd and deterministic "laws of history," his materialism as a replacement for spiritualism, and the underlying folly of "superabundant production."
You don't want to miss this show!
Additional Resources Read Rothbard's important work: Mises.org/APHET
We continue our look at Murray Rothbard's two volume An Austrian Perspective on the History of Economic Thought with a show focused on Adam Smith. Rothbard attacked him mercilessly as a plagiarist who set economic theory back decades with his muddled views on value and price. But was this criticism justified, or was Smith actually an early and valiant proponent of laissez-faire?
Our guest Hunter Hastings defends Smith in this rollicking discussion, while Professor Jonathan Newman is not so sure. They also discuss the Scottish Enlightenment and Smithian thinkers like Bentham and Malthus, and even tackle the contentious question of whether Smith produced Marx. Don't miss this!
Additional Resources Read Rothbard's important work: Mises.org/APHET
Using a recent Paul Krugman column as the jumping off point, the Mises Institute Academic Vice President Joe Salerno explains and defends Austrian business cycle theory.
Mentioned in the Episode and Other Links of Interest: The YouTube version of this interviewBob’s response to Krugman’s NYT pieceJoe Salerno’s 2012 QJAE article responding to ABCT criticsJoe Salerno’s previous appearance on the Bob Murphy Show ep. 16Bob’s critique of Selgin on Canadian fractional reserve banking For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on Apple Podcasts, Google Podcasts, Stitcher, Spotify, and via RSS.
Paul Krugman’s “logical problem” with ABCT derives entirely from his superficial understanding of the theory.
Original Article: "Rebutting Paul Krugman on the "Austrian" Pandemic"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Abstract: In her paper “Corporate Risk Evaluation in the Context of Austrian Business Cycle Theory” recently published in this journal, Joanna Kruk aims to investigate how artificially low interest rates resulting from central bank intervention distort individual investment appraisals and ultimately result in both entrepreneurial misjudgment and resource-wasting malinvestment, fueling the business cycle. She identifies entrepreneurs’ net present value calculations, supposedly unadjusted for risk, as a major issue and suggests adjusting those calculations for risk via both the duration method and the Capital Asset Pricing Model to mitigate the distorting effects. Her argumentation is, however, trapped in neoclassical reasoning and is adversely affected by several misconceptions of the net present value criterion. This comment seeks to reveal those fallacies and explain how to address uncertainty when using net present value calculations to make those calculations part of the solution rather than part of the problem of entrepreneurial misjudgment. The findings are derived from German investment theory rooted in the Austrian school of thought, meaning that they differ compared to those of neoclassical finance theory.
JEL Classification: B31, B41, B53, G32 Thomas Hering (hering@fernuni-hagen.de) is a professor of business economics and holds the Chair of Investment Theory and Business Valuation at Fern-University in Hagen, Germany. Michael Olbrich (olbrich@iwp.uni-saarland.de) is a professor of business economics and chair of the Institute of Auditing at Saarland University, Saarbrücken, Germany. David J. Rapp (david.rapp@imt-bs.eu) is an associate professor of accounting and management control at Institut Mines-Télécom Business School and member of the research lab LITEM, Univ. Paris-Saclay, Univ. Evry, IMT-BS, Evry/Paris, France.
INTRODUCTION In her paper “Corporate Risk Evaluation in the Context of Austrian Business Cycle Theory” recently published in this journal, Kruk (2020) seeks to explain why and how artificially low interest rates brought about by central bank intervention distort individual investment appraisals and eventually lead to clustered entrepreneurial misjudgment, malinvestment, and capital consumption, that is, the business cycle. Her perception of previous research is that “little attention was paid to the analysis of corporate finance and the causes of companies’ erroneous decisions about initiating and carrying out unprofitable undertakings,” which indicates she believes that investigating “the motivation of financial decisions on a micro-level can shed new light on the foundations of the emergence of the business cycle” (Kruk 2020, 131–32). Certainly economic calculation in general, and entrepreneurial investment decisions in particular, are yet to be thoroughly explored from the perspective of the acting individual and those areas should be stringently investigated owing to their significance for both Austrian theorizing (e.g., Austrian business cycle theory [ABCT]) and practice. However, there has already been far more discussion on the topic than Kruk (2020) suggests, both in general terms and with explicit links to ABCT.See, in particular, Rapp (2015); Olbrich, Quill, and Rapp (2015); Herbener and Rapp (2016); Olbrich, Rapp, and Venitz (2016); Rapp, Olbrich, and Venitz (2017); Follert et al. (2018); Rapp, Olbrich, and Venitz (2018); Olbrich, Rapp, and Follert (2020).
In essence, Kruk (2020) asserts that the economy shifts toward a riskier position in response to artificially low interest rates and that decision-makers fail to incorporate that risk appropriately in their investment calculi. By neglecting investment risk, entrepreneurs invest in projects that are only seemingly profitable. To aid in mitigating this issue, Kruk suggests adjusting net present value (NPV) calculations, which serve as the basis of investment decisions, for risk. Kruk’s underlying idea is to decrease resulting NPVs by applying mathematical adjustments to make investment projects look less feasible in order to deter entrepreneurs from making poor investments. Specifically, Kruk suggests NPVs risk-adjusted based on both duration and the Capital Asset Pricing Model (CAPM).
However, entrepreneurs calculating an NPV must consider their individual circumstances if they are to receive a figure that is realistically supportive of the decision-making process, and naturally, this includes the consideration of what Kruk labels risk. Mises (1952, 126, italics added) explains:
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.
Contrary to Kruk’s reasoning, neither duration nor CAPM serves to support entrepreneurs’ speculative decision-making well. This comment aims to uncover the misconceptions inherent in Kruk’s argument and to present alternative ways of addressing uncertainty when using the NPV as a tool to support entrepreneurial decision-making. To do so, we build on Prussian-German business economics, especially investment theory, which has been developed in the German-speaking world based on Austrian economics (Schmalenbach 1919, 334; Mises 1933, 9; [1960] 2003, 226; Schmidt 1933, 106; Herbener and Rapp 2016, 13; Olbrich, Rapp, and Follert 2020) and which fully adopts the perspective of the acting individual rather than building on the well-known escapist assumptions of neoclassicism.
RISK, UNCERTAINTY, AND INVESTMENT DECISIONS Kruk’s (2020, 138) diagnosis is that “wealth maximizing investors are evaluating projects only using risk-free NPV [and that, hence,] they may underestimate the risk associated with their investment decisions.” That is why “we cannot exclude risk from its role in the profitability of the investment projects, and this factor should be included in further analysis” (Kruk 2020, 137).
However, rather than failing to take account of the “risks” associated with a particular investment, investors largely do attempt to consider them in their investment calculi. Kruk (2020, 145–46) herself emphasizes that not only academics but also investment practitioners by and large rely on the CAPM, which is believed to provide a reasonable risk-adjusted discount rate for NPV considerations. In other words: the problem Kruk seemingly identified is a mere straw man and the solution she proposes in response to it exactly corresponds to how most decision-makers already decide on their investments. Nevertheless, the issues of entrepreneurial misjudgment and malinvestment have not been mitigated, let alone resolved. Hence, adjusting NPV calculations for “risk” via the CAPM will evidently not offer a means to reduce clustered entrepreneurial malinvestment. Rapp (2015) indicates that neoclassical models such as the CAPM are part of the problem rather than the solution. In particular, they fuel the business cycle due to their strong interdependence with market data.
Kruk, moreover, is mistaken when associating regular entrepreneurial investment decisions with risk. Rather than probabilistic, calculable risk, it is Knightian uncertainty (Knight 1921) that gives rise to entrepreneurship (Mises 1949) and, hence, entrepreneurial decision problems in the first place. Kruk conveys the impression that entrepreneurial decision problems could—with some assumptions (146, 147) here and there—be solved mathematically. However, in the presence of Knightian uncertainty, decision problems are not well-structured and optimal solutions out of reach (Wilson and Alexis 1962; Adam and Witte 1979; Adam 1983; 1996; Rapp and Olbrich 2020) of even the most elaborate math. Rather, entrepreneurs (must) imagine how the future might look and apply judgment to ultimately make their (investment) decisions (Klein 2008; Foss and Klein 2012; Packard, Clark, and Klein 2017). Such judgment can certainly be informed by genuine economic calculation; given they are unrelated to the real world, however, models springing from neoclassicism, in particular the CAPM, are beyond the scope of any toolbox reasonably applicable for that purpose (Olbrich, Quill, and Rapp 2015; Follert et al. 2018).
ON COMBINING NPV, DURATION, AND CAPM Duration describes the sensitivity of the price of a security to changes in the interest rate in the case of a flat interest rate structure. In a perfect capital market under certainty, the price corresponds to the NPV of the future earningsWe deliberately choose not to apply the term “cash flow” used by proponents of finance theory to describe the numerator in NPV analysis. Proponents of investment theory, as well as Mises (1952, 126), speak of “future earnings,” “future benefits,” or “future income” instead and emphasize the numerator’s subjective nature. “Future benefits must be forecasted from the perspective of the person who is valuing and choosing. Predictions of future benefits depend upon personal factors, such as the dividend policy, individual tax rates including potential tax loss carry-forwards, and individual synergies” (Herbener and Rapp 2016, 16). The importance of synergies in particular for entrepreneurial success has been intensively discussed within the Austrian school; see, e.g., Lachmann (1956, 13), Cwik (2008, 66), Klein (2010, 110), Boettke and Piano (2019, 22). and the duration equals the absolute amount of the interest (factor) elasticity of the price. Duration can be interpreted as an “average capital commitment period,” too, which reflects the average time at which one unit of the NPV flows to the investor (Matschke, Hering, and Klingelhöfer 2002, 173–75; Kruk 2020, 138–39).
A stream of future earnings with a low ratio is interpreted as less “risky” than one with a higher ratio, since the investor is interested in the earliest possible return on his initial investment. In this respect, the duration does indeed contain some information related to the uncertainty of future earnings.
However, the informational value of this key figure is clearly limited. In contrast to investments in traded securities, entrepreneurial ventures usually require investments in tangible assets. In such cases, however, a negative correlation between the interest rate and NPV is anything but a given. Referring to Rothbard (1962 [2009], 62–63), Kruk (2020, 135–38) too assumes a decreasing NPV when interest rates rise. A simple example reveals, however, that this assumption need not be met: Suppose a business in the field of large-scale plant construction accepts a considerable early customer down payment, which leads to the following expected future income stream (–$19,000, $69,000, –$80,000, $28,000, $2,000). The resulting NPV curve of this project is shown in Figure 1 (Hering 2017, 294–95):
Figure 1. Interest rate impact on NPV in our example (Hering 2017, 295)
If the current interest rate is 10 percent, for example, an expected rise in the interest rate does not result in a decreased NPV and, hence, less willingness to invest on the part of the entrepreneur; instead, an increased NPV makes the project appear more attractive than previously. This simple yet realistic example alone shows how an artificial and arbitrary manipulation of the relevant discount rate (which should actually be determined by the entrepreneur’s time preference) intended to reduce NPVs and, thus, decision-makers’ willingness to invest, ultimately fails to do so. Despite this, Kruk (2020, 145–47) recommends discounting with an interest rate adjusted for a risk premium via the CAPM.
Kruk (2020, 139) is correct to point out that the duration estimates NPV reactions to the change in interest rates proportionally. It thus commits an estimation error owing to the relationship being nonlinear. Therefore, the larger the interest rate change, the less is its explanatory power. Additionally and above all, the duration suffers from the unrealistic assumption of a steady interest rate (both before and after the interest rate change) in all periods (Matschke, Hering, and Klingelhöfer 2002, 175). In reality, that is, in imperfect capital markets, such flat interest rate structures are merely rare exceptions rather than standard occurrences.
While the informational value of duration is in itself fairly limited and essentially confined to theoretical borderline cases, linking it to the finance theory-based CAPM as suggested by Kruk (2020, 145–48) worsens matters. In contrast to both NPV and duration, which are decision models, the CAPM is a neoclassical equilibrium model initially established to explain particular market outcomes ex post. For that reason alone, it is entirely pointless for decision-making purposes from an ex ante perspective (Hering 2017, 303–10; 2021, 236–40); the CAPM was simply not designed to support entrepreneurial decision-making (yet has been largely unsuccessful in fulfilling its intended purpose too; hence, it has failed miserably on all counts). Kruk (2020, 145–46) points to CAPM’s popularity among both practitioners and academic proponents of finance theory to justify recourse to it; however, no matter how popular the CAPM has been, that popularity cannot overcome the fundamental issues associated with the model’s application in investment appraisal.
The linking of NPV, duration, and CAPM suffers from another logical flaw: while both NPV and duration are multi-period models, that is, they (in most cases) cover more than one time period and can often span decades, the standard CAPM as described and recommended by Kruk (2020,146) is limited to the consideration of just a single period. In other words: Kruk suggests using a risk-adjusted discount rate derived from a static one-period equilibrium model for the appraisal of uncertain multi-period investment projects in the real world, that is, in dynamic disequilibrium.
HOW TO ACCOUNT FOR UNCERTAINTY IN INVESTMENT APPRAISAL Preparing for investment decisions by acting as if a future state of affairs were fully knowable seems decidedly inappropriate. We thus wholeheartedly agree with Kruk (2020, 146, 148) that (reasonably) considering the uncertainty associated with investment projects in NPV (or duration) calculi can contribute to the entrepreneur’s Verstehen and, thereby, inform his ultimate judgment. Knightian uncertainty neither allows for exact calculations of NPVs in terms of point values nor seemingly definite decision suggestions. The best investment appraisal can do to support entrepreneurs in their decision-making under conditions of uncertainty is to reveal the financial consequences of the range of uncertain future states of affairs imagined by the entrepreneur. Therefore, methods transparently uncovering the uncertainty associated with investment projects, as suggested by proponents of investment theory, rather than hiding uncertainty’s implications in condensed point values, as suggested by neoclassical finance theory, best serve decision-making (Hering 2017, 273–75; Olbrich, Quill, and Rapp 2015, 25–27; Herbener and Rapp 2016, 19–20). Sensitivity analyses and simulations are particularly suitable methods to support the entrepreneur. Figure 2 shows an example (Hering 2017, 334–53) resulting from one such analysis based on a Monte Carlo simulation (Hertz 1964; Coenenberg 1970), which compares NPV distributions of two investment alternatives (A1, A2) given individual entrepreneurial estimations of both future earnings and period-specific discount rates.
Figure 2. Comparison of two simulated NPV distributions (Hering, Schneider, and Toll 2011, 424)
In contrast to the risk premium concept, which manipulates NPV calculi on the level of the input data and immediately presents a seemingly certain point value (Kruk 2020, 147–48), a simulative approach to considering uncertainty in investment appraisal calculates and visualizes the financial consequences of thousands and thousands of combinations of future earnings and discount rates based on the entrepreneur’s estimate, illustrating the possible outcomes of each alternative path of action and thus providing a transparent basis for decision-making. Whether, as figure 2 suggests at least at first glance, alternative A1 should actually be preferred over A2 on the basis of its profile being located somewhat further to the right cannot be decided upon in general terms; instead it ultimately remains an entrepreneurial decision under uncertainty demanding judgment. Needless to say, the entrepreneur may complement the quantitative results provided by investment appraisal with qualitative, non-calculable considerations when formulating his final decision (Herbener and Rapp 2016, 20; Hering 2017, 398–400; Hering 2021, 40–45).
CONCLUSION Neoclassical finance theory follows a (seemingly) objective, market value-based concept and hence, in some sense, resembles “the naive conception of the layman that things have value in themselves, i.e., intrinsic value” (Ritenour 2016, 192). Considering uncertainty in investment appraisal on the basis of escapist models derived from that theory, and particularly the CAPM, therefore cannot support acting humans making investment decisions in the real world. It would be more productive to apply scenario analyses (Hering 2017, 359, 375) and simulations to reveal the possible effects of uncertainty on future states of affairs in imperfect capital markets based on individual entrepreneurial imagination. Doing so would offer entrepreneurs the most transparent source to inform their judgment. The final decision to invest, however, certainly remains a purely entrepreneurial one that eludes mathematical formulation (Hering 2021, 12–13, 44–45, Herbener and Rapp, 2016, 20).
Applying models derived from neoclassical finance theory to support investment appraisal fuels the business cycle. Entrepreneurial evaluations based on actual individual circumstances and estimations of the future (taking into account subjective assessments of the stage of the business cycle) seem superior both on an individual level and in terms of the ability to mitigate the issue of clustered malinvestment as a whole. Although that approach cannot resolve the underlying problem of distorted interest rates and market prices initiated by central bank intervention, it can at least limit its effects (Rapp 2015).
Professor Bradley Birzer from Hillsdale College joins the show to dissect Russell Kirk's famous 1981 essay condemning libertarians. Is libertarianism necessarily utopian and unworkable, as Kirk suggests? Is it hubris to imagine we don't need the state—or even God—to prevent social chaos? Do libertarians have more in common with Communists than conservatives? Or was Kirk simply attacking an absurd strawman of the atomistic individual, with Rothbard as the particular (unstated) target of his ire? Dr. Birzer is a thoroughgoing scholar of Kirk, and provides great insights into the context and thinking behind this critique.
Russel Kirk's "Libertarians, The Chirping Sectaries": Mises.org/Kirk Rothbard's "Myth and Truth About Libertarianism": Mises.org/HAP77a Dr. Birzer's "Kirk and the Libertarians": Mises.org/HAP77b Hornberger's "An Open Letter to Russell Kirk": Mises.org/HAP77c
From climate policy to stimulus to unemployment, Prof. Murphy takes a detailed look at the many practical and theoretical problems of Joe Biden's economic agenda. Presented at Mises University 2021. Download the slides from this lecture at Mises.org/MU21_PPT_27. Recorded at the Mises Institute in Auburn, Alabama, on 22 July 2021.
Download the slides from this lecture at Mises.org/MU21_PPT_24.
Recorded at the Mises Institute in Auburn, Alabama, on 21 July 2021.
In this lecture from 2021's Mises University, Lucas Engelhardt summarizes the basics of Modern Monetary Theory (MMT), its consequences, and the strange ideology behind it. Presented at Mises University 2021.
Murray Rothbard's seminal 1965 essay "Left and Right: The Prospects for Liberty" reads every bit as well today as it did 50 years ago. Rothbard defines liberalism and conservatism against the backdrop of the European Old Order, and skewers the incoherence of both in their modern forms. This brief work, steeped in history and full of optimism, shows Rothbard as a careful and strategic thinker about ideological and political movements. Mises.org editors Tho Bishop and Ryan McMaken join the show to explain the tremendous descriptive power of this essay, and why we need Rothbard as much as Burnham, Machiavelli, or Sun Tzu when it comes to strategy.
Mentioned in this Episode "Left and Right: The Prospects for Liberty": Mises.org/LeftRight
ABSTRACT: There have been many calls for reforming the gold standard since the end of the classical gold standard and especially since the end of Bretton Woods. While these calls have somewhat abated in recent years, this article will attempt to show that the gold standard is still a superior monetary system, and that the reform of the monetary system is still a desirable policy.
Key Words: gold standard, monetary policy, austrian economics, populism
Kristoffer Mousten Hansen (kristoffi@gmail.com) is a research assistant at the Institute for Economic Policy at Leipzig University and a PhD candidate at the University of Angers. He is also a Mises Institute research fellow.
The author thanks Dr. Joseph Salerno for comments as well as an anonymous referee.
We will proceed by first analyzing the shortcomings of the present fiat-money order, indicating how it distorts the market and society through inflation, redistribution, by artificially increasing the importance of financial markets, and by hampering US industrial production in international trade. Then we will show that these problems would cease to exist under the gold standard, and we will indicate a possible reform for returning to gold in the US. Finally, we will argue that such a reform in order to be successful must become a popular crusade—i.e., it must become a populist issue.
INTRODUCTION Politics have become increasingly populist throughout the Western world since the Great Recession. Both left-wing and right-wing parties thunder against political and other elites, suggesting that their specific programs and ideologies will put an end to what they see as unfair exploitation of the people by an unaccountable and increasingly out-of-touch elite. In the United States recent populist movements are the Tea Party movement and Occupy Wall Street, and both Donald Trump and Bernie Sanders used populist rhetoric in their presidential campaigns.
The rise of populism is, in hindsight, perfectly understandable. The war in Iraq would be a “cakewalk”; “if you like your health insurance, you can keep it”; my opponent’s voters are a “basket of deplorables”—mainstream politicians have again and again shown themselves to be out of touch with reality and increasingly, it seems, also with more and more of their voters. Most important for our purposes, the Federal Reserve, charged with managing the money supply and securing low inflation and low unemployment, was oblivious to all dangers on the eve of the Great Recession, and seemed to do what it could to help big banks and investors weather the storm, no matter what the price would be for the rest of the country.
Indeed, the Federal Reserve has proven unable to achieve the goals set for it since its establishment and especially since the final end of the gold standard and the introduction of the fiat dollar in 1971, when its control over the money supply was vastly expanded. The Fed did manage to break the inflationary expectations that had led to double-digit inflation in the 1970s, but this slight improvement has not canceled out the many evil effects of fiat money. The harmonious development of society and the economy depends on sound money, which is itself a spontaneous social institution (Mises 1981, 421), while monetary policy leads to accumulating economic distortions. These distortions favor political and financial elites (Sennholz 1985, 1979): they have greatly expanded the scope of the financial sector and its importance to the economy, and politicians now have greatly increased resources at their disposal to pursue their dreams of remaking society. With our present fiat money system it is much easier for politicians to engage in deficit spending, as this spending artificially enlarges the market for government bonds as well as other financial titles. The public at large, on the other hand, is more and more dependent on financial markets if not outright on the state, while political elites are less beholden to the taxpayers for the resources they need.
More than any other institution, it is our contention that the Federal Reserve has caused economic distortions and increased popular resentment toward elites in general. This is why the gold standard should be the eminently populist cause: against unaccountable elites and for the general welfare of the public at large. Not only that, it is only by making the gold standard a populist crusade that there is any hope of restoring gold to its monetary role (Mises 1981; Sennholz 1985; Paul 1985). Fiat money has greatly distorted the economy and harmed the common man, and returning to the gold standard would resolve these distortions. This does not mean that the restoration of the gold standard would mean the fulfillment of every policy currently advocated by populists, nor that the advocates of gold should stoop to demagogy. The case for gold must be presented honestly. All we mean by making the gold standard a populist cause is to make the appeal directly to the public at large, and especially to that part of the public who are the most victimized by the present system, and who have the most to gain by returning to sound money. The gold standard cannot be just an academic exercise: we must show how a return to gold would improve the economic situation and prospects of the common man.
We will proceed as follows: first, we will present some of the main problems of fiat money. In particular, we will focus on how these problems affect the broad classes of producers in the private sector. Then, we will show how these problems would disappear, or at least be more manageable, under a gold standard. We then sketch how the gold standard would look in the present day and how we could move from fiat dollars to gold and, eventually, to complete monetary freedom. Finally, we will briefly discuss the ways monetary reform might become a populist movement.
We do not pretend to any great originality with this proposal, rather it should be seen as an updated and slightly modified version of Mises’s proposed reform from the 1950s.
THE CASE AGAINST FIAT MONEY What follows is a brief survey of the main problems of fiat money. They are all variations of the effects that additions to the money supply have as new money enter and spread through the economy, the Cantillon effects (named after the Irish economist Richard Cantillon, who first analyzed them in 1755. Cantillon 2010), and are as such all connected. They can be broadly categorized as inflation, redistribution, financialization, and deindustrialization.
Inflation
Price inflation is a constant presence in the age of fiat money. It is true that the high inflation of the 1970s gave way to more moderate inflation in the following decades, but the purchasing power of the dollar has continued to fall steadily (see figures 1 and 2). This moderation might partly have been due to greater restraint on behalf of the Federal Reserve, but it should be pointed out that the money supply continued to grow throughout the period. A more likely explanation is that the advent of moderate price inflation was due to exogenous factors beyond the control of US monetary authorities. The last forty years or so of globalization have seen the integration of first the East Asian tiger economies, then the formerly Communist countries, and especially China, into the world economy, massively increasing global production and trade. Former Fed chairman Alan Greenspan frankly admitted that the period of low inflation was not due to activist central bank policy (Greenspan 2007, 12–15; cf. Stockman 2013, 63–64); indeed, more recently he admitted in an interview with the Gold Investor that during his tenure as chair of the Federal Reserve “US monetary policy tried to follow signals that a gold standard would have created. That is, sound monetary policy even with a fiat currency” (Greenspan 2017, 14). We may question just how effective merely playing at the gold standard is compared to the real deal,One reason to be skeptical of the extent to which Greenspan really imitated the gold standard, or at least to question his success in doing so, is that under the gold standard, the US balance-of-payments deficit would have been eliminated by the outflow of gold. As the deficit grew at an almost constant rate (see figure 4) throughout the 1990s and first decade of the 2000s, the great moderation was clearly not a good imitation of the gold standard. Jacques Rueff (1972) in his The Monetary Sin of the West gives a good explanation of how and why the US balance-of-payments deficit persisted under the gold-exchange standard. The same causes he identified back then are still at work today. but this policy may have led monetary authorities along a less inflationary path for a time.
Figure 1: Purchasing Power of the US Dollar, 1960–2019.
Figure 2: Purchasing Power of the US Dollar, 1960–2019, YOY Change.
Nevertheless, the effect of these positive developments across the globe would, in the absence of government manipulation of the money supply, have been a steep fall in the prices of consumer goods. The 1990s and the first decade of the 2000s should have been marked by deflation, as the amount of goods offered to consumers increased while the supply of money remained steady. This would have spread the benefits of globalization and increased production to all holders of US dollars. But the Fed’s inflationary policy neutralized this beneficial effect, as it pumped more money into the economy in pursuit of its goal of low but stable price inflation. The hollowing out of the purchasing power of the dollar therefore continued at a time when we should have expected a general appreciation in the value of money.
The inflation engineered by the Fed did not cause uniform price increases across the board. The effects of additions to the money supply depend on where the new money enters the economy and how it spreads through the economy. So some consumer goods did fall in price—e.g., consumer electronics—while others rose drastically, such as housing. Figure 3 shows this clearly by comparing changes in the Case-Shiller housing index to the general Consumer Price Index. Housing became drastically more expensive relative to other consumer goods over the last thirty years.
Figure 3: Case-Shiller Housing Index Compared to CPI (1987 = 100).
Figure 4: United States Trade Balance, 1992–November 2018.
Inflation and the erosion of purchasing power do not affect only the consumers; they are also important factors for producers. In an inflationary environment, the entrepreneur cannot simply allow for yearly depreciation based on the purchase price of his assets. He has to also estimate how monetary factors will distort future prices in order to calculate his replacement costs and make adequate allowance for depreciation. At the very least, this increases the costs of doing business, as more time and resources must be spent on accounting; more seriously, it can lead to capital consumption and reduced productivity, as the entrepreneur fails to foresee replacement costs adequately (Rothbard 2009, 993–94; Baxter 1955; cf. Reisman 2002).
Monetary inflation, furthermore, is not simply a hydraulic process, with prices being raised gradually as new money percolates through the economy. Rather, inflation may also affect the quality of products offered for sale by entrepreneurs (Sieroń 2017). Increases in the money supply often affect the prices of producer goods before those of consumer goods, especially when the new money enters the economy in the form of credit expansion. It is not possible to simply pass on the higher costs to the consumers if the demand for goods is elastic, as higher prices would then simply mean lower total revenues. Rather, the entrepreneur must somehow reduce his costs in order to stay profitable, which usually means substituting lower-quality for higher-quality inputs (ibid., 153, 155).
This process of product degradation also takes place over the long term: given that the broad mass of consumers will only receive increased monetary incomes late in the Cantillon process, the entrepreneurs will have to cut costs long before they can raise prices for consumers in order to stay in business. As inflationary credit expansions are perennially reoccurring, entrepreneurs will have to shift their innovative activities toward cost-cutting technologies and finding ever-cheaper substitutes for inputs, at the expense of research into higher-quality products. In the long run, we should therefore expect the inflationary environment of the fiat dollar system to yield progressively worse consumer products over time compared to what would have been produced under a sounder monetary regime.
While it is difficult to isolate this effect in the real world of complex phenomena, there are some clear indications that such product degradation has in fact been taking place. When we look at the consumption of foodstuffs in the United States during the twentieth century, there are some clear trends of changing consumption patterns that follow very closely the change to inflationary fiat money. This is not to say that every change in the diet for the worse is caused by monetary phenomena. For instance, the fall in butter consumption (figure 6) occurred mainly before the end of Bretton Woods and was probably due to the crusade of Dr. Ansel Keys against it (Teicholz 2014), but other changes have a clearer connection to the increasingly inflationary monetary systems of the postwar period and especially after 1971.
The changing trends in the consumption of meats have a clear connection with monetary phenomena. We will make two assumptions for the purposes of our presentation: that people, at least in Europe and America, eat more meat the more prosperous they are and that most people in the western world consider beef a higher-quality meat than pork or chicken. There was a rising trend in per capita consumption of the main kinds of meat—beef, pork, and chicken—until 1971. After this date, however, overall consumption of meat virtually stagnated: it only returned to the 1971 level for an extended period in the 2000s and was in 2017 only 3.5 percent above the 1971 level. What is more, the kinds of meats consumed have changed dramatically: pork consumption has declined and beef consumption has collapsed by more than 30 percent, while the amount of chicken consumed per capita has more than doubled since 1971, and has increased sixfold since 1909 (see figure 5). While changing consumer tastes may account for part of this change, it is hard not to suspect that most people can simply no longer afford the same amount and quality of tasty beef that they could in the 1960s and 1970s.Changing consumer attitudes are not necessarily independent of changes in the relative prices of foodstuffs: if beef is not only more expensive but also rising in price relative to chicken, as it has been, it may be much easier for housewives to accept government propaganda and corporate marketing extolling the supposed superior nutritional qualities of the lower-quality foodstuff. There are, at the very least, some interesting indications here of the way that fiat money has led to the production and consumption of lower-quality products.
Figure 5: Per Capita Availability of Leading Meats, Indexed 1971 = 100.
Figure 6: Proportion of Per Capita Availability of Fats.
Redistribution
It is a fact of nature that economic resources are distributed unevenly. Even if everybody had the same resources initially, different choices would quickly lead to differences in wealth and income. In a market economy, such differences are due to differences in productivity and in entrepreneurial skill. Workers will tend to be paid according to the value of their contribution to production; savers will earn a return on their investment based on the social rate of time preference; successful entrepreneurs will earn higher profits than unsuccessful entrepreneurs; all will earn an income and accumulate wealth based on their contribution to satisfying consumer demand. This inequality is not wrong or evil, but simply a fact of life that results from the free actions of economic agents.
Inflationary monetary policy distorts this picture of market-determined natural inequalities, as Cantillon effects redistribute income and wealth to the early receivers of new money and away from those who receive the new money last or who are on fixed incomes. This process was restricted under the gold standard, since gold cannot be created at will and gold mining does not lead to Cantillon effects, as we shall see below. Increases in the issue of fiduciary media did mean some redistribution, but these increases were severely limited by the danger of an outflow of gold. Since the final destruction of the gold standard in 1971, however, this is no longer an issue: the monetary authorities can keep inflating the money supply and banks can continue to create fiduciary media to the benefit of some at the expense of others.
The result has been stagnating incomes for workers and for the middle class generally, while the politically well connected and the financial operatives who are closest to the source of new money benefit. Recent studies (Bachman 2017; Brill et al. 2017; Bivens et al. 2014) suggest that for the median US worker, earnings (in real terms) have not only been stagnant, but have fallen slightly since 1973. This is not due to falling productivity: rather, the growth in productivity has far outstripped growth in compensation to workers since 1970 (Brill et al. 2017, 8). Up to that point, increasing productivity was reflected in higher wages, as we should expect according to economic theory. While the economy has continued to become more productive, then, the average worker sees less and less of this increased productivity.
Who are the beneficiaries of this hidden redistribution? The main clients of the central bank: the government and the commercial banks (Hülsmann 2013). These have generally been the first to receive the new money, as the banks have been able to expand their issue of fiduciary media and the government has always had a ready market for new debt issues. Since the 1970s, finance has become an increasingly important part of the economy, and even in nonfinancial firms, financial income constitutes an increasing proportion of total revenue (Lin and Tomaskovic-Devey 2013). The reason for this should be clear: as money is pumped into the economy through financial markets, firms that position themselves to take advantage of monetary infusions and easy financial conditions will win out over their less savvy competitors (although this is an advantage that depends on the conditions of easy money and credit expansion). The company officers guiding this process and the workers skilled in financial dealings will naturally earn higher compensations than their colleagues engaged in more mundane activities.Note that Lin and Tomaskovic-Devey attribute the rise of financialization to deregulation.
This does not invalidate the conclusion of economic reasoning that wages are set in accordance with the discounted marginal revenue product (DMRP) of the worker (Rothbard 2009, chap. 7). However, this is the long-run tendency of the market and will only ever be reached in final equilibrium. In the meantime, inflation, especially in the form of credit expansion, temporarily increases the revenue to be gained from financial transactions and makes indebtedness more attractive. It is therefore clear that so long as the inflation lasts, financial incomes will be higher than they otherwise would be. In our inflationary environment, the DMRP of financial wizardry is simply higher than it would otherwise be, and that of workers correspondingly lower.
While real wealth has increased as a result of globalization and increased productivity, the distribution of wealth and incomes has been increasingly skewed since 1970 due to continuous inflation. Private sector workers see their wages stagnate while government employees, government contractors, and the financial sector benefit.Hülsmann (2013) also stresses the redistribution of wealth from “have-nots” to “haves” in general.
Financialization
Fiat money, as we have seen, tends to lose its purchasing power over time. This means that plain saving—hoarding of money and accumulation of durable goods—and direct investment of accumulated funds in capital goods are discouraged. Instead, both the supply and the demand for financial assets increase as savers look for some way to protect their accumulated wealth (Hülsmann 2013, 6). The quality of fiat money is such that it is not a good store of wealth, since price inflation and a falling purchasing power are inherent to fiat money (cf. Bagus 2015b on the importance of the quality of money). Furthermore, as a consequence of central bank policy, the prices of financial assets tend to increase relative to those of nonfinancial assets (Žukauskas and Hülsmann 2019), so saving in forms other than financial titles is discouraged. In order to protect themselves from the wealth-destroying effects of inflation, savers have to engage in financial speculation: they take on debt to invest in financial assets, just to stay ahead of inflation and the redistributive effects of central bank policy.
This all leads to increased dependence on the financial sector, not only for consumers who want to acquire durable consumer goods such as houses and cars, but also for savers who want to accumulate wealth for later consumption and for businesses that want to expand operations (Hülsmann 2008b, 180–85). There is nothing wrong with financial institutions or financial markets in themselves. They provide a valuable service for the individual saver or borrower, and they provide a valuable service for society as a whole by helping to allocate funds to the most valued uses. The problem is that the destruction of sound money has led to a situation where everybody has to make use of financial services simply to preserve their wealth, while the financial markets increasingly depend on central bank interventions, not on the objective facts concerning the real assets underlying the various financial claims (Hülsmann 2014, 11–12). A paper issued by the Bank of England (Bush, Farrant, and Wright 2011) makes a similar point: severe imbalances have been allowed to build up in the international monetary and financial system, and capital movements do not seem be guided by considerations of productivity.
There is also evidence that overreliance on financial markets has had spillover effects on the real economy, as it has distorted the process of valuation and calculation guiding economic action (Ehret 2014). This leads us to the next problem generated by fiat money and privileged financial markets: the perennially reoccurring business cycle.
It should come as no surprise that banks and other financial institutions’ knowledge that they can depend on the central bank to bail them out leads to moral hazard. They can now engage in risky speculation in the hope of huge profits, and when the financial system periodically experiences a crisis or collapse, the taxpayers and hapless depositors are left with the bill. This speculation generally takes the form of increased lending to businesses in the form of fiduciary media, that is, uncovered money substitutes. As this increase in lending is not matched by an increase in saving, the result is that the market rate of interest is driven below its natural level and the business cycle is set in motion (Mises 1981, 357–64).
Austrian economists have thoroughly explained the business cycle resulting from credit expansion (e.g., Hayek 1935; Mises 1998, 535–83; Rothbard 2009, 989–1041; Skousen 1990; Hülsmann 2002; Huerta de Soto 2009; Salerno 2012). Cheap credit initially fuels a boom, as entrepreneurs invest in a longer structure of production. But the real savings needed to complete all investment projects are not available, and this becomes apparent when the infusion of cheap credit has passed through the system and the interest rate again rises to a level determined by the time preference of the economic agents. The boom inevitably turns to bust as nonviable investments are liquidated, workers laid off, and inconvertible capital goods in unprofitable production processes abandoned.
As part of the adjustment process during the bust, there is often so-called secondary or credit deflation (Rothbard 1963, 14–19; Salerno 2012, 37–41). Faced with bankruptcies and financial difficulties among borrowers, banks contract credit, or refuse to roll over short-term loans. At the same time, there is often an increased demand for money, as, faced with greater uncertainty, entrepreneurs and consumer hold off on spending until they are more sure of the economic environment. However, monetary authorities often intervene to prevent this deflation. To do this, they recapitalize overextended banks with new money, and the financial system that initiated the business cycle is largely saved from the ensuing recession. At the same time, workers and entrepreneurs have to scramble to reconstitute the structure of production along sustainable lines, while living through periods of unemployment and reduced incomes.
Deindustrialization
It is difficult to know how much of the decline in manufacturing and deindustrialization in the United States we can ascribe to the natural development of the economic system. The integration of vast areas of the globe into the world economy over the last several decades means that some industries are simply no longer competitive in the United States. Workers and investment will have to shift to other employment where the US still has a comparative advantage. There is no way around this adjustment, but there is some reason to believe that industry in the United States has been disadvantaged by the monetary policy of the Federal Reserve.
The first indication that something is amiss is the permanent deficit in the US balance of payments. Except for periods of recession, the deficit in the trade balance has only grown since the early 1990s (see figure 4). This would not normally be a problem, since the trade deficit would be offset by investments in the US economy. Increasingly, however, the trade deficit is paid for by a continuous outflow of newly created fiat dollars. Under the gold standard, this would be impossible (cf. below), and in this world of fluctuating fiat currencies, inflation should have led to a depreciation of the dollar in terms of foreign currencies, as its supply increased and its purchasing power fell. Yet this has manifestly not happened; the dollar’s exchange rate is by and large stable.
The reason for this is that the fiat dollar deliberately continues to be overvalued against foreign currency. David Stockman (2013) has repeatedly spoken of the “China price,” the downward pressure on prices caused by the flow of goods from China. Yet it is not just increased productivity and market integration that cause this. Lewis Lehrman (2013, 191–95) has argued that China is in effect a financial colony of the United States: by pegging the yuan to the dollar at an undervalued rate, Chinese exports to the US are boosted, and the People’s Bank of China can then inflate its own currency against its artificially overvalued dollar holdings. Indeed, the current international monetary system is best seen as a continuation of the gold-exchange standard introduced in 1922 and reintroduced at Bretton Woods, where the dollar became the world’s reserve currency and the only link to gold. This allowed the US to build up a balance of payments deficit, especially from the late 1950s on. Instead of an outflow of gold from Fort Knox, dollar balances simply accumulated abroad, especially in Western Europe, stoking inflation there, and in effect meant (and means) that the citizens of any country with a positive balance of payments vis-à-vis the United States were financing Americans’ acquisition of tangible assets in their own countries as well as the foreign spending of the US government. Jacques Rueff called this “an unprecedented system of spoliation” (Rueff 1972, 191) and it has continued since the end of Bretton Woods in 1971.Robert Lucas (1990) in an important paper has asked why doesn’t capital flow from rich countries to poor? He suggests several possible answers, but does not consider monetary problems. Yet it is here that the solution lies, as we have indicated in the text. See also the comments to this effect in the paper from the Bank of England already cited (Bush, Farrant, and Wright 2011, 9), as well as the analyses of the gold-exchange standard and Bretton Woods—they are really the same thing—by Jacques Rueff (1964; 1972) and Robert Triffin (1960; 1964). Their diagnosis is, mutatis mutandis, still applicable today: the US is still able to run a “deficit without tears” (Rueff 1972, 23) and benefit from what the French finance minister Valéry Giscard d’Estaing called the “exorbitant privilege” of issuing the world’s only reserve currency (Eichengreen 2011, 4).
The best description of this system is as a policy of American financial imperialism in which the Chinese government and other creditor nations are the junior partners.See Hoppe (2006) for an account of how the modern international monetary system in general functions along similar lines. It should be clear that it is at most the governments of the creditor nations that can be considered junior partners, since they can increase their money supply and government spending on the basis of accumulated dollar reserves. The populations of foreign countries lose, as their purchasing power is diminished: in a free system, either their currencies would be revaluated, or should the gold standard be adopted, gold would flow into the creditor nations. Not only are the incomes of Chinese workers artificially diluted, but the permanent overvaluation of the dollar has made it impossible for American industries to compete with those of other nations, and the result has been widespread deindustrialization in America (ibid., 195). It has been persuasively argued that increased trade contributed significantly to the collapse of manufacturing employment in the 2000s (Houseman 2018), which would corroborate the theory advanced here: monetary policy distorted the benefits from globalization and hobbled American industry. Had the dollar been allowed to depreciate as a consequence of inflationary Fed policy, it is plausible that the dislocations from the emergence of the Chinese economy and its integration into the world economy would not have been as severe. In that scenario Chinese and American industry would both have adapted and evolved according to the law of comparative advantage, to the benefit of both countries. Instead, American workers have had to suffer far more than necessary from the inevitable dislocations of globalization, while the benefits of globalization have been redirected to the people in control of the fiat dollar system: politicians, career bureaucrats, and crony capitalists well connected to the Fed’s money-creating operations.
The fiat dollar, then, has bred serious ills for American economy and society. Yet can the reintroduction of the gold standard—or, rather, the introduction of a pure gold standard—overcome these problems? And how can we go about reestablishing gold as money? We turn now to these questions.
THE SOLUTION: RETURN TO GOLD The goal of this section is to establish that a return to the gold standard would overcome the severe problems that the fiat dollar has caused and that such a return is not only desirable but also eminently feasible. We will also briefly explain why the gold standard is preferable to some other commodity standard, such as a silver standard or a bitcoin standard.
Previous Reform Proposals
There have been very many proposals for a return to or a reform of the gold standard ever since the gradual deformation of the classical gold standard began. The following is not a complete list of these proposed reforms. We are only interested in recent reforms along the lines of a “true” or “pure” gold standard, where gold truly is money and money is seen as a market institution (Salerno 2010a). Money originated in the market as the outcome of the free actions of human beings (Menger 2007, 257–85; 2009), and the ultimate goal of any reform should be to reestablish money as a market institution and banish all government interventions from the monetary sphere. In a way, returning to the gold standard is just a means to this end—once the reform is accomplished, it is up to the actors in the market to either validate the experience of millennia by freely using gold as money or to discard the gold standard in exchange for their preferred medium of exchange.
The “gold standard” of such reforms is Mises’s from 1953 (Mises 1981, 413–57), and this is the one we will use as a blueprint for our own proposal. Rothbard wrote several works calling for a return to gold at a legal par that would lead to 100 percent reserves, and while we agree with his views on fractional reserve banking, we do not agree with this proposed method of achieving 100 percent reserves (Rothbard 2005, 1985; more on this below). Jesús Huerta de Soto has also proposed a reform of money and banking along Rothbardian lines (Huerta de Soto 2009, 715–812). Hayek in his writings on monetary reform in the 1970s does not endorse a gold standard, but his call for full freedom in monetary matters is definitely consonant with the gold standard as envisioned by its champions (Hayek 1976, 1990, 2008). Hans Sennholz (1969, 1979, 1985) and Ron Paul (Paul 1985; Paul and Lehrman 1982) both emphasize the need for complete freedom in monetary matters as part of their reform proposals. The Misesian reform we will outline below is superior to both the Rothbardian approach and a reform that calls for full freedom in monetary affairs but stops short of abolishing the paper dollar.
The way of returning to gold that Rothbard proposes is that the definition of the dollar be changed so that the total stock of gold becomes 100 percent equal to the supply of dollars in circulation (Rothbard 2005, 181–83; Huerta de Soto 2009, 800). When Rothbard wrote this in 1962, it would have required a ten- or twenty-fold rise in the price of gold , and it would require an even greater increase today, but this would simply be the equivalent of a massive inflation and would itself cause grave dislocations. It would also amount to a massive intervention in the monetary sphere, which is not the best strategy when the goal of the reform is the elimination of all such interventions. Rothbard sees a massive deflation of the dollar supply as the only alternative, but if this is so, that is probably the better alternative. In the end, Mises’s plan is preferable, as it depends on the free action of men in the marketplace, not government fiat, to set the new legal par between dollars and gold. If the goal is monetary freedom, then the price of gold should be set by free markets, not by politicians (cf. Salsman 1995, 120). Once the market has established the price, paper money is to be made freely convertible into gold and vice versa. This plan is not a guarantee against a deflationary destruction of fiduciary media, but is the reform least likely to entail such radical economic dislocation. And should such a deflation happen anyway, it will be due to the choices of freely acting men, not a government policy.
The problem with reforms along the lines suggested by Sennholz and Hayek that look only to freedom in establishing a new monetary system is that they overlook the great advantage fiat dollars have in competition with alternative potential moneys. Since it is already established as money, the fiat dollar will generally be preferred to other media of exchange, as it simply fulfills the primary purpose of money better than the alternatives (White 2002, 2004). Since prices are expressed in dollars, it is much easier to continue to use the incumbent money rather than speculate on some other commodity that might in time become widely used as a medium of exchange. This advantage of incumbency could be countered if the issuer of the fiat money, addicted to highly inflationary policies, in the end completely destroyed the monetary system. If we rely only on freedom, only on economic actions and not on political reforms in the establishment of sound money, all we can do is to wait for and even cheer on the complete destruction of the monetary system, while we stock up on the commodities that we think will emerge as media of exchange after the economic apocalypse. This is, however, an immoral and destructive course of action (Hülsmann 2008b, 241), as it amounts to resignation and surrender in the face of a great evil. There is, furthermore, no reason to think that the advocates of sound money will be in a position to prevent the perversion of the monetary regime that would emerge after the end of the fiat dollar.
The goal of all these reforms and of the reform we will present below is not simply anchoring the dollar to gold; rather, the goal is to completely replace fiat money with commodity money. Only in this way can the evils of fiat money be permanently banished.
How the Gold Standard Would Solve the Problems of Fiat Money
Inflation
Unlike with fiat money, there are definite limits to the possible increases in the supply of gold. Gold is an economic good and its production is subject to the same economic laws as all other goods (Hülsmann 2003, 39). In particular, the production of gold is limited by the law of costs (Sennholz 1975, 47–48): over time, the costs of production will tend to equal the selling price, as entrepreneurs bid up the prices of factors of production until the return to capital (the interest rate) is the same in all industries. Should a producer of gold go beyond this limit, he will lose money, just as would be the case in the production of other goods: he would spend more on inputs and wages than he would receive in revenue, so attempts to become rich simply by producing money would be self-defeating.
Furthermore, gold is indestructible; virtually the whole stock ever mined is still in existence, so current annual production is just a fraction of the total aboveground stock, usually 1–2 percent (Skousen 1996, 83–85). The possibilities for monetary inflation, then, are clearly limited under a gold standard.
This does not mean that the supply of gold is completely fixed; the production of gold will respond to an increase in the demand for money. As the demand for money increases, the purchasing power of money increases, meaning that it is now relatively more profitable to produce money. Gold miners will therefore expand their operations and less gold will be used for industrial purposes, as the gold is more highly valued in monetary uses, and manufacturers will search for substitutes to replace the more costly gold. Current production of gold and supply for monetary uses will also respond to a decrease in the demand for money: if the demand for gold for monetary purposes falls, its price will fall and gold miners will curtail their activities, reducing the additions to the present stock of gold. It may also prove possible to use more gold for industrial purposes or for consumer goods at the lower price, and more gold will therefore be switched to these uses, away from the monetary use (Salerno 2010b, 345; White 1999, 31–39).
It is theoretically possible for there to be short-term, localized inflation in gold-producing countries during a gold rush (Skousen 1996, 88), but these are unlikely now that the whole earth has been explored. Should they happen, however, they will only be temporary: the new gold will spread across the globe in such a way that its purchasing power will tend toward equality throughout the world (Mises 1981, 170–78), as it indeed did during the period of the classical gold standard (McCloskey and Zecher 1985). Speculation will speed up this process, further limiting the local inflationary effects of sudden increases in gold production.
Deflation of the money supply will be very limited, since gold is indestructible. Two kinds of changes on the demand side may cause the money supply to fall: a fall in the demand for money will lead to a lower purchasing power of money and higher prices, which would mean a relative increase in the profitability of gold for industrial purposes, leading to increased industrial demand. Similarly, an increase in industrial demand for gold will lower the supply of money, causing a general fall in prices and an increase in the purchasing power of money. In both cases, gold does not disappear completely: it will still be a potential part of the money supply, ready to reenter people’s cash balances should their demand for money increase or the possibility for profitable industrial uses disappear. There will very probably be price deflation during periods of economic growth, but this is on the whole beneficial (cf. Saul 1969; Bordo, Landon-Lane, and Redish 2010), as it just means that the value of everybody’s money holdings will increase slightly, which will not hamper economic growth (Selgin 1997; Thornton 2003; Hülsmann 2008a; Bagus 2015a). A falling price level will tend to stimulate gold production, and increased gold production will then tend to stabilize the price level. This is indeed what happened historically: in the period of 1890–1910, for instance, there was a tremendous economic expansion, but the overall level of prices was much the same in 1910 as it had been in 1890. The reason was that falling prices had stimulated gold production to such an extent that the monetary gold stock increased threefold (Rueff 1972, 45).
The problem of inflation leading to lower-quality products will also disappear under the gold standard. Recall that the substitution of lower-quality for higher-quality inputs was a response to the cost squeeze experienced by entrepreneurs as a result of fiat money inflation affecting input prices before affecting the prices of the final products. These problems will disappear on the gold standard, as money will be produced by entrepreneurs in response to consumer demand, not created arbitrarily.
Redistribution
Unlike the production of fiat money, money production on the free market does not imply redistribution away from producers. Just as in other industries, the incomes to gold miners are due to their productive efforts and entrepreneurial foresight, to how well they satisfy consumer demand.
It might be argued that gold, after all, is money, and that Cantillon effects mean that the production of gold leads to redistribution. But the similarity between the two cases is only on the surface. The “redistribution” to the entrepreneurs operating gold mines is no different from the “redistribution” to entrepreneurs engaged in producing consumer goods and capital goods. The new money produced will be paid out to the entrepreneurs, capitalists, and workers engaged in gold mining, and should increased demand for money or reduced costs increase the profitability of mining, more workers and capitalists will be attracted to the business. Conversely, should the profitability of gold mining decrease for some reason, workers will be laid off and have their wages reduced, capitalists will shift their investments from gold mining to more profitable areas, and entrepreneurs will suffer losses until all the adjustments have been made. All these changes are no different from what happens in other industries, and they do not lead to the kind of redistribution described by the Cantillon effect.
It is true that during a gold rush the workers and capitalists will be able to enjoy their increased incomes before the price effects of the increased money supply have taken effect, but a comparison to the production of a nonmonetary commodity will show that this is no different from increased profits in other sectors. Let us imagine that there is a sudden increase in demand for steel. Steel mills will make larger profits, as their selling prices increase before their buying prices, and these profits will be distributed among the entrepreneurs and workers and capitalists engaged in steel production. Entrepreneurs will bid up factor prices for their inputs in order to expand their production to satisfy the increased demand until production has been expanded and the profits have been distributed to workers and factor owners. The permanent effect of the change in demand has been increased incomes to all the workers and factor owners engaged in steel production, and they can enjoy these incomes before the prices of consumer goods have adjusted fully to the change in consumer demand brought about by the change in income distribution.
When we have commodity money, then, a boom in the production of money does not have effects, when it comes to the distribution of incomes, that are different from those of a boom in any other industry. It will lead to a rise in money incomes, but everybody is free to try their luck in the gold mines, and so the increased monetary incomes here will quickly bid up money wages in other industries. The distribution of incomes will change accordingly as productivity and consumer demand change.
Financialization
Financial markets offer an important service to the economy—what we may call the financial division of laborThis is Jörg Guido Hülsmann’s term—it has not, to my knowledge, been used in published writings.—as they transfer savings to where they are most valued. Savers benefit, as they gain a return on their savings and borrowers benefit, as they can now raise the funds they need for their planned investments instead of having to fund them out of their own savings. Financial intermediaries simply facilitate the process of investment by searching out and evaluating possible investment opportunities, pooling savings, and organizing markets (cf., e.g., Mishkin and Eakins 2016 for more on the true benefits of financial institutions).
However, as detailed above, the role of financial markets has been much exaggerated under the rule of fiat money, as virtually all saving has had to be in the form of financial assets to guard against inflation and as the costs of borrowing have been artificially lowered. Under a gold standard, we can expect money with a stable, probably even increasing, purchasing power. The artificially elevated demand for financial assets will therefore disappear, as it will no longer be necessary to guard against the erosion of one’s savings by investing in financial markets as fast as possible. We can imagine that people would instead accumulate funds and make long-term investments—perhaps in bonds, perhaps in various market funds, and probably to a larger extent in non-financial assets. There will still be an important role for financial markets, and it might even be, as Salerno (2010a, 364–65) speculates, that some financial assets (specifically, money market mutual funds) will supplement gold in its monetary role. But the artificial impetus forcing every small-time saver into the financial market and inducing everybody to take on debt will be gone, as it will no longer be necessary for everybody to dabble in financial markets to protect their savings.
The business cycles and periodic financial collapses will also disappear with the return of the gold standard. There will still be entrepreneurial errors and bad business decisions, and these may lead to the collapse and bankruptcy of companies from time to time. But we will not see the systematic boom of the economy as a whole followed by crisis and recession as the bad investments are liquidated. This phenomenon is dependent on infusions of money into the credit market that drive down the market rate of interest from its natural level—and this simply will not be possible under the pure gold standard. All lending will have to be backed by savings; there will be no fiduciary media. Credit will only be what Machlup (1940, 224n; cf. Mises 1981, 265) called transfer credit and Mises called commodity credit, that is, credit provided out of real savings, not simply granted ex nihilo by banks.
Even the case of a gold-induced business cycle that Mises (1998, 571) thought at least theoretically possible—increases in the supply of commodity money that reach the credit markets first—will not, in our opinion, trigger the business cycle, for what has happened here is not an artificial lowering of the rate of interest; rather, some entrepreneurs with a lower time preference have increased their incomes by better satisfying consumer demand. They have chosen, at the market rate of interest, to increase their investments relative to consumption. There is no difference between this scenario and the case where an entrepreneur in some other sector is successful, amasses a fortune, and invests most of it rather than consuming it. In Machlup’s terms, it is still an (perhaps temporary) increase in transfer credit, not created credit, and such fluctuations are simply part of the dynamic market process (Rothbard 1963, 34–36).
Deindustrialization
We live in a changing world and industries that were once competitive may suddenly find that new competitors in the global economy are undercutting them. This is simply part of reality, and to the extent that worldwide economic integration has made manufacturing in the United States noncompetitive, being on the gold standard would not have changed this. Some short-term pain for some producers is inevitable when the whole world economy has to adjust to the integration of large nations like China into the international division of labor.
The problem of the permanent balance-of-payments deficit and the artificially overvalued dollar would, however, be solved by returning to gold. Increased imports would mean an outflow of gold, and this would lead to a higher purchasing power for gold in the country. Foreigners taking advantage of this would increase their purchases of goods from the United States and the outflow of gold would be reversed to an inflow as speculators exploited the profit opportunity created (Salsman 1995, 34). Gold would tend to be distributed in such a way that its purchasing power is the same in all countries (Mises 1981, 170–72, 178). There are very definite limits to the supply of commodity money and a balance-of-payments deficit could not go on for long. Eventually, it would be reversed and money would start pouring back into the country (Heilperin 1939, 145, 152–53). These adjustments would happen automatically—that is, without the need for intervention by the monetary authorities—and would result in imports, in the long run, being paid for with exports or with foreign investments. Only the gold-producing countries would have a sustained outflow of money.
How would the gold standard affect trade between industrializing nations and the United States and would it limit the tendency for manufacturing to decline in the US? To the extent that imports into the US have been artificially stimulated and production in the United States has been disadvantaged by the fiat dollar system, to that extent the gold standard would restore competitiveness to industry in the United States. This does not mean that the gold standard would hamper international trade; quite to the contrary, it would promote sustainable trade and integration between all trade partners. We can imagine that under the gold standard, the United States would specialize in producing and exporting higher order goods such as specialized machinery, advanced electronics and the like to China, while China exported lower order goods and consumer goods to the United States. Yet all this is speculation; all we can say with any degree of certainty is that the balance of payments would tend to balance in the long term, and that capital flows would finance expansion of production in the most profitable locations and not simply support government and private consumption in the United States.Much more could be said on the international aspects of a restored gold standard. The reader is invited to consult the works referred to in The section on “Previous Reform Proposals” and in footnotes 5 and 6.
The Outline of a Gold Standard for the Twenty-First Century
The gold standard would be a vast improvement over fiat money, as it would solve most of the problems identified above. Furthermore, it is clear that it is the broad strata of the public who would gain from the reform, while only the narrow elites controlling the production of fiat dollars would lose out. The goal of our reform should not, however, be to simply return to the gold standard as it existed before 1933 or 1914, as this system still left the government and the central bank with some influence over monetary policy. Rather, we should aim at complete monetary freedom, at getting the government completely out of the business of producing and managing money.
Mises’s reform plan is, as indicated above, the main inspiration for the present proposal. His reform consists of two simple steps: 1) cease all inflationary activity; this also means 100 percent reserves for all future bank deposits; and 2) once the market price of gold stabilizes, this market price of gold is decreed the new legal parity for the dollar and the dollar is to be convertible unconditionally at this parity (Mises 1981, 448–49). A conversion agency independent of the Federal Reserve should be set up to accomplish this. The goal of this reform is not simply to stabilize the value of the dollar, but to make sure gold coins again circulate as money, that gold is again in everybody’s cash holdings, in order that the common man understands the importance of commodity money and is alerted in time should inflationary schemes be tried (ibid., 450–52). It is therefore important that all five-, ten-, and twenty-dollar bills are withdrawn against new gold coins within a year of the reform.
The first step in any reform, then, must be to stop inflating the money supply. The market can only be expected to find the correct price if disturbing factors are eliminated and the goal of reform is openly announced. It is therefore also necessary that all legal tender laws and all laws and taxes discriminating against the use of gold for monetary purposes be repealed (Paul and Lehrman 1982, 179–81). Naturally, all measures prohibiting or limiting private coinage of gold and silver coins must also be repealed. This will greatly facilitate the production and spread of such coins and prepare the way for the complete privatization of the monetary system.
Once these measures have been implemented and the commitment to restore the gold standard been openly and forcefully communicated, markets will in a short time establish a new dollar-gold ratio that will then be elevated to the new legal parity. It is impossible to say beforehand what this new price will be. Mises thought that the price of gold would settle around $36–$38, but this is obviously nowhere near the present-day market price. The legal price of $42.22 per troy ounce that the Treasury still insists on using in its accounts is equally outdated (Bureau of the Fiscal Service 2019). We can imagine that the imminent reintroduction of gold for monetary uses will create additional demand for gold, although it must be realized that a lot of the present demand for gold is for monetary and investment purposes: out of a total production of 4,490 tons in 2018, 1,810.6 tons were bought by investors and central banks (World Gold Council 2019).See also the additional charts and resources at Goldhub’s research library, https://www.gold.org/goldhub/research. Most likely, a great proportion of the 2,200 tons used for jewelry was also really investment demand, but how much we can only speculate.
For present purposes, imagine that the announcement of the reform and the initial actions suggested above lead the gold price to settle around $1,500—a slight increase from its present level.Since first writing this essay, gold has appreciated somewhat and is now fluctuating in a range between $1,700 and $1,750. I have retained the suggested price of $1,500, since it merely serves an illustrative purpose and is not too far removed from what the price can be expected to settle at should the reform be put in motion today. The basic principles of the suggested reform remain the same no matter what the price of gold rises to. The figures for the money supply used in this paper are also outdated, as the latest data used is from 2019. This price is then decreed the new legal parity—that is, the dollar is now defined as 1/1,500 troy ounce of fine gold. The conversion agency envisioned by Mises then proceeds to exchange all paper dollars presented to it at the legal parity into newly minted gold coins.
Several problems immediately present themselves when we contemplate this plan. For one thing, what kind of dollars, that is, what range of money substitutes should be accepted for redemption? Whether we choose M1 or M2, or just the currency component of M1, it is clear that the Treasury does not have enough gold to fully redeem all fiat dollars now in existence. At our suggested price of $1,500, the gold reserves of about 8,140 metric tons would be valued at about 400 billion dollars (precision is not important for our purposes here). This would be enough to redeem about one-quarter of the currency component of M1, or one-tenth of M1 or one-thirty-sixth of M2 (see figure 7).
Figure 7: US Money Stock, 2019.
Clearly, despite the large gold reserves, immediate redemption of every dollar in existence is not possible at gold prices below $15,000 at a minimum. However, there is no reason to think that the whole dollar stock will be presented for redemption at once. The dollar will, after all, improve considerably in quality once all inflation stops and redemption in gold is resumed. Hopefully, this means that an orderly withdrawal of paper money and its substitution with gold will be possible, and the Treasury will be able to gradually buy up gold in the market as necessary to redeem all dollars with gold as they are presented to the conversion agency. How the Treasury is to find the resources to buy gold as needed is a different question: it might fund the purchases out of tax receipts, which would mean an increase in taxation or a reduction in government expenditures and would therefore be unpopular, as well as keeping paper dollars in circulation, or it might fund its gold purchases by selling off government assets. The government held assets worth $3.48 trillion at the end of fiscal year 2017, to which should be added stewardship land not on the books (Department of the Treasury 2018, 55, 155). Selling off these assets to fund the necessary gold purchases would have the double benefit of not burdening the taxpayer and liberating substantial resources for use by the private sector, increasing real wealth and the production of desirable goods and services. This is clearly preferable to diverting taxes to gold purchases, since taxation not only is unpopular, but it is also destructive of real wealth.
Another serious problem is how to most easily get rid of the paper money in daily use. The use of cash is still widespread, and especially so for small purchases (Kumar, Maktabi, and O’Brien 2018). We agree wholly with Mises that it is desirable to replace banknotes with hard currency, but that is more easily said than done. The smallest gold coin produced by the US Mint is the one-tenth- ounce gold eagle, which at the suggested price of $1,500 per ounce would have a purchasing power equal to $150. Even were it technically possible to produce a one-twentieth-ounce coin, this too would be unusable for smaller purchases. Clearly, some other solution is necessary.
One possibility would be to allow for the existence of the old Federal Reserve notes, which could then assume the function of a token money for small purchases (Paul 1985, 137). This, however, leaves open the possibility of government interference in monetary matters, as only a legal monopoly on the issue of such notes can ensure their monetary character, and the point of the reform is precisely to finally achieve the complete separation of money and the state. Another possibility is to let banks take care of the problem by issuing money certificates and token coinage in small denominations. We can easily imagine that banks and other intermediaries will already be helping the citizens redeem their dollars for gold, so it is not too farfetched to think that the process will to a large degree consist in the transfer of gold bullion from the government to banks rather than of coins to citizens. This will save the cost of coinage for the government and economize on the costs of redemption for the citizens, and the citizens, if they so chose, could then continue to keep their gold in the bank and use money certificates.
There is a risk that the old paper currency will continue in use, simply because its value will be stabilized by the reform. As already said, this is undesirable, as it leaves the government a role in monetary affairs—and thus leaves the door open for the government to start meddling again. The solution to this problem is simple: allow the market to set a premium for gold above paper. Only at the conversion agency should the legal parity be enforced (Paul 1985, 135–36; Sennholz 1985, 82), market actors should be free to prefer gold in exchange and even to refuse to accept paper dollars. It is natural that sound money and trusted money certificates should be preferred to and command a slight premium over paper, since it is a more honest and secure form of money. By allowing this premium to emerge on the market – i.e., by abstaining from government intervention in the market process—while still enforcing the legal parity at the conversion agency, we should see a steady stream of gold out of the US Treasury and into private holdings. The premium may not amount to more than 1 percent, and will perhaps even be less, but that should be enough. This trend can be strengthened by forcing the US government as a whole, not just the conversion agency, to accept paper dollars in payment of fines and taxes at the legal parity. Since paper currency is also not very durable, we should expect it to disappear relatively quickly as old notes are turned in before they disintegrate.
Returning to the gold standard would usher in an era of increased productivity and prosperity for all. This has been the historical experience: the monetary reform in Germany in 1948, for instance, did not lead to a crisis, but rather straight out of a depression (Rueff 1964, 103–21; Lutz 1949) and was an important cause of the German Economic Miracle.See also Concise Encyclopedia of Economics, s.v. “German Economic Miracle,” by David R. Henderson, accessed April 4, 2020, https://www.econlib.org/library/Enc/GermanEconomicMiracle.html. It is true that returning to the gold standard would mean that the government would have to balance it budget in short order, and this may evidently be problematic for companies whose main business is in government contracts of various kinds, but these difficulties would be minor compared to the great prosperity unleashed in the rest of the economy. The financial system too should be able to adapt to sound money quickly, as most banks have ample reserves compared to their demand deposits (see figure 8). These reserves will be a more than adequate cushion for any short-term turbulence in financial markets that might result, especially since the quality of the banks’ reserves will improve as they are gradually swapped for gold through the process of redemption.
Figure 8: Total Reserves and Total Checkable Deposits, 2009–19.
Mises suggested that a monetary reform should be accompanied by the elimination of further issues of fiduciary media (Mises 1981, 438). His idea was to institute a 100 percent reserve requirement on new issues of money substitutes, whether in the form of demand deposits or banknotes.It should be clear that in this Mises was inspired by Peel’s Act. The main difference is that Mises recognized the correct character of demand deposits as money substitutes, and that Mises insisted on complete freedom in banking, subject to the normal commercial code. There is a lively debate over the issues of banking and money among supporters of the gold standard, but here we will limit ourselves to suggesting a reform targeting base money, or money in the narrower sense. A banking reform liberalizing financial institutions and removing undue protections and privileges would be of great benefit in itself and has previously been suggested as an integral part of monetary reform by, for instance, Judy Shelton (1994, 305–6), but we will not here enter into a discussion of the problems or benefits of fractional reserve banking and fiduciary media.I would, however, suggest that there is a clear parallel between the problems of the gold-exchange standard, which Rueff (1972, 28) identified as “a dual pyramidal credit structure based on the world’s gold stock” and a “duplication of the credit structure,” and fractional reserve banking, and that if one accepts Rueff’s criticisms of the former, it is very hard to explain how they do not apply to the latter.
Once the reform has been accomplished and all fiat dollars have been exchanged for gold, it will be a small matter to move on to complete monetary freedom. No special privileges should be afforded the use of gold for monetary purposes. Merchants, banks, and other financial institutions are free to favor one medium of exchange over another, should they so desire, but the same freedom of choice cannot be allowed to the government. While it may continue to keep its accounts in terms of the defunct dollar or in terms of gold, it should be forced to accept any commodity in current use as money in payment of taxes and other dues. This will ensure that, going forward, the market will be free to confirm gold as money, or to replace it with its preferred commodity.
Why Not Silver or Cryptocurrencies?
We have throughout emphasized that the goal of the reform is not simply the gold standard, but full monetary freedom. So why not choose another commodity, such as silver, or something more modern such as bitcoin?
It is entirely possible that the market may, in time, come to prefer these media of exchange to gold. We have proposed a gold standard that would put the minimum of artificial obstacles in the way of such a substitution. Yet there are still good reasons to think that gold is the better choice for a commodity money.
There is, first of all, a long tradition across the globe of gold as a medium of exchange and store of value. This means that there is widespread ownership of gold throughout society and that it would not take much mental effort for the citizenry at large to again come to think of money as gold and gold as money. This is probably as true of silver as it is of gold. Bitcoin, on the other hand, is a recent invention (cf. Barta and Murphy 2017; Ammous 2018 for an introduction to bitcoin). While it could theoretically serve as money, it is not used or owned widely in society yet. Unlike gold and silver, bitcoin requires at least some familiarity with modern digital technologies. This will, in our view, slow down its widespread adoption for some time, even if it should prove to be a higher-quality medium of exchange than gold. The payment of transaction fees is also inherent in the use of bitcoin, while it is free to use gold and silver, although banks might very well charge a fee for the use of their services and credit card companies already charge such fees.
Our preference for gold over silver is purely pragmatic: both metals could conceivably perform the functions of money equally well and have done so historically. However, the US government is in a better position to replace the paper dollar with gold than with silver. The Treasury possesses 8,140 metric tons of gold, or about 261 million troy ounces—enough to redeem a sizable portion of the outstanding paper dollars, as outlined above. Its stock of silver is slight by comparison: only 498 metric tons, or about 16 million troy ounces (US Geological Survey 2018). The conversion agency is bound to buy more gold than the US government already possesses anyway, but the US government is in a much better position to return to gold than to institute a silver standard.
Nevertheless, should the public prefer silver to gold, we can conceive of the conversion agency supplying silver currency as well, although this can only be done if the government buys up large quantities of silver. Having silver circulate as money as well as gold might be one way to solve the problem of small change outlined above, but it should be made clear that a fixed exchange between the two metals is not what we advocate. That would run into the problems described by Gresham’s law, and would at best result in silver becoming a rather expensive token coinage. Instead, it might simply be possible for the citizens to buy silver coins from the conversion agency instead of redeeming their dollars for gold. But this would be a purchase transaction, not an act of redemption, and silver would continue to fluctuate in value in terms of gold. Expanding the possibilities for purchasing silver coins even before the reform is completed would also be in keeping with the ultimate goal of monetary freedom.Strictly speaking, the US Mint need not be involved in coining silver at all. It is enough to repeal all legal tender laws early on and decree that all commonly accepted media of exchange are also acceptable in payment of taxes. The government would still have to use gold as the money of account, but it could then accept silver in payments according to the prevailing market rate at the time. Naturally, such acceptance should be forced on the government, but private parties should be free to accept or refuse payment in whatever money they chose.
WHY THE CASE FOR MONETARY REFORM MUST BE POPULIST “[We] must show how the money system impoverishes most people and benefits politicians, government officials, and entitlement cronies.” - Hans Sennholz (1985, 78)
Such a reform as we have presented above is ambitious, and it might well be asked how it can be a popular cause. However, any social institution depends on popular support for its continued existence, and this is true also of money. In order to promote sound money, the public at large must be convinced of the justice and utility of that reform (Mises 1981, 456).
The reason for making the cause of the gold standard a populist cause is not simply that all branches of government have proved impotent or unwilling to defend sound money (Mises 1981, 452); unfortunately, there does not seem to be any clear political gain to be made from championing sound money, while there is a clear financial and bureaucratic interest in maintaining the status quo. There also seems to be very little understanding of the importance of the gold standard, which to this day is still too often confused with the gold-exchange standard in official circles and academia and therefore dismissed as a barbarous relic.
It is, however, clearly in the interest of the public at large to see a return to sound money, and it is especially in the interest of that portion of the public employed in the private sector or who live off their own funds. We tried to outline in the last two sections how such people are hurt by the fiat dollar and how a return to gold might benefit them especially. Only by making such appeals to the tangible benefit that the public can expect from sound money can we expect them to join a movement for gold (Paul 1985, 131), and only if we can make the cause of the gold standard a popular movement on a par with the free trade movement of the nineteenth century (Hayek 1990, 133) can unwilling politicians and bureaucrats be forced to accept it. It is, in other words, necessary to make sound money a popular crusade in order for a return to the gold standard to become at all possible.
Making the cause for the gold standard a populist one does not mean that just any argument in its favor can be used. The arguments used must always be true and in accord with reality. A popular movement for sound money and gold should not create unrealistic expectations in the public; the gold standard can solve some problems but it is not an economic panacea. The agitation for the gold standard should never go beyond what can reasonably be expected, but we should not be afraid to show the relevance of sound money to whatever question holds the public’s attention at the moment. Some arguments are clearly not compatible with the gold standard: the gold standard imposes golden shackles on the state, and it would be dishonest to pretend otherwise, nor can or should it be hidden that advocacy for sound money was and is intimately connected with the main goals of classical liberalism and libertarianism: laissez-faire, personal freedom, and peace. This does not mean that the public has to be converted to the whole liberal/libertarian program, but it does mean that it would be dishonest and counterproductive to hide the fact that sound money would mean severe limits to the possibilities for expanding state power.
The case for gold probably cannot sustain continued support on its own. A sound money movement would want to ally with other popular movements to advance its cause (Sennholz 1985, 79). Sennholz suggested the tax revolt movement in the 1980s, but there is no reason to be picky. Gun owners, advocates of First Amendment rights, of privacy rights, of religious freedom—wherever there is a movement whose objectives are consonant with the objectives of the sound money movement, there the possibilities for cooperation should be explored. Some causes, no matter how popular, cannot be allies of a movement for restoring the gold standard. Specifically, any movement that seeks to expand the scope of government significantly in pursuit of its goals cannot be an ally of a movement for sound money, as the objectives of such a movement are incompatible with the institution of sound money.
How can the populist appeal, then, be made? This, as already indicated, depends on the specific circumstances of time and place and the problems exercising the public. In general, in the American context, appeals might be made to the injustice of Roosevelt’s confiscation of gold in 1933 and how it would be just to restore the gold to the current owners of dollars; the long tradition of adherence to gold and sound money might also be invoked, from the Jeffersonians and Jacksonians to the late nineteenth century. Fundamentally, any policy rests on the popular acceptance of the doctrines on which it is grounded, which is why any long-term reform must be based on popular support for true principles:
The first condition of any real monetary reform is still to rout completely all populist doctrines advocating Chartalism,The text reads “Chartism,” but this must be an error by the translator: chartalism was the state theory of money made famous be Georg Friedrich Knapp in 1908, whose modern epigones are the promoters of so-called modern monetary theory (MMT). Chartism, on the other hand, was a movement for the extension of suffrage in nineteenth-century Britain. the creation of money, the dethronement of gold and free money. Any imperfection and lack of clarity here is prejudicial. Inflationists of every variety must be completely demolished. We should not be satisfied to settle for compromises with them. The slogan, “Down with gold,” must be ousted. The solution rests on substituting in its place: “No governmental interference with the value of the monetary unit!” (Mises 2011, 21)
CONCLUSION The gold standard, and sound money generally, is still the only solution to the problems generated by fiat money. We have argued in this paper that the economy and society of the United States is still plagued by the evils of fiat money, even though the high inflation of the 1970s gave way to the “Great Moderation”. We have also tried to show how returning to gold would solve the specific problems caused by fiat money, and how a feasible reform returning the dollar to gold would look now, after close to 50 years of fiat money.
The crucial point is that any restoration of the gold standard must originate as a popular movement, and the advocates of the gold standard must therefore make their appeal to the public, not to politicians and central bankers. The benefits of sound money are very real, and so are the abuses of fiat money. There is therefore no reason that sound money cannot become a popular idea at the center of a political program as it once was (Mises 1981, 414).
Murray Rothbard's The Ethics of Liberty is a sweeping treatise which creates nothing short of a normative political philosophy of liberty. Contra Hume, Rothbard attempts to derive an "ought" from an "is," using natural law precepts and rigorous logic. Professor Walter Block joins the show to discuss the first section of the book, and gives us his unstinting (and always deontological!) take on Rothbard's vitally important treatment of natural law philosophy as the foundation for a free society. There are also lots of great Blockean anecdotes you'll want to hear!
The Audiobook version of The Ethics of Liberty is available at Mises.org/EthicsAudio Read Hans-Hermann Hoppe's introduction to the 1998 edition work at Mises.org/EthicsHoppe Find David Hume's A Treatise on Nature at Mises.org/Hume
In Kropotkin's pamphlet on Anarchist Morality, he applauded the empiricist philosophers of the 18th-century Enlightenment for rejecting religious interpretations of human action and adopting an account that made the quest of pleasure and avoidance of pain the source of human motivation. Kropotkin joined with Bentham, John Stuart Mill, and Chernischevsky in affirming that the desire for pleasure was the true motive of all human action. Kropotkin not only maintained that in their conscious, deliberative acts, human beings always seek out pleasure; he saw this motive operating throughout the organic world. Recognition of this truth, Kropotkin argued, placed ethics on a materialistic, naturalistic basis. Furthermore, Kropotkin thought reliance on the findings of science and on evolutionary theory gave to ethics a philosophical certitude, in contrast to the uncertain intuitionalism on which transcendental philosophers like Kant relied.
Key methodological differences between Austrians were highlighted in Milton Friedman's "The Methodology of Positive Economics." A key piece of conflict: Friedman's focus on prediction rather than explanation.
Original Article: "Milton Friedman's Methodological Mistake"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
America's "Old Right"—rooted in 19th century liberalism but birthed in the 1930s to oppose the New Deal—was strongly laissez-faire and non-interventionist. Murray Rothbard wrote the comprehensive story of that movement, it's influences and influence, and its destruction at the hands of Buckleyite Cold Warriorism. Modern conservatism sadly bears little resemblance to the Old Right, and America is worse off for it.
Dr. Patrick Newman and Tho Bishop join the show to dissect the book, which is both a critical history and a fascinating political memoir of Rothbard's own journey to libertarianism.
Read this historic work at Mises.org/Betrayal
One day, the Institute publishes an article criticizing Republicans. The Left cheers, but the Rights denounces us. The next day we criticize Democrats and the Right cheers while the Left is enraged. Yet our position is always consistently against the state.
Original Article: "The Enemy Is Always the State"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Politics degrades our lives in innumerable ways, from personal relationships to work to places of worship. Even sports and movies now seem to have become deeply politicized. The political class and political system in America appear intent on creating division and hatred rather than cooperation. The two political tribes in America—red and blue—are divided on everything: abortion, guns, immigration, Trump, and now Covid. Is there any way to reclaim some semblance of a truce between these warring nations?
Our guest Ross Benes has written an engrossing memoir of his experiences in both worlds, from small town life in his ultra-red Nebraska hometown to his writing career in ultra-blue Brooklyn. It's a fascinating look at how and why we have allowed politicians to alienate us, and a hopeful call for a less political America.
Find Rural Rebellion: How Nebraska Became a Republican Stronghold at Mises.org/RuralBook
As Mark Thornton has shown, the big legislative change that FDR made at the start of his presidency, the decision that affected every single American citizen from one coast to the other, was the repeal of the thirteen-year hell of Prohibition.
Original Article: "Prohibition's Repeal: What Made FDR Popular"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
These regulations have a clear message: "You don't know what is good for you so you must be forced to do what the government thinks is good for you."
Original Article: "A Penchant for Controlling Others"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Rothbard: "At the outset of every step forward on the road to a more plentiful existence is saving….Without saving and capital accumulation there could not be any striving toward nonmaterial ends."
Original Article: "The Upside of Lockdowns: More Saving"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
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
Escaping Paternalismby Mario J. Rizzo and Glen WhitmanCambridge: Cambridge University Press, 2020506 pp.
David Gordon (dgordon@mises.org) is a senior fellow at the Mises Institute and editor of the Journal of Libertarian Studies. This review was originally published Jan. 2, 2020 as “Why Paternalists Keep Calling Us Irrational,” at https://mises.org/wire/why-paternalists-keep-calling-us-irrational.
Some economists, such as the 2017 Nobel Laureate Richard Thaler and his colleague Cass Sunstein, have proposed an unusual justification for government interference with people’s choices. They do not intend, they say, to override the preferences that people have. They don’t want to tell people what they “should” want, according to an external standard that people don’t accept.
They claim, however, that accepting the actual preferences people have still leaves room for government intervention. How is this possible? Their answer is that people often choose in an irrational way. They make mistakes in reasoning and choose impulsively. People don’t “really” want what they choose irrationally, so government intervention that pushes people to choose rationally is consistent with respect for people’s preferences.
One way to challenge this view is to deny that people who choose irrationally aren’t “really” choosing. What you would choose if you had full information and weren’t making mistakes in reasoning may be an interesting question, but the answer to it does not tell us what people want. If it does not, there is no room for government intervention that respects people’s preferences, contrary to Thaler and Sunstein’s assertion.
In Escaping Paternalism, Mario J. Rizzo and Glen Whitman offer a more fundamental response to Thaler and Sunstein’s argument, though the book is by no means limited to a discussion of these authors, nor to the argument that I am about to discuss. To the contrary, the lines of argument pursued in the dense and difficult book, far and away the best discussion of behavioral economics, are many and various.
Rizzo and Whitman ask, “What is the evidence that people choose irrationally?” They find this evidence unconvincing.
Some people might say, “Isn’t it obvious that people sometimes make irrational choices? For example, people often sign up for costly gym memberships and then wind up attending the gym fewer times than they thought they would. They would have saved money if they had paid by the visit. Isn’t the government helping people get what they want if it mandates a period of time for them to cancel long-term gym memberships?”
Rizzo and Whitman aren’t convinced.
The analysis is fundamentally static, and thus the crucial observations that individuals plan to go to the gym more than they actually do and that they delay canceling inappropriate contracts are interpreted as partial naiveté. Indeed the individuals may be naïve to begin with, but does that explain where things end? To answer yes would seem implausible. Consider that the people in this study were new gym members and therefore likely inexperienced…. Why should we expect inexperienced individuals to know how much self-discipline they will have in going to the gym? The only way they will find out is by getting feedback on their initial optimistic expectations. And this will not happen all at once. Inevitably there will be a period during which they will be paying for visits they did not use. The more patient they are about learning, the longer this period will be. Patience in acquiring the knowledge necessary for self-regulation can be confused, ironically, with present bias. (p. 229)
Rizzo and Whitman’s strategy here is subtle. They are not in this example accepting the view of biased behavior held by the behavioral economists, but rather they are asking whether, given this view, it has been shown that people are choosing irrationally. Further, they aren’t here claiming that people for the most part do choose rationally by this standard, though it’s clear from other things in the book that they think a good case can be made for this. Their limited claim here is that it has not been shown that people act in a biased way.
They use the same strategy in analyzing other studies that claim to demonstrate biased choice. In doing so, they confront many examples of alleged biased choice which have become notorious in the popular literature.
Their dissent from one common example of irrational choice illustrates the depth of their analysis. According to one standard account, employees who can choose to participate in a retirement savings program will choose differently, depending on what the “default” option is. That is to say, if people have to choose to join the program, fewer will sign up than will remain in the program when they have to “opt out” in order to leave it. Surely, the argument goes, an important decision like participating in a retirement savings program should not depend on so trivial a matter as the default option. Isn’t this strong evidence for biased choice?
It comes as no surprise that Rizzo and Whitman are unconvinced.
Employees face a complicated decision about whether and when to enroll as well as what savings contribution to make…. The cognitive cost of considering options and reaching a decision is immediate, while the benefits are in the future. Present-biased agents seek to put off the immediate cognitive burden; ‘let me think about this tomorrow.’ … So we must ask; is the fact that many agents eventually opt in explained by their learning about their own bias and then reducing it, or by their learning more about the situation context (including their preferences and the investments options available)? … When they cannot be distinguished, learning looks like procrastination. (p. 294)
Once more, the authors do not claim to have proved that behavioral economists err in asserting that people choose irrationally. Their claim is that irrationality has not been proved to exist.
In other words, we in fact know much less about the prevalence of irrational choice than some behavioral economists think we do. What follows from this, so far as government intervention is concerned? Cass Sunstein answers, “Not all that much.” In the face of objections to claims of irrational choice, he maintains that
it is not enough to offer an array of theoretical, conceptual, and empirical arguments against behavioral paternalism. Rather, we must offer a broad and comprehensive argument that is sufficient to decisively rule out any form of paternalism whatsoever. (p. 412)
Only someone eager to impose his allegedly superior wisdom on the “irrational” masses could take this demand seriously, and the rest of us will join with Rizzo and Whitman in rejecting it.
First Bob explains his contest involving Adventures in Pacifism–winner gets 100 smackers. Then he explains the incredibly powerful, and surprisingly Austrian, result by which Kenneth Arrow showed it was impossible to coherently aggregate individual preferences into a social ranking.
Mentioned in the Episode and Other Links of Interest: The blog post explaining the rules for the contest, Adventures in Pacifism: Louie CK EditionBob’s link for those interested in joining Liberty Classroom. (If you use this link, the site will remember who sent you if you end up joining.)Bob’s mises.org’s article explaining Arrow’s Theorem in the context of the 2020 electionThe Bob Murphy Show ep. 7, explaining Godel’s Incompleteness Theorems For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
Even when an economic bust appears, there may still be enough real savings in the economy to quickly put the economy back on track. This is what brings economic recovery, not artificial "stimulus."
Original Article: "Why Government Stimulus Sometimes Looks like It Revives the Economy".
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Dan McCarthy, Editor at Large of The American Conservative, joins Bob to discuss his view that conservatives and libertarians should stop heaping contempt on democracy. McCarthy argues that the elites are the real threat to liberty, not the masses.
Mentioned in the Episode and Other Links of Interest: The YouTube version of this interviewThe homepages for Modern Age and The American Conservative For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
No, “societal” value is not what you want or think is good, and “we” are not a homogenous entity of observable, aggregated preferences.
Original Article: "Modern Monetary Collectivism"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Why don't elections bring harmony and closure rather than ever greater political friction? Hans-Hermann Hoppe explained all of the fundamental problems with mass democracy more than 20 years ago in Democracy: The God That Failed.
Jeff Deist finishes his series on this devastating classic with a look at Hoppe's final chapters, critiquing conservatism, liberalism, and constitutionalism. Why do both conservatism and liberalism fail? (hint: democratic mechanisms). Liberalism is property, not majority rule, and all governments tend to attack rather than defend property over time. So what is the best way forward, combining a liberal economic program with the old conservative understanding of natural order? And how do we get there? Don't miss this discussion of Hoppe's most controversial and forward-looking book.
Use the code HAPOD for a discount on Democracy: The God That Failed from our bookstore: Mises.org/BuyHoppe
Peter Schiff famously called the housing crash but thinks the real crash is still on the way. He talks with Bob about his background in the financial sector, and why the networks no longer book him for interviews. They also discuss minarchism vs. anarcho-capitalism, and Peter’s decision to move to Puerto Rico.
Mentioned in the Episode and Other Links of Interest: The YouTube version of this interviewThe website for Peter’s books. Peter’s books Crash Proof and The Real CrashThe YouTube compilation, “Peter Schiff Was Right.” Peter’s YouTube channelThe Peter Schiff Show For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
Bob unveils a new series in which he explains and then evaluates apparent contradictions in the way free-market libertarians handle certain issues.
Mentioned in the Episode and Other Links of Interest: Bastiat’s “Petition of the Candlemakers”Bob’s article on price gouging For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
With an ugly presidential election just three weeks away, we dive into Hans Hoppe's classic Democracy: The God That Failed to puncture some of the myths surrounding democracy and voting. Jayant Bhandari joins the show to discuss Hoppe's controversial thesis concerning monarchy and democracy, time preference and its manifestation in the two systems, the forces constraining monarchs, and the terrible incentives created for democratic rulers. This is a must-listen show for anyone interested in Hoppe's most famous work and its application to the problems western states face today.
Find more from Jayant Bhandari on his website (JayantGhandari.com) and his Twitter account (@JayantBhandari5).
Use the code HAPOD for a discount on Democracy: The God That Failed from our bookstore: Mises.org/BuyHoppe
There are many reasons we should be skeptical of the GDP statistic. But it is nonetheless important to understand how it is calculated.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "Calculating GDP Correctly".
When Murray Rothbard wrote Man, Economy, and State in the 1950s, monopoly theory was a mess. Even Mises did not have a full understanding of where neoclassical economics went wrong in diagnosing "market failure." But in Chapter 10 of his great treatise, Rothbard demolished the myths surrounding monopolies and cartels. His friend Dr. Walter Block joins the show to discuss Rothbard's breakthroughs and draw downward-sloping demand diagrams for us!
We discuss why deadweight loss is nonsense; why government privilege and forced union bargaining are the real culprits; and why cartels are inherently unstable. Even Google should not worry us, says Dr. Block—but with a caveat. Don't miss this show on groundbreaking Rothbardian monopoly insights!
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
While collectivism was implied in Sismondi’s idea of a “general interest,” Owen and Fourier offered the first formal expression of full socialist collectivization.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "The First Socialists: The Saint-Simonians and the Utopians".
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_19.
Recorded at the Mises Institute in Auburn, Alabama, on 15 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 the slides from this lecture at Mises.org/MU21_PPT_12.
Recorded at the Mises Institute in Auburn, Alabama, on 20 July 2021.
Bad theories have a long life in the social sciences, and the crude quantity theory of money is one that refuses to go away.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "The Quantity Theory of Money and the Equation of Exchange".
Why economics abandoned the analysis of human action in favor of Keynes-inspired math-centered economics.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "Progressives and the Origins of the Economic 'Consensus'".
This book is a systematic treatment of the historic transformation of the West from limited monarchy to unlimited democracy. Revisionist in nature, it reaches the conclusion that monarchy, with all its failings, is a lesser evil than mass democracy, but outlines deficiencies in both as systems of guarding liberty.
Narrated by Paul Strikwerda.
Download the complete audiobook (15 MP3 files) in one ZIP file here. This audiobook is also available on Soundcloud and via RSS. Purchase the Audiobook on MP3-CD and Audible/Amazon, or paperback at the Mises Store. © 2001 Taylor and Francis, published 2017 by Routledge, an imprint of the Taylor and Francis Group.
Price inflation is so difficult to predict, because there are so many moving parts: money supply, demand, money velocity, and supply of goods and services.
Narrated by Daniella Bassi.
Original Article: "To Prevent Problematic Inflation, We Need More Production. Which Means There's Trouble Ahead."
In theory, it is possible to adjust inflation measures to account for the many constant changes in prices resulting from changing demand, quality, and innovations. But it's essentially impossible to execute these adjustments accurately.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "Why Official Inflation Measures Don't Work"
Abstract: Murray Rothbard wrote an unpublished note in the early 1960s on the economics of antebellum slavery. Essentially, it was a criticism of the methodology of the New Economic History, or cliometrics, of which Conrad and Meyer (1958a) was the breakthrough application, on the topic of the profitability of slavery. Rothbard points out that their procedure in no way supports their conclusion that slavery was profitable or their ideological conclusion that the Civil War was necessary to end American slavery.
civil war — economic history — slavery — cliometrics — new economic historyJEL Classification: B53, N31, N91
Dr. Mark Thornton (mthornton@mises.org) is senior fellow at the Mises Institute and serves as the book review editor of the Quarterly Journal of Austrian Economics.
A manuscript was found in the Rothbard Archives titled “A Note on the Economics of Slavery.” It appears to be an unpublished communication concerning an article and comment that appeared in the Journal of Political Economy. Given the dearth of analysis of the economics of slavery in Murray N. Rothbard’s writings and the revolution in the subject matter that was taking place at the time it was written, the manuscript is certainly worth publishing at this time.By 1956, Rothbard had planned to write about the economic analysis of slavery as an appendix to a chapter on government intervention in his treatise Man, Economy and State (1962). According to Stromberg, the editor of the 2004 edition of Man Economy and State, in a private memo, Rothbard outlined the contents of that appendix and that sketch mimics the contents of Rothbard’s (1960) note. The purpose of this article is to provide the necessary context in which the note was written.
In 1994, I published a paper on the economics of slavery, “Slavery, Profitability, and the Market Process,” in the Review of Austrian Economics, then edited by Rothbard. He had encouraged me to write on the economics of antebellum slavery based on comments I made during an impromptu debate I had with economic historian Robert Higgs at Mises University in the early 1990s.
Not only did Rothbard encourage me to write the article, he guided me with multiple single-spaced pages of references and suggestions. In the process I examined an enormous amount of literature on the economic issues of slavery in antebellum America. It could have easily turned into a second dissertation. However, there was nothing written by Rothbard himself among those recommended sources.
When I was writing, I was well aware of one of the articles that Rothbard commented on in the note. It was a landmark study in the “New Economic History” by Conrad and Meyer that was published in the Journal of Political Economy in 1958. However, I was unaware of the comments by Douglass Dowd (1958) and John E. Moes (1960), which were published in the same journal. The second comment is the direct subject of the Rothbard note. Conrad and Meyer published two revealing replies to both comments. This literature is reviewed here to provide the context of Rothbard’s note.
We assume that Rothbard’s note was submitted and rejected, if for no other reason, because it would have been submitted more than two years after the original article was published. Also, the “note” would have been the third comment on the article, and no other article in the JPE during this period had more than one published comment. For now, I will note that Rothbard did not bring my attention to either the Moes comment or his own note during the process of researching, writing, or publishing my 1994 article. Both would have been helpful, welcome additions to my research. Moes (1960) argues against the seminal article by Conrad and Meyer, a precursor to the classic and highly controversial work by Robert Fogel and Stanley Engerman, Time on the Cross (1974). Rothbard supplements Moes with a more theoretical commentary. It is worth noting here that the Conrad and Meyer (1958a) article was the epicenter of a methodological revolution in economic history.
The Conrad and Meyer article is an attempt to establish whether or not antebellum slavery was in fact profitable. At thirty-five pages, it is an empirical analysis of the available data, much like an historical accounting exercise with the assistance of economic modeling. This article marks the very beginning of cliometrics, a.k.a. the New Economic History, in which economic history would be studied primarily using models and statistics. It was a revolution that would eventually sweep the field of traditional economic history.
Conrad and Meyer’s article is an effort to measure the ordinary profitability of slavery using an economic, as opposed to an accounting, formula of profit. In addition to the revolutionary method, the article confronted a critical ideological issue at the time: can the American Civil War be justified? Was slavery inefficient and unprofitable and would it have soon died off, making the American Civil War unnecessary? Or, was slavery efficient and profitable, thus necessitating, or at least justifying, the war? Rothbard represents a view that slavery is narrowly profitable (due to external forces) but inefficient and could plausibly and quickly wither away.
Conrad and Meyer begin with a production function for slave-based agriculture (i.e., cotton) and a production function for slave breeding as the joint product of slavery. They then bring together various data to examine the cost and the value of slave production in terms of cotton and slave breeding. They conclude that the joint product of slave labor in terms of crop production and slave breeding exceeded the returns on alternative investments and therefore that slavery was profitable.
That they find that slavery was profitable is not surprising, as any ongoing risky business should produce an ongoing positive return. This would be especially true in an expanding business such as cotton, which along with coal and iron was a primary raw material during the Industrial Revolution! The fact that prices were high and output was rising circa 1849–60 is a strong indication that the market for slaves was not in any kind of long-run equilibrium but instead was experiencing sustained increases due to increasing demand for cotton and other forces.
Their result of profitability is not surprising, because any good, factor of production, or institution that remains in use over a significant period of time must be profitable in some sense. The laws of economics dictate this result. However, in the long-run equilibrium economy, or evenly rotating economy, economic profits should always be bid away.
This might not be true for things that provide psychic income, which offsets the lack of monetary profits, but it is only true until losses consume all the invested capital. Therefore this would not be an equilibrium situation. Or it could be that cross subsidies maintain an unprofitable operation in order to provide support for a profitable operation. For example, the owner of an apartment building might continue to operate an unprofitable laundry service on the premises because it increases the demand for the apartments or generates “good will” with tenants.
But what could the logic be with antebellum slavery? Did the slave owners get some kind of psychic income from slave ownership? Did they enjoy whipping their slaves? Or did they feel some kind of personal obligation to maintain slave ownership? Such arguments have been made about antebellum slavery, including by Moes (1960), but it seems doubtful that under ordinary conditions, such concerns could be maintained for centuries and over multiple generations.
In any case, those arguments fail, because the number of slaves continued to grow. Slave markets continued to grow and were increasingly vibrant and resilient during the late antebellum period. There was also an increasing long-term trend in inflation-adjusted slave prices. This evidence suggests that such psychic reasons could not be an important factor here, if they existed at all.
However, the fact that Conrad and Meyer (1958a) found slavery to be profitable satisfies their desire to justify the American Civil War:
In sum, it seems doubtful that the South was forced by bad statesmanship into an unnecessary war to protect a system which must soon have disappeared because it was economically unsound. This is a romantic hypothesis which will not stand against the facts. (Conrad and Meyer 1958a, 121)
Moreover, they also blame “inexorable economic forces” for the stability of slavery from the “strict economic standpoint.”
Furthermore, the American experience clearly suggest[s] that slavery is not, from the strict economic standpoint, a deterrent to industrial development and that its elimination may take more than the workings of inexorable economic forces. (Conrad and Meyer, 1958a, 122, emphasis added)
They reiterate in the closing paragraph of the article that slavery is the fault of the market, that the market would continue to support slavery, and that ending slavery would necessarily require “the adoption of harsh political measures,” i.e., the American Civil War.
To the extent, moreover, that profitability is a necessary condition for the continuation of a private business institution in a free-enterprise society; slavery was not untenable in the ante bellum American South. Indeed, economic forces often may work towards the continuation of a slave system, so that the elimination of slavery may depend upon the adoption of harsh political measures. Certainly that was the American experience. (Conrad and Meyer 1958a, 122, emphasis added)
The first comment on the Conrad and Meyer article was by Douglas F. Dowd (1958). He challenges Conrad and Meyer for taking a simple and narrow approach to something that is very complex, particularly the question of the lack of economic development in the slave states. More generally, Dowd argues, correctly, that the institution of slavery prevented “the basic elements of a capitalist society” from taking root. He notes that the maintenance of slavery in the “land of the free” required the development of an “irrational ideology” which had a pervasive impact on society. Dowd writes:
The authors argue as though slavery were merely another, more manipulable, form of labor; as though it were, one might say, institutionally neutral. And, working essentially within the methodology of neoclassical economics (with time allowed in occasionally) they have analyzed the “economic” meaning of slavery as though they were analyzing the representative firm in the long run (or even, at times, in the short run). (Dowd 1958, 441)
In other words, although Dowd agrees that slavery was profitable, he finds that result largely insignificant compared with the impact of the institution on Southern society, particularly its displacement of capitalism and its drag on economic development. In a different context, it could be argued that dealing illegal drugs on the streets is profitable, but that fixes our attention on an obvious and irrelevant aspect of this issue (of course it must be profitable in some sense) and disregards all the real problems (e.g., crime, corruption, overdose deaths, violence, among others).
In their reply, Conrad and Meyer (1958b) do not disagree with Dowd, but rather claim that he is commenting on issues that were beyond the scope of their paper. They reemphasize that their result “means that the imminent demise of slavery in the ante bellum South must be argued on grounds other than unprofitability from now on.” This is a curious claim given such facts as the steam tractor’s development in the 1870s and its full commercialization during the first quarter of the twentieth century. Would slavery have survived this development?
The true economic question, if not the only important question, is why slavery was profitable. Conrad and Meyer essentially bypass the economic question. They attribute the cause of the profitability to murky and ill-defined “market forces.” As we will see, Rothbard asks the right question.
The second comment was by John E. Moes (1960). It is a brute-force frontal assault on Conrad and Meyer (1958a). He argues that the decline of slavery in Rome depended on voluntary manumission, i.e., granting a slave freedom, but that manumission was not a widespread procedure in the antebellum South. According to Moes (1960, 185) “it remained a very minor affair” for the following reasons:
- Antimanumission laws restricting or prohibiting the freeing of slaves2. Racial prejudice and white supremacy3. Freed slaves’ very precarious legal status (unlike in Rome)4. Antiabolitionist ideology turned slave owning from a business into a calling. The ideology made manumission unprofitable in a real sense due to personal repercussions from family, friends and neighbors.
Moes suggest that with free manumission, the relative inefficiency of slaves (without prospects for freedom), and the increasing diversification of the Southern economy, slavery would certainly have declined or disappeared altogether. In other words, if slaves could buy their freedom and that of their family and friends, then leased slaves would work harder and save their income to make purchases of freedom. They would try to get themselves leased by their owners into higher-paying industries, such as manufacturing and railroads, and high-skill occupations, such as blacksmithing and telegraph operation. Based on historical experience, Moes thinks that this would have been more profitable for slave owners too, generating higher returns compared to slave-based agriculture. This argument undermines the ex post facto argument that the American Civil War was necessary to end slavery in the antebellum South.
In their reply to Moes, Conrad and Meyer (1960, 187) note that Moes’s concerns were beyond “our original discussion of the economics of slavery in the American South.” Their main concern was to test the hypothesis that slavery as it existed in the antebellum American South was profitable according to the “private-enterprise standards of the period.” Again, they simply ignore relevant and important issues and subtly place the blame for slavery on private enterprise.
One can well image that Rothbard would be opposed to Conrad and Meyer for several reasons, methodological, theoretical, and historical, among others. Their linking of slavery with capitalist institutions would obviously be unacceptable to him or any good historian of the subject, as slavery has historically been the result of war, not commerce. Antebellum slavery was hardly a capitalist institution: African states were the largest slave hunters, the Royal African Company (founded by the English monarchy) was one of the largest transporters of slaves to the New World, and slavery only survived in the Southern states due to an extensive system of government intervention made up of slave codes, slave patrol statutes, fugitive slave laws, etc.
The first argument that Rothbard makes in the manuscript is that the true economic profits of slavery occurred in the past, when slave hunters and traders exploited the original supply of slaves. The original price would have reflected the anticipated present value of the flow of net revenues over time. The price would have also included the anticipated present value of the net revenues from slave breeding. In the long run, even slave hunting would only yield a normal market return on investment. Rothbard is arguing from a long-run equilibrium view that in the short term slave hunters could earn an economic profit while subsequent owners would only earn a normal operating profit ceteris paribus.
What this means is that any detection and measurement of economic profits in a short-run disequilibrium situation in the real world would be the result of some factors other than slavery per se. For example, both Rothbard (1960) and Moes (1960) note that antimanumission laws passed in slave state legislatures were a key element in preventing the withering away of slavery. Rothbard also notes that the constitutional measure to shut down international trade in slaves increased the profitability of slave breeding.
Other exogenous factors—including the US Constitution’s slave clause, the 1793 Fugitive Slave Act, the invention of the cotton gin in 1793, the Industrial Revolution, the expansion or strengthening of slave codes and slave patrol statutes (laws designed to prevent runaways by socializing the costs of slave security), and of course the passage of the Fugitive Slave Act of 1850—also increased the profitability of slave-based agriculture. The invention of the farm tractor, the weakening of slave codes (especially the antimanumission laws), and Southern secession and the likely repeal of the Fugitive Slave Act would all have decreased profitability and increased the likelihood of the breakdown of slavery.
Relative to Ludwig von Mises’s (2003, 239) topology of malinvestments in capital, antebellum slave labor could qualify as a capital malinvestment in three of five possible cases. First, it could be classified as labor that was economically justified at one time but in the future would no longer be justified because of the rise of new methods, e.g., the adoption of farm machinery. Second, it could become economically unjustified due to other changes in the market data, e.g., a decrease in slave security or a decrease in the demand for the product of the labor. Third, it could be classified as labor that was uneconomic but could still be used “by virtue of interventionist measures that have now been abandoned,” e.g., by repealing antimanumission laws and adapting the land tenure system to more profitably exploit the labor.
Rothbard therefore makes two main points in his note. First, slavery itself was not economically profitable past the early slave-hunting stage and was more generally inefficient; it was other factors that made slave-based cotton agriculture highly profitable in the antebellum period. Second, political forces were the primary factor keeping the system from withering away. This second point is what I expanded on in my 1994 paper and other publications on this topic.See Thornton (1994), and Brad Ewing, Mark Thornton, and Mark Yanochik (2001, 2003a, and 2003b). Therefore Rothbard (1960), Moes (1960), Dowd (1959), Hummel (1996), Tullock (1967), myself, and many others are in a tradition that concedes that slavery is potentially “profitable” but otherwise inefficient and requires government support to remain viable.
In conclusion, Rothbard, writing from the vantage point of economic theory, asked the correct economic question and provided the correct answers to the fathers of the “New Economic History” at the time of its birth. Rothbard was not opposed to mathematics or statistics in economic articles and books. In fact, in a private memo written around this time (2010a, May 1961), he criticizes two mainstream economists for the dearth of basic statistics, among other things, in their book on American history.For a fuller version of his critique, written in a private unpublished memo at the time, see Rothbard (2010b, September 1961). Rather his primary criticism is a fundamental attack on the methodology of the New Economic History and the subsequent dangerous ideological conclusions that are drawn from it, e.g., that war does good things for society. Historiography might have been different had the editors of the Journal of Political Economy decided to publish his note.
A Note on the Economics of Slavery Murray N. Rothbard
Professor Moes, in his illuminating contribution to the discussion of the economics of slavery, points out that slavery has an inherent tendency to wither away because the keen incentive of working to buy one’s freedom will foster the practice of selling manumission to the slave, a practice profitable to master and slave alike.John E. Moes, “The Economics of Slavery in the Ante-Bellum South: Another Comment,” Journal of Political Economy LXVIII (April, 1960): pp. 183–87. There is another economic factor operating also to make slavery unprofitable, which Moes does not mention. And this is the fact that the price of any capital good on the market, will always tend to equal the discounted value of the sum of future net earnings from that capital. In the slave economy, of course, slaves are capital. Therefore, the price of slaves will tend to equal the discounted value of the sum of future net returns that the master is expected to gain from exploiting the slave’s labor. Any rise in returns from slaves will raise the slave price. Therefore, since the rate of net return in every business and from every piece of capital on the market, including slaves, tends to be the same, the profit from exploiting slave labor will be imputed backward, from the slaveholder, to the slave trader, and eventually to the slave hunter. Only the slave hunter, therefore, the original person who converted a free man into a slave, reaps a long-run economic gain from slavery; the current slave-master earns only the usual “natural interest” rate of return that every business earns in the long run.
In their reply to Moes, Professors Conrad and Meyer assert that the particular factor making slavery profitable in the South was a high return on slave breeding.Alfred H. Conrad and John R. Meyer, “Reply,” ibid., pp. 187–89. But in the natural course of the market, the particular breeding-productivity of any slave would have been discounted in the original slave price that the master paid for the slave-ancestors. For the price of a slave bought from a trader (ultimately from the hunter), included the expected future value of the increase of slave population from slave-breeding. In short, slave-breeding was just another productive return which the market price of slaves would have discounted. To deny this, we would have to say that the slave hunters and traders were systematically and persistently less able and insightful entrepreneurs then the final slave-masters, and there is certainly no reason to make such an assumption.
In the long run, in fact, even slave-hunting will be unprofitable. For if the slave hunting business enjoys the extra imputed profit of slave-exploitation, then more people will flock to slave hunting and the increased competition will raise the costs of slave-hunting, and lower slave prices, until the long-run fate of net return is no greater in slave hunting than in any other industry. And this is why the business of slavery can only continue to be profitable when the supply of slaves is replenished suddenly and fitfully, from non-market resources, e.g., from wars, which can surmount, for a time, the limiting forces of competition.
It should be clear that the supply of new slaves will come only from two sources: external people newly-enslaved, and domestic breeding. For it is difficult to see how any stable society can exist where domestic free citizens are continually enslaved. Such a condition would certainly bring about a perpetual “war of all against all” with everyone trying to enslave everyone else, and an end to any sort of civilization. The newly-enslaved must therefore originate from beyond the borders. War, of course, is an ideal method of building fresh supply, because the ethic engendered by wa[r]Original reads “way.” leads to the idea that the one’s prisoners are one’s to command. When, therefore, as Moes, Conrad, and Meyer agree, the drying up of external sources of supply caused slavery to decline in the Roman Empire, this too demonstrated the inherent economic weakness of slavery, and the natural tendency of the backward-capitalization of slave prices and the equalization of rates of return, to eliminate the exploitation-gains of slavery. A system, in short, where no one—master or even slave-hunter—gains, and the slaves themselves definitely lose, is a system where new supply will dry up and the incentives of voluntary manumission will cause slavery to wither away. Only prisoners taken in war can temporarily reverse this decline.
In the case of slavery in the South, Moes has pointed out how anti-manumission laws greatly slowed the process of decline. There were also other factors. After 1808, the outlawing of the slave trade paradoxically made the withering process much more difficult, for it meant an effective crippling of the slave market. With the slave market hobbled, domestic slaveholders could only increase their supply by domestic breeding—and any increase in the rate of breeding could no longer be fully capitalized backward in the prices of purchased slaves. Hence, the gains from higher productivity of breeding were no longer imputed backward to the slave traders and slave hunters. Thus, given a rise in breeding rates, the constitutional prohibition of the slave trade helped perpetuate slavery at home. Before 1808, another factor delayed the onset of competitive decline and kept the slave trade profitable longer than it would have been. For many slaves were not so created by the slave-hunters, but instead were bought from their existing “slave-masters,” the tribal chieftains of Africa. And since the tribal chieftains were outside the market framework, and were therefore poor entrepreneurs, the slave traders were able to reap great gains from the trade and leave the chieftains with a much lower return than they could have obtained. Of course, even these gains would have been competed away in the long run, but the fact the chieftains were the original enslavers delayed the process of eliminating the exploitation-gains of slavery.
Conrad and Meyer conclude their reply by chiding the Roman Empire for not realizing the rich gains of slavery, presumably from slave-breeding. But [A. H. M.] Jones has shown, in an important and neglected article, that slave-breeding in the Roman Empire, after the Pax Romana had ended the great wars (as well as that other main source of external slaves—piracy), was a costly and ineffective business. When not breeding, after all, the female slaves were largely a net liability, while children were per se a total loss, especially since so many children of ancient days died before reaching working age. That slave breeding was a shaky affair may be seen by the government laws and regulations trying to prop it up. For example, Rome decreed in 52 A.D. that if a free woman cohabitated with a slave, the slave’s owner was entitled to claim ownership of her—and her subsequent offspring. Here was a clear-cut attempt to prevent slaves from breeding outside of the slave framework. Moreover, the emperors decreed that any infants of free parents abandoned and brought up as slaves could not be reclaimed by their parents unless the latter repaid the costs of rearing the children. Augustus would not free any of his personal slaves until they had produced slave-sons to substitute for them in his service. In such ways did the Roman Empire try to shore up the dwindling supply of bred slaves.A.H.M. Jones, “Slavery in the Ancient World,” The Economic History Review IX (April, 1956): pp. 185–99, especially pp. 190–97. Jones also points out that only widespread piracy, kidnapping, and perpetual inter-tribal wars permitted slavery to flourish in Athens. Even aided by these laws, breeding was unsuccessful, and slavery gave way to the processes of voluntary sale of manumission.
Paul Krugman is now claiming that reopening the economy and allowing people to go to work almost surely will cause a depression.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "Krugman: We Need More Unemployment—to Save Us from Unemployment"
Central bankers think too much saving is a problem that must be solved with more money creation. But the real problem is the Keynesian-style fractional reserve banking system.
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Original Article: "Why Americans Don't Have Any Savings"
Chapter 2 of Democracy: The God That Failed. Narrated by Paul Strikwerda.
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Chapter 1 of Democracy: The God That Failed. Narrated by Paul Strikwerda.
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Chapter 6 of Democracy: The God That Failed. Narrated by Paul Strikwerda.
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Chapter 5 of Democracy: The God That Failed. Narrated by Paul Strikwerda.
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Chapter 4 of Democracy: The God That Failed. Narrated by Paul Strikwerda.
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Introduction to Democracy: The God That Failed. Narrated by Paul Strikwerda.
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Acknowledgments from Democracy: The God That Failed. Narrated by Paul Strikwerda.
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Chapter 10 of Democracy: The God That Failed. Narrated by Paul Strikwerda.
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Chapter 9 of Democracy: The God That Failed. Narrated by Paul Strikwerda.
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Oren Cass is the executive director of American Compass (AmericanCompass.org), a conservative think tank that stresses the importance of family and domestic industry, in opposition to a singleminded devotion to economic efficiency. Cass was previously a senior fellow at the Manhattan Institute for Policy Research, and was the domestic policy director for Mitt Romney’s 2012 presidential campaign. Bob and Oren have a friendly discussion about their disagreements on economic policy.
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I. INTRODUCTION The complex issues relating to the interpretation and meaning of different concepts of probability and to the legitimate scope of their useful application in the social sciences and in economics belong to the more controversial topics within the subfield of economic methodology. Several of the most influential economists have expounded outspoken views about the matter. Thus it is probably no exaggeration to assert that John Maynard Keynes’s second-best-known book—after his The General Theory of Employment, Interest, and Money—is his A Treatise on Probability. Ludwig von Mises’s views about probability have been no less influential within the context of the Austrian school and even beyond. In this respect some commentators have claimed that Ludwig von Mises basically embraced the frequency interpretation of probability of his brother Richard von Mises,See, for instance, Hoppe (2006), who assumes that Ludwig von Mises is a representative of the frequency interpretation of probability. Whether or not this author’s views on probability are defensible, it is not quite correct to impute these same views to Ludwig von Mises.Moreover we are unable to detect any essential or exclusive connection between Keynes’s economics and Keynes’s views on probability; therefore a rejection of Keynesian economics—see e.g., Hoppe (1992)—need not entail a rejection of Keynes’s views on probability. Attempts to forge a supposedly essential connection between a particular philosophical (ideological) or economic Worldview on the one hand and a particular interpretation of probability on the other, are not new.Thus, as is also pointed out in Lad (1983), the objective interpretation of probability seems to have been rather influential in Marxist-Leninist philosophy and in Soviet thought under the influence of the mode of thinking of the Russian probabilist B. V. Gnedenko, who wrote about the subjective characterization of probability that “(t)he final outcome of consistently using such a purely subjectivistic interpretation of probability is inevitably subjective idealism” (2005 [1962], 25; also quoted in Lad [1983, 286]). Against this interpretation, Lad (1983) argues that an operational subjective construction à la de Finetti is free of Gnedenko’s charges and fits Marxist philosophical presuppositions better. thus suggesting that Ludwig von Mises’s views on probability are no less antagonistic to those of John Maynard Keynes than his views on economic theory and public policy. This latter view will here be challenged. While it is not contended that any historical evidence points to any direct historical influence between the views on probability of these two authors, it will be argued that in some relevant respects Ludwig von Mises’s views with respect to the meaning and interpretation of probability exhibit a closer conceptual affinity with the views of John Maynard Keynes about probability than with the views concerning probability of his brother Richard von Mises.
As regards the views about probability of Ludwig von Mises, it is undeniably true that these display considerable nuance and that they can be considered as being of a sui generis variety. Even if Ludwig von Mises’s views on probability exhibit a closer conceptual affinity with Keynes’s philosophy of probability than with the frequency interpretation espoused by his brother Richard von Mises, an important difference between the views of Ludwig von Mises and those of John Maynard Keynes in this respect will nevertheless be acknowledged.
II. THE SUMMA DIVISIO IN THE PHILOSOPHY OF PROBABILITY: EPISTEMIC VERSUS OBJECTIVE INTERPRETATIONS OF PROBABILITY Interpretations of probability are commonly divided into (1) epistemological (or epistemic) and (2) objective. Epistemological interpretations of probability take probability to be concerned with the knowledge (or belief) of human beings. On this approach, any probability assignment describes a degree of knowledge, a degree of rational belief, a degree of belief, or something of this sort. The approaches of both Ludwig von Mises and John Maynard Keynes belong to this category. Objective interpretations of probability, by contrast, take probability to be a feature of the objective material world, which has nothing to do with human knowledge or belief. The theory of Richard von Mises belongs to this category.The logical, subjective and intersubjective interpretations are all epistemological. The frequency and propensity interpretations are objective. For a survey and discussion of the different interpretations, see Gillies (2000).
Despite the fact that Ludwig von Mises himself clearly embraced what must be considered an epistemic view regarding the interpretation of probability, the objectivist view has been propounded by several Austrian economists, especially among those belonging to the praxeological camp. These authors apparently take it for granted that Ludwig von Mises had simply adopted the philosophy of probability of his brother Richard von Mises. Thus in a characteristic passage of Man, Economy, and State M. N. Rothbard wrote:
The contrast between risk and uncertainty has been brilliantly analyzed by Ludwig von Mises. Mises has shown that they can be subsumed under the more general categories of “class probability” and “case probability.” “Class probability” is the only scientific use of the term “probability,” and is the only form of probability subject to numerical expression.Rothbard (2004, 553).
In the two footnotes accompanying this passage M. N. Rothbard refers both to Ludwig von Mises’s discussion in Human Action, and to Richard von Mises’s Probability, Statistics, and Truth, thus conflating the views of the two brothers.Rothbard’s interpretation is questionable for at least two reasons. First, Ludwig von Mises embraces an epistemic interpretation of his concept of numerical class probability whereas Richard von Mises’s interpretation of the concept of frequency probability is objective. Second, whereas for Richard von Mises there is indeed only one scientific use of the term probability, from the perspective of Ludwig von Mises both the concept of class probability and the concept of case probability are scientifically legitimate. See further. For other references by Prof. Rothbard to Richard von Mises’s theory, see in particular Rothbard (1997, 24n, 24-27, 122n, 229n).
Views like the ones expressed by M. N. Rothbard are often, if not always, accompanied, and rather consistently, by a rejection of quantitative methods for the conduct of applied research in economics. Again M. N. Rothbard tells the story of how he came to decide to leave the world of statistics in rather dramatic terms:
After taking all the undergraduate courses in statistics, I enrolled in a graduate course in mathematical statistics at Columbia with the eminent Harold Hotelling, one of the founders of modern mathematical economics. After listening to several lectures of Hotelling, I experienced an epiphany: the sudden realization that the entire “science” of statistical inference rests on one crucial assumption, and that that assumption is utterly groundless. I walked out of the Hotelling course, and out of the world of statistics, never to return.Rothbard (1995, 38).
According to Professor Rothbard the questionable assumption is the following:
In the science of statistics, the way we move from our known samples to the unknown population is to make one crucial assumption: that the samples will, in any and all cases, whether we are dealing with height or unemployment or who is going to vote for this or that candidate, be distributed around the population figure according to the so-called “normal curve.”Rothbard (1995, 38).
Statements like these have been both severely criticized and misunderstood. Thus David Ramsey Steele, in his review of Justin Raimondo’s An Enemy of the State: The Life of Murray N. Rothbard writes:
If the young Rothbard really had found something that refuted all statistical theory, this would be a momentous discovery, and a great consolation to tobacco producers. But, sixty years on, the edifice of statistics has not registered any tremors.
In the Rothbard-Raimondo account, statisticians accept the bell curve because of a single example, the distribution of hits around the bull’s eye on a target. In fact, statisticians don’t view the bell curve as sacrosanct. Since a great many phenomena are, as a matter of fact, so close to normally distributed that the assumption of normal distribution will yield correct predictions, normal distribution can be treated as an empirical generalization and a useful instrument.
Alternatively, normal distribution can be strictly derived by the Central Limit Theorem, which shows that where some variable is influenced by a large number of unrelated random variables, that variable will be normally distributed. This result holds subject to certain conditions, which are very widely, but not universally, encountered. Statisticians are open to the possibility of non-normal distributions where these conditions don’t apply. It doesn’t seem likely that Rothbard successfully debunked all of statistics around 1942.See Steele (2000). The Central Limit Theorem (in the classical sense) is the generic name of a class of theorems which give, in precise mathematical terms, conditions under which the distribution function of a suitably standardized sum of independent random variables is approximately normal. This theorem is one of the most remarkable results in all of mathematics. For an introduction to the Central Limit Theorem from a historical perspective, see also W. J. Adams (1974).
This interpretation of Rothbard’s position is certainly questionable. It doesn’t seem likely after all that Rothbard was intent upon questioning the mathematical validity of the Central Limit Theorem or of any other theorem of formal probability calculus. It may still remain true, however, that in contexts where random collectives do not exist (that is, contexts characterized by lack of independent repetitions), as will often be the case in economics, objective probabilities cannot be used. Given that Rothbard embraced an objective, frequency interpretation of numerical probability, his rejection of statistics is a defensible and logically consistent corollary. Moreover the rejection of the use of objective probabilities in economics is in agreement with the conclusions of some of the most recent research about these matters, and with general arguments for interpreting probabilities in economics as epistemological rather than objective.See Gillies (2000, 187 ff.). The main reason why objective probabilities cannot be validly introduced in economics is not too difficult to grasp and can be related to the impossibility of introducing a satisfactory notion of independent repetitions of conditions and of random and homogeneous samples. In a typical experimental situation in physics, a sequence of independent repetitions of the experiment is perfectly possible. The experiment can be performed in the same laboratory on different days, or in different laboratories on the same day etc., and these repetitions will typically be independent. The conditions necessary for the introduction of objective probabilities are satisfied. It might seem as if there exists a certain structural similarity between a typical situation in economics and the typical experimental situation in physics. The two cases nevertheless differ in important respects. Could we not conceivably use observations of the behavior and performance of economic systems as samples of independent repetitions of conditions similar to the ones present in the typical experiment in physics? The different samples could be taken from either (1) data related to the same economic system at different times, or (2) data related to different economic systems at a similar stage of development. One author who recently re-examined these questions aptly summarizes his answer to this question as follows: “In the first case, if the samples refer to ‘snapshots’ of the economy which are too close together in time, it is hard to maintain that the more recent performance is not influenced by that of the previous periods; thus the independence of the samples cannot be maintained. If the samples relate to historical periods far enough from each other to render the assumption of independence plausible, one is unlikely to get homogeneous samples; thus invalidating the ‘experiment’. In the second case the use of a sample of cross-section data would still not give independence as economic systems tend to be integrated in terms of trade and production, and particularly as the flow of information from one country is likely to affect the behavior of agents in others.” See Gillies (2000, 192). This view with respect to the interpretation of probability is thus apparently dictated by the fundamentally different nature of the phenomena under study in the realm of human action, when compared with physical phenomena. Acting individuals in a market economy are very different from, say, the molecules of a gas. Since an economic system is composed of acting individuals, who have thoughts and beliefs, an independent repetition of any situation becomes difficult if not impossible.
It is worth pointing out that for quite some time the objectivist view had also been rather influential in certain Marxist-Leninist circles. Whereas the objectivist view had indeed been dominant in statistical theory and practice throughout most of the previous century, it was in particular in certain Soviet writings that attempts had been made to provide the objectivist view with supposedly Marxist-Leninist philosophical underpinnings, and to dismiss the subjective characterization of probability as inevitably leading to subjective idealism.In this respect attention can be drawn to the influence of B. V. Gnedenko, author of the often revised and reprinted Theory of Probability containing an objective characterization of chance and at once the most complete statement of the Soviet Marxist understanding of probability. See also footnote 1 above and the discussion in Lad (1983).
The critical issue we want to examine here, however, is whether the precepts of praxeological methodology and epistemology indeed entail an exclusive commitment to the objectivist viewpoint. An examination of Ludwig von Mises’s viewpoint in this respect has not convinced us that this is actually the case.
In fact, and as mentioned briefly already, Ludwig von Mises’s views with respect to the interpretation of probability, are more akin to Keynes’s views than to the philosophy of probability of his brother Richard von Mises. In order to substantiate this view, we will compare Ludwig von Mises’s position concerning this matter with the positions both of John Maynard Keynes and of Richard von Mises. The two main approaches to the interpretation of probability theory which will be considered here are thus the frequency interpretation, as developed systematically by Richard von Mises, and the logical interpretation, as developed systematically by John Maynard Keynes.These correspond by and large—although not exactly—to Carnap’s two concepts of probability: probability as used in logic (degree of confirmation) on the one hand, and probability as used in statistical and physical science (relative frequency), on the other. See Carnap (1945). Keynes’s views on probability are contained in Keynes (2004 [1921]); for our analysis of Richard von Mises’s views we will use Richard von Mises (1981 [1957]) and (1964).
In the third and fourth sections hereafter I present a general characterization of the views on probability of these two authors. In section V I argue that the thesis that Ludwig von Mises embraced the objective frequency interpretation of probability of his brother Richard von Mises is disputable in view of a number of Ludwig von Mises’s own statements with respect to this subject matter.
In the sixth section I examine further whether and in what respects Ludwig von Mises’s views on probability indeed exhibit a conceptual affinity with John Maynard Keynes’s interpretation of probability. In the seventh section an important difference between the respective views about probability of Ludwig von Mises and of John Maynard Keynes is highlighted.
III. RICHARD VON MISES’S OBJECTIVE APPROACH TO PROBABILITY: THE FREQUENCY INTERPRETATION The principal goal of Richard von Mises was to make probability theory a science similar to other sciences. According to the frequency view probability theory is considered a science of the same order as, say, geometry or theoretical mechanics. He criticizes the view that probability can be derived from ignorance:
It has been asserted—and this is no overstatement—that whereas other sciences draw their conclusions from what we know, the science of probability derives its most important results from what we do not know.Richard von Mises (1981 [1957], 30).
Probability should be based on facts, not their absence. The frequency theory relates a probability directly to the real world via the observed objective facts (or the data), in particular repetitive events. As Richard von Mises wrote:
By means of the methods of abstraction and idealization (…) a system of basic concepts is created upon which a logical structure can then be erected. Owing to the original relation between the basic concepts and the observed primary phenomena, this theoretical structure permits us to draw conclusions concerning the world of reality.Richard von Mises (1981 [1957], v).
In the logical approach to be examined in the next section, probability theory is seen as a branch of logic, as an extension of deductive logic to the inductive case. In contrast to this view, the frequency approach sees probability theory as a mathematical science, such as mechanics, but dealing with a different range of observable phenomena. Probability should thus not be interpreted in an epistemological sense. It is not lack of knowledge (uncertainty) which provides the foundation of probability theory, but experience with large numbers of events.
A probability theory which does not introduce from the very beginning a connection between probability and relative frequency is not able to contribute anything to the study of reality.Richard von Mises (1981 [1957], 63).A key question raised by this view relates to how mathematical sciences relate to the empirical material with which they are concerned. Since Richard von Mises was an empiricist, the starting point for him was always some observable phenomenon such as an empirical collective. In fact, according to the random frequency definition it is possible to speak about probabilities only in reference to a properly defined collective. Probability has a real meaning only as probability in a given collective. The basis of Richard von Mises’s theory of probability is thus the concept of a collective. The rational concept of probability, as opposed to probability as used in everyday speech, acquires a precise meaning only if the collective to which it applies is defined exactly in every case. Essentially a collective consists of a sequence of observations which can be continued indefinitely. Each observation ends with the recording of a certain attribute. The relative frequency with which a specified attribute occurs in the sequence of observations has a limiting value, which remains unchanged if a partial sequence is formed from the original one by an arbitrary place selection.On the concept of collective, see also Mises (1964, 11–15). As explained further, a collective is a mass phenomenon or an unlimited sequence of observations fulfilling two conditions, the convergence condition and the randomness condition. According to Richard von Mises, many types of repeatable experiment generate collectives, or at any rate would do so if they could be continued indefinitely. The task of statistics is to identify which experiments have this collective-generating property and to elicit the associated probability distributions over their class of possible outcomes. The task of probability calculus in mathematical statistics consists in investigating whether a given system of statistical data forms a collective, or whether it can be reduced to collectives. Such a reduction provides a condensed, systematic description of the statistical data that may properly be considered an “explanation” of these data. See Richard von Mises (1981 [1957], 222).
To deal with such phenomena, we obtain by abstraction or idealization some mathematical concepts, such as, in this instance, the concept of mathematical collective. We next establish on the basis of observation some empirical laws which the phenomena under study obey. Then again by abstraction or idealization we obtain from these empirical laws the axioms of our mathematical theory. Once the mathematical theory has been set up in this way, we can deduce consequences from it by logic, and these provide predictions and explanations of further observable phenomena.
Applying this scheme to the case of probability theory, there are, according to Richard von Mises, two empirical laws which are observed to hold for empirical collectives. The first of these can be named the Law of Stability of Statistical Frequencies; it refers to the increasing stability of statistical frequencies and is designated by Richard von Mises as “the ‘primary phenomenon’ (Urphänomen) of the theory of probability.”Richard von Mises (1981 [1957], 14). In fact, the expression “Stability of Statistical Frequencies” is Keynes’; see Keynes (2004 [1921], 336).
As Mises explains:
It is essential for the theory of probability that experience has shown that in the game of dice, as in all the other mass phenomena which we have mentioned, the relative frequencies of certain attributes become more and more stable as the number of observations is increased.Richard von Mises (1981 [1957], 12).
The first law of empirical collectives was fairly well known before Richard von Mises. The second law, however, is original to him and it relates to a decisive feature of a collective. This feature of the empirical collective is its lack of order, that is, its randomness.
Richard von Mises’s ingenious idea is that we should relate randomness to the failure of gambling systems.
As he wrote:
The authors of such systems have all, sooner or later, had the sad experience of finding out that no system is able to improve their chances of winning in the long run, i.e., to affect the relative frequencies with which different colours or numbers appear in a sequence selected from the total sequence of the game.Richard von Mises (1981 [1957], 25).
In other words, not only do the relative frequencies stabilize around particular values, but these values remain the same if we choose, according to some rule, a subsequence of our original (finite) sequence. This second empirical law can be called the Law of Excluded Gambling Systems.
The next step in Richard von Mises’s programme is to obtain the axioms of the mathematical theory by abstraction (or idealization) from these empirical laws. The first axiom can be easily obtained from the Law of Stability of Statistical Frequencies:
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One of the main objections to this theory is that it is too narrow, for there are many important situations where we use probability but in which nothing like an empirical collective can be defined. In particular this definition is too narrow in the context of economics. This was the viewpoint of important economists such as Ludwig von Mises, John Maynard Keynes and John Hicks.
Nevertheless Richard von Mises considers this alleged disadvantage to be a strong point in favour of his theory. We can, according to Richard von Mises, start with the imprecise concepts of ordinary language but when we are constructing a scientific theory we must replace these by more precise concepts. Thus we can of course start with the vague ordinary language concept of probability, but for scientific purposes it must be made precise by a definition. This is done by the limiting frequency definition of probability. This definition excludes some ordinary language uses of probability for which a collective cannot be defined, but this is no bad thing. On the contrary, it is positively beneficial to exclude some vague uses of probability which are unsuitable for mathematical treatment. Summing up this line of argument, he writes:
‘The probability of winning a battle,’ for instance, has no place in our theory of probability, because we cannot think of a collective to which it belongs. The theory of probability cannot be applied to this problem any more than the physical concept of work can be applied to the calculation of the ‘work’ done by an actor in reciting his part in a play.See Richard von Mises (1981 [1957], 15). Regarding his positivist ideas Richard von Mises was much influenced by E. Mach whom he greatly admired. See Richard von Mises (ibid., 225) where he writes: “The point of view represented in this book corresponds essentially to Mach’s ideas.” See in this connection also Richard von Mises (1951, passim).
The limiting frequency definition of probability is supposed to be an operational definition of a theoretical concept (probability) in terms of an observable concept (frequency). It could be claimed, however, that it fails to provide a connection between observation and theory because of the use of limits in an infinite sequence. It is well known that two sequences can agree at the first n places for any finite n however large and yet converge to quite different limits. A similar objection relates to the question of whether the representation of a finite empirical collective by an infinite mathematical collective is legitimate.
Richard von Mises’s answer to this difficulty is that such representations of the finite by the infinite occur everywhere in mathematical physics, and that his aim is only to present probability theory in a fashion which is as rigorous as the rest of mathematical physics. In mechanics, for example, we have point particles to represent bodies with a size, infinitely thin lines to represent lines with a finite thickness, and so on. Richard von Mises argues that he is trying to present probability theory as a mathematical science like mechanics, but it is unreasonable to expect him to make it more rigorous than mechanics. As he wrote:
the results of a theory based on the notion of the infinite collective can be applied to finite sequences of observations in a way which is not logically definable, but is nevertheless sufficiently exact in practice. The relation of theory to observation is in this case essentially the same as in all other physical sciences.See Richard von Mises (1981 [1957], 85). The practical difficulty arises from the fact that a collective is defined for an infinite sequence. A collective is an idealization. Strictly speaking, no relative-frequency probability statement says anything about any finite event, group of events or series. In other words, any calculated frequency is perfectly consistent with any probability attribution from zero to one. Combined with the injunction that there is no such thing as a probability of a “singular” event, it would appear that any definitive empirical attribution of numerical probabilities is a chimera. A statement about the limit of a sequence of trials hypothetically continued to infinity contains by itself absolutely no information about any initial segment of that sequence. Any initial segment of a collective—and we are, of course, only ever capable of observing initial segments—can be replaced with any arbitrary sequence of the same length without affecting any of the limits in the collective. Richard von Mises acknowledges that “[i]t might thus appear that our theory could never be tested experimentally.” (ibid. 84) His probabilistic solution to this problem is a pragmatic one. The empirical validity of the theory does not depend on a logical solution, but is determined by a practical decision. This decision should be based on previous experience of successful applications of probability theory, where practical studies have shown that frequency limits are approached comparatively rapidly. Moreover the idealization of the collective is comparable with other wellknown idealizations in science, such as the determination of a specific weight (perfect measurement being impossible), the existence of a point in Euclidean space, or the concept of velocity.The velocity of an accelerating object at a moment in time is the ratio of the change in distance to the change in time, ds/dt. Supposing the motion is not uniform, as in the case of a freely falling body whose velocity increases as it falls, to obtain the velocity we calculate the “instantaneous rate of change” of the distance with respect to the time by taking the limit as follows:i.e., v = lim ds/dt.dt ⇒ 0It is impossible to verify that this limit exists. It does not follow, however, that the concept of velocity is nonoperational. This criticism would duplicate the criticism of probability as the limit of a sequence, but it would not be considered a serious objection, because the definition of velocity as a limit has proven itself to be applicable to many different instances of motion, in just the same way the frequency theory has been successfully applied to many instances. The relation of theory to observation in the latter case is essentially the same as in all other physical sciences. It is reminded here that Ludwig von Mises’s definition of class probability, which is discussed further, is finitist in the sense that it dispenses entirely with any reference to the concept of a limit. In that limited sense it can be considered that Ludwig von Mises’s definition of class probability constitutes an improvement upon the definition of a collective offered by Richard von Mises.
To complete Richard von Mises’s programme, it must be examined how the second mathematical axiom—the axiom of randomness—can be obtained from the empirical Law of Excluded Gambling Systems. It turns out that the formulation of the axiom of randomness does involve some rather considerable mathematical difficulties. Even if these were eventually overcome, the quite subtle mathematical developments which finally gave Richard von Mises’s theory a rigorous mathematical foundation, are of little relevance in the present context. The main idea is reminded here, however:
Randomness condition:
The fixed limits to which the relative frequencies of particular attributes within a collective tend are not affected by any place selection, that is, by choosing an infinite sub-sequence whose elements are a function of previous outcomes. That is, if we calculate the relative frequency of some attribute not in the original sequence, but in a partial set, selected according to some fixed rule, then we require that the relative frequency so calculated should tend to the same limit as it does in the original set. In this respect Richard von Mises made the following stipulation:
The only essential condition is that the question whether or not a certain member of the original sequence belongs to the selected partial sequence should be settled independently of the result of the corresponding observation, i.e., before anything is known about this result.See Richard von Mises (1981 [1957], 25). As indicated already, the fulfillment of the second condition, insensitivity to place selection, is also described by Richard von Mises as the Principle of the Impossibility of a (successful) Gambling System. (ibid.)
An important implication of Richard von Mises’s frequency theory is that, when dealing with unique events, statistical or stochastic methods will be essentially useless. Where collectives do not exist, probability theory and the calculations based on it will add nothing to our knowledge concerning the world of reality. Only where previous experience has established that events can be considered as belonging to a collective, can statistical methods play a role. The calculations of insurance companies for instance demonstrate that stochastic methods play a legitimate role in certain kinds of business decisions, namely when dealing with events belonging to a collective. The theory of probability starts with certain given frequencies and derives new ones by means of calculations carried out according to certain established rules. In other words, each probability calculation is based on the knowledge of certain relative frequencies in long sequences of observations, and its result is always the prediction of another relative frequency, which can be tested by a new sequence of observations. The task of the theory of probability is thus to derive new collectives and their distributions from given distributions in one or more initial collectives.The derivation of a new collective from the initial ones consists in the application of one or several of the four fundamental operations of selection, mixing, partition and combination. See Richard von Mises (1981 [1957], Second Lecture; 1964, 15–35).As regards the frequentist solution to the problem of inference given by Richard von Mises, it consists of a combination of the frequency concept of a collective with Bayes’s theorem, a result known as the ‘Second Law of Large Numbers’. (ibid. 125) Bayes’s formula shows a relationship between prior and posterior probability functions. If knowledge of the prior distribution does exist, there is no conceptual problem with the application of Bayes’s theorem. Often the prior probability function will not be known, however, and it is then an important part of probability theory to know what influence the prior probability function has in the calculation of the posterior distribution. In general the following will hold: no substantial inference can be drawn from a small number of observations if nothing is known a priori, that is, preliminary to the experiments, about the object of experimentation. If the prior distribution is not known, and the number of observations, say rolls of a die, is small, then the posterior distribution will not allow to draw any conclusions accurately. On the other hand, a large number of observations limits the importance of knowing the prior distribution. As long as the number of experiments is small, the influence of the initial distribution predominates; however, as the number of experiments increases, this influence decreases more and more.Often the prior distribution will not be known. The actor will then have to guess at a distribution, sample the population, and then revise his guess according to Bayes’s formula. This means that actions of an individual will also be guided by the accuracy of his or her guess.
Richard von Mises’s limiting frequency definition of probability was clearly intended to limit the scope of the mathematical theory of probability, and, in fact, of the scientific concept of probability.As he wrote: “Our probability theory has nothing to do with questions such as: ‘Is there a probability of Germany being at some time in the future involved in a war with Liberia?’” See Richard von Mises (1981 [1957], 9).We can only, he claims, introduce probabilities in a scientific sense—which here also means: in a mathematical or quantitative sense—where there is a large set of uniform events, and he urges us to observe his maxim: “First the collective—then the probability.”Richard von Mises (1981 [1957], 18).Richard von Mises thus advocated a monist view of probability, that is, he asserts that there is only one concept of probability that is of scientific importance, in contradistinction to his brother Ludwig von Mises who espoused a dualist view of probability.
Despite controversy it can be expected that the frequency theory of probability will remain significant for the conduct of natural science.For recent testimony of this fact, see e.g., Khrennikov (1999). This author argues that certain problems in the foundations of quantum mechanics—such as the Einstein-Podolsky-Rosen paradox—are connected with the foundations of probability theory and thus have a purely mathematical origin. In particular, the pathological (or nonclassical) behaviour of “quantum probabilities”—in particular Bell’s inequality—is a consequence of the formal use of Kolmogorov’s probability model. This author uses the ensemble and frequency interpretations as the two fundamental interpretations of probability and arrives at surprising results. Bell’s inequality cannot be used as an argument for non-locality or nonreality. Historically, and although it has been argued that the philosophical background of subjective probability strongly resembles that underlying quantum mechanics (see Galavotti 1995), it is frequentism that became the “received view” of probability and seems to have been tacitly assumed also by the upholders of the Copenhagen interpretation of quantum mechanics (although the attribution of probabilities to the single case was generally admitted). In this context attention has often been drawn to Heisenberg’s viewpoint according to which “(t)he probability function combines objective and subjective elements. It contains statements about possibilities or better tendencies (“potential” in Aristotelian philosophy), and these statements are completely objective, they do not depend on any observer; and it contains statements about our knowledge of the system, which of course are subjective in so far as they may be different for different observers. In ideal cases the subjective element in the probability function may be practically negligible as compared with the objective one. The physicists then speak of a ‘pure case.’” See Heisenberg (1958 [1990], 41), and also the discussion in Galavotti (1995).
IV. JOHN MAYNARD KEYNES’S EPISTEMIC APPROACH TO PROBABILITY: THE LOGICAL INTERPRETATION The logical interpretation of probability considers probability as the degree of a partial entailment. Keynes’s Treatise is concerned with the general theory of arguments from premises leading to conclusions which are reasonable but not certain. Let e be the premises and h the conclusion of an argument. Keynes holds that the familiar relation ‘e implies h’ is the limiting case of a more general (probability) relation ‘e partially implies h.’ Keynes’s aim in the Treatise is to systematize statements involving such relations of partial implication. The logical theory uses the word “probability” primarily in relation to the truth of sentences, or propositions.
It aims at assigning truth values other than zero or one to propositions. In this process, that part of our knowledge which we obtain directly, supplies the premises of that part which we obtain indirectly or by argument. From these premises we seek to justify some degree of rational belief about all sorts of conclusions. We do this by perceiving certain logical relations between the premises and the conclusions. The kind of rational belief which we infer in this manner is termed probable (or in the limit certain), and the logical relations, by the perception of which it is obtained, we term relations of probability.See Keynes (2004 [1921], 111). Keynes mostly takes the empiricist line that knowledge acquired by direct acquaintance constitutes true and certain knowledge. Knowledge by argument, in contrast, proceeds through direct knowledge of relations of the form ‘e implies h’ or ‘e partially implies h.’
Comparisons are possible between two probabilities, only when they and certainty all lie on the same ordered series. Probabilities which are not of the same order cannot be compared. Only when numerical measurement of probabilities is possible, which is only occasionally possible and which is thus a matter for special enquiry in each case, algebraical operations such as addition and arithmetical multiplication, can be performed. The numbers zero and one figure as extreme cases. A probability of zero indicates impossibility, a probability equal to one indicates the truth of a proposition.
The idea of a logic of probability which should be the art of reasoning from inconclusive evidence was systematically developed by John Maynard Keynes although hints towards this approach had been expressed at least since Leibniz. Keynes regards probability theory, like economics, as a branch of logic. Although Richard von Mises calls Keynes “a persistent subjectivist,”Richard von Mises (1981 [1957], 94).Keynes makes it clear at the beginning of his book that his theory is, in an important sense, an objective one. For Keynes probability was degree of rational belief not simply degree of belief. The relevant passage is worth being quoted in its entirety:
The terms certain and probable describe the various degrees of rational belief about a proposition which different amounts of knowledge authorise us to entertain. All propositions are true or false, but the knowledge we have of them depends on our circumstances; and while it is often convenient to speak of propositions as certain or probable, this expresses strictly a relationship in which they stand to a corpus of knowledge, actual or hypothetical, and not a characteristic of the propositions in themselves. A proposition is capable at the same time of varying degrees of this relationship, depending upon the knowledge to which it is related, so that it is without significance to call a proposition probable unless we specify the knowledge to which we are relating it.
To this extent, therefore, probability may be called subjective. But in the sense important to logic, probability is not subjective. It is not, that is to say, subject to human caprice. A proposition is not probable because we think it so. When once the facts are given which determine our knowledge, what is probable or improbable in these circumstances has been fixed objectively, and is independent of our opinion. The Theory of Probability is logical, therefore, because it is concerned with the degree of belief which it is rational to entertain in given conditions, and not merely with the actual beliefs of particular individuals, which may or may not be rational.See Keynes (2004 [1921], 3–4). It is widely held that Keynes yielded to Ramsey’s (1988) critical arguments and that he abandoned the idea that rational beliefs are founded on logical relations of partial implication and accepted instead that they are closer to our perceptions and our memories than to formal logic. As Runde (1994) points out, Keynes’s theory of comparative probability emerges unscathed. On the one hand Ramsey’s theory embodies strong implicit presuppositions of its own and is in certain respects a considerably more idealistic construction than Keynes’s. On the other hand, Keynes’s emphasis is on incompleteness and on the fact that numerically definite probabilities can only be determined in situations which approximate games of chance.
It is important to acknowledge the point for point disagreement which exists between the theories of Richard von Mises and John Maynard Keynes.See also Gillies (1973, 14–15).For Richard von Mises probability is a branch of empirical science; for Keynes it is an extension of deductive logic. Von Mises defined probability as limiting frequency; Keynes as degree of rational belief. For von Mises the axioms of probability are obtained by abstraction from two empirical laws; for the other they are perceived by direct logical intuition. On one point there seems to be some agreement. Neither thinks that all probabilities have a numerical value, but the attitude of the two authors to this situation is very different. For Richard von Mises only probabilities defined within an empirical collective can be evaluated and only these probabilities have any scientific interest. The remaining uses of probability are examples of a crude prescientific concept towards which he takes a dismissive attitude. For Keynes on the other hand all probabilities are essentially on a par. They all obey the same formal rules and play the same role in our thinking. Certain special features of the situation allow us to assign numerical values in some cases, though not in general. Through the acknowledgement that frequency probability does not cover all we mean by probability, Keynes’s position is thus also closer to that of other economists such as Ludwig von Mises and John Hicks. Finally the position of statistics is different in the two accounts. For von Mises it is a study of how to apply probability theory in practice, similar to applied mechanics. For Keynes statistical inference is a special kind of inductive inference and statistics is a branch of the theory of induction.
The most striking differences between John Maynard Keynes and Richard von Mises are thus:
— according to Richard von Mises, the theory of probability belongs to the empirical sciences, based on limiting frequencies, while Keynes regards it as a branch of logic, based on degrees of rational belief; and
— Richard von Mises’s axioms are idealizations of empirical laws, Keynes’s axioms follow from the intuition of logic.
It is a quite remarkable fact that the practical significance of these differences in principles does not prevent the two authors from reaching nearly complete agreement on almost all of the mathematical theorems of probability, as well as on the potentially successful fields of application of statistics. Thus their complete disagreement on all the philosophical issues is accompanied by complete agreement on the mathematical side. Moreover an essentially similar conclusion can be drawn as regards the potential scope of successful application of numerical probability concepts.
Thus in Part V of the Treatise in the context of his discussion of statistical inference, Keynes has the great merit of noticing that the applicability of some of the essential parts of the classical doctrine assumes independence or irrelevance.As Keynes writes: “It is assumed, first, that a knowledge of what has occurred at some of the trials would not affect the probability of what may occur at any of the others; and it is assumed, secondly, that these probabilities are all equal à priori. It is assumed, that is to say, that the probability of the event’s occurrence at the nth trial is equal à priori to its probability at the nth trial, and, further, that it is unaffected by a knowledge of what may actually have occurred at the nth trial.” (2004 [1921], 344).As Karl Popper points out, the theory of independence or irrelevance is equivalent to the law of the excluded gambling system. See Popper (1983, 299).
Keynes also suggested renaming the law of large numbers the Law of Stability of Statistical Frequencies, which provides a clear summary of its meaning:
But the ‘Law of Great Numbers’ is not at all a good name for the principle which underlies Statistical Induction. The ‘Stability of Statistical Frequencies’ would be a much better name for it. The former suggests, as perhaps Poisson intended to suggest, but what is certainly false, that every class of event shows statistical regularity of occurrence if only one takes a sufficient number of instances of it. It also encourages the method of procedure, by which it is thought legitimate to take any observed degree of frequency or association, which is shown in a fairly numerous set of statistics, and to assume with insufficient investigation that, because the statistics are numerous, the observed degree of frequency is therefore stable. Observation shows that some statistical frequencies are, within narrower or wider limits, stable. But stable frequencies are not very common, and cannot be assumed lightly.Keynes (2004 [1921], 336).
According to the frequency view the successful application of probability theory, in particular for purposes of statistical inference, is conditioned by the fulfillment of a particular presupposition: in a particular domain of reality, one or more collectives exist as a matter of fact. This means that adequate applications of the laws of large numbers rest on a supposition of homogeneity with respect to the phenomena which are subjected to study.
Quite remarkably Keynes, when examining the validity and conditions of applicability of Bernoulli’s Theorem and its Inversion, arrives at similar conclusions.
As he wrote:
If we knew that our material world could be likened to a game of chance, we might expect to infer chances from frequencies, with the same sort of confidence as that with which we infer frequencies from chances.Keynes (2004 [1921], 384–85) Significantly, Keynes also wrote in connection with the application of Bernoulli’s formula: “In cases where the use of this formula is valid, important inferences can be drawn; and it will be shown that, when the conditions for objective chance are approximately satisfied, it is probable that the conditions for the application of Bernoulli’s formula will be approximately satisfied also.” (ibid. 290).
These reservations are similar to those expressed by several Austrian economists. For instance Ludwig von Mises clearly doubts whether the empirical Law of Stability of Statistical Frequencies is operative in social reality:
However, what the statistics of human actions really show is not regularity but irregularity. The number of crimes, suicides, and acts of forgetfulness (…) varies from year to year. These yearly changes are as a rule small, and over a period of years they often—but not always—show a definite trend toward either increase or decrease. These statistics are indicative of historical change, not of regularity in the sense which is attached to this term in the natural sciences.See Ludwig von Mises (1969 [1957], 84-5). See also (1978 [1962], 56) where Mises wrote: “There is no such thing as statistical laws.” According to this view, statistics is rather a sub-discipline, or an auxiliary discipline, of historiography.
V. RICHARD VON MISES VERSUS LUDWIG VON MISES, WITH RESPECT TO PROBABILITY In this section a certain amount of evidence is presented which is drawn from Ludwig von Mises’s writings and which is difficult to square with the thesis that Ludwig von Mises embraced what is basically the frequency interpretation of probability of his brother Richard von Mises.
It is remarkable that some of Ludwig von Mises’s most revealing statements about the nature and meaning of the concept of probability relate to a context which is alien to economic science proper. If there is one field of scientific enquiry where the nature and interpretation of the probability calculus have been the subject of much and reiterated debate, it is the domain of quantum mechanics and the philosophy of quantum mechanics. We have already noted at the end of section III that, controversy notwithstanding, the frequency interpretation remains highly significant for the conduct of natural science. Here we turn our attention more particularly to a comparison of Ludwig von Mises’s concept of class probability with Richard von Mises’s concept of frequency probability.
The writings of Ludwig von Mises contain many important insights with respect to the philosophy of the sciences and it is not quite surprising that he had an outspoken opinion about the matter. In Theory and History, in a section entitled Determinism and Statistics, he expressed his view with respect to quantum mechanics as follows:
Quantum mechanics deals with the fact that we do not know how an atom will behave in an individual instance. But we know what patterns of behavior can possibly occur and the proportion in which these patterns really occur. While the perfect form of a causal law is: A “produces” B, there is also a less perfect form: A “produces” C in n percent of all cases, D in m percent of all cases, and so on. Perhaps it will at a later day be possible to dissolve this A of the less perfect form into a number of disparate elements to each of which a definite “effect” will be assigned according to the perfect form. But whether this will happen or not is of no relevance for the problem of determinism. The imperfect law too is a causal law, although it discloses shortcomings in our knowledge. And because it is a display of a peculiar type both of knowledge and of ignorance, it opens a field for the employment of the calculus of probability.Ludwig von Mises (1969 [1957], 87–88).
Mises then provides the well-known definition of his concept of class probability:
We know, with regard to a definite problem, all about the behavior of the whole class of events, we know that A will produce definite effects in a know proportion; but all we know about the individual A’s is that they are members of the A class. The mathematical formulation of this mixture of knowledge and ignorance is: We know the probability of the various effects that can possibly be “produced” by an individual A.Ludwig von Mises (1969 [1957], 88).
Significantly Ludwig von Mises is also explicitly critical of the mainstream indeterminist interpretation of quantum mechanics since he pursues:
What the neo-indeterminist school of physics fails to see is that the proposition: A produces B in n percent of the cases and C in the rest of the cases is, epistemologically, not different from the proposition: A always produces B. The former proposition differs from the latter only in combining in its notion of A two elements, X and Y, which the perfect form of a causal law would have to distinguish. But no question of contingency is raised.Ludwig von Mises (1969 [1957], 88).
In Human Action Ludwig von Mises raised similar concerns when he wrote:
“The treatment accorded to the problem of causality in the last decades has been, due to a confusion brought about by some eminent physicists, rather unsatisfactory. (…)
There are changes whose causes are, at least for the present time, unknown to us. Sometimes we succeed in acquiring a partial knowledge so that we are able to say: in 70 per cent of all cases A results in B, in the remaining cases in C, or even in D, E, F, and so on. In order to substitute for this fragmentary information more precise information it would be necessary to break up A into its elements. As long as this is not achieved, we must acquiesce in a statistical law.Ludwig von Mises (1998, 22). In The Ultimate Foundation of Economic Science Ludwig von Mises also wrote: “There is always in science some ultimate given. For contemporary physics the behavior of the atoms appears as such an ultimate given. The physicists are today at a loss to reduce certain atomic processes to their causes. One does not detract from the marvelous achievements of physics by establishing the fact that this state of affairs is what is commonly called ignorance.” (1978 [1962], 23).
These passages are important and interesting because they clearly illustrate the fact that in the context of the well-known historical debate between physicists who believed that quantum mechanics is incomplete and who were tempted to assume that “God does not play dice,” on the one hand, and the physicists who, on the contrary, believed that the fundamental laws of nature are irreducibly probabilistic, on the other hand, Ludwig von Mises takes sides with the former.In particular quantum theory is irreducibly probabilistic. Unlike classical probabilities, quantum probabilities do not reflect our ignorance of the intricate details of some underlying physical reality. In particular Einstein disliked the element of chance implied by quantum theory. In a letter to Max Born, dated 4 December 1926, he wrote: “Quantum mechanics is very impressive. But an inner voice tells me that it is not yet the real thing. The theory produces a good deal but hardly brings us closer to the secret of the Old One. I am at all events convinced that He does not play dice.” Quoted in Baggott (2004, 34). Reference can in this context also be made to the confrontation between Einstein and Bohr over the interpretation of quantum theory, and to subsequent debates along similar lines, and which have often been portrayed in the past as a direct conflict between realism and positivism. For a good survey and discussion of these issues see also Baggott (2004). The issue for Einstein indeed seems to have been realism rather than determinism. Ludwig von Mises is apparently on the realist side. For a sophisticated analysis of Einstein’s views in this respect, see also Fine (1986); Einstein’s remark about the dice-playing God (“…ob der liebe Gott würfelt”) is also related in Bohr (1949, 218); see also Fine (1986, 29).Ludwig von Mises clearly associates the use of the probability calculus with partial knowledge, that is, with ignorance and the imperfections of our knowledge, and not with the existence of any contingency in re. Similarly Einstein believed, from the very beginning, that quantum theory lacked some key ingredients and that, in a very significant sense, it was “incomplete.” He compared it with the theory of light before the advent of light quanta. Quantum theory, he believed, was perhaps a “correct theory of statistical laws,” but it provided “an inadequate conception of individual elementary processes.”Einstein, Albert, letter to Sommerfeld, Arnold, dated 9 November 1927. Quoted in Fine, A. (1986, 29).
Thus Ludwig von Mises’s concept of class probability, in contradistinction to the frequency concept of his brother Richard von Mises, contains a reference to the deficiency of our knowledge, that is, to the idea that any probability assignment describes only a state of knowledge. A statement is probable if our knowledge concerning its content is deficient.Ludwig von Mises (1998, 107).According to this view the use of statistical laws signals partial knowledge and fragmentary information. There do not exist any statistical laws in an objective, physical sense.
As Popper reminds us too, the widely held view that whenever probability enters our considerations, this is due to our imperfect knowledge, is reminiscent of subjective interpretations of the probability calculus.Popper (1983, 295).The objective frequency interpretation does not have this connotation.
According to the mainstream view with respect to this matter, (nearly all) the probabilities appearing in theoretical quantum mechanics are indeed objective probabilities. That is to say, they inhere in the world and do not simply reflect the degrees of belief, or the degrees of knowledge, of an observer.See Hughes (1992, 218). The possible exceptions occur when a system is in a mixed state. Under the ignorance interpretation of a given mixture, a subjective probability is assigned to each of the pure states represented in it, and each of these in turn assigns objective probabilities to events. Not all mixtures can be given the ignorance interpretation, however. For a discussion of pure and mixed states, see also van Fraassen (1991, ch. 7). The interpretation of quantum states is a matter of much debate. For in-depth discussions of these and related matters, see in particular also Willem M. de Muynck (2002 passim).
These remarks are sufficient to establish the fact that Ludwig von Mises’s interpretation of numerical probability theory, and in particular his interpretation of the concept of class probability, is in a fundamental sense distinct from that of his brother Richard von Mises. Indeed, according to Richard von Mises, the point of view that statistical theories are merely temporary explanations, in contrast to the final deterministic ones which alone satisfy our desire for causality, is nothing but a prejudice which is bound to disappear with increased understanding.See Richard von Mises (1981 [1957], 223). As Richard von Mises writes: “The assumption that a statistical theory in macrophysics is compatible with a deterministic theory in microphysics is contrary to the conception of probability expressed in these lectures. Modern quantum mechanics or wave mechanics appears to be a purely statistical theory; its fundamental equations state relations between probability distributions.” (ibid. 223) The incompatibility with the views expressed by his brother Ludwig von Mises in this respect cannot be clearer. Therefore we do not share the view of an author who explains the absence of any reference in Ludwig von Mises’s Human Action to Richard von Mises’s frequency interpretation with reference to a supposed “estrangement” between the two brothers. See Hoppe (2006, 13). Clearly the two brothers disagreed on philosophical grounds.
The contrast between the views of Ludwig von Mises and of Richard von Mises in this respect can also be related to the fact that Ludwig von Mises’s worldview, in contradistinction to that of his brother Richard von Mises, apparently exhibited some leaning towards metaphysical determinism.See e.g., Ludwig von Mises (1978 [1962], 115). Turning back to quantum mechanics, it may be noted that the American-born physicist David Bohm has formulated in the 1950s an alternative interpretation of quantum mechanics that is fully deterministic (although non-local). The very idea of probability enters into this theory as some kind of an epistemic idea, just as it enters into classical statistical mechanics. Despite all the advantages of Bohm’s theory, an almost universal refusal even to consider it, and an almost universal allegiance to the standard formulation of quantum mechanics has persisted in physics throughout most of the past fifty years. For a summary introduction to Bohm’s approach, see David Z Albert (1994).
It is true that the contrast between Ludwig von Mises’s concept of class probability and Richard von Mises’s notion of a collective remains somewhat concealed and thus runs the risk of going unnoticed because of the fact that on a few occasions Ludwig von Mises uses terminology which is reminiscent of the idea of “frequency.”
In Human Action for instance Ludwig von Mises explicitly and unambiguously characterizes the notion of class probability as a variant of frequency probability.Ludwig von Mises (1998, 107).
Nevertheless this terminological issue cannot invalidate our thesis that, all things considered, Ludwig von Mises’s philosophy of probability exhibits a closer affinity with an epistemological view—such as Keynes’s logical theory—than with the frequency view of his brother Richard von Mises. The conclusion at which we have thus arrived is nuanced. On the one hand Ludwig von Mises clearly relates the idea of probability to the state of knowledge of the knowing subject. This is true both of class probability and of case probability. A statement is probable if our knowledge concerning its content is deficient. This view is shared by all adepts of an epistemological interpretation of the concept of probability, including John Maynard Keynes. Richard von Mises, to the contrary, very explicitly rejects the idea that the concept of probability refers to a state of partial or deficient knowledge. On the other hand, Ludwig von Mises clearly recognizes that the meaning of probability is different according to the field of knowledge in which it is used or according to the kind of phenomena to which it is applied. He thus embraces a dualist view in the philosophy of probability.Accordingly probability sometimes involves a reference to the notion of relative frequency, but relative frequency is not the general defining characteristic of the scientific concept of probability according to Ludwig von Mises.But in this respect his view is again clearly different from and opposed to that of his brother Richard von Mises who obviously embraces a monist theory of probability.
Moreover, from the perspective of the logical theory of probability too, the concept of probability sometimes refers to relative frequency. Contemporary adepts of the idea of probability theory as extended logic are confident that their approach can encompass frequentist methods, but merely as only one specialized application of probability theory.See Jaynes (2003, passim).
Apparently this was also Keynes’s view since he wrote that “the theory of this Treatise is the generalised theory, comprehending within it such applications of the idea of statistical truth-frequency as have validity.”Keynes (1921 [2004], 104).
In other words, on this view the problems that can be solved by frequentist probability theory form a subclass of those that are amenable to probability as logic; probability theory as logic, however, can also be applied consistently in many problems that do not fit into the frequentist preconceptions.
It would be premature to conclude that such concerns about the meaning of probability as are raised by Ludwig von Mises have now become obsolete and unambiguously belong to the history of the philosophy of probability. As one adept of the logical interpretation of probability explained recently:
Probabilities in present quantum theory express the incompleteness of human knowledge just as truly as did those in classical statistical mechanics; only its origin is different.
In classical statistical mechanics, probability distributions represented our ignorance of the true microscopic coordinates—ignorance that was avoidable in principle but unavoidable in practice, but which did not prevent us from predicting reproducible phenomena, just because those phenomena are independent of the microscopic details.
In current quantum theory, probabilities express our ignorance due to our failure to search for the real causes of physical phenomena; and, worse, our failure even to think seriously about the problem. This ignorance may be unavoidable in practice, but in our present state of knowledge we do not know whether it is unavoidable in principle; the ‘central dogma’ simply asserts this, and draws the conclusion that belief in causes, and searching for them, is philosophically naïve. If everybody accepted this and abided by it, no further advances in understanding of physical law would ever be made; indeed, no such advance has been made since the 1927 Solvay Congress in which this mentality became solidified into physics. But it seems to us that this attitude places a premium on stupidity; to lack the ingenuity to think of a rational physical explanation is to support the supernatural view.See Jaynes (2003, 328–29). In particular, this author’s views contrast sharply with those of Popper. With respect to the situation in physics, Popper, who argues for the compatibility of indeterminism with realism and objectivism, has gone so far as to blame the determinist interpretation of classical physics, or rather, what he characterizes as some unconscious determinist prejudice with respect to classical physics, for the subjective theory of probability and its consequence, the invasion of mysticism, irrationalism etc., into physics. See Popper (1982, passim).
Again a disagreement about the meaning of probability at the philosophical level need not preclude an approximate consensus regarding the legitimate scope of application of numerical probability theory. It is certainly doubtful whether the criterion of convergence and the conditions for the availability of a collective are ever satisfied in economic or econometric applications. Probabilities in economics are not the kind of physical entities that Richard von Mises seems to have had in mind in constructing his theory.
The empirical foundation for probability in this sense, that is to say for objective frequency probability, will typically be lacking. Richard von Mises himself seems to have suggested that the frequentist conception is not applicable to the moral sciences owing to the absence of events meeting the conditions of a collective. As he wrote:
The unlimited extension of the validity of the exact sciences was a characteristic feature of the exaggerated rationalism of the eighteenth century. We do not intend to commit the same mistake.See Richard von Mises (1981 [1957], 9).
On this point Ludwig von Mises and Richard von Mises seem to have agreed.
VI. MORE ABOUT LUDWIG VON MISES AND JOHN MAYNARD KEYNES, WITH RESPECT TO PROBABILITY Attention has already been drawn to the fact that both Ludwig von Mises and John Maynard Keynes embrace an epistemological rather than an objective interpretation of probabilities. Both of these authors also point to certain limits of the applicability of numerical probability, and in particular of the laws of large numbers. These authors’ respective views on probability have another important characteristic in common, however. Both authors recognize and acknowledge the epistemological and scientific legitimacy of qualitative, nonmeasurable probabilities.
With respect to the question of whether a numerical measurement of probabilities is always possible, John Maynard Keynes was critical of the tendency to interpret probabilities as being, in general, numerically measurable. Thus he wrote:
The attention, out of proportion to their real importance, which has been paid, on account of the opportunities of mathematical manipulation which they afford, to the limited class of numerical probabilities, seems to be a part explanation of the belief, which it is the principal object of this chapter to prove erroneous, that all probabilities must belong to it.Keynes (2004 [1921], 37).
In similar vein Ludwig von Mises wrote:
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.Ludwig von Mises (1998, 107).
Ludwig von Mises, who distinguishes between two kinds of probability—class probability, which by and large corresponds to frequency probability, and case probability—accorded the second meaning of probability important scientific status.
In Ludwig von Mises’s words:
Case 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.Ludwig von Mises (1998, 110).
Here too, however, the idea of probability relates to the general idea of partial or imperfect knowledge; in this respect, and only in this respect, case probability is indeed similar to class probability:
Case probability has nothing in common with class probability but the incompleteness of our knowledge. In every other regard the two are entirely different.Ludwig von Mises (1998, 110).
Keynes, while he does not adopt the terms case and class probability, believes, like Ludwig von Mises, that frequency probability does not encompass all we mean by probability. Clearly the random frequency definition of probability is too narrow to encompass what we mean when we use the term probability. We do say of unique events that they are more or less probable. Many decisions that people make daily are based on probability statements that have no frequency interpretation.
In Chapter VIII of A Treatise on Probability, while discussing Venn’s elaboration of the frequency theory, he wrote:
It is the obvious, as well as the correct, criticism of such a theory, that the identification of probability with statistical frequency is a very grave departure from the established use of words; for it clearly excludes a great number of judgments which are generally believed to deal with probability.Keynes (2004 [1921], 95).
While the frequency theory of probability is concerned with a cardinally measurable degree of probability, case probability is not open to any kind of numerical evaluation according to Ludwig von Mises.Keynes (2004 [1921], 95).
According to this view, case probability focuses on individual events which as a rule are not part of a sequence, and case probability is not measurable in any but an ordinal sense; there is no cardinal measure of case probability.
What is commonly considered as a numerical evaluation of case probability, Mises argues, exhibits, when more closely scrutinized, a different character, viz. that of a metaphor.See Ludwig von Mises (1998, 114). Ludwig von Mises’s view regarding this matter is thus distinct from the view of Bayesians such as Howson and Urbach who argue that choices of personal fair betting quotients can provide a basis for making numerical assessments of uncertainty. See Howson and Urbach (2006, 51 ff.).When we proceed to a numerical evaluation of case probability, this amounts to an attempt to elucidate a complicated state of affairs by resorting to an analogy borrowed from the calculus of probability. As it happens, this mathematical discipline is more popular than the analysis of the epistemological nature of understanding. As has been pointed out already, a distinctive feature of Keynes’s view too is that not all probabilities are numerically measurable, and in many instances, they cannot even be ranked on an ordinal scale.In the Treatise Keynes illustrates this point with the famous example of the “beauty contest.” (2004 [1921], 25 ff.)Keynes explains how one of the candidates of the contest sued the organizers of the Daily Express for not having had a reasonable opportunity to compete. Readers of the newspaper determined one part of the nomination. The final decision depended on an expert, who had to sample the top fifty of the ladies chosen by the readers. The candidate complained in front of the Court of Justice, that she had not obtained an opportunity to make an appointment with this expert. Keynes argues that the chance of winning the contest could have been measured numerically, if only the response of the readers (who sent in their appraisals and thus provided an unambiguous ranking of the candidates) had mattered. The subjective taste of the single expert could not be evaluated in a similar way. Hence, a rational basis for evaluating the chances of the unfortunate lady was lacking. Keynes concludes:Whether or not such a thing is theoretically conceivable, no exercise of the practical judgment is possible, by which a numerical value can actually be given to the probability of every argument. So far from our being able to measure them, it is not even clear that we are always able to place them in an order of magnitude. Nor has any theoretical rule for their evaluation ever been suggested. (ibid. 27–28)
Keynes’s views on the applicability of large number statistics to singular propositions are in this respect somewhat similar to those espoused by Ludwig von Mises. Keynes was clear on why one might adopt case probability judgments even where large number statistics are available:
In some cases, moreover, where general statistics are available, the numerical probability which might be derived from them is inapplicable because of the presence of additional knowledge with regard to the particular case.See Keynes (2004 [1921], 29). In similar vein, Hoppe (2006), analyzing the meaning of Ludwig von Mises’s concept of case probability, points out that the method of Verstehen can be characterized as a method of place selection, or a method of individualization.
VII. THE DISTINCTIVENESS OF LUDWIG VON MISES’S POSITION IN THE PHILOSOPHY OF PROBABILITY Acknowledging certain similarities between Ludwig von Mises’s and John Maynard Keynes’s respective positions in the philosophy of probability should not blind us to the fact that their respective views also exhibit some important differences. The most important of these relates to the fact that Ludwig von Mises advocates a pluralist, and in particular a dualist view of probability. According to a pluralist view of probability, there exist several different, though possibly interconnected, notions of probability which apply in different contexts, or with respect to different kinds of phenomena. Ludwig von Mises’s dualist position in the philosophy of probability is an aspect of his more general methodological dualism, which is based on a recognition of certain fundamental ontological, epistemological and methodological differences between the natural sciences on the one hand and the sciences of human action on the other, and between the natures of their respective subject matters. Moreover, in the particular case of Ludwig von Mises, his dualism in the philosophy of probability coincides with the distinction between measurable, numerical probability on the one hand and nonmeasurable, nonnumerical probability on the other, that is, with the distinction between class probability and case probability.It is not the case that according to Ludwig von Mises’s dualist (twoconcept) view with respect to probability, the different concepts of probability are conceived of as different interpretations of the same mathematical calculus, or as applications of the same mathematical calculus to different sets of phenomena, as is the case according to certain other dualist views of probability. The distinction between class probability and case probability is ultimately based upon the different kind of cognitive accessibility of human actors in contrast to noncommunicative entities. See Hoppe (2006).Ludwig von Mises’s view with respect to the meaning of probability may thus seem to occupy a truly unique place in the philosophy of probability. Another economist who adopted a nuanced viewpoint in this connection is John Hicks. This author wrote: “I have myself come to the view that the frequency theory, though it is thoroughly at home in many of the natural sciences, is not wide enough for economics.” (1979, 105) Hicks is contrasting two interpretations of probability—the frequency and the logical. The framework used here is wider since we distinguish objective theories of probability from epistemological theories.
Ludwig von Mises’s solution to the problem of defining the concept of probability remains, no less than Keynes’s, original and highly relevant. Where others have pleaded in favour of the introduction of operationalist procedures in the social sciences, as an alternative way of making the qualitative quantitative,See Gillies (2000, 200 ff.).Ludwig von Mises’s concept of case probability remains radically nonnumerical, geared to the needs of historical and entrepreneurial understanding.
VIII. CONCLUSION While certain fundamental differences between the natural and the social sciences and the consequent need for a nuanced solution to the problem of finding an adequate definition of the concept of probability have been recognized by various authors and schools of thought, the solutions to this problem offered by both Ludwig von Mises and John Maynard Keyes remain both interesting from a theoretical perspective and useful from a more practical viewpoint.
We have been entitled to conclude that Ludwig von Mises’s views concerning the interpretation of the concept of probability, as they can be ascertained from certain passages of his writings, are in some respects more akin to the logical interpretation of probability as developed by John Maynard Keynes than to the frequency view as developed by his brother Richard von Mises. Summarizing, it can be acknowledged that this conclusion is supported by the fact that the views of Ludwig von Mises and of John Maynard Keynes about the interpretation of probability—that is, their philosophy of probability—have two important characteristics in common which are not shared by the probability theory of Richard von Mises.
First, both Ludwig von Mises and John Maynard Keynes adopt an epistemological (or epistemic) interpretation of probability, whereas Richard von Mises clearly embraces an objective theory of probability. The viewpoints of Ludwig von Mises and John Maynard Keynes, in so far as they amount to an argument for interpreting probabilities in economics as epistemological rather than objective, are thus in agreement with the conclusions of recent research. Second, both Ludwig von Mises and John Maynard Keynes, in their respective ways, acknowledge the existence and the epistemological and scientific legitimacy of nonmeasurable (or nonnumerical) probabilities, besides the usual measurable probabilities having a definite numerical value in the interval [0, 1]. Although Richard von Mises did acknowledge that there was an ordinary language or common sense notion of probability which was not covered by his frequency theory, he asserts that there is only one concept of probability that is of scientific importance. In other words, according to this view there is, in a scientific approach to the subject matter, no room for a purely qualitative notion of probability.
While some authors have gone so far as to question the adequacy of the orthodox frequency theory even for the physical sciences, there is a somewhat greater amount of consensus in favour of the conclusions (1) that in any case an objective interpretation of probability such as the orthodox frequency theory is not wide enough for economics, and (2) that in economics a qualitative nonnumerical concept of probability is both needed and scientifically legitimate. Both of the aforementioned characteristics have much relevance for the conduct of social science in general and of economics in particular.
An important difference between the views of Ludwig von Mises and those of John Maynard Keynes in this respect has nevertheless been acknowledged. Whereas Keynes advocated a monist view of probability and claimed that his interpretation of probability applies to all uses of the concept, Ludwig von Mises, in accordance with his methodological dualism, embraced a dualist view, recognizing more emphatically the existence of important differences between the natural sciences on the one hand and the social sciences, including economics, on the other. The particular solution offered by Ludwig von Mises thus remains highly distinctive and sophisticated, even if in comparison with the Keynesian approach, it has until present received somewhat less attention.Those contemporary Austrian economists who acknowledge the usefulness of modern data analysis methods for the conduct of applied research in economics can be confident that the now more and more widespread practice of interpreting probabilities as merely epistemological is in general agreement with Ludwig von Mises’s approach to probability. Moreover, it is neither clear nor obvious why a recognition of the usefulness of modern data analysis methods would have to amount to a denial of the essential importance of the method of understanding or Verstehen.
Political Capitalism: How Economic and Political Power Is Made and MaintainedRandall HolcombeCambridge: Cambridge University Press, 2018x + 294 pp.
Abstract: Randall Holcombe's new book adds a historical dimension to public choice theory by combining it with "elite theory." In doing this, he arrives at a controversial thesis: a new economic system, "political capitalism," has come to replace market capitalism. Holcombe extends the public choice analysis of government of Buchanan and Tullock, who challenged the standard neoclassical contention that the free market cannot adequately supply public goods and therefore needed to be supplemented by state intervention.
economic freedom progressivism constitution public choice capitalism Randall Holcombe is best known as an economist for his work in public choice, but in this impressive new book, he adds a historical dimension to public choice by combining it with “elite theory.” In doing this, he arrives at a controversial thesis: a new economic system, “political capitalism,” has come to replace market capitalism. In arguing for his thesis, Holcombe shows a remarkable knowledge of the literature in economics, political science, and sociology.
By “political capitalism,” Holcombe means the same as what is often called “crony capitalism,” and as he notes, the concept is a well-established one. There is widespread agreement by people with different political views that the American economy is dominated by an alliance of elite business and political interests. David Stockman and Joseph Stiglitz are usually at odds, but not here. Stiglitz argues,
“We have a political system that gives inordinate power to those at the top, and they have used that power not only to limit the extent of redistribution but also to shape the rules of the game in their favor.” Echoing those views, Stockman says... “the state bears an inherent flaw that dwarfs the imperfections purported to afflict the free market, namely that policies undertaken in the name of the public good inexorably become captured by special interests and crony capitalists who appropriate resources from society’s commons for their own private ends.” (p. 5)1
Holcombe contends that political capitalism is a new system, distinct from market capitalism and socialism. The term, he tells us, comes from Max Weber, who used it to “describe the political and economic systems of ancient Rome.” (p. 8). Holcombe applies the concept to contemporary America. “The analysis that follows concludes that political capitalism, in which the political and economic elite control the system for their own benefit, is not market capitalism and should be analyzed as a separate economic system.” (p. ix) It is this thesis that I should like to examine.
He argues for it by extending the public choice analysis of government by James Buchanan and Gordon Tullock ([1962] 1999). These economists challenged, though they did not altogether reject, the standard neoclassical contention that the free market cannot adequately supply public goods and so needed to be supplemented by state intervention. In the standard view, economic actors motivated by self-interest will tend to “free ride,” relying on others to produce public goods. The consequence is an underproduction of them.
Buchanan and Tullock posed a devastating question that weakened the force of the standard view’s policy conclusions, though doing so without challenging the assumptions of the neoclassical model. Why assume that government policymakers are less self-interested than market actors?
Government is not omniscient. Policymakers do not have all the information necessary to allocate resources to match the theoretically optimum welfare maximum. Government is not benevolent. People in government look out for their own interests just as people do in the private sector. Their incentives need to be taken into account to understand how public policy works in the real world. (p. 14)
Buchanan and Tullock rejected theories of group exploitation, but Holcombe does not agree:
Buchanan and Tullock “also reject any theory or conception of the collectivity which embodies the exploitation of a ruled by a ruling class. This includes the Marxist vision, which incorporates the polity as one means through which the economically dominant group imposes its will on the downtrodden.” The public choice approach to analyzing political decision making, as Buchanan and Tullock see it, leaves no room for the group behavior and elite theories that are the subject of this chapter [and book]. (pp. 64–5)
How does Holcombe accept group exploitation theories without rejecting Buchanan and Tullock’s stress on the motivations of individual actors? The key to the mystery lies in the Coase theorem.
When transaction costs are low, people can bargain to allocate resources in a way that maximizes the value to the members of the low-transaction cost group---the people who are able to bargain. When transaction costs are high, people will not be able to bargain to allocate resources to maximize the value to them…. The people in the low-transaction group bargain with each other to make public policy. The people in the high-transaction cost group... find themselves subject to the policies designed by those in the low-transaction cost group. Those in the low-transaction cost group are the elite; those in the high-transaction cost-group are the masses. (p. 76)
This difference in transaction costs permits the continuity over time that elite theory requires. So long as the difference persists, long-lasting dominance by an elite group or class is possible. For example, incumbents in Congress, regardless of party, are often allied against challengers. Owing to the difficulty of ousting them, they can retain power for a substantial period of time.
Those who have political power conspire to keep it, and have more in common with each other than with others in their same party who do not have that power…. The more significant dimension of political competition is between those who with power versus their challengers for that power, not the competition of one party against another. This is true in political capitalism, but also true of government in general. (p. 191)
Holcombe devotes a great deal of attention to the mechanisms of rent-seeking and regulatory capture, by which elites in government join forces to exploit the masses. It is sometimes difficult to tell whether government or business interests dominate the coalition. In one maneuver, the legislature will threaten to pass laws that would adversely affect certain interests, inducing the interested parties to offer “donations” to induce the legislature to turn its attention elsewhere. “Those in government have an incentive to extract payment in exchange for legislative action, or inaction, and those who are paying have an incentive to continue paying to avoid having costs imposed on them.” (p. 129)
Holcombe’s argument within its own terms is powerful, but it suffers from a limitation that the more wide-ranging approach of Murray Rothbard avoids. The public choice school says, in effect, “Politicians are not impartial public servants, aiming for the good of all. They too are self-interested actors.” Everyone’s dominant motivation is to gain wealth, and ideological considerations play a minor role. Why, for example, do incumbents want to remain in power? The primary reason, as Holcombe views the matter, is to extract economic rents.
Rothbard allows far more room to those dominated by ideas, though he also emphasizes people’s economic self-interest. People made the American Revolution, for example, in part because they genuinely believed in the ideals stated in the Declaration of Independence. Lenin genuinely believed in communism: he did not start the October Revolution to make himself a millionaire. It is of course true that both of these revolutions also benefited some at the expense of others.
To this contention, there is a well-known public choice response, best expressed in Gordon Tullock’s The Social Dilemma (1974). Revolutionary action is a public good, and ideological revolutionaries will prefer to free ride on the actions of other revolutionaries, thus avoiding costs to themselves. Even if this analysis is correct, it proves less than Tullock and other exponents of public choice think it does. Tullock has applied the standard neoclassical analysis of public goods to revolutions, but, as previously mentioned, the standard model concludes that a public good will not be supplied efficiently. It does not hold that the good will not be supplied at all. If Tullock is right, perhaps we have less than the efficient quantity of ideological revolutions. But the historical record shows that we have some of them.
Given the malign effects of political capitalism, Holcombe naturally wonders what can be done to restrain it. He says that his book is concerned primarily with an analysis of the system rather than remedial action, but he does suggest that limiting the power of the state through constitutional checks and balances is desirable. Such limits hold some promise to impede a rapacious government. The Progressive movement of the late nineteenth and early twentieth centuries favored government action to limit corporate predation, but this did not work: “The Progressive ideology legitimizes the use of force for the economic benefit of some at the expense of others.” (p. 230) Holcombe’s suggestions are all to the good, and he has written in greater detail with insight and erudition about this topic in From Liberty to Democracy (2002).
There is another limit to political capitalism, and explaining it requires us to challenge Holcombe’s central thesis that political capitalism is a new economic system. From a Misesian point of view, there are no intermediate economic systems between capitalism and socialism. As Mises remarks: “With regard to the same factors of production there can only exist private control or public control.” (Mises [1949] 1998, 712) Measures of the sort analyzed in Holcombe’s book hamper the free market, but they do not provide an alternative way to allocate resources efficiently. If political capitalism were a “third system,” it would be faced with the calculation problem. Because economic calculation requires a free market, political capitalism is inherently parasitic on the free market and this is a barrier to the damage it can do. Given its bad results, that is small consolation.
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.
Quarterly Journal of Austrian Economics 22, no. 2 (Summer 2019) full issue. ABSTRACT: This paper examines John Maynard Keynes’s ethical theory and how it relates to his politico-economic thought. Keynes’s ethical theory represents an attack on all general rules. Since capitalism is a rule-based social system, Keynes’s ethical theory is incompatible with capitalism. And since socialism rejects the general rules of private property, the Keynesian ethical theory is consistent with socialism. The unexplored evidence presented here confirms Keynes advocated a consistent form of non-Marxist socialism from no later than 1907 until his death in 1946. However, Keynes’s ethical theory is flawed because it is based on his defective logical theory of probability. Consequently, Keynes’s ethical theory is not a viable ethical justification for socialism.
ethics socialism keynes JEL Classification: B22, B24, E122, P20 INTRODUCTION John Maynard Keynes (1883–1946) was the most influential economist of the twentieth century. However, ethics and probability were Keynes’s primary intellectual interests for the first seventeen years of his academic career. In fact, his early ideas on ethics and probability inspired and suffused his politico-economic theory. His biographer, Robert Skidelsky, agrees: “His theories of politics and economics were expressions of his beliefs about ethics and probability” (1991, 104). The Keynes scholar Athol Fitzgibbons states, “His economics has not been adequately recognized as an expression of his probabilistic and moral philosophies. These are the implicit and inseparable foundations of Keynes’s economic policies” (1988, 5). The editor of The Further Collected Writings of John Maynard Keynes, Rod O’Donnell, writes, “To comprehend the political-economist adequately, we must first understand the philosopher” (1989, 1–2). Simply put, a complete understanding of Keynes and his economics requires an understanding of his ethical theory and his theory of probability.
Unfortunately, Keynes’s theories of ethics and probability were almost completely unknown for five decades after he published The General Theory of Employment, Interest and Money (1936). These theories only started receiving serious scholarly attention in the 1980s. Still, the literature remains problematic. Specifically, the literature never connects his radical stance on general rules to capitalism and socialism, and the literature never addresses potential problems with the Keynesian probability theory. First, this paper shows that Keynes’s ethical theory is an intellectual justification for violating general rules. Then the paper shows that Keynes was a non-Marxist socialist, and his ethical theory is consistent with his non-Marxist socialism. Finally, the paper explains why Keynes’s probability theory is flawed.
GENERAL RULES AND PROBABILITY THEORY Keynes’s ethical master was the British philosopher George Edward Moore (1873–1958). Moore’s Principia Ethica (1903) was “the most important book in [Keynes’s] life” (Skidelsky 1983, 119). Keynes first read Principia Ethica in October 1903, just after starting his second undergraduate year at the University of Cambridge. He described the book as “a stupendous and entrancing work, the greatest on the subject” (1903). He exclaimed, “It is impossible to exaggerate the wonder and originality of Moore.… How amazing to think that we and only we know the rudiments of the true theory of Ethic” (1906, 123–24).
Opposed to natural law, Moore argued it is impossible to prove that a general rule of conduct is correct. He writes, “It is plain that no moral law is self-evident” (1903, 148). Still, Moore was highly skeptical that human beings could know all the consequences of their actions: “Our causal knowledge is utterly insufficient to tell us what different effects will probably result from two different actions…. We can only pretend to calculate the effects of actions” (1903, 202). Despite his claim that general rules can never be proved universally true, Moore concluded that general rules must always be obeyed: “With regard to any rule which is generally useful, we may assert that it ought always to be observed…. Though we may be sure that there are cases where the rule should be broken, we can never know which those cases are, and ought, therefore, never to break it” (1903, 162–63). In short, Moore rejected natural law and advocated a form of rule consequentialism.
On reading Principia Ethica, Keynes embraced Moore’s view that it is impossible to prove a general rule is universally true. While he adopted Moore’s attack on the truth of general rules, however, he was revolted by the conclusion that general rules must be obeyed. Like Moore, Keynes rejected natural law.On Keynes and natural law, see Dostaler (2007, 82) and O’Donnell (1989, 286; 1991, 6). But he went even further and categorically rejected all general rules: “What we ought to do is a matter of circumstance; metaphysically we can give no rules” (1905a, 2). He wanted to overturn Moore’s case for following rules, so he developed a variation of Moore’s ethical theory. He kept the basic structure of Moore’s framework, but he modified it in a way that allowed actors to violate general rules. Keynes declared in a 1938 speech called “My Early Beliefs,”
[I rejected] the part [of Moore’s theory] which discussed the duty of the individual to obey general rules. We entirely repudiated a personal liability on us to obey general rules. We claimed the right to judge every individual case on its merits, and the wisdom, experience and self-control to do so successfully. This was a very important part of our faith, violently and aggressively held.… We repudiated entirely custom morals, conventions and traditional wisdom. We were, that is to say, in the strict sense of the term, immoralists…. I remain, and always will remain, an immoralist. (CW 10, 446–47)
Keynes’s rebellion against general rules propelled him into probability theory. As he saw it, Moore’s conclusion that rules must be obeyed followed from his theory of probability. Keynes recalled in 1938, “[Moore] has a section on the justification of general rules of conduct. The large part played by considerations of probability in his theory of right conduct was, indeed, an important contributory cause to my spending all the leisure of many years on the study of that subject [probability]” (CW 10, 445). Although he studied mathematics at Cambridge, he wrote his fellowship dissertation on the philosophy of probability. The dissertation was rejected in 1908 and accepted in 1909, meaning Keynes was elected a fellow of King’s College, Cambridge for his theory of probability, not for his economics. A revised version of the dissertation was published twelve years later as A Treatise on Probability (1921). Although he published two works before 1921, A Treatise on Probability must be considered his first book.
On Keynes’s interpretation, Moore’s conclusion that rules must be obeyed was premised on the frequency theory of probability. As Keynes noticed, the frequency theory of probability places strict limits on the scope of probability. According to the frequency theory, probability can only be applied to repeatable events. The mathematician Richard von Mises was a leading developer of the frequency theory, and he writes: “In order to apply the theory of probability we must have a practically unlimited sequence of uniform observations” ([1928] 1981, 11; Gillies 2000, 89–90). In short, probability can only be applied when it is possible to construct a long series of homogeneous repetitions.
Significantly, the frequency theory’s requirement of repeatability makes probability inapplicable to human action. Mises writes, “The theory of probability can never lead to a definite statement concerning a single event” ([1928] 1981, 33; Gillies 2000, 97). Human actions are singular events because the conditions of human action are never homogeneous and repeatable. Thus, on the frequency theory, it is illegitimate to apply probability to human action. Keynes realized the “narrow limits” of the frequency theory and concluded, “If we allow [the frequency theory] to hold the field, we must admit that probability is not the guide of life” (CW 8, 103–04).
What does all this have to do with general rules? As Keynes interpreted Moore, it is best to follow general rules because it is impossible to have any probabilistic knowledge about action. To Keynes’s mind, the strict limits of the frequency theory forced Moore to conclude that general rules must always be obeyed.
Keynes developed his logical theory of probability to replace the frequency theory in Moore’s ethical framework. On the frequency approach, probability theory is a branch of empirical science. But for Keynes, it is a branch of logic. In classical logic, the logical structure of the human mind can intuitively perceive whether a conclusion follows from the premises. In the same way, Keynes argues the logical structure of the human mind can intuitively perceive probability. The human mind can naturally grasp probability without empirical observation of repetitions. This means that, in sharp contrast to the frequency theory, the logical theory allows one to apply probability to singular events. Consequently, the logical theory makes probability applicable to human action. Compared to the frequency theory, the logical theory greatly magnifies the human capacity to intuitively understand the probable consequences of actions.Intuition is vital to Keynes (Moggridge 1992, 553; O’Donnell 1989, 209–13; Skidelsky 1992, xix, 411, 424; 2009, 141). In this way, the logical theory of probability sets actors free to violate general rules.
For example, consider the general rule “Thou shalt not steal.” While stealing is bad for the victim, it is good for the thief. To Moore, it is impossible to comprehend and weigh all the good and bad consequences of stealing in a probabilistic manner. Thus, the rule “Thou shalt not steal” must always be obeyed. But the logical theory amplifies the human ability to understand the consequences of action. It allows the actor “to judge every individual case on its merits” (CW 10, 446). The logical theory permits the thief to form (objective) probabilistic beliefs about the consequences of stealing. While objective, these probabilities are non-numerical rather than numerical. In fact, for Keynes, most probabilities are non-numerical: “Not all probabilities are numerical … Numerical measurement is often impossible” (CW 8, 70).On Keynes’s non-numerical probability, see Carabelli (1988, 42–50), Gillies (2000, 33–35), Lawson (1985, 913), Meltzer (1988, 139), Moggridge (1992, 149), O’Donnell (1989, 50–55; 1990), Runde (1995, 334), and Skidelsky (1992, 59). Still, non-numerical probability enhances the thief’s ability to understand the consequences of stealing. If the probable consequences of stealing are good, then the thief should steal the property. This example illustrates that the logical theory functions as an intellectual justification for breaking general rules such as “Thou shalt not steal,” “Thou shalt not kill,” “Thou shalt not aggress against person and property,” and the like.
KEYNES ON SOCIALISM Keynes categorically rejected all general rules, but how does this relate to his political vision? Unfortunately, controversy over his political thought has muddled the relation between his ethics and politics. The standard interpretation is that Keynes was a great liberal. Robert Skidelsky writes, “Keynes was a lifelong liberal” and “He was not a socialist” (2009, 135, 157; 1992, 233; 2000, 478).Also see Backhouse and Bateman (2011, 148), Clarke (2009, 101, 179), Davidson (2007, 13–14), and Harrod (1951, 192). Contrary to Skidelsky, important Keynes scholars have aligned him with socialism.Keynes’s socialism has been acknowledged in passing by Dostaler (2007, 98), Fitzgibbons (1988, 191), Groenewegen (1995, 153), Lekachman (1985, 37), and Moggridge (1976, 38; 1992, 469). Joan Robinson worked closely with Keynes, and she considered him a socialist (Lekachman 1985, 37). For example, Rod O’Donnell writes, “Keynes envisaged and espoused a particular form of socialism” and “It is clear, explicit and unambiguous; he used the term socialism to characterise his own views” (1999, 149, 164; 1989, 322; 1992, 781–82). To comprehend the real significance of Keynes’s ethical theory, it is necessary to explore his politico-economic thought.
The evidence confirms Keynes was a non-Marxist socialist throughout his adult life.Ludwig von Mises used the term non-Marxist or non-Marxian socialism ([1922] 1981, 12, 356; 1949 [1998], 52, 503, 579; [1944] 2011, 234; 1956 [2006], 51; [1957] 2005, 43). In fact, he dedicated a paper to anti-Marxian socialism ([1929] 1977, 120–27). Later, Mises aligned Keynes with socialism: “Keynes was influenced by the German socialists of the chair and … he outdid them in many points” (quoted in Hülsmann 2007, 881). Although O’Donnell’s work on Keynes’s socialism is noteworthy, there are several problems with his account. First, O’Donnell (1999, 149) avoids defining capitalism or socialism, and this leads him to neglect Keynes’s policy views. Second, O’Donnell (1999, 150) argues Keynes first embraced socialism in the mid-1920s. However, his ethical theory was on display by January 23, 1904, and he wrote a draft outline of his dissertation The Principles of Probability by September 5, 1905 (1904a, 1905b, document 1). Hence, O’Donnell faces a temporal problem when he connects Keynes’s ethical and political thought.Skidelsky faces a similar temporal problem. He incorrectly claims Keynes’s life before 1914 was a period of “political indifference” (1983, 229, 262). Even a cursory examination of the Keynes Papers (OC/1–6) will show Keynes was deeply interested in politics when he was developing his ethical theory. Contrary to O’Donnell, the evidence indicates Keynes advocated a stable form of non-Marxist socialism from no later than October 1907 until his death in 1946.
Just after reading Principia Ethica, Keynes supported the motion “that this house approves of the rise of the Independent Labour [socialist] Party in present day English Politics” (1904b). He was an early member of a socialist club at the University of Cambridge called the Cambridge University Fabian Society (Dow 2016, 11n24). The Fabian leader George Bernard Shaw spoke to the club on October 24, 1907, and Keynes wrote to his lover Lytton Strachey the next day: “Mr. Bernard Shaw converted us all to socialism last night” (1907, document 2).Keynes and Shaw were lifelong friends. Keynes wrote in 1927, “What a debt every intelligent being owes to Bernard Shaw!” (CW 9, 320). In 1946, Keynes noted the “love and honour in which I hold G.B.S.” (CW 10, 381). Shaw was a socialist and a supporter of Hitler, Mussolini, Lenin, and Stalin. Also see note 27. At the Cambridge Union on February 7, 1911, Keynes argued publically that “the progressive reorganisation of Society along the lines of Collectivist Socialism is both inevitable and desirable” (1911). He was extremely close to his father John Neville Keynes, and Neville recorded in his diary on September 6, 1911: “Maynard avows himself a Socialist and is in favour of the confiscation of wealth” (1911, emphasis added, document 3). This shows that Keynes described himself as a socialist, and did so in the first decade of the twentieth century.
Keynes celebrated the Bolshevik Revolution of 1917. He wrote to his mother, “I was immensely cheered up and excited by the Russian news” (1917). On December 24, 1917, he proclaimed, “The only course open to me is to be buoyantly bolshevik” (CW 16, 266). That month, he cofounded the socialist 1917 Club with Ramsay MacDonald, the man who became Britain’s first socialist prime minister (Thomas 1973, 68). In February 1918, he confessed to “being a Bolshevik” (CW 16, 267). The famous financial journalist Clarence W. Barron met Keynes in September 1918, and he reported: “Lady Cunard says Keynes is a kind of socialist and my judgment is that he is a Socialist of the type that does not believe in the family” ([1918] 1930, 189).
Keynes wrote in 1922, “An extraordinary experiment in socialism is in course of development. I think there may be solid foundations on which to build a bridge” (CW 17, 420). That year, he stated Vladimir Lenin’s “political control of affairs was of a high intellectual competence. The histories of revolution contain nothing more remarkable or more coldly and splendidly glittering than the career of Nicholas [sic] Lenin” (CW 17, 436–37). He demanded in 1923, “Liberals must move towards Labour [socialism] and not in the other direction” (1923a). He declared in a 1924 speech, “In many respects [the Labour Party] want[s] the same thing [as the Liberal Party]” (1924a, 262). Although he was a member, Keynes always wanted to transform Britain’s Liberal Party into a socialist party of the far left.Keynes’s affiliation with the Liberal Party does not mean he was a liberal. Keynes’s friend Kingsley Martin recognized that most British socialists at this time “aimed at the permeation of the existing political parties” (1970a, 33). Although Keynes, Leonard Woolf, Gerald Shove, David Garnett, Francis Birrell, Rupert Brooke, and James Strachey were involved in Liberal Party politics and clubs, they all aligned themselves with socialism. This shows not all members of liberal parties are liberals.
In February 1924, he boasted that he joined a “new USSRian Society,” and in May he joined “a new Society… for getting into intellectual touches with Russians!” (1924b, 1924c). On June 8, 1924, he drafted an outline for a book called Prolegomena to a New Socialism (1924d, document 4). In July 1924, Keynes was a founding vice president of the Society for Cultural Relations with the USSR (SCR 1924, document 5). This explicitly pro-Soviet society was financed and controlled by VOKS, the Soviet government’s international propaganda agency (Miner 2003, 228, 248). In September 1925, he visited the USSR and he addressed the Soviet politburo. Leon Trotsky attended, and Trotsky described Keynes as an advocate of socialism: “Even the most ‘progressive’ economist Keynes told us only the other day that the salvation of the British economy lies in Malthusianism! And for England, too, the road of overcoming the contradiction between city and country leads through Socialism” (1925, 286).
Contrary to O’Donnell, the evidence above shows Keynes aligned himself with socialism long before the mid-1920s. Overlooked evidence confirms he aligned himself with socialism until his death in 1946. For example, in 1926, his close friendship with the leaders of Fabian socialism, Sidney and Beatrice Webb, led Virginia Woolf to observe: “Lydia [Keynes’s wife] and Maynard are both completely under the sway of the Webbs…. [The great Keynes] is at [Beatrice Webb’s] feet” ([1926] 1978, 289). Beatrice wrote, “There is no reason why Keynes … should not be among the leaders of the Labour Party—[he] is certainly more advanced than [the socialist Ramsey] MacDonald” ([1926a] 1985, 103). Keynes proclaimed, “I am less conservative in my inclinations than the average Labour [socialist] voter; I fancy that I have played in my mind with the possibilities of greater social changes than come within the present philosophies of, let us say, Mr Sidney Webb.... The republic of my imagination lies on the extreme left of celestial space” (CW 9, 309).Ludwig von Mises describes Sidney Webb as “the outstanding man in the British socialist movement” ([1922] 1981, 484).
After his 1928 trip to the Soviet Union, he noted “my sympathy with communists over money motives” (1928a). That year, he endorsed the socialist program Labour and the Nation: “Since this motion was framed, [the] Labour Programme [Labour and the Nation was] published. The Lib[eral] Summer School met with pleasure and no false sense of proprietorship how much of it overlaps … [The] Lib[eral] and Lab[our] [Parties] shall cooperate. For there is a large enough measure of agreement on what to do next” (1928b). This program was concerned with “transforming Capitalism into Socialism” and “the establishment of the Socialist Commonwealth” (Labour Party 1928, 3, 14).Keynes made these statements in a debate with Labour politician Thomas Johnston. In that debate, Johnston “regarded many of the proposals in the Liberal Yellow Book as proposals for which Socialists could vote with both hands” (1928, 11). Moggridge notes, “Keynes’s contributions to the Inquiry’s report Britain’s Industrial Future, or the Yellow Book as it was and is known, were substantial” (1992, 458). Mises writes, “The English ‘Liberals’ of today are more or less moderate socialist” ([1922] 1981, 17). He continues in a footnote, “This is shown clearly in the programme of present-day English Liberals: Britain’s Industrial Future” ([1922] 1981, 17n3).
In a 1929 speech, “Social Reform as the New Socialism,” he sketches his “type of social[ist] action for the future” (1929).Hayek notes that the term ‘social reform’ is a euphemism for socialism: “Efforts for social reform, for something like a century, have been inspired mainly by the ideals of socialism” ([1960] 2011, 369). Keynes abandoned the Liberal Party after the 1929 general election, and he proclaimed, “England must break sharply with the Liberal tradition” (quoted in Martin 1970a, 198). He became an important economic advisor to Britain’s first socialist prime minister, Ramsay MacDonald, after the 1929 election. At a meeting with MacDonald on June 1, 1930, Keynes described himself as “the only socialist present” (quoted in Dalton 1986, 115). His first major work on economic theory, A Treatise on Money (1930), imagines “socialistic action by which some official body steps into the shoes which the feet of the entrepreneurs are too cold to occupy” (CW 6, 335).
Keynes began meeting with the socialist politician Oswald Mosley frequently in late 1930 (Mosley 1968, 238; Smith 1996, 244). That year, Mosley produced his famous Mosley Manifesto, a socialist proposal calling for “industrial reorganisation in the form of the big merger involving standardisation and the pooling of resources” (Mosley 1930, 11). Keynes thought the socialist proposal was “a very able document and illuminating,” and “I do not see what practical socialism can mean for our generation in England, unless it makes much of [Oswald Mosley’s] manifesto its own—this peculiar British socialism” (Henderson 1930; CW 20, 475). Mosley founded a socialist political party in early 1931 called the New Party, which later became the British Union of Fascists and National Socialists. Harold Nicolson, another leader of the party, reported to Mosley:
Dined with Clive Bell and Keynes. Keynes is very helpful about the economics of the New Party. He says that he would, without question, vote for it.… He feels that our Party may really do an immense amount of good and that our Programme is more sound and certainly more daring than that which any other party can advance. (Nicolson [1931] 2004, 79; Mosley 1968, 237–38)Mosely recalled, “I had the massive support of Keynes, not only in his theory but as already noted in his personal intervention” (1968, 253). Mosley says, “The background of my economic thinking was first developed by a study of Keynes—more in conversation with him than in reading his early writings” (1968, 178).
In early 1931, Keynes became the chairman of Britain’s leading socialist newspaper, New Statesman and Nation, and he maintained that position until his death in 1946. He described the paper as “an independent organ of the Left,” and the paper’s historian acknowledges it was an “unequivocally socialist weekly” (Smith 1996, 249, 156).Harrod and Skidelsky argue the editor Kingsley Martin was responsible for the newspaper’s socialist policy. Skidelsky notes the paper’s “sympathy for Soviet communism” and says “the New Statesman was unmistakably Kingsley Martin’s” (1992, 389). However, Martin refutes this notion: “Maynard was the only active director of the N.S.&N.… His biographer, Sir Roy Harrod, mentions his intimate connection with the Nation and then says that as the years went by he fell out of sympathy with the N.S.&N. policy. This does not tell the story” (1970b, 41). Also see Hyams (1963, 125) and Martin (1970a, 198). On December 13, 1931, he gave a speech to the Society for Socialist Inquiry and Propaganda called “A Survey of the Present Position of Socialism.” He declares, “I should like to define the socialist programme as aiming at political power,” and he discusses the “grand experiment of the ideal [socialist] republic,” (CW 21, 34; Moggridge 2012, 58). Around this time, he joined the New Fabian Research Bureau, Britain’s leading socialist think tank (Cole 1961, 235). The New Fabian Research Bureau was the sister organization of the Society for Socialist Inquiry and Propaganda (Cole 1961, 230), and it amalgamated with the Fabian Society in November 1938.
Keynes lived with members of the socialist Bloomsbury group throughout his adult life.On Bloomsbury’s socialism, see Marler (1993, xviii) and Rosenbaum (2003, 85). Skidelsky writes, “The Bloomsbury group [was] a commune of Cambridge-connected writers and painters” (2015, xvii). The Bloomsbury “communal household” was conceived by Virginia Woolf in late 1911, and Keynes was one of the first residents (Delany 2015, 147, 156). Woolf’s biographer reports, “Virginia looked back on this communal household as one of her pioneering achievements,” and Virginia referred to the residents as “inmates” (Lee 1997, 301, 288). Virginia nicknamed Keynes “dear old Hitler” ([1938] 1984, 163; Lee 1997, 680, 715), and she recorded in 1933: “We are going over to Tilton [Keynes’s country home], to be converted by Maynard to what I suspect of being a form of Fascism [national socialism]” ([1933] 1979, 222). That same year, “Mosley wrote to him [Keynes] congratulating him on his ‘fascist’ economics” (Skidelsky 1975, 306).Although Skidelsky denies Keynes’s socialism, he admits that “Keynesianism was [Mosley’s] great contribution to fascism. It was Keynesianism which in the last resort made Mosley’s fascism distinctively English” ([1975] 1990, 302). Murray N. Rothbard notes “Keynes’s strong fascist bent,” and states “Keynes was a fascist” ([1992] 2010, 51, 56).
Keynes supported the socialist Labour Party in the 1930s, and he declared in October 1935, “I do not really agree with … maintaining the separate identity of the Liberal Party” (CW 21, 373).Moggridge agrees, “In the course of the 1930s [Keynes] frequently commented on Labour policy proposals, more often than not sympathetically.… He was more inclined to support individual Labour candidates” (1992, 465). O’Donnell writes, “Keynes identified three main political ‘parties’ or groupings—the Socialists, Liberals and Conservatives. It was with the ‘Socialist’ grouping that his general sympathies lay” (1999, 158; Clarke 1988, 221). As Scott Newton recognizes, “Harrod concealed the drift of Keynes’s sympathies from the Liberal Party to Labour in the 1930s” and “felt it his duty to protect the public name of Keynes from association with the socialists” (2001, 15–16, 24). Like Harrod, Skidelsky conceals Keynes’s support of Labour after 1929. In the general election of 1935, he voted for Britain’s Labour Party just three months before The General Theory was published. Notably, the Labour platform was entitled For Socialism and Peace, and it called for “creating a new social order and a British Socialist Commonwealth” (Labour Party 1934, 29). He wrote, “I scarcely know where I stand. Somewhere, I suppose, between Liberal and Labour, though in some respects to the left of the latter [Labour]” (CW 21, 372–73).
He praised the Soviet experiment just four months after The General Theory was published: “Until recently events in [Stalin’s] Russia were moving too fast and the gap between the paper professions and the actual achievements was too wide for a proper account to be possible. But the new system is now sufficiently crystallised to be reviewed. The result is impressive” (CW 28, 333). Keynes’s engagement diaries show that he met with the Webbs at least twenty-two times between 1931 and 1937. And just five months after The General Theory was published, Beatrice Webb recorded that he desired “a modified socialism” ([1936] 1985, 371). The novelist John Buchan dined with Keynes regularly for over a decade, and Buchan reported Keynes was a “gentlemanly Communist” and “His line is that he despises capitalism” (1936, 105–06). Keynes confirmed, “Private capitalism is an out-of-date institution incapable of meeting the requirements of the twentieth century” (CW 21, 491).
In 1939, he praised “the splendid material of the young amateur communists” and applauded the socialist Left Book Club as “one of the finest and most living movements of our time” (CW 21, 496). That year, Stafford Cripps attempted to unify the Labour and Communist Parties, and Keynes announced, “I am all for Sir Stafford Cripps, and I would join his movement” (CW 21, 496). He congratulated Cripps: “I am in full sympathy with what you are doing” (CW 21, 502). Critically, Keynes proclaimed in 1939, “The question is whether we are prepared to move out of the nineteenth century laissez-faire into an era of liberal socialism” (CW 21, 500). In the early 1940s, he described Beatrice Webb as “the greatest woman of the generation,” and she reported that he was still “going ‘left’” (Keynes 1943; Webb [1942] 1985, 488). In 1944, Keynes was running the British Treasury and planning the new world monetary system at Bretton Woods. Still, he remained vice president of the socialist Society for Cultural Relations with the USSR, an arm of the Soviet propaganda agency VOKS (SCR 1944, document 6).
KEYNES AND SOCIALIST POLICY Keynes aligned himself with socialism throughout his entire adult life, and he described himself as a socialist. But can he actually be defined as a socialist? Did he actually advocate socialist policy? Traditionally, socialism is defined as a system of social organization based on government ownership of the means of production. Many Keynes interpreters have used the traditional definition of socialism to argue that Keynes was not a socialist. For example, Skidelsky writes, “He had no time for public ownership” and “His demand in the General Theory for a somewhat comprehensive socialisation of investment was a demand not for greater public ownership—which he always opposed” (1990, 52; 2000, 274). The traditional definition of socialism leads many interpreters to conclude that “He never embraced socialism” (Skidelsky 1992, 437).
The traditional definition of socialism can lead to error, for it is misleading if ownership is not properly defined. In economics, ownership is defined as ultimate control over a scarce good. Murray Rothbard writes, “Ownership is the ultimate control and direction of a resource” ([1962] 2004, 1277, 91–92, 959, 1273–74). Rather than using the proper economic definition, interpreters who argue Keynes was not a socialist must rely on a purely legal definition of ownership. But as Ludwig von Mises warns, “It is a mistake to deal with economic problems according to legal criteria” ([1957] 2005, 73).
Ownership is power of disposal, and when this power of disposal is divorced from its traditional name and handed over to a legal institution which bears a new name, the old terminology is essentially unimportant in the matter. Not the word but the thing must be considered. Limitation of the rights of owners as well as formal transference is a means of socialization. If the State takes the power of disposal from the owner piecemeal, by extending its influence over production; if its power to determine what direction production shall take and what kind of production there shall be, is increased, then the owner is left at last with nothing except the empty name of ownership, and property has passed into the hands of the State. (Mises [1922] 1981, 45)
Again,
Ownership means full control.... This catallactic [economic] notion of ownership and property rights is not to be confused with the legal definition of ownership and property rights as stated in the laws of various countries…. nowadays there are tendencies to abolish the institution of private property by a change in the laws determining the scope of the actions which the proprietor is entitled to undertake with regard to the things which are his property. While retaining the term private property, these reforms aim at the substitution of public ownership for private ownership…. In dealing with private property, catallactics [economics] deals with control, not with legal terms, concepts and definitions. Private ownership means that the proprietors determine the employment of the factors of production, while public ownership means that the government controls their employment. (Mises [1949] 1998, 678–79, emphasis added; Rothbard [1962] 2004, 1273).
There is no economic difference between government ownership and government control of the means of production. To avoid error, it is best to define socialism with the term control rather than the term ownership. Specifically, socialism is a system of social organization based on government control over the means of production. Although Mises used the term ownership to define socialism, he also frequently used the more precise term control: “Socialism is a social system based on public control of the means of production” ([1922] 1981, 505).For examples of Mises using the term control to define socialism, see Mises ([1922] 1981, 211; [1927] 2005, 35; 1944 [2011], 201, 203; 1949 [1998], 701; [1956] 2006, 38). For examples of Mises using the term ownership to define socialism, see Mises ([1919] 2006, 142; [1920] 2008, 3; [1922] 1981, 22, 498; [1940] 2011, 1, 71; [1944] 2011, 60; [1949] 1998, 183, 712). Still, he stressed, “To avoid any misunderstanding we will henceforth use the words, ‘ownership of the means of production’ in the generally accepted sense, i.e. to signify the immediate power of disposal [control]” ([1922] 1981, 32). Keynes’s friend Sidney Webb, the leader of Fabian socialism, defines socialism as “control by the community of the means of production” (1890, 4). Joseph Schumpeter writes, “By socialist society we shall designate an institutional pattern in which the control over means of production and over production itself is vested with a central authority” ([1943] 2006, 167).Murray Rothbard writes, “When government ownership or control extends to the entire productive system, then economics system is called socialism” ([1962] 2004, 958). According to Milton Friedman, “Socialism means government control of the means of production. That’s the old-fashioned definition and a good one” (1993, 4). In fact, Skidelsky admits that socialism means “control and direction of human resources” ([1975] 1990, 136, 145).
To determine whether Keynes was a socialist, it is necessary to examine whether he advocated government control over the means of production. As it turns out, Keynes’s main policy recommendation was government control, or socialization, of investment. To him, socializing investment is the only way to permanently solve cyclical and secular unemployment: “A somewhat comprehensive socialisation of investment will prove the only means of securing an approximation of full employment” (CW 7, 378, emphasis added). It must be remembered that in economic theory, investment refers to real investment, not financial investment. Investment goods refers to property, plant, and equipment—that is, the means of production (Garrison 2001, 37). Thus, Keynes’s call to socialize investment is a call for government control over the means of production. Therefore, Keynes fits the definition of a socialist.
It is important to emphasize that Keynes advocated government control over investment long before The General Theory. In February 1910, he already expressed the cynical view of private investment contained in The General Theory: “[The investor] will be affected, as is obvious, not by the net income which he will actually receive from his investment in the long run, but by his expectations. These will often depend upon fashion, upon advertisement, or upon purely irrational waves of optimism or, depression” (CW 15, 46). Like the other Cambridge business cycle theorists, he did not believe private businessmen can make good investment decisions: “There are still a good many perfect fools amongst our business men” (1910).
He stated in 1923, “The present organisation of investment is not such as to maximise the individual investor’s self interest, even in so far as it does this, it does not follow that it maximises the national income” (1923b, 252). He said the day before drafting Prolegomena to a New Socialism, “The state encouragement of new capital undertakings… is becoming an inevitable policy” (CW 19, 229). He verifies government control of investment is a socialist policy in Prolegomena to a New Socialism: “Investment of Fixed Capital” is one of the “Chief preoccupations of the State” (1924d, document 4). He says, “A great deal of money was being invested by those who had no special knowledge” (1924e, 313). On December 12, 1924, he said that private investors could not “direct the new savings of the community into ideal channels” and government must “improve our organisation for employing our capital” (1924f, 315, 318).
He exclaimed in his 1925 speech to the Soviet politburo, “I direct all my mind and attention to the development of new methods and new ideas for effecting the transition from the economic anarchy of the individualistic capitalism which rules today in Western Europe towards a regime which will deliberately aim at controlling and directing economic forces” (CW 19, 439). He continues, “I believe that there are many other matters, left hitherto to individuals or to chance, which must become in future the subject of deliberate state policy and centralised state control. Let me mention two—(1) the size and quality of the population and (2) the magnitude and direction of employment of the new national savings year by year” (CW 19, 441).
He wrote during 1926, “I do not think that these matters [investment] should be left entirely to the chances of private judgment and private profits” (CW 9, 292). It was Keynes who inspired the socialist Labour Party to include “centrally planned investment” in its 1926 program, Socialism in Our Time (Walker 1988, 84). Beatrice Webb penned after Keynes attended the Socialist Summer School in 1926: “Keynes seems such a treasure!…. I see no other man that might discover how to control the wealth of nations in the public interest” ([1926b] 1985, 93–94).
During 1928, he devised a National Investment Board “to mobilise and to maintain the supply of capital and the stream of savings” (1928c, 69). In “Social Reform as the New Socialism,” he states, “Modern economic organisation is liable to produce unintended and undesired results unless it is controlled from the centre” (1929, 187). Again, “I conceive that the greatest contribution that the politically minded can now make to Social progress is by thinking out the central controls scientifically sound” (1929, 191).
In A Treatise on Money, he wants to “control the rate of investment,” and “perhaps the ultimate solution lies in the rate of capital development becoming more largely an affair of the state, determined by collective wisdom and long views” (CW 5, 151–52, 190; CW 6, 145). He declared, “I am in favor of an admixture of public works, but my feeling is that unless you socialize the country to a degree that is unlikely, you get to the end of the public works program…. You have shot your bolt, and you are no better off.… I should be afraid of that as the sole remedy” (1931, 494). He declared during his 1931 speech to the Society of Socialist Inquiry and Propaganda, “The central control of investment” is “urgently called for on practical grounds” (CW 21, 36). Clearly, Keynes advocated the socialist policy of controlling investment many years before he started developing his general theory in late 1931.
In September 1932, he advocated “a large measure of control over the volume of new investment” (CW 21, 130). Importantly, Keynes conceived socialism as government control over investment: “The chief problem would be to maintain the level of investment at a high enough rate to ensure the optimum level of employment…. The grappling with these central controls [on investment] is the rightly conceived socialism of the future” (CW 21, 137). This passage shows that Keynes viewed socialism as government control over investment, and he can be identified with socialism because he advocated this policy.
Keynes developed his general theory by mid-1933, and it must be stressed that he invented the theory to serve as an economic justification for his previously held political and policy views.This is not controversial. Don Patinkin writes, “the purpose of the theory is to provide a rigorous underpinning for a policy” (1976, 18, xxiii, 9; Meltzer 1988, 5, 303). According to Gilles Dostaler, “The economic theory he developed, known more appropriately as ‘political economy’, was subordinate to politics” (2007, 80). In short, Keynes was not a value-free economist: “economic theory was seen by Keynes as being scope-dependent. It had lost all presumptions of neutrality from values” (Carabelli 1988, 159; Fitzgibbons 1988, 43–44). He wrote, “I am not one of those who believe that the business cycle can be controlled solely by manipulation of the short-term rate of interest, that I am indeed a strong critic of this view.… My proposals for the control of the business cycle are based on the control of investment” (1933a, 675). Under capitalism, “there should be on the average a tendency to severe unemployment” (KL, L9); but there is “no unemployment [in a] Socialist or Communist state” (KL, I3).The Keynesian economist Paul Davidson realizes, “There is never involuntary unemployment of slaves” (2007, 192n3). According to Mises, “total enslavement of all members of society is not a merely accidental attendant phenomenon of the socialist management. It is rather the essential feature of the socialist system…. Either man is free to live according to his own plan or he is forced to submit unconditionally to the plan of the great god state” ([1968] 2007, 44). Hayek writes, “Socialism means slavery” ([1944] 1994, 16). He declared in November 1934, “Private capitalism is in this matter [i.e., investment] an open scandal and grossly inefficient. There may be no remedy except the direction of long-term investment by the State” (KL, H32). The Labour Party put Keynes’s National Investment Board in its 1935 program, For Socialism and Peace, and thereby certified that he advocated socialist policy (Walker 1988, 123). Labour leader Hugh Dalton recognized, “Such a board will, I believe, be one of our most effective instruments of Socialist planning” (quoted in Pimlott 1985, 218).
In The General Theory, he asserts that the “functionless investor” has “uncontrollable and disobedient psychology” (CW 7, 376, 317). Investors’ “animal spirits” mean “the mass psychology of a large number of ignorant individuals is liable to change violently” (CW 7, 161–62, 154). For Keynes, “The weakness of the inducement to invest has been at all times the key to the economic problem” (CW 7, 347–48). Therefore, “I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organizing investment” (CW 7, 164). He declares, “I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands” (CW 7, 320; CW 29, 232).
He writes in a 1938 letter to President Roosevelt, “Durable investment must come increasingly under state direction” and investors should be treated like “domestic animals” because they have “delusions” (CW 21, 438). For Keynes, “The Board of National Investment would in one way or another control by far the greater part of investment” (CW 14, 49, emphasis added). He warned in 1943, “Public works at short notice is a clumsy form of cure and not likely to be completely successful” (CW 27, 326). Instead, he demanded “the bulk of investment … under public or semi-public control” (CW 27, 322). Three months before his death in 1946, he boasted that the idea of a “National Investment Board … is a very ancient one with me” (1946). In summary, Keynes must be defined as a socialist because he wanted to transfer ultimate control over investment from private investors to government.
Keynes realized that government control over investment leads to government control over virtually all economic activity. As Mises writes, “People can consume only what has been produced” ([1955] 2007, 53). Comprehensive government control of investment means government determines what is produced and, consequently, what is eventually consumed. Keynes admits, “It is not possible to control production without controlling consumption in an equally drastic manner” (CW 16, 114). But investment and consumption are the only components of aggregate demand in the Keynesian framework. Keynes knew that socializing investment gives the government control over both components of aggregate demand. In short, Keynes’s call for government control of investment was a call for government control over the entire economy.
In addition to the non-human factors, Keynes advocated government control over the human means of production. If the government controls investment goods, it must also control the workers that work with those goods. The government must control each person’s occupation, meaning it must control where each person lives and works. Simply put, government control of investment requires extensive government control over the population. Actually, Keynes went beyond simple control of the workforce. In addition, he advocated systematic government control over the quantity and quality of the population.
Keynes was a lifelong eugenicist. He became treasurer of the Cambridge University Eugenics Society in 1911 (Marshall 1911, 284; Toye 2000, 141), and he was vice president of the British Eugenics Society from 1937 to 1944. Just sixty-seven days before his death, he endorsed “the most important, significant and, I would add, genuine branch of sociology which exists, namely eugenics” (1946b, 40). In Prolegomena to a New Socialism, he confirmed a direct link between his socialism and ideas on population by listing “Population, Eugenics” as “Chief preoccupations of the State” (1924d, document 4). He proclaimed to the Soviets in 1925, “There is no more important object of deliberate state policy than to secure a balanced budget of population” (CW 19, 437). Keynes declared in another speech,
In the light of present knowledge I am unable to see any possible method of materially improving the average human lot which does not include a plan for restricting the increase in numbers [of population]…. It may prove sufficient to render the restriction of offspring safe and easy … Perhaps a more positive policy may be required…. [I] would like to substitute schemes conceived by the mind in place of the undesigned outcome of instinct and individual advantage playing within the pattern of existing institutions. (CW 17, 453, emphasis added)
Beyond quantity, Keynes wanted government to control the quality of the population: “the community as a whole must pay attention to the innate quality as well as to the mere numbers of its future members” (CW 9, 292). He was chairman of the Malthusian league, and that organization’s motto was non quantitas sed qualitas (not quantity but quality). He declared in his 1927 address, “We of this society are neo-Malthusians,” and “I believe that for the future the problem of population will emerge in the much greater problem of Hereditary and Eugenics. Quality must become the preoccupation” (1927, 114). These passages show that Keynes called for comprehensive government control over all aspects of production, including the human beings who comprise the labor force.Other than O’Donnell (1992, 779–80), influential Keynes historians, including Harrod, Patinkin, Skidelsky, and Moggridge, never mention his views on population and eugenics. But such views are inevitable given his socialism. Mises explains, “Without coercive regulation of the growth of population, a socialist community is inconceivable. A socialist community must be in a position to prevent the size of the population from mounting above or falling below certain definite limits” ([1922] 1981, 174). Also see Mises ([1922] 1981, 531; [1949] 1998, 224).
Keynes and Marx had similar visions, and Keynes had far more sympathy for the Soviet experiment than is commonly recognized. However, Keynes was a non-Marxist socialist. First, he rejected Marx’s revolutionary approach to socialism. Opposed to Marx, he wanted to implement socialism gradually: “Socialisation can be introduced gradually,” and “We have everything to lose by the methods of violent change” (CW 7, 378; CW 9, 267). Second, Keynes was an elitist, and his elitism made him allergic to Marx’s proletarian class analysis: “The Class war will find me on the side of the educated bourgeoisie,” and “The right solution will involve intellectual and scientific elements which must be above the heads of the vast mass of more or less illiterate voters” (CW 9, 297, 295). Opposed to Marx’s proletarian socialism, he advocated elitist socialism. Keynes was a non-Marxist socialist, and he viewed his brand of “anti-Marxian socialism” as “the true socialism of the future” (CW 7, 355; CW 19, 222).
THE ETHICS OF CAPITALISM AND SOCIALISM Although the significance of Keynes’s ethical theory is often emphasized, its extreme radicalism is not. Keynes’s categorical rejection of general rules is radical to the extreme. General rules make society possible. Hayek writes, “Life of man in society, or even of the social animals in groups, is made possible by the individuals acting according to certain rules” (Hayek [1960] 2011, 216). In fact, “Rules of conduct [are] the basis of a prescriptive science of ethics” (Hayek [1982] 2013, 24). By overthrowing general rules, Keynes seems to overthrow the basis of society and ethics. Thus, from an ethical standpoint, he was certainly correct to describe himself as a “radical” and “heretic” (CW 20, 265, 527; CW 13, 489). How is Keynes’s radical ethical thought related to his views on capitalism and socialism?
Traditionally, capitalism is defined as a social system based on private property in the means of production. As this definition indicates, capitalism is a social system based on rules—precisely, the general rules of private property. Fundamentally, free market capitalism is a social system based on one supreme ethical rule: never use violence against the person or property of another human being, unless defending person and property from aggressive violence. This general rule of conduct is called the non-aggression principle.Murray N. Rothbard was the twentieth century’s most consistent champion of the non-aggression principle ([1962] 2004, 1053n4; [1973] 2006, 27, 55, 282; [1982] 1998, 24, 42, 52, 82, 131). Among economists, similar ideas are found in Friedman ([1962] 2002, 14, 22, 39), Hayek ([1982] 2013, 221), and Knight (1939, 5). Pure capitalism is a social system in which the non-aggression principle is universally obeyed. Rothbard writes, “the free market is a society in which all exchange is voluntary [non-violent]. It may most easily be conceived as a situation in which no one aggresses against person or property” ([1962] 2004, 1067).This idea is not unique to Rothbard. Mises writes, “In the market economy the individual is free [from violence] in his actions as far as private property and the market extend … no force is used unless for the protection of private property and of the market against violence” ([1940] 2011, 14). Rothbard writes, “A society formed solely by the market has an unhampered market, or free market, a market not burdened by the interference of violent action” (Rothbard [1962] 2004, 90–1; 1982 [1998] 40). Free market capitalism is predicated on an ethical position that accepts a general rule of conduct—the non-aggression principle.
For Moore, it is impossible to prove the general rules of private property are universally correct. Still, he insists they should never be broken: “The common legal rules for the protection of property must serve greatly to facilitate the best possible expenditure of energy…. A general observance of them would be good as a means” (1903, 157). In sharp contrast, Keynes’s ethical system is an attack on rules and, by extension, the rules of private property. The Keynesian ethical theory is utterly incompatible with the non-aggression principle. He wrote, “I am afraid of principle” and “What a very odd, and sometimes terrible, thing are strict principles!” (CW 20, 379; CW 10, 234). Actually, Keynes emphatically rejected capitalism’s non-aggression principle, and ridiculed it as “dogma” and the “political economist’s religion” (CW 9, 280–81).Keynes’s rejection of non-aggression explodes the claim that he was liberal. Mises writes, “For the liberal, any system which does not exclude every violent interruption of peaceful development is, from the very outset, out of the question” ([1927] 2005, 134). Frank Knight notes, “The essential social-ethical principle of liberalism … is that all relations between men ought ideally to rest on mutual free consent, and not on coercion” (1939, 5). In contrast to liberalism, “Socialism is the expression of the principle of violence” (Mises [1922] 1918, 320). Capitalism is a rule-based social system, and Keynes categorically rejected all rules. Therefore, Keynes’s ethical theory is incompatible with capitalism.
Keynes’s rejection of general rules is consistent with socialism. As Hayek writes, “Socialism lacks any principles of individual conduct” ([1982] 2013, 484).From a legal perspective, Keynes’s ethical theory means he was a legal positivist. But as Hayek wrote, “Legal positivism is … the ideology of socialism” (Hayek [1960] 2011, 353; [1982] 2013, 211). Also, Keynes’s rejection of rules means he rejected the rule of law: “The rule of law and socialism are incompatible” (Hayek [1960] 2011, 357n64). In distinct contrast to capitalism, socialism is always based on an ethical position that rejects the rules of private property. George Bernard Shaw, the man who converted Keynes to socialism in 1907, wrote, “Socialism, reduced to its simplest legal and practical expression, means the complete discarding of the institution of private property.… In Socialism, private property is anathema.… In Capitalism, private property is cardinal” (1929, 3).Kingsley Martin recalled, “Maynard Keynes wrote that they [H.G. Wells and G.B. Shaw] were our two schoolmasters; Wells was the stinks master, while Shaw taught divinity” (1970b, 94). Also see note 8. Keynes’s categorical rejection of general rules means he categorically rejected the rules of private property: “There is no ‘compact’ conferring perpetual rights on those who Have or on those who Acquire [property]” (CW 9, 287). On the spectrum of ethical thought that runs from pure socialism to pure capitalism, Keynes’s radical ethical theory is one of pure socialism. Although his ethical theory by itself does not make him a socialist, the Keynesian ethical theory is compatible with socialism.
Indeed, Keynes was a non-Marxist socialist, and his ethical theory was central to his socialism. Socializing investment requires government to systematically break the general rules of private property; it requires government to systematically violate capitalism’s non-aggression principle. However, Keynes does not view this as an ethical problem, for there is no need to obey general rules in his ethical theory. To him, “It is not true that individuals possess a prescriptive natural liberty…. Individuals acting separately to promote their own ends are too ignorant or too weak” (CW 9, 287–88). He argues socializing investment will benefit everyone, including the victims of government’s aggressive violence:
Whilst, therefore, the enlargement of the functions of government … would seem to [advocates of rules] to be a terrific encroachment on individualism, I defend it, on the contrary, both as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative. (CW 7, 380)
A CRITIQUE OF KEYNES’S ETHICAL THEORY Importantly, Keynes maintained his early ethical theory throughout his entire life. As noted above, he boasted in his 1938 speech “My Early Beliefs,” “I remain, and always will remain, an immoralist” (CW 10, 447).Bateman (1987), Davis (1994, 70–71, 98, 139, 176), and Gillies (2006, 204–16) argue Keynes abandoned the logical theory around 1931. After 1931, however, Keynes confirmed his conceptual framework never changed (CW 7, 148n1; CW 16, 113; CW 29, 289). Those who agree he maintained the logical theory include Carabelli (1988, 151, 155, 173, 176), Lawson (1985, 914), Meltzer (1988, 120, 139, 199, 182–83), Moggridge (1992, 623), O’Donnell (1989, 141–48, 248), Runde (1994), and Skidelsky (1992, 83, 87, 543). Keynes’s logical theory of probability is the lynchpin of his ethical attack on general rules. However, if the logical theory is flawed, then his ethical theory cannot justify violating general rules, including the general rules of private property. Is the logical theory of probability viable?
Since the very beginning, Keynes’s logical theory of probability has been almost universally rejected by philosophers of probability. As noted, he wrote his fellowship dissertation on the logical theory, and it was rejected in March 1908. One dissertation examiner, Alfred North Whitehead, reported his theory was “muddled and of very mediocre value” and parts of the theory were “very perfunctory,” “poor in quality,” and a “hopeless fog” (1908, 2). The other examiner, William Ernest Johnson, wrote that facets of Keynes’s theory were “essentially unsound” and he had “not fully understood the arguments of his opponents” (1908, 3). Even Lytton Strachey, Keynes’s lover and confidant, described the logical theory as “a mass of muddled facetiousness” ([1908] 2005, 138). Lawrence Klein, a Keynesian economist and later Nobel laureate, noted in 1951, “Keynes’s ideas on probability represent a minority position among current workers on the subject and are not those for which we shall long remember his work … He did not make a sensational advance in probability theory” (1951, 446; Runde 1994, 97).
There are several technical problems with Keynes’s logical theory of probability. First, on the logical theory, numerical probability is only possible when all outcomes are equally probable. Keynes writes, “In order that numerical measurement may be possible, we must be given a number of equally probable alternatives” (CW 8, 44, 70). This is an extremely strict requirement for numerical probability. It essentially means probability mathematics can only be applied to games of chance. Keynes’s requirement of equal probability means his logical theory cannot explain a loaded die (Mises [1928] 1981, 69; Gillies 2000, 18). Furthermore, the equal probability requirement means the logical theory can only explain the uniform probability distribution. It cannot explain other distributions, such as the normal distribution. The normal distribution is perhaps the most important concept in statistics, and any theory of probability that is incompatible with the normal distribution must be problematic.
Moreover, the logical theory of probability cannot explain the continuous probability distribution. Keynes writes, “A rule can be given for numerical measurement when the conclusion is one of a number of equiprobable, exclusive, and exhaustive alternatives, but not otherwise” (CW 8, 122). For Keynes, numerical probability requires exhaustive and “indivisible alternatives” (CW 8, 65). However, the continuous probability distribution means the alternatives are not indivisible; the alternatives are in a continuous interval with an infinite number of values. This means the logical theory can only explain the discrete distribution, and not the continuous distribution (Gordon 1992, 155; Gillies 2000, 43, 48). But many important and successful applications of probability mathematics involve the continuous case. A theory of probability that cannot explain the continuous probability distribution must be inadequate.
Beyond all this, the entire program of the logical theory is problematic. For Keynes, probability is a logical relation between the premises and the conclusion of a logical argument: “Let our premises consist of any set of propositions h, and our conclusion consist of any set of propositions a, then if a knowledge of h justifies a rational belief in a of degree α, we say that there is a probability-relation of degree α between a and h” (CW 8, 4; 1908, 139, 142). To demonstrate, consider the following logical argument:
h1. All men are mortalh2. Socrates is a man∴ a. Socrates is mortal
Given the premises that all men are mortal (h1) and Socrates is a man (h2), the conclusion that Socrates is mortal (a) is logically certain, so the probability α = 100 percent. On the other hand, the conclusion that Socrates is immortal (-a) is logically impossible, so the probability is 0 percent. In the logical theory, the extreme of logical certainty is the maximum probability 100 percent, and the extreme of logical impossibility is the minimum probability 0 percent. But for Keynes, logical certainty is not achievable in most practical situations. In most cases, the conclusion only partially follows from the premises, so the probability will usually fall in a range between 0 and 100 percent. For example, consider the case of rolling a three spot on a die:
h1. The die has six sidesh2. The die has a single three spoth3. The die is fair∴ a. The outcome is three
The conclusion of rolling a three spot is not logically certain and is not logically impossible. Given the premises, the conclusion only partially follows, so the probability falls somewhere between the logical extremes of 0 and 100 percent. In the case of rolling a three spot, logical intuition tells us that the probability α = 16.67 percent. When dealing with a syllogism, the logical structure of the human mind intuitively perceives that the probability is 100 percent. Similarly, when rolling a die, the logical structure of the human mind intuitively perceives that the probability of rolling a three spot is 16.67 percent. Since the logical theory extends logic beyond the syllogism, Keynes viewed his theory as a more “general theory” of logic (CW 8, 106).
In logic, however, the conclusion is true only if the premises are true. This means logical probabilities can only successfully guide action if the premises are true. But how can we know whether the premises are true? How can we know the die has six sides and a single three spot? Moreover, how can we know whether the die is fair and not loaded? Since these premises are not self-evidently true, the only way to confirm the truth of these premises is to empirically examine the die. But this introduces an empirical requirement into the logical theory. The only way to confirm the die is fair and not loaded is to roll the die numerous times in the real world, and evaluate the empirical outcomes. This example illustrates that logical probability can only describe the real world if the premises are confirmed with the frequency theory: “Without the complement of the frequency definition, probability theory cannot yield results that are applicable to real events” (Mises [1928] 1981, 221–22, 70). Contrary to Keynes, it is impossible for probability to be “purely logical” (CW 8, 4).
Keynes’s entire ethical justification for violating general rules depends on his logical theory of probability. The logical theory amplifies the human ability to understand the probable consequences of action, and thereby frees actors to violate general rules like the non-aggression principle. Keynes’s ethical justification for violating general rules is central to his politico-economic thought, because his brand of non-Marxism socialism requires government to systematically break the general rules of private property. However, since the logical theory of probability is flawed, Keynes’s ethical theory is not viable. In the end, the ethical foundation of Keynes’s non-Marxist socialism is flawed.
CONCLUSION Not all ethical theories are compatible with capitalism or socialism. Instead, capitalism and socialism are based on irreconcilable ethical views about private property. Specifically, capitalism accepts and socialism rejects the general rules of private property. Keynes rejected all rules, and he invented his ethical theory as an intellectual justification for violating general rules. As Robert Skidelsky writes, “He invented theory to justify what he wanted to do” (1992, 344). Keynes’s categorical rejection of all rules means his ethical thought is incompatible with capitalism and consistent with socialism. He embraced the ethic of pure socialism by January 1904, and the evidence confirms he was a non-Marxist socialist from no later than October 1907 until his death in April 1946. However, the logical theory of probability, the key to his ethical justification for non-Marxist socialism, is flawed. Therefore, Keynes’s radical ethical theory is not a successful ethical justification for any brand of socialism, including his own.
APPENDIX Document 1. The Principles of Probability (1905)
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Document 2. Keynes to Lytton Strachey (1907)
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Document 3. John Neville Keynes (1911)
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Document 4. Prolegomena to a New Socialism (1924)
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Document 5. Society for Cultural Relations with the USSR (1924)
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Document 6. Society for Cultural Relations with the USSR (1944)
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Ben Powell, head of the Free Market Institute at Texas Tech, discusses his newly-released book Socialism Sucks (co-authored with Robert Lawson). Powell and Lawson toured countries around the world to observe firsthand life under ACTUAL socialism—in places like North Korea and Venezuela—versus places that merely have large welfare states (like Sweden). They concluded that, well, socialism sucks.
For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
In a special episode of the "Part of the Problem" podcast, Dave Smith interviews Mises Institute president Jeff Deist.
Recorded at the Mises Institute in Auburn, Alabama, on 19 July 2019.
Steve Patterson—host of “Patterson in Pursuit”—talks to Bob about one of his recent essays, in which Patterson challenges the standard Misesian/Rothbardian view of economics. Specifically, Patterson claims that you can’t get very far with pure a priori reasoning—even pretty basic economic laws rely on empirical assumptions.
For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
Confucian Capitalism: Shibusawa Eiichi, Business Ethics, and Economic Development in Meiji Japanby John H. SagersCham, Switzerland: Palgrave Macmillan, 2018, xvi + 245 pp.
Jason Morgan (jmorgan@reitaku-u.ac.jp) is an associate professor at Reitaku University in Chiba, Japan.
Quarterly Journal of Austrian Economics 22, no. 1 (Spring 2019), for full issue, click here.
Shibusawa Eiichi (1840–1931) is one of the most respected figures in modern Japanese history. Often referred to as the “father of Japanese capitalism,” Shibusawa rose from humble origins—he was the son of a small-scale indigo farmer and spent his boyhood helping in the family fields and with keeping the books—to become the most powerful business magnate in Japan. He was involved in the founding of hundreds of corporations (many of which are still in operation today), sat on the boards of countless organizations and firms, and was in the Ministry of Finance before being appointed president of the First National Bank of Japan. He was also a devoted philanthropist. The founder and supporter of hospitals, schools, charities, and social service programs, Shibusawa is today remembered mostly for being an “ethical capitalist,” or, more specifically, a “Confucian capitalist.”
Why “Confucian”? From the time he was a boy, Shibusawa, at the behest of his Confucianist father, studied the Chinese classics every day with a scholar in a nearby village, eventually committing much of the Confucian corpus to memory. Later eschewing neo-Confucianism and its metaphysical innovations, Shibusawa was most fond of the Analects, one of the original Confucian texts compiled by Confucius’ followers after his death. Unlike the neo-Confucianists, Confucius had a generally positive view of trade and business, and Shibusawa agreed that commerce ethically practiced could be beneficial for society as a whole. This Confucian grounding was the motif of Shibusawa’s entire career. In his business dealings and charitable activities alike, Shibusawa cited the Analects, and Confucius’ social-mindedness in general, as the guiding principles of his public activities.
So why the renewed interest in a long-deceased Japanese industrialist with a fondness for Spring-and-Autumn Period Chinese philosophy? In the wake of the 2008 financial meltdown and subsequent acceleration of the boom-bust cycle, many in academia and beyond have increased their calls for the taming, if not outright abolition, of capitalism. In Confucian Capitalism: Shibusawa Eiichi, Business Ethics, and Economic Development in Meiji Japan, John H. Sagers—whose other works include Origins of Japanese Wealth and Power: Reconciling Confucianism and Capitalism, 1830–1885—wants to revisit his earlier thinking about Japan, Inc. (the close relationship between government and business that was the secret of Japan’s success until the end of the bubble economy in the early 1990s) in order to emphasize that “the system [Shibusawa helped build] now needs to be dismantled.” (viii–ix) As Sagers puts it:
Shibusawa’s Confucian capitalism was essentially an ideological strategy to create both ethical guidelines and a positive new identity for the commercial classes. First, Shibusawa called himself a business leader or "person of practical affairs" jitsugyoka, which he defined in contrast to several characters of Japanese society: the government official, the military leader, the politician, the scholar, and the old-fashioned merchant. Where government and military officials defended the nation and carried out policies, jitsugyoka produced valuable goods and services that contributed to the people’s well-being. Unlike the newly emerging politicians, jitsugyoka did not pander to public opinion and pursue narrow self-interest. Unlike scholars, jitsugyoka were not concerned with abstractions, but focused on practical affairs. Unlike Tokugawa-era merchants who were greedy for gain for their households, jitsugyoka worked for the good of the whole nation. Furthermore, his Confucianism allowed him to define himself in contrast to foreign and domestic liberals who called for Japan’s wholesale Westernization. (113–14)
Critical of “corruption in high places and an economy mired for decades in seemingly inescapable stagnation” (217), Sagers argues that corporations must practice greater corporate social responsibility (CSR) (4) and posits Shibusawa as the model for his proposed reforms.
Divided into eight chapters, Sagers’ book is a thematic biography of a famous figure in which the theme largely eclipses the biography. Only two of the chapter titles—the introduction and the conclusion—contain the name “Shibusawa Eiichi.” All the rest zoom out to take in the social and economic changes taking place before and during Shibusawa’s long life. Protectionism, business networks, stock exchanges, central banks, labor unions, the gold standard, war financing, infrastructure, bureaucratic involvement in corporate governance, and the influence of technologies and ideas from America and Europe are just some of the big topics Sagers tackles here. This is an ambitious book, and one worth reading if only for the scope of the hundred years or so of modern Japanese history it takes into account.
And yet, as in old Japanese maps, there is a cloud bank obscuring some of what Sagers purports to examine. Indeed, this book, for all of the valuable information it offers the reader, suffers not so much from peripheral blurring as from macular degeneration. There is a big blind spot right in the middle of the book’s field of vision. Namely, one wonders what Sagers means by the term “capitalism.” Sagers uses the word in the title of his book and on page after page in his text, but in the end we never quite know how he understands it.
The closest we get is when Sagers quotes historian of capitalism Joyce Appleby in defining capitalism as a “relentless revolution.” Awkwardly, Sagers then has Shibusawa “answer” Appleby (from more than one hundred years before Appleby wrote her volume) that Confucianism was the key to maintaining old societal values while advancing business in a given polity. (22)Citing Joyce Appleby (2010, 7). But is this purported dichotomy between capitalist and society—framed by Appleby, endorsed by Sagers, and apparently confirmed and then overcome by Shibusawa Eiichi—real? Did Shibusawa “answer” Appleby’s challenge by pursuing a kind of “Confucian capitalism” that took the edge off the Northern European variety? Is the “capitalism” of which Sagers and Appleby write capitalism at all?
Elsewhere in the same book that Sagers quotes above, Appleby writes:
There can be no capitalism, as distinguished from select capitalist practices, without a culture of capitalism, and there is no culture of capitalism until the principal forms of traditional society have been challenged and overcome. (119)
Is Shibusawa Eiichi the exception to the Appleby Rule, then? Was Confucianism really the skeleton key that allowed Shibusawa to unlock the business potential of a traditional society while leaving its traditions largely in place? And is the thing, “capitalism,” that Sagers argues needs reforming really capitalism at all?
The notion of a “Confucian capitalism” is plausible if the premise that “capitalism” is a destructive force, a “relentless revolution” continuously clear-cutting social practices in the quest for more and more money, can be shown to apply in all cases. But if capitalism is not really that at all—that is, if capitalism is just human nature, one of the ways in which human beings attempt to survive and thrive—then “Confucian capitalism” as a heuristic device loses much of its analytic power.
Indeed, if we widen our scope a bit further we can see that the use of the term “capitalist” can be, and has been, applied so willy-nilly to so many different things that it breaks down and is virtually meaningless. Shibusawa Eiichi used technologies such as the joint-stock corporation and the stock exchange to distribute risk and raise money for his various plans. But the Chinese do this, too, and in a way that out-capitalists the very representatives of capitalism themselves. If the Chinese do not have an Applebian “culture of capitalism,” then surely the set phrase can have no ideological purchase, and must be rejected. And if that definition falls, then so, too, does Sagers’ thesis, that some kind of philosophical harness, such as Confucianism, is needed to promote virtue among the industrialist class.
Unfortunately for Sagers, Confucius’ homeland is a buzzing, blooming capitalist Tilt-a-Whirl. As Kai-fu Lee points out in AI Superpowers: China, Silicon Valley, and the New World Order (2018), Stanford-based entrepreneurs once laughed at Chinese startups as cheap knockoffs, but now admit that they cannot keep up with the competitiveness of the Chinese market. American companies routinely fail in China, according to Lee, because they do not take the time to study Chinese culture. If capitalism really does destroy local practices, then China should be indistinguishable from Palo Alto. But as anyone who has ever been to China can attest, China is very much not the Bay Area. In other words, “capitalism” has not destroyed anything. It has amplified existing cultural norms and enriched great swaths of humanity. Is this the thing that Sagers thinks needs reforming?
What about elsewhere? In Debt: The First 5000 Years, David Graeber reminds us that commerce, and the intricate financial practices and social networks that make commerce possible, have long been a central feature of the Islamic world. This may not qualify as Appleby’s “culture of capitalism,” but it hardly matters, because business in the dar al Islam is still firmly rooted in the religious and cultural practices of the region. Whatever capitalism is, it has been very polite to its Muslim hosts—so culturally quiet, in fact, that one hardly notices it’s there. In Africa, too, despite the Orientalist fantasy of the eternally childlike native, men and women prefer to prosper, to thrive materially while improving their social standing. Cheats and con artists always try to turn a quick profit at the expense of morality, but such people are readily sifted out of the market everywhere. (It is only when government intervenes to protect scofflaws, as it does in the United States for the robber barons in Goldman Sachs, that “capitalism” can be said to inflict harm on local societies.) Getting rich, testing schemes, doing good by doing well—these are not somehow proprietary to the West. So, one is left wondering, if “capitalism” is a universal, then how is it modified by Confucianism?
Indeed, even the “Confucian” aspect of Shibusawa’s thought was more complicated than might first appear. For example, in arguing in favor of protectionism after initially supporting English-style liberal trade policies for Japan, Shibusawa cited Adam Smith’s Theory of Moral Sentiments in advocating a business approach oriented to society as a whole, and not beholden solely to the entrepreneur. (138) Adam Smith as reining in “capitalism”? (It might be time to bring in the fainting couch for Mr. Krugman.)
And when Sagers chides Shibusawa for his too-cozy relationship with government bureaucrats and the managerial state, one wonders if this, too, can really be called capitalism. Sagers himself uses what is arguably the correct term—“crony capitalism”—to describe this inherently corrupt arrangement. Drawing on the work of Morikawa Hidemasa, an earlier Shibusawa scholar, Sagers writes:
Morikawa […] noted that Shibusawa Eiichi’s name always comes up when it is fashionable to criticize big business as in the case of the 1970s Lockheed scandal or the oil shock and scholars like Tsuchiya [Takao] say that today’s managers need to look again at Shibusawa Eiichi’s thinking to solve contemporary problems. But for Morikawa, the system of crony capitalism known as ‘Japan, Inc.’ (Nihon Kabushiki Gaisha) that Shibusawa helped create was the root of Japan’s problems. (220)Citing Morikawa Hidemasa (1976, 72–73).
But is “Japan, Inc.” capitalist in any real sense of the term? Shibusawa himself floated back and forth between finance and government (he was the recipient of a coveted amakudari golden parachute from the Finance Ministry into the “private” sector in 1873 [90]), and used his connections transecting the osmotic membrane between economy and state to enrich himself enormously. It is highly debatable, then, that Shibusawa Eiichi was a capitalist at all, unless “capitalist” also means “crony capitalist,” in which case it means nothing at all. If the state picks winners and losers and uses the implied threat of fines and incarceration to enforce bureaucratic fancy, then perhaps Sagers’ and others’ critiques of such a system as a fault of “capitalism” are greatly misplaced.
Lastly, on whether Confucianism is the best leaven for the purported excesses of “capitalism,” even though it is beyond doubt that Shibusawa’s Confucian beliefs inspired him to pour enormous amounts of money into social welfare programs, it can hardly be said that the Analects is the only book to have spurred the wealthy to part with some of their gains for the sake of the commonweal. The Islamic merchants Graeber mentions grounded their business ethics solidly in the Quran, for example, and Christian and Jewish businessmen and -women have done incalculable good for humankind through charitable giving that, quite frankly, puts the Confucianists to shame. Jacob Schiff, Richard DeVos, Howard Ahmanson, Jr., Julius Rosenwald—these tycoons stooped to embrace the forgotten and destitute because the God of Jacob and Abraham, or the Son of Man, said it was good to do so. Even today, Judeo-Christian America remains the most charitable nation on earth. Given all this, one question that might be posed to advocates of Confucian capitalism is, “Why did you pass up capitalism of the Torah, the Hadith, and the New Testament?”
However, these questions for broadening the scope of Sagers’ investigation should not be interpreted as detracting from his work. He has clearly scoured the archives in search of material, and his book is an important stepping-off point for debates about this important topic. At the very least, Sagers is correct in his assessment that Japan, Inc.’s days are probably over. As the recession in Japan racks up birthdays and the government continues to shoot arrows from its Keynesian quiver at the indifferent beast, it must be clear to all candid observers that further intervention in the economy is not the answer to capitalism’s woes. Sagers’ book is a valuable contribution to the deliberations about where to go once—and may the day come quickly—the bureaucrats in Japan and elsewhere grow tired of failure and adopt a more Daoist approach by doing precisely nothing to “help” capitalism recover. It may very well be that a “Confucian capitalism,” wherein philanthropy is couched in Confucian practices, is a viable solution to the two lost decades (and counting). Whatever the eventual outcome, Sagers’ work is very useful in thinking through the answers to the pressing questions Japan faces as crony capitalism dies a very drawn-out death.
For those considering buying and reading Sagers’ book, though, a word about style. Sagers is to be commended for his research, but many of his paragraphs felt like pachinko runs, and there is a cubism to Sagers’ argumentation that frequently mystified your humble correspondent, even after multiple tries at comprehension. The syntax of this book is not for the faint of heart. Sagers darts about from topic to topic, and grasping at the meaning of a given passage can be a bit like trying to catch eels in a pond.
And then there is the glossing trouble. Sagers uses a lot of Japanese terms, which is a good thing, but he glosses them, well, diversely. For example, on the very same page (75), Sagers glosses shokusan fukyo (Sagers must mean shokusan kōgyō (殖産興業)) as “promoting production and building wealth and strength” and then, about two dozen lines later, as “promoting production for a wealthy country.” On page 62, Sagers gives the exact same phrase as “promote production, encourage industry.” Which is it? Other terms are similarly kaleidoscopic, but gapponshugi wins the prize. Gapponshugi is a Shibusawa neologism referring to the ‘pooling of monetary capital, managerial talent, and labor to serve the public interest.’45, citing Shimada Masakazu (2011, 30–34). Sagers glosses this term repeatedly, and with substantial variation. Sometimes it is just ‘pooled resources,’ but elsewhere Sagers adds a political valence: “resources united to build enterprises that served the nation.” (69; see similar gloss on 97) Important terms like these should be made consistent, especially when much of the argument hangs upon how they are translated.
As Shibusawa himself might have said, though, if you want something, you’ll have to work for it. This dictum applies in full force for anyone who is about to wade through the tall grass of this often challenging book. Confucian Capitalism is a welcome return to the life and philosophy of one of the greatest Japanese magnates of the past two hundred years. It is also an opportunity to set the record straight on whether Shibusawa Eiichi—or Japan, Inc.—was, or is, “capitalist” at all.
The Human Action Podcast reviews another overlooked classic by Mises: The Anti-Capitalistic Mentality. This book takes no prisoners, showing how envy motivates progressive and conservative intellectuals who fear dynamic capitalism. The real reactionaries, according to Mises? Socialists who want to keep everyone stuck at one station in life.
Our friend Andy Duncan from Mises UK, who recently reviewed the book, joins the show to discuss.
Read the book free here, or enter code "HAPOD" in our bookstore to buy a softcover for only $5!
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Bob shares an interview he did on C. Jay Engel’s podcast, Austro-Libertarian, where they discussed Doug Henwood’s critique of MMT that ran in the socialist publication, Jacobin magazine. Henwood’s article was an excellent summary of the academic roots of MMT, and thus supplements the pragmatic discussions (from the perspective of Warren Mosler) that have recently been featured on The Bob Murphy Show.
For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
By popular demand, Bob explains some of his major disagreements with the views Warren Mosler expressed back in Episode 18 ("Warren Mosler Defends the Essential Insights of Modern Monetary Theory (MMT)"). At that time, Bob was just having a friendly discussion, not a debate; but, in this episode, Bob explains where he thinks Mosler went wrong.
For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
It's been almost 100 years since Mises literally wrote the book on socialism. His arguments against central economic planning, still acutely relevant today, have never been refuted—in theory or dismal practice. Joining the Human Action Podcast to discuss this monumental book is Dr. Shawn Ritenour, professor of economics at Grove City College and editor of the Mises Reader.
Subscribe and listen on iTunes, YouTube, Stitcher, Soundcloud, Google Play, Spotify, or via RSS.
Bob brings on MMT superstar Warren Mosler to explain—not to debate!—his understanding of Modern Monetary Theory. After summarizing Mosler’s interesting background, the two discuss the assumptions behind MMT and its implications for economic policy.
For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
Alex Tabarrok is a professor of economics at George Mason University and co-author (with Tyler Cowen) of the very popular blog, Marginal Revolution. Bob and Alex cover a wide range of topics, including his early experience with Rothbardians, the brief window when economics blogs were the center of discussion, problems with the FDA, how a kidney market might work, and why Bitcoin is not as secure as some of its fans believe.
For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
Globalists: The End of Empire and the Birth of NeoliberalismQuinn SlobodianCambridge: Harvard University Press, 2018, X + 381 pp.
David Gordon (dgordon@mises.com) is a Senior Fellow at the Ludwig von Mises Institute.
Quarterly Journal of Austrian Economics 21, no. 3 (Fall 2018) full issue, click here.
Quinn Slobodian, a historian at Wellesley College, tells us that Globalists
is a long-simmering product of the Seattle protests against the World Trade organization in 1999. I was part of a generation that... became adolescents in the midst of talk of globalization and the End of History... we were made to think that nations were over and the one indisputable bond uniting humanity was the global economy. Seattle was a moment when we started to make collective sense of what was going on and take back the story line... This book is an apology for not being there and an attempt to rediscover in words what the concept was that they went there to fight. (p. 303)
Slobodian discloses here a confusion that mars his book. He sees little difference between the free market and a governmentally imposed regime of globalization. Rule over the European economy by Brussels bureaucrats and attempts to control world trade by the WTO and the World Bank stem from a “Geneva School” that includes Ludwig von Mises. His view must at once confront an objection. Mises supported a complete free market, with a minimal state; how then can he have helped bring about a globally directed economy? Slobodian’s answer is this: Mises wished to use force to compel people to accept a system of private property, run in the interests of business. He professed to favor freedom but in fact supported coercion. The distance between Mises and global governance of the economy, which likewise imposes its plans on people, is not far.
Friedrich Hayek counts even more than Mises as a supporter of this line of thought, and many contemporary neoliberals have been influenced by him. Like Mises, he wanted to limit democracy to promote private property and the market. Hayek, though, countenanced more government intervention than Mises. Slobodian, by the way, cites Hans Hoppe’s criticism of Hayek for this, (p. 315, note 2), though he has missed Mises’s review of Hayek’s The Constitution of Liberty (2011 [1960]), dealing with same issue.
As Slobodian sees matters, the rise of colonial peoples to independence in the twentieth century posed a problem for those, like Mises and Hayek, committed to capitalism. What would happen if the new countries, dissatisfied with what they viewed as exploitation by the developed countries, enacted restrictions on trade? Combined with this was a threat to business interests by anti-capitalist classes and parties in the developed world. What if, e.g., socialists won power in a democratic election?
To prevent these dire developments, Mises and Hayek promoted world federalism. The power of national governments to control the free market would be strictly limited. Property rules would be a matter of international law, enforced by a central authority.
Slobodian merits great credit for his detailed account of Mises and Hayek’s interest in world federalism, but he fails to grasp the fundamental issue motivating what they said. For Mises, the free market was the only viable system of social cooperation. Accepting it fully would bring peace and prosperity. Government interferences with the economy would necessarily fail to achieve their purpose. Price controls would not make goods available to the poor but would instead cause shortages. Socialism would collapse into chaos.
For Mises, these were incontrovertible truths established by economic science. The issue for him was not imposing economic freedom on people by force, but rather persuading them that freedom was the best course of action. Constitutional limits to democracy, including federalist plans, were strictly subordinate to promoting the free market. Mises does not say that he favored forcing people to accept these limits, if they were to vote freely against them. Violent attempts to overthrow a legal system of private property are an altogether different matter. It is hardly “undemocratic” to oppose them.
Slobodian does not agree. For him, to suppress violence against property is undemocratic. Mises claimed that the free market was controlled by the monetary votes of consumers, but Slobodian finds this freedom lacking: “[D]emocracy was not an absolute value for Mises... a crucial complement to voters’ democracy was what he would later call a ‘consumer’s democracy,’ expressed by purchases and investments in the marketplace... Wealth, he wrote, was ‘always the result of a consumer’s plebiscite.’” (p. 45) But when the Social Democrats called a general strike in Vienna in 1927, Mises supported its violent suppression. Does this not show his commitment to democracy was limited? “In 1927, democracy had ceased to fulfill its primary function. It did not prevent revolution. In that case, Mises believed, it was perfectly legitimate to suspend it and enforce order by other means.” (p. 45)
Contrary to Slobodian, Mises’s position was perfectly consistent. Mises supported peaceful cooperation through the free market. Political democracy, in his view, promoted peace. But it is not undemocratic to use emergency powers to suppress violence.
For Mises, schemes for international organization were intended only as means to promote the free market. When Mises realized that in the statist climate of the day, these plans could not work, he for the most part abandoned them. In Omnipotent Government, e.g., he says: “Under present conditions an international body for foreign trade planning would be an assembly of the delegates of governments attached to the ideas of hyper-protectionism. It is an illusion to assume that such an authority would be in a position to contribute anything genuine or lasting to the promotion of foreign trade.” (Mises, 2010 [1944], p. 250)
Slobodian does not see what is at stake in the dispute over the free market because, for him, economic arguments for the market are mere business propaganda. He does not grasp that the argument for free exchange follows from elementary economy theory. People would not willingly engage in trade if they did not expect to benefit. This consideration by itself strikes a fatal blow at tariffs and other trade restrictions.
Slobodian ignores this and, displaying both his fascination with Hayek’s thought and his repulsion from it, he takes the case for the free market to be complex and mystifying. “Yet even as he [Hayek] disparaged the fallacy of computer-aided models, he drew inspiration from the same source of system theory. From the language of ‘pattern predictions’ to his citation of Warren Weaver, Hayek did not argue against system theory in his Nobel speech but with it.” (p. 225)
In trying to establish a line of continuity between the “Geneva School” and today’s global bureaucrats, Slobodian places great stress on the “Ordo liberals.” This group, which included Franz Böhm and Walter Eucken, favored a very active government to promote the social institutions for a “social market economy.” Many of these authors were influenced by Hayek, but in his erudite discussion, Slobodian has missed the fact that Mises had little use for them. As Guido Hülsmann points out in Mises: The Last Knight of Liberalism, “And the prospect of cooperating with the fashionable Ordo School, be it in the Mont Pèlerin Society or elsewhere, did not exactly warm his heart either. He believed the Ordo people were hardly better than the socialists he had fought all his life. In fact, he eventually called them the ‘Ordo-interventionists.’” (Hülsmann, 2007, p. 1006)
The book contains many strengths. The discussion of the activities of Maurice Heilperin, an outstanding supporter of fee trade, is especially well done. Slobodian displays a fine eye for architectural detail, evident, e.g., in his description of the Chamber of Commerce building on Vienna’s Ringstrasse. (pp. 30–31)
That said, the book also has its share of errors. Harold Laski was a political scientist, not an economist (p. 96). Garrett Hardin was a biologist, not a philosopher (p. 239). Hans Kelsen was not among the Austrian elite who moved in the 1930s in the same circles as the British elite (p. 122). Arthur Balfour is given the wrong title (p. 39).
The book’s main failing, though, does not lie in these minor errors. It lies rather in Slobodian’s refusal to take seriously arguments for the free market. Limits on government control of property are for him simply ideological efforts by business to limit the popular will. He here adopts exactly the viewpoint of Nancy MacLean’s Democracy in Chains, a disaster for scholarship. Slobodian operates on a much higher level than she does, though he does not scruple to cite her book.
To understand the marketplace, it is not necessary to believe in the existence of a selfish, profit-maximizing human.
Original Article: "The Homo Economicus Straw Man".
[Editor's note: MMT is back in the news, championed by Congresswoman Alexandria Ocasio-Cortez and former Bernie Sanders advisor Stephanie Kelton. Economists like Brad DeLong and Paul Krugman are giving MMT at least faint praise, and even National Review has favorable things to say. Ironically, MMT is neither modern nor truly "monetary;" instead it is a combination of tired fiscal and monetary policies. Our Senior Fellow Robert Murphy first wrote this article debunking MMT in 2011, but every word applies today.] Modern Monetary Theory (MMT) is a hip economic/financial paradigm apparently sweeping a world unsatisfied with mainstream economics. Over the past year, I have been hearing a growing number of people refer to MMT: either fans who think it blows up my Austrian views, or foes who think it deserves a full-scale critique.
MMT's underground popularity derives from its seeming mathematical rigor, its disagreement with the obviously flawed doctrines of standard neo-Keynesian orthodoxy, and its underlying message of hope that the perceived constraints on government deficit spending are an illusion. The MMT proponents tell us that fiat monetary systems have removed the shackles associated with the gold standard, and that our economic recovery is limited only by our failure to understand how modern money and banking work.
After my admittedly brief exploration, I have concluded that the MMT worldview doesn't live up to its promises. However, as an Austrian economist I know how annoying it is when "big guns" in the economics profession reject my own position as nonsense without even taking the time to spell out what is supposedly wrong with the Misesian approach. Therefore, in the present post I'll try to fairly summarize a major plank in MMT thought and show why it is misleading at best, and downright false at worst.
Background on MMT One thing I should make clear upfront is that MMT is not the same thing as neo-Keynesian economics, as expounded by the likes of Paul Krugman. In fact, Krugman has actively criticized the MMTers himself (to which they responded here and here, to list just two instances).
MMT is linked to the older doctrine of "chartalism," for readers who are more familiar with the latter term. The fascinating aspect of MMT is that it turns standard views on their head. For example, MMTers hold that the sovereign issuer of fiat currency can never become insolvent. For the MMTers, the point of taxation isn't to raise revenue for the government, but rather to regulate aggregate demand.
It would be foolish for me to try to summarize the MMT position, as I am sure I would offend its proponents by my imprecision. As Morpheus said of the Matrix, I cannot tell you of the worldview of the MMTers; you must see it for yourself. Warren Mosler's website is reputed to be the best one-stop shop, and the comments at my open-ended blog post are filled with suggested readings from actual MMTers.
The Counterintuitive MMT Position on Government Deficits To illustrate my problems with MMT, let's focus on a specific issue: the debate over the government budget deficit. With Austrians and other libertarian types calling for immediate cuts in spending, while Keynesians call for future spending restraint and tax hikes to slow the increase in debt down the road, the MMTers come along and say both sides are ignorant.
According to many proponents of MMT, "deficits don't matter" when a sovereign government can issue its own fiat currency, and all the hand wringing over the government's solvency is absurd. In fact, the MMTers claim that given the reality of a US trade deficit, a sharp drop in the government's budget deficit would hamper the private sector's ability to save. Thus, the Austrians are unwittingly calling for a collapse in private saving when they foolishly demand government austerity.
I have scoured the websites of a few prominent MMTers and here is the best explanation of this reasoning that I could find. The quotation below is somewhat lengthy and contains equations, but reproducing it is the only way to be sure I am not misrepresenting the MMT position:
The national accounts concept underpins the basic income-expenditure model that is at the heart of introductory macroeconomics. We can view this model in two ways: (a) from the perspective of the sources of spending; and (b) from the perspective of the uses of the income produced. Bringing these two perspectives (of the same thing) together generates the sectoral balances.
So from the sources perspective we write:
GDP = C + I + G + (X — M)
which says that total national income (GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X — M) [i.e., exports minus imports].
From the uses perspective, national income (GDP) can be used for:
GDP = C + S + T
which says that GDP (income) ultimately comes back to households who consume (C), save (S) or pay taxes (T) with it once all the distributions are made.
So if we equate these two perspectives of GDP, we get:
C + S + T = C + I + G + (X — M)
This can be simplified by cancelling out the C from both sides and re-arranging (shifting things around but still satisfying the rules of algebra) into what we call the sectoral balances view of the national accounts.
(I — S) + (G — T) + (X — M) = 0
That is the three balances have to sum to zero. The sectoral balances derived are:
The private domestic balance (I — S) …
The Budget Deficit (G — T) …
The Current Account balance (X — M) …
A simplification is to add (I — S) + (X — M) and call it the non-government sector. Then you get the basic result that the government balance equals exactly $-for-$ … the non-government balance (the sum of the private domestic and external balances). This is also a basic rule derived from the national accounts and has to apply at all times.
For the purposes of our discussion, let's simplify things by taking out the international-trade aspect. (We can justify this by looking at the world as a whole, which obviously can't run a trade deficit or trade surplus,In his third bullet point, the MMT writer Bill Mitchell incorrectly referred to (X − M) as the "current account balance," when strictly speaking it is the trade balance since we are talking about GDP rather than GNP. This is a very subtle distinction that is unimportant for this article, but the interested reader can read Greg Mankiw's explanation. and then analyzing the effects of changes in the total budget deficits of all the various governments.)
So if we take out exports and imports, and rearrange the remaining terms, we derive this equation:
G − T = S − I That is, the amount of government spending minus total tax revenue, is necessarily equal to private saving minus private investment. The MMTers might succinctly express this relationship in words:
Government Budget Deficit = Net Private Saving. This equation underpins the MMTers' disdain for the tea party's call for fiscal austerity. We derived the above equation through accounting tautologies, not by relying on any particular economic theory, so it should be impregnable. And gosh it sure looks like if the government were to reduce its budget deficit, then the private sector's saving would necessarily go down. Yikes! Have the Austrians been unwittingly advocating massive capital destruction without realizing it?
Of Course You Don't Need the Government in Order to Save When I first encountered such a claim — that the government budget deficit was necessary to allow for even the mathematical possibility of net private-sector saving — I knew something was fishy. For example, in my introductory textbook I devote Chapter 4 to "Robinson Crusoe" economics.
To explain the importance of saving and investment in a barter economy, I walk through a simple numerical example where Crusoe can gather ten coconuts per day with his bare hands. This is his "real income." But to get ahead in life, Crusoe needs to save — to live below his means. Thus, for 25 days in a row, Crusoe gathers his ten coconuts per day as usual, but only eats eight of them. This allows him to accumulate a stockpile of 50 coconuts, which can serve as a ten-day buffer (on half-rations) should Crusoe become sick or injured.
Crusoe can do even better. He takes two days off from climbing trees and gathering coconuts (with his bare hands), in order to collect sticks and vines. Then he uses these natural resources to create a long pole that will greatly augment his labor in the future in terms of coconuts gathered per hour. This investment in the capital good was only possible because of Crusoe's prior saving; he wouldn't have been able to last two days without eating had he not been able to draw down on his stockpile of 50 coconuts.
This is an admittedly simple story, but it gets across the basic concepts of income, consumption, saving, investment, and economic growth. Now in this tale, I never had to posit a government running a budget deficit to make the story "work." Crusoe is able to truly live below his means — to consume less than his income — and thereby channel resources into the production of more capital goods. This augments his future productivity, leading to a higher income (and hence consumption) in the future. There is no trick here, and Crusoe's saving is indeed "net" in the sense that it is not counterbalanced by a consumption loan taken out by his neighbor Friday.
So how in the world are we to interpret the MMTers' proclamation that "net private saving" necessarily equals the government's budget deficit (if we ignore international trade)?
When I raised this question on my blog, Nick Rowe — who is a very sharp economist — defended the MMT statement in this way:
Robert [Murphy]: "In particular, I think it is crazy when people say that if the federal government runs a budget surplus, then by simple accounting the private sector can't save."
[Nick Rowe:] That's perfectly correct, and standard, once you do the translation. Assume [an economy closed to international trade]. Define "private saving" as "private saving minus Investment" … which is how MMTers normally use the word "saving", or sometimes "net saving". Then it's just standard National Income Accounting. Y=C+I+G, and S=Y-T-C, therefore S-I=G-T.
And there you have it: When MMTers speak of "net saving," they don't mean that people collectively save more than people collectively borrow. No, they mean people collectively save more than people collectively invest.
I'm not trying to make fun of Nick Rowe; he is a professional economist who has written some very nuanced posts relating MMT to more orthodox mainstream economics. But look at what he was forced to type: "Define 'private saving' as 'private saving minus investment.'" As I noted in my response to Rowe, if we define "private saving" as "private saving," then my critique of MMT stands. (That's supposed to be funny, by the way — at least insofar as economics can be funny.)
Now Nick Rowe and the MMTers are certainly correct when they observe that "private saving net of private investment" can't grow without a government budget deficit (again if we disregard foreign trade). But so what? The whole benefit of private saving is that it allows for more private investment.
This is the fundamental problem with relying on macro-accounting tautologies; people often bring in causal arguments from economic theories without realizing they are doing so. Let's look again at the equation causing so much confusion:
G − T = S − I As a free-market economist, I don't need to run from this tautology. I can use it to underscore the familiar "crowding out" critique of government deficit spending. Specifically, if government spending (G) goes up while tax revenue (T) remains the same, then the left-hand side of the equation gets bigger as the government budget deficit grows. So the accounting tells us that the right-hand side must get bigger too. It may happen partially because people cut down on consumption and save more (due to higher interest rates and their expectation of higher tax burdens in the future), but it may also happen because private-sector investment goes down. In other words, as the government borrows and spends more, the equation tells us we might see lower private consumption, rising interest rates, and real resources being siphoned out of private investment into pork-barrel spending projects. I can tell my "story" of the dangers of government deficit spending with that equation just fine.
Of course, the Keynesians and MMTers would have a different spin on the result of higher government spending in our current economic environment, but that's not really the issue here. My point is that the national-income accounting tautologies aren't a good critique of the tea party after all. Those equations are just as consistent with economic theories claiming that government spending cuts will lead to faster economic growth. The fans of MMT should therefore stop pointing to those identities as if they prove the futility of government austerity during an economic downturn. Those tautologies, and the cherished equations of the three sectors, are consistent with post-Keynesian and tea party economics.
As a final way to illustrate the non sequitur of the equations involving government budget deficits, note that we could do the same thing with, say, Google. Go back through all the equations above, and redefine G to mean "total spending by Google." Then C would be "total consumption spending by the-world-except-Google," and so on.
After doing this, we would be able to prove — with mathematical certainty — that unless Google were willing to go deeper into debt next year, the world-except-Google would be unable to accumulate net financial assets, in the way MMTers define that term. The proper response to this (perfectly valid) observation is, Who cares?Note too that Google's lack of a printing press isn't relevant for the establishment of the accounting tautologies. The MMTers' sectoral equations are true whether the government has a fiat currency or gold commodity money.
Not All Spending and Income Are Created Equal Thus far I have accepted the MMT premises on their own terms, and shown that MMT's proponents often read more into their neutral accounting relationships than is justified by the relationships per se. However, in this final section I want to point out something even subtler.
One way to describe MMT is that is a "nominal" model of the economy, looking at flows of money without inquiring too deeply about the economic significance behind the flows. This article is already lengthy, so let me illustrate the problem with an analogy.
Suppose Tabitha has an income of $100,000, out of which she consumes $90,000. Tabitha takes her savings of $10,000 and lends it at 5 percent interest to Sam, who signs over an IOU promising to pay Tabitha $10,500 in 12 months.
Now let's stop and ask, did Tabitha save money in this scenario? Yes, of course she did. Another question: did Tabitha accumulate net financial assets? Yes, of course she did: she is holding a legally binding IOU from Sam, which possesses a current market value of $10,000 and will grow in value over time as the payoff date approaches. (Changes in Sam's solvency and interest rates of course might inflict capital gains or losses along the way.)
Now let's tweak the scenario. Suppose I tell you that Sam plans to raise the money needed to repay his loan by selling services to Tabitha. For example, suppose Sam used the $10,000 loan to buy equipment that he will then use to perform landscaping work on Tabitha's property over the course of a year. Every month Tabitha pays Sam a fee for his services, and after the 12th month Sam takes these fees, which are equal to $10,500, and hands them back to Tabitha.
In this revised scenario, is it still true that Tabitha acquired a net financial asset when she bought the $10,000 IOU from Sam in the beginning? Yes, of course it is. Tabitha voluntarily purchases the landscaping services from Sam; the flow of money back and forth is a bookkeeping convenience. Economically, what happened is that Tabitha exchanged a stock of present goods up front for a stream of services over the course of the year.
Now let's tweak the scenario one last time: Suppose that Tabitha lends $10,000 to Sam, who gives her an IOU promising $10,500 in 12 months. After the year passes, Sam walks up to Tabitha and sticks a gun in her belly, demanding $10,500 in cash. She hands it over to him, and then he gives it right back and tears up his IOU.
In this scenario, did Tabitha acquire a net financial asset when she originally lent the money to Sam? No, not really — especially if she knew how he planned on "repaying" her. In this case, Tabitha's savings of $10,000 would have simply been confiscated by Sam. He can go through the farce of giving her an IOU and then robbing her in the future to "redeem" it, but economically that is equivalent to him simply robbing her of the $10,000 upfront. From Tabitha's viewpoint, her $10,000 in savings vanished, while Sam's consumption can rise by $10,000 without increasing his own indebtedness.
Now let's expand the groups. Instead of the individual Tabitha, consider the group of all Taxpayers. And instead of the individual thief Sam, consider the institution Uncle Sam. The MMTers correctly tell us that the Taxpayers can't accumulate "net financial assets" — i.e., drawing on income streams that originate outside the group — unless Uncle Sam runs deficits and issues them bonds.
But what is the point of accumulating bonds that will only be redeemed when Uncle Sam coercively raises the necessary funds from the same group of Taxpayers in the future? Any individual taxpayer can justifiably look at a Treasury bond as a net asset, because his or her own tax contributions will not vary significantly based on his or her investment decisions regarding Treasuries. But the private sector as a whole surely shouldn't naively assume that if the government runs a $1.6 trillion deficit this year, this foretells of a shower of new income flowing "into the private sector" down the road.
I hope I've convinced the reader that something is very fishy with the MMT conclusions regarding private saving and government budget deficits. The error crept in at step one, with the equation GDP = C + I + G + (X − M). The only justification for measuring "output" (left-hand side) by the summation of spending (on the right-hand side) is that in a market exchange, the "value" of something is whatever the buyer spends on it.
However, if the government can raise revenues through present taxation or by borrowing now and paying back with future taxes, then this justification falls away. It's simply not true that $1,000 in private consumption or investment spending is an equivalent amount of "real output" to $1,000 spent by bureaucrats who raised the money without the consent of their "customers" and who may very operate under a "use it or lose it" appropriations process.
Conclusion The MMT worldview is intriguing, if only because it is so different from even the way conventional Keynesians think about fiscal and monetary policy. Unfortunately, it seems to me to be dead wrong. The MMTers concentrate on accounting tautologies that do not mean what they think.
This is the last Mises Weekends episode!
But don't despair, Jeff will soon be back with a brand new format: The Human Action Podcast. The new show is not radically different, but focuses more exclusively on Austrian economics, its great books, and its great thinkers — with longer, more in-depth interviews. But don't take our word for it, tune in next week to the first show with David Gordon!
Your RSS-fed platforms like Stitcher and SoundCloud will continue to support the new show, while Mises.org will still host both streaming and downloadable audio files. And your iTunes subscription will redirect you from Mises Weekends to The Human Action Podcast.
This week Jeff takes a hard look at socialism and why it seems to gain greater support in the US and across the West. Do people really understand socialism as Mises did, and do they really want collective ownership of industry? Or do they just want what he termed "pseudo-socialist" economic systems that redistribute wealth? What motivates socialists? And how do they reconcile their moralizing self-regard with the doctrine that socialism is inevitable and inexorable?
Mises's Socialism: An Economic and Sociological Analysis.
Jeff Deist on why support for socialism persists.
ABSTRACT: Peter H. Lindert and Jeffrey G. Williamson, in their book Unequal Gains: American Growth and Inequality since 1700 (Princeton University Press, 2016), explore the reasons for the decline in the share of income captured by top earners in industrialized nations. Embedded in their take on the “Greatest Leveling” is a push for progressive redistribution policies, based on old misconceptions from Malthus and the Classical economists.
KEYWORDS: inequality, economic growth, Piketty, Malthus JEL CLASSIFICATION: B12, N11, N12, O15
Dr. Mark Thornton (mthornton@mises.org) is Senior Fellow at the Mises Institute and Book Review Editor of the Quarterly Journal of Austrian Economics. Quarterly Journal of Austrian Economics 21, no. 2 (Summer 2018) full issue, click here. In a core chapter in their book, Unequal Gains: American Growth and Inequality since 1700 (Princeton University Press, 2016), Peter H. Lindert and Jeffrey G. Williamson present “The Greatest Leveling of All Time,” circa 1910 to 1970. In this chapter, the two prominent economic historians explore the reasons why “virtually every industrialized country went through a pronounced decline in the share of income captured by the those at the top” (p. 194) combined with significant economic growth.
The modern norm is that economic growth causes measured income inequality to increase. The authors ask “Will the bottom 99 percent ever have such good fortunes again?” (p. 195) They note that “The interpretive stakes are high. Understanding the causes of this combined leveling and strong growth would inform today’s policy debate.” What caused this combined great leveling, i.e., more economic equality and strong economic growth?
What I found lurking in this chapter was an elaborate attempt to put the best face on their normative views concerning economic equality. The “leveling” is typically explained by a combination of the world wars, Spanish Flu, and the Great Depression which destroyed capital, killed off labor, and reduced the growth of the population and work force. Our authors would very much like to downplay these factors and to showcase progressive redistributive policies as the main cause.
They consider three general possibilities. First, the cause(s) could be something “we could control,” (p. 195) such as more progressive policies. Second, it could be something understandable, but beyond policy control or just a fluke. Third, it could be something we can neither forecast nor control. They note that the leveling occurred in most industrialized countries both before and after the adoption of progressive taxation and transfers, i.e. welfare for the low-income population. They show that it was not just that the top 1 percent saw its share fall by 50 percent, income grew more equal even within the bottom 99 percent.
Lindert and Williamson note that for “some countries, it was mostly a matter of sharp inequality reductions during World War II.” (p. 198) They note that this was especially true in Japan whose military and occupation governments enacted land reform, confiscated assets, and imposed high taxes to subdue the wealthy during the period from 1937 to 1950. In the US and several other countries, gains occurred for low-skilled labor vs. high skill labor during World War II, but in the US, wages remained compressed after wage controls were removed. “Something more fundamental must have been at work.” (p. 199)
They do note that “White-collar workers generally lost ground in both world wars, not regaining it after either war.” (p. 202) But they conclude on the basis of the evidence:
In many, if not most, cases, the occupational rates were not dictated by government policy but rather by market forces. Thus, our search for causes of the Great Leveling within the lower 99 percent must focus on the market fundamentals that could have pushed the entire occupational wage structure towards equality even in the absence of changes in government wage-setting policies. (p. 202)
I have emphasized “market forces” and “market fundamentals” here because it appears the authors want it emphasized.
The authors identify six likely causes of the great leveling. The first of which is uncontrollable shocks such as war, macroeconomic instability, i.e. the Great Depression, and political shocks, i.e., “(especially the leftward shifts that expanded fiscal redistribution). The first two are understandable but are hard to control. The third is clearly within the control of the political process.” (p. 207)
The authors agree, “Piketty is surely on the mark here. His explanation combines periods of diverse historical shocks into a single, long chaotic era from the 1910s to 1970s.” (p. 207) Here they are downplaying the really important factors: World War I, the Spanish Flu, the Great Depression, and World War II in favor of random chaos. They also strangely note that the shocks they wish to emphasize have a common denominator—a political shift to the left—and then they homogenize all these shocks and supposed shifts to the left into “progressive fiscal redistribution.” (p. 208) That is an unbelievable transformation, from wars and depressions to progressive redistribution!
Thomas Piketty is correct that World War I, the Great Depression, and World War II are the three primary events which most of the industrial world had in common, along with the Spanish Flu. These events were also episodes that destroyed or suppressed vast amounts of capital around the world. They were also events that killed or disabled more than one million Americans and tens of millions of young adults around the world who would have been highly likely to get married and have children. In the case of the Great Depression, family formation and child bearing decreased precipitously. The population growth rate was about half the normal level. So, the fact that labor gained while the income from capital relatively fell is not big surprise. Labor income also increased as a result of the Black Plague. Harsh immigration restrictions stopped the flow immigrants and this largely explained the gains to low-skilled workers vs. high skilled workers. Notice that immigrants are not permanently low-skilled, low-wage workers, but often move up the income distribution ladder.
The fact that marginal income tax rates were exorbitant during and after World War I and World War II had virtually nothing to do with redistribution in the typical sense. Rates were raised to pay for the US’s role in these tragedies. The top 1 percent was a very small number of taxpayers and they paid little taxes in the highest marginal rate category. The fact that Lindert and Williamson claim that the 2 percent – 10 percent experienced little relative change strongly suggests that the highest 1 percent of income earners turned their income earning assets into tax free income earning assets, such as municipal bonds or kept other income within their corporations as retained earnings, as has been shown by Gene Smiley and Richard H. Keehn.
There are five other causes that Lindert and Williamson discuss. Some of them, such as the reduction in labor supply growth rates, stems from the primary causes above, while others are probably not very relevant or temporary, but they are all framed to readers as if all causes might have a roughly balanced impact.
This chapter also reveals a little of what the authors know about the history of economic thought. In what might be the only reference to the history of economic thought in the book, the authors discuss the impact of labor supply on incomes. They correctly note that any ratio of income per capitalist relative to labor would be affected by changes in labor supply. “This inequality argument goes back at least to David Ricardo and Karl Marx.” (p. 209)
In fact, the argument does go back further in time, to Malthus. His “Principle of Population,” which is now considered invalid when applied to capitalism, says that population is limited by subsistence and that an increase in production of food will increase population and this will create a tendency to keep labor at a subsistence existence. The Classical model of some of the leading classical economists shows that capitalists accumulate greater and greater amounts of capital while labor is held at subsistence. This misconception and other errors of Classical economics is what led Marx to his theory of the exploitation of labor. In turn, this theory seems to be the force behind our authors’ ideology and their zeal for progressive redistribution policies which they define as taxing the rich and subsidizing low income poor people.
It is possible to have greater income equality and greater economic growth. It simply requires more free market policies and less government interventionism. It is too bad that more economists do not know this simple fact.
There are many popular myths that are used to try to justify the existence of the state, and also many popular myths about libertarianism and the free market. Zack Rofer's work explodes both sets of myths, and is both a primer for those taking a first look at these topics, as well as a tool for libertarians looking to sharpen their advocacy.
Narrated by Jim Vann.
Download the complete audiobook (nine MP3 files) here. This audiobook is also available on Soundcloud, Apple Podcasts, Google Podcasts, and via RSS.
Afterword to 'Busting Myths About the State and the Libertarian Alternative' by Zack Rofer. Pages 242–243 in the text. Narrated by Jim Vann.
The Preface to Busting Myths about the State and the Libertarian Alternative by Zack Rofer. Pages 7–10 in the text. Narrated by Jim Vann.
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.
Among the great books of mankind are the immortal writings by the Greek philosopher Plato. The Republic and The Laws, written 2300 to 2400 years ago, dealt not only with philosophy, the theory of knowledge, epistemology, but also with social conditions. The treatment of these problems was typical of the approach which philosophical and sociological problems, discussions of state, government, and so on, continued to receive for more than 2000 years.
Although this approach is familiar to us, a new point of view toward social philosophy, the sciences, economics, and praxeology has developed during the last hundred years. Plato had said that a leader is called on by “Providence” or by his own eminence, to reorganize and to construct the world in the same way that a builder constructs a building—without bothering with the wishes of his fellowmen. Plato’s philosophy was that most men are “tools” and “stones” to be worked with for the construction of a new social entity by the “superman” in control. The cooperation of the “subjects” is unimportant for the success of the plan. The only requirement is that the dictator have the requisite power to force the people. Plato assigns to himself the specific task of being adviser to the dictator, the specialist, the “social engineer” reconstructing the world according to his plan. A comparable situation today may be seen in the position of the college professor who goes to Washington.
The Platonic pattern remained the same for almost 2,000 years. All the books of that era were written from this point of view. Each author was convinced that men were merely pawns in the hands of the princes, the police, and so on. Anything could be done, provided the government was strong enough. Strength was considered the greatest asset of government.
An indication of the success of this thinking may be realized in reading the adventures of Télémaque by Bishop Fénelon [François de Salignac de la Mothe Fénelon, 1651–1715]. Bishop Fénelon, a contemporary of Louis XIV, was an eminent and great philosopher, a critic of government, and tutor to the Duke of Burgoyne, heir to the French throne. Télémaque, written for the young Duke’s education, was used in French schools until recently. The book tells of world travels. In each country visited, all that is good is credited to the police; everything of value is attributed to the government. This is known as the “science of the police”—or in German Polizeiwissenschaft.
The eighteenth century saw a new discovery—the discovery of a different approach to social problems. The idea developed that there was a regularity in the sequence of social problems similar to the regularity in the sequence of natural phenomena. It was learned that legal decrees and their enforcement alone would not remove an ill. The regular sequence or concatenation of social phenomena must be studied to find out what can be done, and what should be done. Although regularity had been recognized in the field of the natural sciences, the existence of order and of regular sequences also in the field of social problems had not been recognized before.
The Utopian conditions of the natural state, as described by Jean Jacques Rousseau [1712–1778], are transformed, it was held, by “wicked” men and by their evil social institutions to produce the destitution and misery that exists. It was believed that the happiest man—the one living under the most satisfactory conditions—was the Indian of North America. North American Indians were idealized in European literature of that time; they were considered happy because they were not acquainted with modern civilization.
Then came Thomas Robert Malthus [1766–1834] with the discovery that nature does not provide the means of existence for everybody. Malthus pointed out that there prevails for all humans a scarcity of the requirements of subsistence. All men are in competition for the means of survival and for a share of the world’s wealth. The aim of man was to remove the scarcity and make it possible for a greater number of persons to survive.
Competition leads to the division of labor and to the development of cooperation. The discovery that the division of labor is more productive than isolated labor was the happy accident that made social cooperation, social institutions, and civilization possible.
If all production is consumed immediately, any improvement of conditions would be impossible. Improvement is possible only because some production is saved for use in later production—that is only if capital is accumulated. Savings are important!
In the eyes of all reformers such as Plato, the “body politic” could not operate without interference from the top. Intervention by the “king,” by government, and by the police was necessary to obtain action and results. Remember that this was also the theory of Fénelon; he described the streets, factories, and all progress as being due to the police.
In the eighteenth century, it was discovered that even in the absence of the police—even if no one gives orders—people naturally act in such a way that the fruits of production finally appear. Adam Smith [1723–1790] cited the shoemaker. The shoemaker doesn’t make shoes from an altruistic motive; the shoemaker provides us with shoes because of his own selfish interest. Shoemakers produce shoes because they want the products of others which they can get in exchange for shoes. Every man, in serving himself, of necessity serves the interest of others. The “king” doesn’t have to issue orders. Action is brought about, therefore, by the autonomous actions of people in the market.
The eighteenth century’s discoveries with respect to social problems were closely connected with, and inseparable from, the political changes brought about during that period—the substitution of representative for autocratic government, free trade for protection, the tendency toward international peace instead of aggressiveness, the abolition of serfdom and slavery, and so on. The new political philosophy also led to substituting liberty for monarchism and absolutism. And it brought about changes in industrial life and social life which altered the fact of the world in a very short time. This transformation is customarily called the Industrial Revolution. And this “revolution” resulted in changes in the whole structure of the world, populations multiplied, the average length of life expectancy increased, and standards of living rose.
With specific reference to the population, it is four times greater today [1951] than it was more than 250 years ago. If Asia and Africa are eliminated, the growth is even more startling. Great Britain, Germany, and Italy, three countries that were completely settled and where every bit of land was already in use by 1800, found room to support 107 million more people by 1925. (This seems all the more remarkable when compared with the United States—many times the area of these three countries—which increased its population by only 109 million in that same period.) At the same time, the standard of living was raised everywhere as a result of the Industrial Revolution by the introduction of mass production.
Of course, there are still unsatisfactory conditions; there are still situations that can be improved. To this, the new philosophy responds: There is only one way to improve the standard of living of the population—increase capital accumulation as against the increase in population. Increase the amount of capital invested per capita.
Although this new doctrine of economic theory was true, it was unpopular for many reasons with certain groups—monarchs, despots, and nobles—because it endangered their vested interests. In the nineteenth and twentieth centuries, these opponents of this eighteenth-century philosophy developed a number of objections, epistemological objections which attacked the basic foundation of the new philosophy and raised many very serious and important problems. Their attack was more or less a philosophical attack, directed at the epistemological foundations of the new science. Almost all their criticism was motivated by political bias; it was not brought forth by searchers for the truth. However, this does not alter the fact that we should study seriously the objections to the various truths of the eighteenth century—sound philosophy and economics—without reference to the motives of those who bring them forth. Some were well founded.
During the last hundred years, opposition to sound economics has arisen. This is a very serious matter. The objections raised have been used as arguments against the whole bourgeois civilization. These objections cannot be simply called “ridiculous” and dismissed. They must be studied and critically analyzed. As far as the political problem is concerned, some people who supported sound economics did so in order to justify, or to defend, the bourgeois civilization. But these defenders didn’t know the whole story. They limited their fighting to a very small territory, similar to the situation today in Korea where one army is forbidden to attack the strongholds of the other army.[After the capture of the North Korean stronghold, Pyongyang, it became evident that the armies of Communist China were amassing for attack north of the Yalu River, the boundary between North Korea and Communist-controlled Manchuria. Yet requests by General Douglas MacArthur to do anything to forestall an attack were denied; his planes were not allowed to bomb the bridges over the Yalu; and the Red Chinese forces were even granted a five-mile-deep sanctuary south of the Yalu where they could assemble.—Ed.] In the intellectual struggle, the same situation exists; the defenders are fighting without attacking the real foundation of their adversaries. We must not be content to deal with the external paraphernalia of a doctrine; we must attack the basic philosophical problem.
The distinction between “left” and “right” in politics is absolutely worthless. This distinction has been inadequate from the very beginning and has brought about a lot of misunderstanding. Even objections to the basic philosophy are classified from that point of view.
Auguste Comte [1798–1857] was one of the most influential philosophers of the nineteenth century, and probably one of the most influential men of the last hundred years. In my own private opinion, he was a lunatic as well. Although the ideas he expounded were not even his own, we must deal with his writings because he was influential and especially because he was hostile to the Christian church. He invented his own church, with its own holidays. He advocated “real freedom,” more freedom, he said, than was offered by the bourgeoisie. According to his books, he had no use for metaphysics, for freedom of science, for freedom of the press, or for freedom of thought. All these were very important in the past because they gave him the opportunity to write his books, but in the future there would be no need for such freedom because his books had already been written. So the police must repress these freedoms.
This opposition to freedom, the Marxian attitude, is typical of those on the “left” or “progressive” side. People are surprised to learn that the so-called “liberals” are not in favor of freedom. Georg Wilhelm Friedrich Hegel [1770–1831], the famous German philosopher, gave rise to two schools—the “left” Hegelians and the “right” Hegelians. Karl Marx [1818–1883] was the most important of the “left” Hegelians. The Nazis came from the “right” Hegelians.
The problem is to study basic philosophy. One good question is why have the Marxists been to a certain extent familiar with the great philosophical struggle, while the defenders of freedom were not? The failure of the defenders of freedom to recognize the basic philosophical issue explains why they have not been successful. We must first understand the basis for the disagreement; if we do, then the answers will come. We will now proceed to the objections that have been raised to the eighteenth-century philosophy of freedom.
Keynes’s General Theory was, at least in the short run, one of the most dazzlingly successful books of all time. In a few short years, his “revolutionary” theory had conquered the economics profession and soon had transformed public policy, while old-fashioned economics was swept, unhonored and unsung, into the dustbin of history.
How was this deed accomplished? Keynes and his followers would answer, of course, that the profession simply accepted a starkly self-evident truth. And yet The General Theory was not truly revolutionary at all but merely old and oft -refuted mercantilist and inflationist fallacies dressed up in shiny new garb, replete with newly constructed and largely incomprehensible jargon. How, then, the swift success?
Part of the reason, as Schumpeter has pointed out, is that governments as well as the intellectual climate of the l930s were ripe for such conversion. Governments are always seeking new sources of revenue and new ways to spend money, often with no little desperation; yet economic science, for over a century, had sourly warned against inflation and deficit spending, even in times of recession.
Economists— whom Keynes was to lump into one category and sneeringly disparage as “classical’ in The General Theory — were the grouches at the picnic, throwing a damper of gloom over attempts by governments to increase their spending. Now along came Keynes, with his modern “scientific” economics, saying that the old “classical” economists had it all wrong: that, on the contrary , it was the government’s moral and scientific duty to spend, spend, and spend; to incur deficit upon deficit, in order to save the economy from such vices as thrift and balanced budgets and unfettered capitalism; and to generate recovery from the depression. How welcome Keynesian economics was to the governments of the world!
In addition, intellectuals throughout the world were becoming convinced that laissez-faire capitalism could not work and that it was responsible for the Great Depression. Communism, fascism, and various forms of socialism and controlled economy became popular for that reason during the 1930s. Keynesianism was perfectly suited to this intellectual climate.
But there were also strong internal reasons for the success of The General Theory. By dressing up his new theory in impenetrable jargon, Keynes created an atmosphere in which only brave young economists could possibly understand the new science; no economist over the age of thirty could grasp the New Economics. Older economists, who, understandably, had no patience for the new complexities, tended to dismiss The General Theory as nonsense and refused to tackle the formidably incomprehensible work. On the other hand, young economists and graduate students, socialistically inclined, seized on the new opportunities and bent themselves to the rewarding task of figuring out what The General Theory was all about.Harry Johnson put the strategy perceptively: “In this process, it helps greatly to give old concepts new and confusing names. … [T]he new theory had to have the appropriate degree of diffi culty to understand. Th is is a complex problem in the design of new theories. Th e new theory had to be so diffi cult to understand that senior academic colleagues would fi nd it neither easy nor worthwhile to study, so that they would waste their eff orts on peripheral theoretical issues, and so off er themselves as easy market for criticism and dismissal by their younger and hungrier colleagues. At the same time, the new theory had to appear both diffi cult enough to challenge the intellectual interest of young colleagues and students, but actually easy enough for them to master adequately with a suffi cient investment of intellectual endeavor. Th ese objectives Keynes’s General Th eory managed to achieve: it neatly shelves the old and established scholars, like Pigou and Robertson, enabled the most enterprising middle-and lower-middle-aged like Hansen, Hicks, and Joan Robinson to jump on and drive the bandwagon, and permitted a whole generation of students … to escape from the slow and soul-destroying process of acquiring wisdom by osmosis from their elders and the literature into an intellectual realm in which youthful iconoclasm could quickly earn its just reward (in its own eyes at least) by the demolition of the intellectual pretensions of its academic seniors and predecessors. Economics, delightfully, could be reconstructed from scratch on the basis of a little Keynesian understanding and a loft y contempt for the existing literature—and so it was” (1978, pp. 188–89).
Paul Samuelson has written of the joy of being under 30 when The General Theory was published in 1936, exulting, with Wordsworth, “Bliss was it in that dawn to be alive, but to be young was very heaven.” Yet this same Samuelson who enthusiastically accepted the new revelation also admitted that The General Theory
is a badly written book; poorly organized. … It abounds in mares’ nests of confusions. … I think I am giving away no secrets when I solemnly aver—upon the basis of vivid personal recollection—that no one else in Cambridge, Massachusetts, really knew what it was all about for some twelve to eighteen months aft er publication. Samuelson, Paul A. 1948 [1946]. “Lord Keynes and the General Theory,” in Harris 1948. Orig inally appeared in Econometrica (July 1946).Hodge, Ian. 1986. Baptized Infl ation. Tyler, Tex.: Institute for Christian Economics.
It must be remembered that the now-familiar Keynesian cross, IS-LM diagrams, and the system of equations were not available to those trying desperately to understand The General Theory when the book was published; indeed, it took 10 to 15 years of countless hours of manpower to figure out the Keynesian system. Oft en, as in the case of both Ricardo and Keynes, the more obscure the content, the more successful the book, as younger scholars flock to it, becoming acolytes.
Also important to the success of The General Theory was the fact that, just as a major war creates a large number of generals, so did the Keynesian revolution and its rude thrusting aside of the older generation of economists create a greater number of openings for younger Keynesians in both the profession and the government.
Another crucial factor in the sudden and overwhelming success of The General Theory was its origin in the most insular university of the most dominant economic national center in the world. For a century and a half, Great Britain had arrogated to itself the role of dominance in economics, with Smith, Ricardo, and Mill all aggrandizing this tradition. We have seen how Marshall established his dominance at Cambridge and that the economics he developed was essentially a return to the classical Ricardo/Mill tradition.
As a prominent Cambridge economist and student of Marshall, Keynes had an important advantage in furthering the success of the ideas in The General Theory. It is safe to say that if Keynes had been an obscure economics teacher at a small, Midwestern American college, his work, in the unlikely event that it even found a publisher, would have been totally ignored.
In those days before World War II, Britain, not the United States, was the most prestigious world center for economic thought. While Austrian economics had flourished in the United States before World War I (in the works of David Green, Frank A. Fetter, and Herbert J. Davenport), the 1920s to early 1930s was largely a barren period for economic theory. Anti-theoretical institutionalists dominated American economics during this period, leaving a vacuum that was easy for Keynes to fill.
Also important to his success was Keynes’s tremendous stature as an intellectual and politicoeconomic leader in Britain, including his prominent role as a participant in, and then severe critic of, the Versailles treaty. As a Bloomsbury member, he was also important in British cultural and artistic circles.
Moreover, we must realize that in pre-World War II days only a small minority in each country went to college and that the number of universities was both small and geographically concentrated in Great Britain. As a result, there were very few British economists or economics teachers, and they all knew each other. This created considerable room for personality and charisma to help convert the profession to Keynesian doctrine.
The importance of such external factors as personal charisma, politics, and career opportunism was particularly strong among the disciples of F.A. Hayek at the London School of Economics. During the early 1930s, Hayek at the LSE and Keynes at Cambridge were the polar antipodes in British economics, with Hayek converting many of Britain’s leading young economists to Austrian (that is, Misesian) monetary, capital, and business-cycle theory.
Additionally, Hayek, in a series of articles, had brilliantly demolished Keynes’s earlier work, his two-volume Treatise on Money, and many of the fallacies Hayek exposed applied equally well to The General TheoryHayek, Friedrich A. 1931a. “Reflections on the Pure Theory of Money of Mr. J. M. Keynes.” Economica 11. ,Hayek, Friedrich A. 1931b. “A Rejoinder to Mr. Keynes.” Economica 11. ,Hayek, Friedrich A. 1932. “Reflections on the Pure Theory of Money of Mr. J.M. Keynes (continued).” Economica 12. For Hayek’s students and followers, then, it must be said that they knew better. In the realm of theory, they had already been inoculated against The General Theory. And yet, by the end of the 1930s, every one of Hayek’s followers had jumped on the Keynesian bandwagon, including Lionel Robbins, John R. Hicks, Abba P. Lerner, Nicholas Kaldor, G.L.S. Shackle, and Kenneth E. Boulding.
Perhaps the most astonishing conversion was that of Lionel Robbins. Not only had Robbins been a convert to Misesian methodology as well as to monetary and business-cycle theory, but he had also been a diehard pro-Austrian activist. A convert since his attendance at the Mises privatseminar in Vienna in the 1920s, Robbins, highly infl uential in the economics department at LSE, had succeeded in bringing Hayek to LSE in 1931 and in translating and publishing Hayek’s and Mises’s works.
Despite being a longtime critic of Keynesian doctrine before The General Theory, Robbins’s conversion to Keynesianism was apparently solidifi ed when he served as Keynes’s colleague in wartime economic planning. There is in Robbins’s diary a decided note of ecstatic rapture that perhaps accounts for his astonishing abasement in repudiating his Misesian work, The Great Depression (1934).
Robbins’s repudiation was published in his 1971 Autobiography: “I shall always regard this aspect of my dispute with Keynes as the greatest mistake of my professional career, and the book, The Great Depression, which I subsequently wrote, partly in justification of this attitude, as something which I would willingly see forgotten”Robbins, Lionel, Autobiography of an Economist. London: Macmillan. . Robbins’s diary entries on Keynes during World War II can only be considered an absurdly rapturous personal view. Here is Robbins at a June 1944 pre–Bretton Woods draft conference in Atlantic City:
Keynes was in his most lucid and persuasive mood: and the effect was irresistible… . Keynes must be one of the most remarkable men that have ever lived—the quick logic, the wide vision, above all the incomparable sense of the fitness of words, all combine to make something several degrees beyond the limit of ordinary human achievement. Only Churchill, Robbins goes on to say, is of comparable stature. But Keynes is greater, for he uses the classical style of our life and language, it is true, but it is shot through with something which is not traditional, a unique unearthly quality of which one can only say that it’s pure genius. The Americans sat entranced as the godlike visitor sang and the golden light played all around.Hession, Charles H. 1984. John Maynard Keynes. New York: Macmillan.
This sort of fawning can only mean that Keynes possessed some sort of strong personal magnetism to which Robbins was susceptible.Robbin’s biographer, D.P. O’Brien, labors hard to maintain that, despite what he admits is Robbins’s “elaborate” and “exaggerated contrition,” Robbins never really, deep down, converted to Keynesianism. But O’Brien is unconvincing, even aft er he tries to show how Robbins waffl ed on some issues. Moreover, O’Brien admits that Robbins dropped his Misesian macro approach, and he fails to mention Robbins’s astonishing treatment of Keynes as “godlike” (O’Brien 1988, pp. 14–16, 117–20).
Central to Keynes’s strategy in putting The General Theory over were two claims: first, that he was revolutionizing economic theory, and second, that he was the first economist—aside from a few “underworld” characters, such as Silvio Gesell—to concentrate on the problem of unemployment. All previous economists, whom he lumped together as “classical,” he said, assumed full employment and insisted that money was but a “veil” for real processes and was therefore not a truly disturbing presence in the economy.
One of Keynes’s most unfortunate effects was his misconceiving of the history of economic thought, since his devoted legion of followers accepted Keynes’s faulty views in The General Theory as the last word on the subject. Some of Keynes’s highly influential errors may be attributed to ignorance, since he was little trained in the subject and mostly read work by his fellow Cantabrigians. For example, in his grossly distorted summary of Say’s law (“supply creates its own demand”), he sets up a straw man and proceeds to demolish it with ease.
This erroneous and misleading restatement of Say’s law was subsequently repeated (without quoting Say or any of the other champions of the law) by Joseph Schumpeter, Mark Blaug, Axel Leijonhufvud, Thomas Sowell, and others. A better formulation o fthe law is that the supply of one good constitutes demand for one or more other goods.Hutt, William H. 1974. A Rehabilitation of Say’s Law. Columbus: Ohio State University Press.
But ignorance cannot account for Keynes’s claim that he was the first economist to try to explain unemployment or to transcend the assumption that money is a mere veil exerting no important influence on the business cycle or the economy. Here we must ascribe to Keynes a deliberate campaign of mendacity and deception—what would now be called euphemistically “disinformation.”
Keynes knew all too well of the existence of the Austrian and LSE Schools, which had flourished in London as early as the 1920s and more obviously since 1931. He himself had personally debated Hayek, the chief Austrian at LSE, in the pages of Economica, the LSE journal. The Austrians in London attributed continuing large scale unemployment to wage rates kept above the free-market wage by combining union and government action (e.g., in extraordinarily generous unemployment-insurance payments).
Recessions and business cycles were ascribed to bank credit and monetary expansion, as fueled by the central bank, which pushed interest rates below genuine time-preference levels and created overinvestment in higher-order capital goods. These then had to be liquidated by a recession, which in turn would emerge as soon as the credit expansion stopped. Even if he had not agreed with this analysis, it was unconscionable for Keynes to ignore the very existence of this school of thought then prominent in Great Britain, a school which could never be construed as ignoring the impact of monetary expansion on the real state of the economy.
In order to conquer the world of economics with his new theory, it was critical for Keynes to destroy his rivals within Cambridge itself. In his mind, he who controlled Cambridge controlled the world. His most dangerous rival was Marshall’s handpicked successor and Keynes’s former teacher, Arthur C. Pigou. Keynes began his systematic campaign of destruction against Pigou when Pigou rejected his previous approach in the Treatise on Money, at which point Keynes also broke with his former student and close friend, Dennis H. Robertson, for refusing to join the lineup against Pigou.
The most glaring misstatement in The General Theory, and one which his disciples accepted without question, is the outrageous presentation of Pigou’s views on money and unemployment in Keynes’s identification of Pigou as the major contemporary “classical” economist who allegedly believed that there is always full employment and that money is merely a veil causing no disruptions in the economy—this about a man who wrote Industrial Fluctuations in 1927 and Theory of Unemployment in 1933, which discuss at length the problem of unemployment! Moreover, in the latter book, Pigou explicitly repudiates the money veil theory and stresses the crucial centrality of money in economic activity.
Thus, Keynes lambasted Pigou for allegedly holding the “conviction…that money makes no real difference except frictionally and that the theory of unemployment can be worked out…as being based on ‘real’ exchanges.” An entire appendix to chapter 19 of The General Theory is devoted to an assault on Pigou, including the claim that he wrote only in terms of real exchanges and real wages, not money wages, and that he assumed only flexible wage rates.
But, as Andrew Rutten notes, Pigou conducted a “real” analysis only in the first part of his book; in the second part, he not only brought money in, but pointed out that any abstraction from money distorts the analysis and that money is crucial to any analysis of the exchange system. Money, he says, cannot be abstracted away and cannot act in a neutral manner, so “the task of the present part must be to determine in what way the monetary factor causes the average amount of, and the fluctuation in, employment to be different from what they otherwise would have been.”
Therefore, added Pigou, “it is illegitimate to abstract money away [and] leave everything else the same. The abstraction proposed is of the same type that would be involved in thinking away oxygen from the earth and supposing that human life continues to exist”Pigou, A.C. 1933. The Theory of Unemployment. London: Macmillan. . Pigou extensively analyzed the interaction of monetary expansion and interest rates along with changes in expectations, and he explicitly discussed the problem of money wages and “sticky” prices and wages.
Thus, it is clear that Keynes seriously misrepresented Pigou’s position and that this misrepresentation was deliberate, since, if Keynes read any economists carefully, he certainly read such prominent Cantabrigians as Pigou. Yet, as Rutten writes, “These conclusions should not come as a surprise, since there is plenty of evidence that Keynes and his followers misrepresented their predecessors”Rutten, Andrew. 1989. “Mr. Keynes on the Classics: A Suggestive Misinterpretation?” Unpublished manuscript. . The fact that Keynes engaged in this systematic deception and that his followers continue to repeat the fairy tale about Pigou’s blind “classicism” shows that there is a deeper reason for the popularity of this legend in Keynesian circles. As Rutten writes,
There is one plausible explanation for the repetition of the story of Keynes and the classics.…This is that the standard account is popular because it offers simultaneously an explanation of, and a justification for, Keynes’s success: without the General Theory, we would still be in the economic dark ages. In other words, the story of Keynes and the Classics is evidence for the General Theory. Indeed, its use suggests that it may be the most compelling evidence available. In this case, proof that Pigou did not hold the position attributed to him is … evidence against Keynes. … [This conclusion] raises the … serious question of the methodological status of a theory that relies so heavily on falsified evidence.
In his review of The General Theory, Pigou was properly scornful of Keynes’s “macédoine of misrepresentations,” and yet such was the power of the tide of opinion (or of the charisma of Keynes) that, by 1950, aft er Keynes’s death, Pigou had engaged in the sort of abject recantation indulged in by Lionel Robbins, which Keynes had long tried to wrest from himPigou, A.C. 1950. Keynes’s General Theory: A Retrospective View. London: Macmillan.,Johnson, Elizabeth, and Harry G. Johnson. 1978. Th e Shadow of Keynes. Oxford: Basil Blackwell. ,Corry, Bernard. 1986. “Keynes’s Economics: A Revolution in Economic Th eory or Economic Policy?” in R.D. Collison Black, ed., Ideas in Economics. Totowa, N.J.: Barnes and Noble.
But Keynes used tactics in the selling of The Genera Theory other than reliance on his charisma and on systematic deception. He curried favor with his students by praising them extravagantly, and he set them deliberately against non-Keynesians on the Cambridge faculty by ridiculing his colleagues in front of these students and by encouraging them to harass his faculty colleagues. For example, Keynes incited his students with particular viciousness against Dennis Robertson, his former close friend.
As Keynes knew all too well, Robertson was painfully and extraordinarily shy, even to the point of communicating with his faithful, longtime secretary, whose office was next to his own, only by written memoranda. Robertson’s lectures were completely written out in advance, and because of his shyness he refused to answer any questions or engage in any discussion with either his students or his colleagues. And so it was a particularly diabolic torture for Keynes’s radical disciples, led by Joan Robinson and Richard Kahn, to have baited and taunted Robertson, harassing him with spiteful questions and challenging him to debate.Johnson, Elizabeth, and Harry G. Johnson. 1978. Th e Shadow of Keynes. Oxford: Basil Blackwell.
[Chapter "Selling the General Theory" in Keynes, the Man.]
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.
[Full Issue of the Quarterly Journal of Austrian Economics 20, no. 4 (2017)]
ABSTRACT: Roger Garrison (2001) employs the concept of “secular growth” in which a one-shot (but permanent) fall in time preferences can yield a long string of doses of net investment, so long as gross saving exceeds depreciation. However, Salerno (2001) argues that secular growth is incompatible with orthodox Austrian capital theory, and suggests ways that Garrison’s appeal to neoclassical readers can be maintained while respecting the framework bequeathed by Rothbard. Commenting on the dispute, Young (2009) argues—perhaps ironically—that the mainstream growth literature, steeped in the famous Solow model, comes down on the side of Salerno. The present paper clarifies some ambiguities in Young’s discussion, and then argues that Garrison’s usage of “secular growth” is more likely to resonate with a neoclassical reader than Salerno’s approach. To be sure, Rothbardians may ultimately reject Garrison’s standard exposition (because of Salerno’s objections), but Time and Money still represents a smooth gateway to introduce neoclassical readers to capital-based macroeconomics
KEYWORDS: Solow growth model, secular growth, capital theoryJEL CLASSIFICATION: B25, E21, E22, O11, O12, O16, O43I. INTRODUCTIONRoger Garrison’s (2001) Time and Money, and its accompanying PowerPoint presentations,Garrison’s series of PowerPoint presentations are available at https://www.auburn.edu/~garriro/tam.htm. provide a creative graphical exposition of Austrian macroeconomics in the form of three interlocking diagrams. Specifically, Garrison relates the Hayekian triangle to the “Production Possibilities Frontier” (PPF) so familiar in mainstream textbooks, which in turn he links to a standard loanable funds diagram familiar to Austrians and neoclassicals alike. Besides making for an entertaining seminar presentation, Garrison’s framework thus tells the Mises-Hayek business cycle story in a way that neoclassical economists can understand.To be sure, not all Austrians are happy with Garrison’s approach. For example, Barnett and Block (2006) reject the Hayekian triangle outright, while Hülsmann (2001) argues that Garrison’s approach to money “is irreconcilable with the standpoint developed in the writings of Menger, Mises, Rothbard, and others,” and indeed that “Garrison’s macroeconomics is…macroeconomics without money” (p. 34).
Although he appreciates Garrison’s return to the fundamentals of Austrian capital, interest, and business cycle theory—what Garrison himself dubs “capital-based macroeconomics”—Joseph Salerno (2001) worries that Garrison has unwittingly employed an analytical concept that conflicts with the verbal-logical foundations of Austrian macroeconomics. Specifically, Garrison adopts a baseline of “secular growth” as more realistic than a stationary (no growth) economy. As Garrison defines the term:
Secular growth occurs without having been provoked by policy or by technological advance or by a change in intertemporal preferences. Rather, the ongoing gross investment is sufficient for both capital maintenance and capital accumulation. (Garrison, 2001, p. 54)
Salerno (2001) argues that this concept of secular growth is dubious from an Austrian perspective. For one thing, Garrison’s discussion suggests that during periods of secular growth the economy is on “autopilot” (my term), whereas the Mengerian tradition roots Austrian analysis as causal from the foundations of the School.Salerno (2010) establishes Menger as the founder of a “causal-realist” tradition which was then elaborated by Mises and Rothbard.
More specifically, Salerno reminds us that in Rothbard’s treatment (which he viewed as merely elaborating capital theory in the tradition of Böhm-Bawerk, Mises, and Hayek), a change in time preferences corresponds to a new resting state. There may be a transition period as the production structure evolves, but in the Austrian framework
[t]he increase in real income resulting from a given dose of net investment does not buy, as it were, an automatic and continuous flow of extra capital goods that can be utilized for further extensions of the structure of production; all capital goods created by an act of net saving are fully absorbed in maintaining the enhanced flow of real income characterizing the new stationary economy. (Salerno, 2001, p. 45)
Salerno then illustrates his position with a numerical Robinson Crusoe example, in which each period Crusoe engages in discrete acts of net saving, jumping from one stationary economy to the next, in a succession of growing output. Although superficially this may seem like Garrison’s “secular growth,” Salerno argues that it is quite distinct, because each jump involves a further drop in time preference and a conscious decision to accumulate additional capital goods.
I agree with Salerno that Garrison’s notion of “secular growth” is at odds with Rothbard’s treatment in Man, Economy, and State (2004 [1962]). There, a one-shot (and permanent) fall in the community’s time preferences results in a new stationary state for the economy, with a lower interest rate, deeper capital structure, and higher gross investment to maintain it.For a numerical illustration of Rothbard’s approach to modeling the economy’s growth in response to a one-shot drop in time preferences, see Murphy (2006) pp. 96–98. But in Rothbard’s approach, once the economy adjusts to the new parameters, the process stops; we are back in a long-term equilibrium unless something disturbs it. In particular, there is no reason for the capital stock to continue growing, or for the flow of consumer goods to continue rising.
However, in the present paper we are not asking whether Garrison or Salerno has the approach to capital accumulation that is more compatible with Rothbard. Rather, here we focus attention on the narrow question of, “What approach is more likely to resonate with the way neoclassical economists think about capital accumulation?” At first blush, it would seem that Garrison comes out the clear winner, largely because of the way mainstream economists define their terms. In Section II of this paper, we will spell out this affinity between mainstream economics and Garrison’s terminology.
Yet even though I believe it will be easy to demonstrate that mainstream economists would quickly identify with Garrison’s treatment of secular growth, ironically Young (2009) reaches the opposite conclusion. Specifically, Young (2009) argues that neoclassical readers, familiar with the growth literature based on the famous Solow model, would agree with Salerno’s take on the concept of secular growth. In Section III of this paper, I will show that although superficially plausible, Young’s argument falls apart when we consider the time involved in moving to a new “steady state” in the Solow model. Notwithstanding the well-known results of the Solow model concerning savings rates and economic growth, it is still the case that mainstream economists would side with Garrison’s definition of “secular growth” over Salerno’s approach.
II. THE TERMINOLOGY OF MAINSTREAM GROWTH ACCOUNTINGIn abstract mathematical models of the economy—such as the canonical Solow growth model—it is customary to treat savings and investment the way that Garrison does in his book. In particular, if we start at a steady-state of no growth, where gross savings each period just balances physical depreciation, and then we suddenly increase the savings rate, there will be a succession of periods of what mainstream economists would label “net investment,” defined as that portion of gross investment that exceeds depreciation.A standard graduate level text is Romer (1996), and its introduction and discussion of the basic Solow model is covered in Chapter 1. (We will go over specific numerical examples of this phenomenon in Section III.)
The mainstream approach lines up perfectly with Garrison’s notion of secular growth in which “the ongoing gross investment is sufficient for both capital maintenance and capital accumulation” (Garrison, 2001, p. 54). In other words, during a period of secular growth, gross investment is high enough that it contains a component covering both depreciation (“capital maintenance”) and a remainder for net investment (“capital accumulation”).
To reiterate, this is how mainstream economists use these terms. To be sure, this labeling would not be due to deep philosophical considerations, but would instead be a matter of definition, carried over from a straightforward accounting treatment in the business world. For example, consider this discussion drawn from Investopedia.com’s entry on “Net Investment”:
If gross investment is consistently higher than depreciation, net investment will be positive, indicating that productive capacity is increasing. Conversely, if gross investment is consistently lower than depreciation, net investment will be negative, indicating that productive capacity is decreasing, which can be a potential problem down the road.Quotation taken from: http://www.investopedia.com/terms/n/netinvestment.asp, accessed January 11, 2017.
Thus we see that as a simple matter of definitions, mainstream economists would immediately understand what Garrison means when he describes secular growth occurring when gross investment exceeds depreciation, leading to net investment. In particular, if intertemporal preferences should suddenly change and disrupt an original “steady state” equilibrium, mainstream economists would endorse Garrison’s framework in which there would be many succeeding periods of positive net investment, while the growing capital stock (and hence growing depreciation each period) had not yet caught up with the sudden jump in gross saving/gross investment.
In contrast, I do not think the standard mainstream economist—used to thinking about capital as an aggregate quantity “K”—would be able to make much sense of Salerno’s discussion. Salerno’s point is that an Austrian theorist must view capital as a collection of specific capital goods with specific ends to serve, and in that framework, there are difficulties with Garrison’s approach. Yet these types of worries are not ones that would bother a mainstream economist. He or she would immediately adopt Garrison’s approach to savings rates, gross vs. net investment, and hence secular growth.
III. ANDREW YOUNG PITS SOLOW AGAINST GARRISONIn the previous section, I argued that simply by a matter of definition—and because they think of capital in aggregates like “K” rather than as concrete capital goods embedded in a subjective plan—mainstream economists would more easily embrace Garrison’s approach to “secular growth” than Salerno’s framework. However, there is one glaring complication to my argument: it is well-known in the growth literature that a higher savings rate cannot explain permanent differences in growth rates between countries, at least if we use standard models such as the Solow model.
Aware of this fact, Young (2009) weighs in on the Garrison/Salerno dispute over secular growth, and explains why he thinks neoclassical economists would declare Salerno the victor:
Salerno argues that, in the absence of technological or institutional change, time preferences must be falling over time for capital accumulation to be sustainable. Furthermore, Salerno’s argument echoes one of the primary conclusions of neoclassical growth theory [references omitted]…. As Robert Lucas (2002, p. 29) summarizes: the theory “emphasizes a distinction between ‘growth effects’…and ‘level effects.’…[C]hanges in savings rates are level effects….” In the absence of technological change, only a continually rising savings rate (and falling rate of time preference) can result in secular growth.
[…]
Either Salerno’s argument or that of neoclassical growth theory poses a challenge to Garrison’s theory of secular growth. Furthermore, despite their differences, there is little, if anything, contradictory between the two arguments. Most Austrians are not uncomfortable with diminishing returns, and neoclassical growth theorists would not likely deny that more capitalistic methods of production are also more time-consuming. (Young 2009, pp. 36–37, italics in Young’s original, bold added.)
Although Young’s general summary of the neoclassical growth literature is correct, there are some slight nuances in his handling of the matter that—in this case—actually defeat the purpose of his argument. To demonstrate this, I will first present two numerical counterexamples, and then I will explain in broad terms why Young is wrong to pit the Solow model against Garrison.
Counterexample #1 to Young: Perpetual Growth Despite Diminishing Returns and Constant Savings Rate
The standard Solow growth model—which we will exposit in discrete time—relates output to the input of homogenous capital and homogenous labor:
Yt = F(Kt, Lt)
Every period, output is divided between consumption and investment. Furthermore, capital grows with investment but every period depreciates at some rate δ, where 0 ≤ δ < 1. These considerations give the equations:
Yt = Ct + It
Kt+1 = Kt + It – δKt
One of the defining features of the Solow model (which is relaxed in later models in the neoclassical growth literature) is that the savings rate s, where 0 < s < 1, is exogenous and constant (at least for purposes of determining the “steady state” equilibrium). This gives us:
It = sYt
Kt+1 = Kt + sYt – δKt
Kt+1 = Kt + sF(Kt, Lt) – δKt
In standard expositions of the Solow model, there are more assumptions on the growth of the population, and of a technology parameter that “augments” the labor stock. For our purposes, we can dispense with these complexities, and hold technology and population constant. For simplicity, we will set the labor supply to 1 for all periods.
In this first counterexample, we will set δ=0, meaning that there is no physical depreciation in the capital stock. Further, we set Yt = F(Kt, Lt) = (Kt)1/2(Lt)1/2 = (Kt)1/2. That is, output every period is equal to the square root of the size of the capital stock that period.Because we have chosen Lt=1 for all t, labor’s contribution to output falls out of the equation. Notice that our production function is an example of the Cobb-Douglas class, with the shares of capital and labor each set to ½.
With this setup, in Table 1 we simulate the evolution of an economy where the initial capital stock is 100.
Table 1: Counterexample #1: An economy with diminishing returns and constant savings rate, yet perpetual growth
In Table 1, we see that the simulated economy enjoys perpetual (and constant) growth, as measured in absolute terms. Specifically, total real output grows by 0.05 units every period. Every period, the additional volume of output is split 10/90 between investment and consumption: Specifically (and as shown in the last column), net investment itself grows by 0.005 units each period, whereas consumption grows by 0.045 units (though space constraints prevent us from showing this in the table). Be careful not to become confused with rates of change: investment (like consumption) is a flow variable that, in this numerical example, itself increases linearly over time. However, the total amount of capital in each period is a stock variable that, in this example, grows exponentially over time.
Note that in this specific numerical example, there is no steady-state to which the economy moves; real output is 0.05 units higher every period, forever. Each period, the community enjoys 0.045 units of more (real) consumption, forever. Furthermore, this perpetual growth occurs despite the fact that we assumed a constant savings rate, and furthermore chose a production function (of the standard Cobb-Douglas class) that exhibits diminishing returns. That is to say, it is still true in this example that a given increase in K leads to ever smaller increases in Y (and hence investment and consumption) as K grows larger. (Thus, if this hypothetical economy experienced a perpetual stream of net investment of the same absolute size every period, then in the long run, the increase in real output each period would tend towards zero.) Nonetheless, there is no tendency in this economy for the growth in real output to asymptotically approach zero, even though there is a constant savings rate and a typical production function. On the contrary, real output grows without limit. Rereading Young’s block quotation above, and contrasting his description with our specific example, it is clear that something is amiss.
The “trick” we’ve used in Counterexample #1—and which is driving the results that probably strike most readers as initially counterintuitive—is that even though the derivativeOf course the derivative is only defined if we recast the model in continuous, not discrete, terms. of the production function with respect to K is diminishing as K increases, that feature does not imply that output is diminishing with respect to t. As the “Net Investment” column indicates, the periodic increments in K themselves constantly increase over time. Therefore, even though a given dose of additional capital will yield ever diminishing increments in output, perpetually increasing doses of additional capital can yield a constant increment in output over time.We can switch our Solow model to continuous time to verify analytically that our claims do indeed hold, and are not just a fluke of Excel rounding and (perhaps) an inadequate length of time in the simulation. Specifically, with Y(t) = K(t)1/2, and with dK/dt = (0.1)*Y(t), we can use calculus and substitution to determine that the second derivative of K(t) with respect to t is always +0.005, and that the derivative of Y(t) with respect to t is always +0.05. Thus, the relevant columns in Table 1 are not misleading; they accurately depict the operation of the Solow model with our chosen parameters. Additionally, we can determine that K(t) = [(0.05)t + K(0)1/2]2, which grows without limit as t tends to infinity. Indeed, that is exactly what we have illustrated in Table 1.
To be sure, the model depicted in Counterexample #1 is not very realistic. (In the next section we address this concern.) Yet it served the purpose of isolating the role that different assumptions play in yielding the standard results of the Solow model. In particular, Counterexample #1 showed that a constant savings rate plus “diminishing returns in the production function” do not rule out perpetual growth in real output, even though one might have thought otherwise from reading Young’s discussion of the neoclassical growth literature. It should go without saying that Young is aware of the importance of depreciation in these models, but nonetheless the results in Table 1 may be counterintuitive for many readers, and it is important to show that “diminishing returns” by itself does not prevent perpetual growth.
Counterexample #2 to Young: Long-Term (Secular?) Growth Even with Depreciation
An obvious objection to our first counterexample is that it did not include physical depreciation of the capital stock, and thus may have been an unfair test of Young’s position.In his comment on Young, Engelhardt (2009) also emphasizes the importance of depreciation in the analysis. Specifically, Engelhardt argues that it is not positive externalities, but rather the assumption of no depreciation, that drives Young’s own model of secular growth. I have two responses to such an objection.
First, even if it were true that employing a positive depreciation rate “fixed” everything and made secular growth once again appear untenable, my first counterexample would still underscore that Young’s emphasis on diminishing returns was not the full story. Young did not mention depreciation in his attempt to unite Salerno with the neoclassicals, and thus Counterexample #1 would be useful if only to clarify the terms of the marriage.
Second and more important, even when we add a positive depreciation rate to the Solow model, it still can take many periods—what we might interpret as “a long time”—for the periodic increases in real output to peter out. We illustrate this possibility in Table 2 where we have made the depreciation rate 5 percent of the existing capital stock, and where we have changed the initial capital stock to 1.000 to make the first few calculations intuitive.
Table 2: Counterexample #2: An economy with diminishing returns, constant savings rate, and depreciation, yet long-lasting growth
With our chosen parameter values, the typical neoclassical economist would characterize the “steady state” equilibrium by noting that when Kt = 4, investment exactly counterbalances depreciation.In this case, total output is SQRT(4) = 2. A savings rate of 10 percent thus implies gross investment of 0.2. But the 5 percent physical depreciation rate on the 4 units of capital implies total depreciation of 0.2, which totally absorbs the gross investment leaving 0 net investment. The capital stock will thus be 4 next period, and the period after, forever. If the capital stock were ever to exceed the level of 4, then depreciation would exceed gross investment and the capital stock would decline. Thus, once we add in physical depreciation, a constant savings rate—coupled with diminishing returns to capital in the production function—means that real output will indeed approach a plateau. In this case, real output will settle down in the steady state at a level of SQRT(4) = 2.
However, does this mean that Young is right after all, and that a typical neoclassical growth model leaves no room for secular growth in the Garrisonian sense? I would argue no. As Table 2 shows, even though real output is bounded above, it can grow by significant amounts for extended periods.
For example, we can imagine that Table 2 shows the evolution of an economy that starts with an initial savings rate of 5 percent, and then suddenly doubles the savings rate to 10 percent. Note that the time 0 values would constitute an original steady state at the lower savings rate (or higher time preference rate). Specifically, at time 0, if the savings rate is 5 percent, and the capital stock is 1, then investment just balances depreciation.
Now the rest of the table shows what happens if, for some reason, we disrupt that initial steady state by having time preferences suddenly fall, such that the constant savings rate jumps up to 10 percent. In Garrisonian terms, in the immediate aftermath of this preference change, gross investment is more than sufficient to cover depreciation, so that there is net investment—the capital stock grows. Garrison would label this as a period of secular growth.
Now Salerno (and Young) would presumably argue that no, this is not genuine secular growth, because it merely represents a transition period to the new steady state. In particular, once capital has quadrupled to 4, and real output has doubled to 2, gross investment will once again be adequate only to just offset depreciation. Net investment will have fallen to zero.
That is certainly true, but consider the length of this transition period. For one thing, the economy will never quite attain the new steady state, but will only asymptotically approach it. (Such an asymptotic approach is clearly not how Salerno is thinking about the issues, when he has in mind a transition to a new production structure consisting of particular capital goods.) Yet more significant than this mathematical trivia, is the proportion of the ultimate increase that has yet to be reaped after a significant passage of time. For example, note that by period 55, real output is 1.75 units, which is only seven-eighths of its steady state value. If we interpret time periods to be years, then the “transition period” (to which Salerno and Young wish to deny the label “secular growth”) spans at least two generations.
The Speed of Adjustment in the Neoclassical Growth Literature
Our conclusion from Counterexample #2—namely, that the speed of convergence to a new steady state can take a long time—corresponds with the neoclassical growth literature’s attempts to calibrate their models to real economies. For example, using standard parameter values for population growth, depreciation, capital’s share of income, and so forth, Romer (1996) writes in his graduate macro textbook, in his discussion of the Solow model:
Thus in our example of a 10% increase in the saving rate, output is 0.04(5%) = 0.2% above its previous path after 1 year; is 0.5(5%) = 2.5% above after 18 years; and asymptotically approaches 5% above the previous path. Thus not only is the overall impact of a substantial change in the saving rate modest, but it does not occur very quickly. (Romer, 1996, pp. 22–23)
To paraphrase Romer’s analysis, he is saying that when we plug plausible parameters into the Solow growth model, an increase in the savings rate from, say, 20 percent to 22 percent would eventually boost output by 5 percent relative to the original level. However—and this is crucial for our discussion—after the first 18 years of the sudden jump in savings, output would only have closed half of the gap to its new steady-state level.
For another example showing how neoclassical economists view time in growth models, consider the following commentary on a transition from a capital stock below the “golden rule” (GR) level—which, by definition, maximizes steady-state consumption—up to the GR level:
Note that in the transition to the GR [Golden Rule] point, there will be “initial” effects and “long-run” effects. Say we’re below the GR. As we increase savings, there will be a temporary decrease in consumption, and then a long run increase. Why? Because an increase in savings means less consumption right away…. However, as capital accumulates, output increases, and thus so does consumption. This situation gives us a look into why it’s called the Golden Rule…because we sacrifice consumption now for higher consumption for the people of the future. As Mankiw puts it, the welfare of all generations is given equal weight, so sacrifice by this generation is outweighed by the gains of future generations. (Sanders, 2008, p. 4, emphasis added)
As this commentary (which is taken from study notes on the Solow model) indicates, when neoclassical economists say that a higher savings rate cannot explain economic growth, they may be thinking in terms of generations. The time frame is much much longer than, say, Salerno’s thought experiment of Crusoe building a house over the course of 3,000 hours.
Discussion
To be sure, I am not endorsing the way that typical neoclassical economists deploy the Solow model when interpreting economic statistics. In particular, I have argued elsewhere that Romer (who is merely echoing the rest of the profession) is plunging headlong into the fallacy of the naïve productivity theory of interest that Böhm-Bawerk brilliantly refuted so long ago. (Murphy, 2005)
Instead, my modest point is that when economists such as Robert Lucas (whom Young quoted) say that a constant savings rate can only explain level effects, not growth effects, this observation does not pose a problem for Garrison and his notion of secular growth. As we have seen, the standard Solow model—calibrated with plausible parameter values—predicts that a one-time increase in the savings rate would lead to a permanently higher (but constant) level of output, but that this transition process could take decades before the bulk of the increase had been reaped. During those decades, gross investment would be higher than depreciation, such that the capital stock would grow with each successive burst of “positive net investment” (defined in the standard way that accountants and business owners would use the terms). Is this not entirely compatible with the Garrisonian framework?
Young is certainly correct when he points out that the typical neoclassical growth literature—at least with models that exclude the type of positive externalities from investment that Young believes will solve Garrison’s problem—has no room for growth in the steady state as a result of mere capital accumulation.
However, what the neoclassical economist means by “growth in the steady state” is not exactly the same concept as “secular growth” in Garrison’s framework. Now perhaps Garrison did intend to suggest that an economy could experience rightward shifts in its Production Possibilities Frontier (PPF) indefinitely, as the result of a one-shot increase in the savings rate. That would indeed be inconsistent with the neoclassical literature, and indeed would be hard to reconcile with diminishing returns and (physical) depreciation. However, in his diagrams in Time and Money as well as his PowerPoint presentations, Garrison only shows a few periods of secular growth in response to a fall in time preference, all of which is perfectly consistent with the neoclassical treatment.Even if he did not intend it, Garrison’s descriptions could understandably mislead some readers into thinking that a one-shot change in the savings rate could fuel perpetual growth, even with physical depreciation. For example, in his 2003 PowerPoint presentation on “Sustainable and Unsustainable Growth”—available at https://www.auburn.edu/~garriro/ppsus.ppt—at one point in the demonstration the slide reads: “With gross investment greater than capital depreciation, the economy experiences secular growth. This rate of growth is sustainable.” Strictly speaking, Garrison no doubt means that investments that occur because of a (one-shot) fall in time preferences, wherein gross investment exceeds depreciation, will not lead to a boom-bust cycle. However, his statement is definitely liable to lead some readers to conclude that the economy will continue this (“sustainable”) growth indefinitely, and that indeed this is the baseline of real-world economic growth upon which we add technological innovations. If that is what Garrison was trying to convey, then Young is certainly correct: neoclassical economists would argue that such an analysis ignores the straightforward implications of the standard Solow model. Specifically, if we assume diminishing returns to physical capital, and that depreciation is proportional to the stock of capital, then for fixed technology and a constant savings rate, the economy will eventually reach a “steady state” where gross investment just covers physical depreciation.
IV. CONCLUSIONGarrison’s definition of “net investment” accords with the way accountants, business people, and neoclassical economists use the term. As such, his related notion of “secular growth” will also resonate with mainstream economists. Salerno is right that Garrisonian secular growth is hard to reconcile with Rothbardian capital theory. However, perhaps the primary virtue of Time and Money is its exposition of capital-based macroeconomics in terminology and graphs that non-Austrian economists can understand. On this criterion, Garrison’s “secular growth” passes with flying colors.
There is an admitted complication that Andrew Young has brought up: a well-known result in the growth literature is that a sudden increase in the savings rate does not lead to permanently higher growth in the Solow model. However, all this means is that Garrison should be clear that his concept of secular growth is not permanent, but rather can last “only” 50 years (with plausible parameter values). This presents no problem for his book’s graphs or his PowerPoint presentations, since they only show a few years of “secular growth” where the PPF shifts outward in response to a one-shot increase in savings. There is nothing in Garrison’s exposition that depends on secular growth lasting literally forever, as opposed to (say) only 50 years.
In other words, Garrison’s treatment is entirely compatible with the neoclassical growth literature so long as he clarifies that his “secular growth” is a long-run but not an infinitely long phenomenon.
[The author thanks Joe Salerno for providing unpublished material, and William Barnett, Walter Block, Adam Martin, and an anonymous referee for feedback on earlier drafts. Alan Murphy helped derive results for the continuous-time version of the Solow model.]
Was the Potato Famine an ecological accident, as historians usually say, or a politically created one? Text version: "What Caused the Irish Potato Famine?" Narrated by Chris Calton.
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.
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The great Austrian economist Friedrich Hayek celebrated a birthday earlier this week, while the prominent monetarist (and Fed historian) Allan Meltzer passed away the same day. Joining us to discuss monetarism is our friend Bob Murphy, who lays out the central tenets of the Chicago school and its godfather Milton Friedman. At its heart, Bob explains, monetarism is a cousin of Keynesianism—one advocates fiscal stimulus, the other monetary stimulus. Both go astray when it comes to money, and both fail to see the trees in the macro forest. Bob explains why in this great discussion of the differences between the Austrian and Chicago schools.
[From the Austrian Economics Newsletter, Fall 1987.]
James McGill Buchanan is the founder of the New Political Economy called Public Choice. He had devoted his 40-year career to applying the economic tools of methodological individualism and subjectivism to the study of government and political decision making. He has made important and pioneering contributions in the areas of Constitutional Economics, public deficits and debt, the subjective nature of cost, public resource allocation and political theory. In recognition of his many contributions he was awarded the 1986 Alfred Nobel Prize in Economic Science.
Professor Buchanan, currently teaching at George Mason University, received his doctorate from the University of Chicago in 1948 where he was a student of Frank Knight. In 1957, he and Prof. Warren Nutter founded the Thomas Jefferson Center for Studies in Political Economy and Social Philosophy at the University of Virginia. Buchanan and Prof. Gordon Tullock established the Center for the Study of Public Choice and the journal, Public Choice at Virginia Polytechnic Institute in Blacksburg, Virginia in 1969. In 1982, both Buchanan and the Center relocated at George Mason University in Fairfax, Virginia.
Buchahan has authored or co-authored a prodigious 23 books. The Calculus of Consent written with Gordon Tullock, formed the foundation of Public Choice theory. Cost and Choice and L.S.E. Essays on Cost (edited with G.F. Thirlby) are influential “classics” on the subjective notion of costs. His work on government deficits and debt was capped off with Democracy in Deficit: The Political Legacy of Lord Keynes written with Richard Wagner. Also to his credit are over 300 articles and contributions to books. The following interview was conducted by Austrian Economics Newsletter editors Mark Thornton and Sven Thommesen earlier this year during Professor Buchanan’s visit to Auburn University.
AEN: Professor Buchanan, congratulations on being awarded the Nobel Prize in Economics.
Buchanan: Thank you. It is an honor that I did not expect. I had heard rumors last year that I was being considered for the Prize. However, when it was awarded to Sir Richard Stone, a man who had been retired for many years, I gave up hope of ever winning the Prize.
AEN: People have often labeled your work “normative.” Could you give us your thoughts on striking the balance between truth-seeking and advocacy?
Buchanan: I have never been especially concerned about making a sharp dividing line between what is positive and what is normative. I don’t consider myself a scientist whose task is discovering a reality that somehow exists independently of me. The model of hard sciences is not at all appropriate for economics. There is an important distinction to be made between taking an ideological position and then trying to make arguments to support that position, and on the other hand, working out the consequences of ideas and coming to an ideological position.
People do sometimes interpret my work as always being in defense of liberty. But it is less a preconceived notion and more a result of my methodology. It’s analogous to an artists that only knows and uses red paint. You should not be surprised when his paintings come out in various shades of red. Methodological individualism characterizes everything that I’ve done because I simply don’t know how to proceed with anything else, as if I only had red paint. Another artist might consciously decide to create a red painting so he goes out and buys red paint. But that is an entirely different approach.
AEN: You have made several important contributions in the area of government deficit finance. What do you think of Robert Eisner’s (recently elected President of the American Economic Association) recent work on government deficits?
Buchanan: The work itself is rather confusing. What is clear, however, is that he is an unreconstructed Keynesian and starts from a position of Keynesian advocacy of government deficit financing. He argues that deficits are not really so enormous, if we use his measure. This is a very good example of how data can be manipulated to support and prove anything. And it’s also very good evidence that econometrics doesn’t mean much.
Professors Leland Yeager and Roger Garrison have pointed out that it is insidious to use inflation as a means to argue that the deficit is not very high. You can always totally eliminate the deficit by printing enough money. By confiscating the value of assets from people who hold dollar claims you could argue that inflation has lowered the “real” value of the deficit, but it seems to me just perverse and extreme to do so.
AEN: There is a wide spectrum of subjectivism from mainstream orthodoxy to Shackle and Lachmann. Where would you place yourself on the spectrum?
Buchanan: Well, I’m certainly much closer to Shackle than I am to the mainstream. I’ve been tempted to go completely along with Shackle and become a very radical subjectivist. But I recognize that if you go all the way down that road you end up with a very nihilistic position. I’m somewhere between von Mises and Yeager on the one hand and Shackle on the other. The person who comes closest to my methodological position is Jack Wiseman.
AEN: Speaking of radical subjectivism, what do you think of the prospects of hermeneutics in the realm of economics?
Buchanan: People I respect a great deal from the German tradition, who know and work in the hermeneutics literature, are very negative on what it can offer economics. I have met some very capable people in interpretive philosophy and they do have a very convincing critique of modern science and in particular economics. But in a way, it’s very much like Shackle, if you go too far you end up with nothing. It’s not a viable independent research program.
AEN: Do you consider yourself an Austrian economist?
Buchanan: I certainly have a great deal of affinity with Austrian economics and I have no objections to being called an Austrian. Hayek and Mises might consider me an Austrian but surely some of the others would not.
AEN: You have become famous by extending economic thinking into the political arena. Other economists are also now involved in some very non-traditional areas such as experimental economics and sportometrics. Is this economic imperialism, as members of other disciplines charge?
Buchanan: Economics have moved into spheres that were previously barren, analytically and intellectually. Political Science was analytically empty before we started talking about Public Choice. The criticism leveled at Public Choice is that economic motivations have been elevated to a role of primary central importance. Well, it need not be that at all. We argue that economic interest is an important consideration of everybody who participates in a choosing role. The challenge of those who critique Public Choice is to come up with another model.
AEN: You must be very excited to see the debate on monetary constitutions growing. What would you like to see the monetary constitution look like?
Buchanan: I think we need some monetary constitution, but the choice of which one in particular is less important. If you could, in fact, have a gold coin system — pure and simple — that might be best. I confess that I simply cannot understand the Yeager-Greenfield BFH System. I have tremendous respect for Leland Yeager so there must be more to it than I have understood. Some argue that we are gradually evolving towards his system right now. Given the place we are now and the difficulty of making dynamic changes, I would prefer a commodity bundle system or a constant purchasing power dollar.
AEN: What about the problem of incentives for federal bureaucrats, and the tremendous information problem involved with the constant purchasing power dollar schemes?
Buchanan: You can design an incentive structure by indexing the salaries and pensions of the members and employees of the Federal Reserve System. Fix the salaries and pensions in nominal dollars, which would prevent them from inflation and use double indexing, so that they would lose from deflation as well.
The big problem with any of these systems is credibility, and of course, that’s the big virtue of having some kind of market money like a commodity bundle or gold. It builds in predictability. However, you can still have the credibility problem because you can’t be sure if government will leave the system alone. They have always interfered in the past. That’s also a problem with Hayek’s competitive money.
AEN: What do you see as good developments in economics?
Buchanan: I think there are many very productive developments such as the new-institutional economics, law and economics, property rights, public choice, the new economic history, and the revival of Austrian economics. All of these areas are complementary and all, in a sense, can be seen as an attack on the conventional orthodoxy.
AEN: In the past you have said that modern economics is without any ultimate purpose or meaning. Has your opinion on that changes?
Buchanan: I have been quoted as saying that economics lacks passion. In the last several decades economics has taken a scientistic, econometristic, and formalistic turn. As a result, the economics profession has been attracting students who are not driven by an underlying passion to use the science of economics for anything except intellectual tools and exercise. In my generation people who went into economics had a real passion to save the world. We were all socialists, but some of us became converts or zealots of the market order, individual liberty, and libertarianism.
AEN: Who were the influential people in your intellectual life?
Buchanan: Frank Knight was very influential as a teacher, while Knut Wickesell’s Finanztheoretische Untersuchungen (A New Principle of Just Taxation), had a tremendous impact on my career. I was not as directly influenced by Mises because I was exposed to him quite late. When I was a graduate student nobody even mentioned Mises, although Hayek’s Road to Serfdom had just been published; Hayek was notorious in a sense.
I didn’t become acquainted with Mises until I wrote an article on individual choice and voting in the market in 1954. After I had finished the first draft I went back to see what Mises had said in Human Action. I found out, amazingly, that he had come closer to saying what I was trying to say than anybody else.
[This "report" appears to have been written while Professor Raico was a university student. No date is given. The paper was found in a folder in the Rothbard Papers that included several unpublished papers by Raico.]
I. The Marxist Theory of StagesThe distinctive feature of Marxism among the socialist ideologies is its historical theory, especially the doctrine of the inevitability of socialism. Already in 1847, Marx credits the "petty bourgeois socialists like Sismondi, with having practically completed the critique of capitalism on economic grounds, and having exposed "the hypocritical apologies of economists."Marx: The Communist Manifesto, New York, 1948, p. 34. What these men had so far neglected to do was to lay bare the laws of historical development, whereby an epoch follows necessarily from the one preceding, and develops, necessarily, into the one following, until, at the end of this chain, lies socialism.
The great moving powers in history are, according to Marx, "the material productive forces," evidently meaning the sum of capital goods at any given time. To these correspond, at every stage of their development, certain "relationships of production." These relationships are "determined, necessary, and independent of human will." On this framework of property relationships there is elaborated the whole intellectual, political, and social "superstructure."Marx: Kritik der Politischen Oekonomie, Introduction, Propositions 1–3.
Throughout Marx's whole exposition of his theory, machines are assumed to be active, not passive factors. It is not surprising to find, therefore, that at some point, the "material productive forces" come to feel themselves cramped in the system of property relationships within which they had previously peacefully evolved. They fall into conflict with the old relationships, fight it out, and create new ones, more appropriate to the new, higher stage of the "material productive forces.''Marx: Kr. der Pol. Oek., Intro., Prop. 5–7.
Now, "in bold outline, one may consider the Asiatic, Antique, Feudal and Modern Bourgeois forms of production as the progressive economic forms of society."Marx: ibid., Prop. 13. At some point in history, says Marx, one mode of production, e.g., the feudal (ownership of the tools by the worker) begins to be too narrow for the means of production. "It has to be annihilated; it is annihilated."Marx: Das Kapital, Moscow, 1932. Vol. 1, p. 802.
Capitalism, likewise, carries within itself the seeds of its own destruction. Not only does the tendency toward centralization of all wealth in the hands of monopolies assure the final, natural elimination of all except one capitalist, but capitalism breeds its own grave-diggers, the proletariat. This "special and essential product of capitalism" has "been schooled, united and organized" by the bourgeoisie itself. It grows with the system of which it is the characteristic feature. Just as with feudalism, "the centralization of the means of production and the socialization of labor reach a point where they become incompatible with their capitalist shell. It is burst. The knell of capitalist private property sounds. The expropriators are expropriated."Marx: ibid., p. 303. Capitalism was the last antagonistic social form; with it ends mankind's pre-history.Marx: Kr. der Pol. Oek. Intro., Prop. 14 and 15. The class conflict, which had filled the chief chapter in the history of civilization, has ceased forever, now that the free development of each is the condition for the free development of all.
Now, it is important to realize that, not only did Marx neglect to define the most important concepts in his theory, but no proof is offered for any of his grand generalizations. Most of the Marxist philosophy of history is contained in fifteen numbered propositions in the Introduction to his Critique of Political Economy. They stand as conclusions would at the end of a long argument, only the argument is missing.
The fundamentals of the theory are open to obvious criticisms, e.g., machines are not self-creating or self-moving, but are the product of human thought and will. But we will restrict ourselves to a few observations on the idea of stages.
Why, at a certain point, must the means of production have outgrown the feudal mode of production? This assumes a steady increase in capital, which is what actually did happen, but did not necessarily have to happen, or, rather was not predetermined on account of the previous stage of capital accumulation. It is conceivable, for instance, that local wars and barbarian incursions could have kept the sum of capital at a constant level for thousands of years, and that, finally, Europe might have been entirely overwhelmed by one of the barbarian people. What actually happened was that human skill and human prudence, under favorable conditions, succeeded in so transforming the medieval economy that now one could speak of a capitalist economy.
Throughout history, the "material productive forces" have changed, and with them, the "relationships of production." That is the basis of Marx's theory. But, someday, something very curious will occur. Once socialism is established, the means of production will continue to progress, but property relationships will not. Although the foundation continues to change, the first and second stories are, apparently — for some reason — independent, and do not change accordingly. Naturally, no explanation of this contradiction is offered.
Marx's theory is put into the form of a philosophy of history because it is "scientific socialism," and value-free. Ostensibly, Marx does not say that socialism is better than capitalism; as a great scientist, he could not say that. Rather, he asserts, it is, bound to come, with "the necessity of a process of nature." His theory is, therefore, a substitute for an argument, since to say that socialism will inevitably come about because of force "immanent" in capitalism says nothing about its desirability. If we were to accept the crude set of "historical epochs" of Marx, then at one point — the transition from ancient to feudal production — society experienced a regression in the division of labor and general well-being. What is the guarantee that the transition from capitalism to socialism is not of the same type?
But, as is clear to anyone who reads the Communist Manifesto, Marx's theory is anything but scientific. It resembles less the philosophies of continual historical progress of the Enlightenment than it does the Christian view of history as the fulfillment of the scheme of salvation. Marx asserts a Garden of Eden, pre-historic society, and an original sin, the introduction of private property. The penalty for this sin is class-warfare, which is waged ceaselessly until a savior, (the proletariat) brings on a last judgment (the dictatorship of the proletariat) and paradise (naturally, socialism). Marx's whole philosophy of history is a wish-fulfillment, and is inferior even to the Christian scheme, which, at least, has had the good grace not to arrogate to itself the name of "science."
Marx, of course, knew no more of the future than any other human. His prediction of the inevitable coming of socialism is comparable to the election-eve predictions of the chairman of the national committee of a political party. It was made simply to fire the enthusiasm of Marx's own party and to shake the courage of his opponents. It has been executing both functions admirably now for more than a century.
II. The Withering Away of the StateOrthodox Marxist political theory begins by positing a definition of the State which rejects both Hegelian mysticism and liberal social theory. Marxism sees the State neither as "the image and reality of Reason" nor as the coercive instrument necessary to insure the peaceful progression of the processes of production. It is, first of all, not necessary, being according to Engels, "the product of Society at a certain stage of its development,'' and "an acknowledgement that the given Society has become entangled in an insoluble contradiction with itself, that it has broken up into irreconcilable antagonisms, of which it is powerless to rid itself."Engels: Ursprung der Familie, des Privateigentums, und des Staates, quoted by Lenin in State and Revolution, p. 10. The State is, according to Marx, and especially Engels, the organ of class domination, of the oppression of one class by another. In the ancient "gentilic'' or tribal organization, there existed an armed body of the whole population, which might redress wrongs, etc. With the break-up of Society into classes, and consequently into oppressed and oppressing groups, it became impossible to perpetuate this system, for the oppressed could obviously not be trusted with the possession of arms. The chief distinguishing characteristic of the modern State is, therefore, "the establishment of a public population no longer identical with the population,'' in the form of special groups of armed men, prisons, etc.
Since the State is the instrument of class control, the history of the class conflict has been a political one — the struggle for control of the governmental apparatus. The bourgeoisie labored for centuries to turn the State from the service of the landed feudal nobility, the result being the modern liberal state.Marx: Com. Man., pp. 10, 11. The victory of the proletariat will likewise be signaled by the capture of the government, but, "The proletariat takes control of the State authority, and, first of all, converts the means of production into State production. But by this very act it destroys itself, as a proletariat, destroying at the same time all class differences and class antagonisms, and with this also, the State.Engels: Herrn Eugen Duehrings Unwaelzung der WIssenschaft, p. 302. Between the period of capitalist state and of the communist no-State, there is the period of the proletarian state, or "dictatorships of the proletariat" that transitional period when all opposition is silenced, entrepreneurs liquidated, etc. The slogan, "withering away of the State," refers to this proletariat State; the "capitalist State" is forcibly overthrown."Engels: ibid., p. 303.
The founders of Marxism insisted that in the socialist society there would be no State: "Society will banish the whole State machine to a place which will then be the most proper one for it — to the museum of antiquities side by side with the spinning wheel and the bronze-ax."Lenin: op.cit., p. 21. Not only will the class-conflict no longer occasion the intervention of a police-force, but even isolated individual crimes will disappear, once the want and wretchedness which drove men to steal, murder, etc., is replaced by the literally unbounded wealth which socialism offers every man. The problems of the enforcement of the decrees of the Socialist production authorities is given one sentence by Engels. After asserting that the State must vanish with the capitalist order, he adds: "The authority of government over persons will be replaced with the administration of things and the direction of the processes of production."Engels: Anti-Duehring, p. 303. But things cannot be directed without directing people, and the processes of production are sets of series of acts by people. Even with the founders of Marxism, therefore, the doctrine of the "withering away of the State" is a fiction.
What remains is to show how the chief interpreter of Marxism, Lenin, and, consequently, the socialist regime in the Soviet Union, have abandoned this idea altogether.
Lenin reiterates that "excesses" will vanish with socialist prosperity. "Freed from capitalist slavery ... people will gradually become accustomed to the observation of the elementary rules of social life." As for isolated criminal acts, no special machinery is needed; the armed national will stop these, just as a crowd today will part to combatants. But what of the peculiar problems of Socialism? What is the guarantee that people will be satisfied with the portion allotted to them for consumption. The State, says Lenin, will wither away at the highest stage of Communism, when "there will be need for any exact calculation by Society of the quantity of products to be distributed to each of its member; each will take freely according to his needs." "But it has never entered the head of any Socialist 'to promise' that the highest phase of Communism will actually arrive. ... As long as it has not arrived the socialists demand the strictest control, by Society and by the State, of the quantity of labor and the quantity of consumption."Lenin: op.cit., p. 100 and 101.
The precondition for disappearance of the State is, then, an abundance which the world has not even up to this time experienced. Because of the real anarchy of production under a world Socialist regime, resulting from the impossibility of economic calculation, this precondition can never be realized. On the contrary. Each year will see increased want and misery. The most colossal State in history will be necessary to suppress the starving masses, constantly on the point of crime or revolt. No one will care that now the State is, at least, no longer the tool of the capitalist class.
Let me begin with a quote from an article that my old friend Ralph Raico wrote some 15 years ago:
Ludwig von Mises and F. A. Hayek are widely considered the most eminent classical liberal thinkers of this century. They are also the two best known Austrian economists. They were great scholars and great men. I was lucky to have them both as my teachers.… Yet it is clear that the world treats them very differently. Mises was denied the Nobel Prize for economics, which Hayek won the year after Mises's death. Hayek is occasionally anthologized and read in college courses, when a spokesman for free enterprise absolutely cannot be avoided; Mises is virtually unknown in American academia. Even among organizations that support the free market in a general way, it is Hayek who is honored and invoked, while Mises is ignored or pushed into the background.
I want to speculate — and present a thesis — why this is so and explain why I — and I take it most of us here — take a very different view. Why I (and presumably you) are Misesians and not Hayekians.
My thesis is that Hayek's greater prominence has little if anything to do with his economics. There is little difference in Mises's and Hayek's economics. Indeed, most economic ideas associated with Hayek were originated by Mises, and this fact alone would make Mises rank far above Hayek as an economist. But most of today's professed Hayekians are not trained economists. Few have actually read the books that are responsible for Hayek's initial fame as an economist, i.e., his Monetary Theory and the Trade Cycle and his Prices and Production. And I venture the guess that there exist no more than 10 people alive today who have studied, from cover to cover, his Pure Theory of Capital.
Rather, what explains Hayek's greater prominence is Hayek's work, mostly in the second half of his professional life, in the field of political philosophy — and here, in this field, the difference between Hayek and Mises is striking indeed.
My thesis is essentially the same one also advanced by my friend Ralph Raico: Hayek is not a classical liberal at all, or a "Radikalliberaler" as the NZZ, as usual clueless, has just recently referred to him. Hayek is actually a moderate social democrat, and since we live in the age of social democracy, this makes him a "respectable" and "responsible" scholar. Hayek, as you may recall, dedicated his Road to Serfdom to "the socialists in all parties." And the socialists in all parties now pay him back in using Hayek to present themselves as "liberals."
Now to the proof, and I rely for this mostly on the Constitution of Liberty, and his three volume Law, Legislation, and Liberty which are generally regarded as Hayek's most important contributions to the field of political theory.
According to Hayek, government is "necessary" to fulfill the following tasks: not merely for "law enforcement" and "defense against external enemies" but "in an advanced society government ought to use its power of raising funds by taxation to provide a number of services which for various reasons cannot be provided, or cannot be provided adequately, by the market." (Because at all times an infinite number of goods and services exist that the market does not provide, Hayek hands government a blank check.)
Among these goods and services are
protection against violence, epidemics, or such natural forces as floods and avalanches, but also many of the amenities which make life in modern cities tolerable, most roads … the provision of standards of measure, and of many kinds of information ranging from land registers, maps and statistics to the certification of the quality of some goods or services offered in the market.
Additional government functions include "the assurance of a certain minimum income for everyone"; government should "distribute its expenditure over time in such a manner that it will step in when private investment flags"; it should finance schools and research as well as enforce "building regulations, pure food laws, the certification of certain professions, the restrictions on the sale of certain dangerous goods (such as arms, explosives, poisons and drugs), as well as some safety and health regulations for the processes of production; and the provision of such public institutions as theaters, sports grounds, etc."; and it should make use of the power of "eminent domain" to enhance the "public good."
Moreover, it generally holds that "there is some reason to believe that with the increase in general wealth and of the density of population, the share of all needs that can be satisfied only by collective action will continue to grow."
Further, government should implement an extensive system of compulsory insurance ("coercion intended to forestall greater coercion"), public, subsidized housing is a possible government task, and likewise "city planning" and "zoning" are considered appropriate government functions — provided that "the sum of the gains exceed the sum of the losses." And lastly, "the provision of amenities of or opportunities for recreation, or the preservation of natural beauty or of historical sites or scientific interest … Natural parks, nature-reservations, etc." are legitimate government tasks.
In addition, Hayek insists we recognize that it is irrelevant how big government is or if and how fast it grows. What alone is important is that government actions fulfill certain formal requirements. "It is the character rather than the volume of government activity that is important." Taxes as such and the absolute height of taxation are not a problem for Hayek. Taxes — and likewise compulsory military service — lose their character as coercive measures,
if they are at least predictable and are enforced irrespective of how the individual would otherwise employ his energies; this deprives them largely of the evil nature of coercion. If the known necessity of paying a certain amount of taxes becomes the basis of all my plans, if a period of military service is a foreseeable part of my career, then I can follow a general plan of life of my own making and am as independent of the will of another person as men have learned to be in society.
But please, it must be a proportional tax and general military service!
I could go on and on, citing Hayek's muddled and contradictory definitions of freedom and coercion, but that shall suffice to make my point. I am simply asking: what socialist and what green could have any difficulties with all this? Following Hayek, they can all proudly call themselves liberals.
In distinct contrast, how refreshingly clear — and very different — is Mises! For him, the definition of liberalism can be condensed into a single term: private property. The state, for Mises, is legalized force, and its only function is to defend life and property by beating antisocial elements into submission. As for the rest, government is "the employment of armed men, of policemen, gendarmes, soldiers, prison guards, and hangmen. The essential feature of government is the enforcement of its decrees by beating, killing, and imprisonment. Those who are asking for more government interference are asking ultimately for more compulsion and less freedom."
Moreover (and this is for those who have not read much of Mises but invariably pipe up, "but even Mises is not an anarchist"), certainly the younger Mises allows for unlimited secession, down to the level of the individual, if one comes to the conclusion that government is not doing what it is supposed to do: to protect life and property. And the older Mises never repudiated this position. Mises, then, as my own intellectual master, Murray Rothbard, noted, is a laissez-faire radical: an extremist.
Dr. Tom DiLorenzo has a fantastic new book out entitled The Problem with Socialism, and his talk summarizing it was a great hit recently at Mises University. This is Tom at his best: witty and provocative, but always bravely revisionist when it comes to skewering sacred cows like welfare, minimum wage, and progressive income taxes. His book—and this talk—are a must for anyone who wants a concise and easy refutation of the enduring myths surrounding socialism.
A private graduate seminar. Recorded at the Mises Institute in Auburn, Alabama, on 28 July 2016.
The Journal of Libertarian StudiesAn Interdisciplinary ReviewVolume 16, Number 4, Fall 2002Hans-Hermann HoppeSymposium Introduction
Walter BlockHenry Simons is Not a Supporter of Free Enterprise
Murray N. RothbardMilton Friedman Unraveled
Thomas J. DiLorenzoGeorge Stigler and the Myth of Efficient Government
Gary NorthUndermining Property Rights: Coase and Becker
Joseph T. StrombergDouglass C. North and Non-Marxist Institutional Determinism
The F.A. Hayek Memorial Lecture sponsored by Don Printz. Recorded at the 2016 Austrian Economics Research Conference. Includes an introduction by Joe Salerno.
Recorded during the Authors Forum at the 2016 Austrian Economics Research Conference, Paul Cleveland (Birmingham-Southern College), discusses his recent book, The Great Utopian Delusion (Boundary Stone, 2015). Includes an introduction by Mark Thornton.
Quarterly Journal of Austrian Economics 18, no. 4 (Winter 2015): 572–577
It is a shame that most economic students, whether at the undergraduate or graduate student level, are exposed to precious little about the different schools of economic thought. Most course work is based on the “Neoclassical synthesis” with mathematical models and econometric testing being the ultimate goal.
This situation could be the simple result of competition. Some economists argue that the status quo is the result of a competition between economists in the publication market, where economists compete for journal page space and citations to their publications. Neoclassical economics won that competition and absorbed everything of value from the other schools and it only makes sense to concentrate the student’s time on the winner. In fact, most Neoclassical economists would argue that there is little in the manner of a fixed doctrine or dogma in the Neoclassical school. Just about everything is subject to questioning, change or evolution.
This weekend Jeff recaps his recent talk in Houston entitled "Socialist Left vs. alt-Right: What it Means for Liberty"— a talk which generated plenty of comments from libertarians, progressives, and the alt-Right. Jeff discusses why we should celebrate the death of supposed "democratic consensus," why the progressive left doesn't care about winning votes, how the alt-Right turns identity politics against social justice warriors, and what libertarians should learn from populism and even demagoguery.
Two noted professors on opposite sides of the cultural wars come together and engage in "cooperative argumentation." One, a "Jewish, atheist libertarian" and the other a "mixed blood American Indian" bring to the table two radically different worldviews to bear on the role of colleges and universities in studying social and ecological justice. The result is an entertaining and enlightening journey that reveals surprising connections and previously misunderstood rationales that may be at the root of a world too polarized to function sanely.
The collapse of socialism didn't deter the Marxists, who moved on to invent new rationales for their system. But David Gordon has caught up with them, and used the knife of the Austrian School to cut their theories to pieces. A masterful demonstration of philosophical technique. The book in particular addresses the arguments of the analytical Marxists: G.A. Cohen, Jon Elster, and John Roemer.
This sweeping book is a systematic treatment of the historic transformation of the West from limited monarchy to unlimited democracy. Revisionist in nature, it reaches the conclusion that monarchy, with all its failings, is a lesser evil than mass democracy, but outlines deficiencies in both as systems of guarding liberty. By focusing on this transformation from private to public government, the author is able to interpret many historical phenomena, such as rising levels of crime, degeneration of standards of conduct and morality, the decline in security and freedom, and the growth of the mega-state.
In addition, Hoppe deconstructs the classical liberal belief in the possibility of limited government and calls for an alignment of anti-statist conservatism and libertarianism as natural allies with common goals. He defends the proper role of the production of defense as undertaken by insurance companies on a free market, and describes the emergence of private law among competing insurers.
The author goes on to assess the prospects for achieving a natural order of liberty. Informed by his analysis of the radical deficiencies of social democracy, and armed with the social theory of legitimation, he forsees secession as the likely future of the US and Europe, resulting in a multitude of region and city-states. Democracy-The God that Failed is a brilliant and unflinching work that will be of intense interest to scholars and students of history, political economy, and political philosophy.
Robert Nisbet argues here that conservatism has become as corrupt as liberalism in its celebration of militarism and war and its unrelenting call for the state to monitor and regulate private life. Far from sustaining the culture, this approach to policy has debased the culture and fed an economic corruption of special-interest clamoring for privilege.
His attack on the Reagan administration goes further than most anything you read on the left side of the political perspective. He shows that conservative devotion to his presidency is nothing but a species of the dictatorship complex working itself out in democratic form. He applies the same critique to the left's love of FDR.
Austrian economists are known for supporting free markets and criticizing government intervention. In fact, many people mistakenly think of Austrian economics as nothing more than a radical defense of free markets, though it’s really a framework for studying human action and its social implications.A similar error is to describe critics of free markets as “Keynesians.”
Still, you can usually spot free market conclusions lurking in the background of Austrian work, and this raises important questions about how policy implications influence the development of theory. For example, is it possible that the need to justify free market policies distorts Austrian research? This is the argument made in a new collection of essays edited by Guinevere Nell, titled Austrian Theory & Economic Organization: Reaching Beyond Free Market Boundaries.
Nell claims that contemporary Austrian economists focus on doing research that they know will arrive at “mandatory free market conclusions.” Thus, according to Nell, their work is more about ideology than methodology, and any research questioning free market orthodoxy is shunned and dismissed.
According to Nell, the Austrian status quo must give way to a more unbiased “post-Austrian” approach to economics, especially in organization theory (the focus of this collection). Of course, not all of this book’s contributors share her views. However, most of the chapters are consistent with her goal of developing Austrian ideas without concern for making them fit free market conclusions.
In practice, this boils down to making several claims Austrians are likely to find controversial. There are variations on the core themes, but the basic ideas are as follows:
free markets produce extensive social and economic problems,government (e.g., market socialism) can be a valuable form of spontaneous order, andgovernment can improve on market outcomes, especially with regard to social justice.I’m not convinced the book succeeds in defending any of these propositions. Before explaining this assessment, however, I’d like to emphasize that this is only a short summary of some issues I noticed while reading the book. For a fuller discussion of its merits and failings, my full-length review (with additional references) is here.
To begin, the book’s core premise strikes me as flawed, because it’s not obvious to me that the eponymous free market boundaries exist, and if they do, how Austrian research has suffered from them. Now, I don’t object to posing questions about this kind of bias, because complacency and prejudice are real and constant threats to academic research. However, I do think it’s reasonable to expect that any claims of bias be supported with specific evidence, and furthermore, that critics be able to clearly explain, in detail, how bias hinders the development of current research.
Unfortunately, contributors to this volume offer precious few examples of free market bias undermining research, and when examples do appear, they’re usually mistaken. For instance, one author claims Mises and Rothbard were unable to discuss utility and welfare economics, while another suggests that cooperatives and other horizontal forms of organization can’t be explained by an Austrian approach. A basic literature review shows these claims are unfounded.
This brings me to another major theme of the collection: alternative forms of economic organization. Several chapters criticize traditional corporations, and propose replacing them with cooperatives and other “democratic” organizations. I actually agree these are topics worth exploring, as it’s clear that in a free society the role of the corporate form would be, at the very least, greatly reduced. If the authors limited themselves to discussing such problems, I would have few objections. Unfortunately, some of them try to push further by arguing that alternative forms of organization represent solutions to free market problems that Austrian economists can’t or won’t acknowledge.
In particular, several chapters seem to suggest that Austrian economics consists of little else but singing the praises of traditional, hierarchical, profit-maximizing business. I find this claim simply baffling, and unsurprisingly, the authors don’t support it with serious evidence. Even worse, most chapters ignore the most valuable Austrian contribution to organization theory: Mises’s writing on economic calculation. Mises not only provided the definitive critique of central planning; his work is also vital for showing whether any form of production — from market anarchy to totalitarian socialism — will work in practice. These forms include cooperatives, social enterprises, and many others.
Sadly, errors of omission and commission are scattered throughout the book. Unsupported assertions and missing evidence are common, as is blaming the market for public policy failures. There are even tired allusions to Hayek and the Grand Neoliberal Conspiracy™. Such comments make it clear that the chapters most critical of Austrian economics are actually the ones least familiar with it.
Happily, several chapters — in my view, the most successful ones — actually support the views Nell criticizes. These essays are presented as a kind of benchmark against which to measure the more controversial chapters, but they do a good job of showing why there isn’t much reason to fear that Austrian economics is hopelessly biased by free market ideology.
For instance, Randall Holcombe’s chapter offers a nice overview of the concept of spontaneous order, and explains why top-down methods to improve these orders are doomed to failure. Likewise, Per Bylund provides a searching essay on the necessity of hierarchy in market firms. Last, Ed Stringham and Caleb Miles review historical and anthropological evidence on the origin of states. They show convincingly that, contrary to popular belief, states did not emerge as the result of a social contract, but through a combination of force and persuasion.
Yet, each of these papers cuts against the general motivation of the book as well as its most ambitious contributions; if anything, they highlight the value and necessity of the Austrian tradition, and the persistent relevance of economists like Mises.
Philip Mirowski, known for his book More Heat than Light: Economics as Social Physics, Physics as Nature’s Economics in which he criticizes neoclassical economics for adopting methods from the natural sciences, recently published a book on neoliberalism and the economics profession during the financial crisis. In Never Let a Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown, his main thesis is that the economics profession utterly failed in predicting and explaining the financial crisis. Nevertheless mainstream economists did not suffer any negative consequences but continue with business as usual.
In Mirowski’s view, neoclassical economics, neoliberalism, and the political right came out of the crisis stronger thanks to a complicated propaganda effort and an intricate lobbying machine headed by the Mont Pelerin Society (MPS). According to Mirowski, the Mont Pelerin Society functions at the heart of a complex web of conservative and free-market think tanks and the neoliberal academics that controls politics.
Mirowski’s analysis is interesting even though it comes from a far left and egalitarian perspective. Especially pertinent is his analysis and critique of neoclassical economics.
The Lamentable State of the Mainstream Economics ProfessionThe neoclassical mainstream profession was unable to predict the Great Recession. As neoclassical economists believed in a new age of macroeconomic stability, dubbed the Great Moderation, in which central banks had basically abolished harsh recessions, they were taken by surprise by the immense problems the financial system and the world economy started to experience in 2008.
Mirowski explains this failure as the result of a methodological dead end. The neoclassical profession was unable to predict the Great Recession with their methodological instruments such as the infamous dynamic stochastic equilibrium models (DSGE). Since in the DSGE there is basically no room for crises, neoclassical economists were not only unable to predict the financial crisis, they are also unable to explain it in retrospect.
Mirowski diagnoses a cognitive dissonance in the neoclassical camp. As neoclassical theories are unable to explain the financial crisis, there is a gap between the accepted theory and reality. To bridge this gap neoclassicals have, according to Mirowski, reacted in accommodating (or distorting) the empirical evidence to fit their theories somewhat. Instead of recognizing that a paradigmatic change is necessary in mainstream economics, the economics profession stubbornly sticks to their mathematical models.
Mirowski describes accurately the inertia of mainstream orthodoxy. Sunk costs of intellectual capital investments for neoclassical economists are enormous. The profession remains without orientation and vision, stumbles, and stagnates in mediocrity. Indoctrination propagates the orthodoxy. Students are socialized with economics textbooks using an incoherent potpourri of theories. They are made to read short-lived articles published in highly ranked journals using mainstream methodology. In this context, Mirowski points to the fact that journals in general have stopped publishing articles on methodology and economic history in favor of mathematical and statistical articles. Mirowski correctly connects the mathematization with the incorporation of natural scientists into economics and regards this development as one reason for the financial crisis.
The Methodology ProblemMirowski criticizes neoclassical methodology arguing that economists envy the physical sciences. Due to this envy, economists started to imitate the method and models of physics. It was the mathematical approach used in physics that made neoclassical economists unable to foresee the crisis. Mirowski’s critique does not shy away from leftist neoclassical economists. Consistent in his approach he not only chides Greenspan and Bernanke, but also Stiglitz and Krugman. While there may be ideological differences between them, they all employ DSGE models in which a representative agent maximizes utility functions.
According to Mirowski it was the DSGE model that allowed for the unification of economics again after microeconomics had been separated from macroeconomics due to the Keynesian revolution. DSGE models allowed employing the mathematical approach of microeconomics in the macrosphere by introducing utility maximizing agents and high aggregation. Mirowski goes so far as to say that without DSGE, neoclassical economics disappears.
While Mirowski calls for a reset of economics and the end of the neoclassical paradigm, he fails to provide an alternative, and he does not seem to be aware of the praxeological approach of the Austrian school. The realistic alternative Mirowski calls for already exists. He is also unaware that due to their realistic approach, Austrian economists were not surprised at all by the financial crisis, which was predicted by some of them. Unfortunately, the ignorance of Mirowski concerning the Austrian school is immense as we will see in his interpretation of Hayek and his complete neglect of the works of Ludwig von Mises and Murray Rothbard; not to speak of his neglect of contemporary Austrians.
Mirowski’s Confusion About Schools of ThoughtThe main problem of Mirowski is his confusion when it comes to the Austrian school and libertarianism. Mirowski regards most neoclassical economists as neoliberals (with some exceptions on the left such as Stiglitz or Krugman). Implicitly he also incorporates the Austrian school in the neoliberal camp. He even writes about “Hayekian neoliberals.” Yet, Austrians are neither neoclassical nor can many be considered to be neoliberal.
It is true that in some parts of his book Mirowski distinguishes between neoliberal versus libertarian, and neoclassical versus Austrian, but he does not apply this distinction consistently. This lack of consistency produces curious results.
For instance, he argues that Chicago’s efficient market hypothesis (EMH) formalizes Hayek’s theory of knowledge. This seems to imply that Hayek, or other Austrians, share the method of neoclassical economists, and belong to one and the same neoliberal camp.
Nothing could be further from the truth. Hayek’s theory of subjective knowledge treats knowledge as being tacit, private, subjective, and decentralized. Hayek’s treatment of subjective knowledge is fundamentally opposed to any mathematical or formalized treatment of information. More specifically, the creative nature of entrepreneurial knowledge in the Austrian tradition contrasts with the objective and given type of information of the EMH.
The EMH states that market prices are efficient as they incorporate all relevant information and assumes an objective kind of information that can be bought and sold on the market place. Yet, what is important is not the objective and given information, but rather the subjective interpretation thereof and the creation of new entrepreneurial knowledge in a dynamic process. Past prices are just historical exchange relationships that serve market participants to create new information. Mirowski distorts Hayek by stating that according to Hayek the market transmits the knowledge of what we need to know. Instead Hayek pointed out that market prices allow us to use the subjective knowledge of other market participants. The market does not automatically transmit the knowledge that we need to know, rather market participants need to discover and create what they need to achieve their ends.
There are additional problems with Mirowski’s mixing of subjectivism and Hayek’s theory of knowledge with EMH, CAPM, and the Black-Scholes model. There is nothing subjectivist in an equilibrium construct such as the EMH, the CAPM; or Black-Scholes. In all these mathematical models all relevant information is already given. They are static. Mirowski simply misses Hayek’s main point that entrepreneurs in a competitive market process discover new information. As the market is a process, the market is never perfect. Market participants may err or fall prey to illusion; Mirowski’s whole book is a prime example for that.
Another curious result from Mirowski’s failure to distinguish clearly between the Austrian school and neoliberals comes when he deals with constructivism. Mirowski regards neoliberals as constructivist. At the same time Mirowski includes Hayek in the group of neoliberals (and one might wonder the whole Austrian school) and tries to reconcile Hayek’s criticism of constructivism with neoliberalism. But how can Hayek, who has fought most vigorously against scientism and constructivism in the twentieth century, be a constructivist?
Austrians vs. ChicagoansThe implicit mixing of the Austrian and Chicago schools is especially problematic. Mirowski claims that neoliberals subscribe to the concept of the spontaneous order. Yet, the spontaneous order is a concept employed mainly by Hayek and other Austrians. In contrast, neoliberals of the Chicago school use the equilibrium construct as an analytical tool. Yet, equilibrium analysis is fundamentally opposed to the Austrian school’s analysis of the dynamic market process. In short, neoliberals of the Chicago school do not employ the concept of spontaneous order consistently.
Writers such as Mark Skousen (2006) have tried to bridge the gap between the Chicago school and the Austrian school. Yet, this endeavor is an impossible undertaking. The main and fundamental difference between the two schools of thought is their methodological approach. Austrians in the Misesian tradition logically derive a priori economic laws from the axiom of human action with the help of some general presuppositions. Instead of making experiments and looking into the outside world, they look inside using introspection to find truth.
In contrast, Chicago school economists following Milton Friedman (1953) employ a positivist methodology. While Austrians maintain that one needs a theory first in order to understand history, followers of the Chicago school try to derive economic laws from history; sometimes applying econometric analysis. While scholars in the tradition of the Austrian school view reality as a dynamic process of human interaction, Chicago scholars employ equilibrium models, in which entrepreneurship and creativity are absent by definition and the dynamic market process is frozen. While Austrian economists regard the aim of an economist to understand and to explain the laws that govern the dynamic market process, Friedman’s aim is to make correct predictions. While Austrian economists aim at a realistic explanation of the market process, for Friedman realism of the assumptions is irrelevant. Only the predictive power of a theory counts.
In his book, Mirowski criticizes Friedman’s approach stating that model building for predictions has been a disastrous failure, an assessment many Austrians would share. Unfortunately, Mirowski fails to mention Austrian methodology in his book and seems to be unaware of this alternative defended by many members of the “neoliberal” MPS.
Directly related to these methodological differences between Vienna and Chicago is the opposed view on competition. While Chicago scholars tend to support and devise antitrust laws in order to bring reality closer to their model of perfect competition, Austrian scholars oppose the intervention of the government into the dynamic market process in the form of antitrust laws.
The high aggregation required by model building and mathematization has also lead to directly opposed views on capital by both schools. Capital, which is presented by the letter “K” in Chicagoite models, is viewed as a homogenous, permanent fund that synchronously and automatically produces income. The view of capital as a homogenous fund and production as instantaneous is a direct consequence of the mathematization and formalization of the Chicago school.
The Austrian view on capital is fundamentally opposed to the neoclassical one. Indeed, there was an intense debate between Chicago and Vienna on the concept of capital. Friedrich Hayek (1936) and Fritz Machlup (1935) criticized Frank Knight for the meaningless concept of capital as a homogenous, automatically self-maintaining fund. Austrian capital theory and the view of production as a time consuming process allowed Austrian economists to develop a theory of intertemporal distortions in the structure of production induced by credit expansion unbacked by real savings. Austrian business cycle theory is commonly not understood by the Chicago school as neoclassical economists lack the necessary theoretical instruments; instruments they are unable to develop with their methodological approach.
Explaining Booms and BustsConsequently, the interpretations of the Great Depression (and the Great Recession) by Austrians and Chicagoites differ widely. The Chicago school, following Milton Friedman and Ana J. Schwartz, maintains that the severity of the Great Depression was due to errors committed by the Federal Reserve. More precisely, the Federal Reserve according to Friedman and Schwartz did not expand the monetary base fast enough during the early 1930s. Following the Chicago interpretation, Ben Bernanke (2002) promised Milton Friedman not to commit the same mistake again, which explains the Federal Reserve’s reaction to the Great Recession in the form of Quantitative Easing.
In contrast, Austrian business cycle theory explains the Great Depression by the extraordinary credit expansion of the 1920s. Reinflating the money supply, in the Austrian view, disturbs the necessary readjustment as it stabilizes artificially old malinvestments and stimulates additional ones. Austrians explain the severity of the Great Depression by the size of the credit expansion in the 1920s and the concomitant malinvestments as well as the government interventions introduced in the 1930s such as the Smoot-Hawley Tariff Act or the New Deal in general.
Austrian economists were not blinded by the apparent price stability in the early 2000s. In fact, Mises and Hayek warned against policies of general price level stabilization hailed by Fisher and other monetarists. In times of economic growth such policies require the continuous injection of new money which is the source of intertemporal distortions. Due to their business cycle theory, Austrians were not taken by surprise by the financial crisis in contrast to Chicago economists. The same is true for the years leading to the Great Recession. Thus, Mirowski is just plain wrong with his sweeping statement that the (whole) economics profession did not foresee the financial crisis. It is true that neoclassical economists due to their methodological approach could not develop the theoretical tools necessary to understand the problems of the ongoing credit expansion of the early 2000s. In contrast, Austrian economists had those tools.
Unsurprisingly, another main area of disagreement between Chicago and Vienna, which Mirowski does not explain, is on monetary policy. Most Austrians favor the abolition of central banks and the introduction of a free market money, such as a 100 percent gold standard. Chicago school economists generally do not want to entrust the money supply to the market but are in favor of a central bank issuing fiat money. Central planning in money is not seen as a problem, but as a solution to crisis in the banking sector by defenders of the Chicago school.
Mirowski does not touch upon all these fundamental differences. He is correct, when he points to the central bank correctly as a neoliberal institution. Yet, he also claims that the Tea Party in the US is basically a neoliberal group. Later in the book he states that Ron Paul wants to abolish the Federal Reserve. Mirowski also mentions that Ron Paul is in the tradition of Hayek who is in favor of free banking. However, Ron Paul is regarded to be close to the Tea Party. The reader remains confused. Why would a hero (Ron Paul) of a neoliberal group (Tea Party) want to abolish a neoliberal institution (Federal Reserve)?
We are faced with another apparent contradiction caused by not distinguishing clearly between Austrians and Chicagoites or neoliberals and libertarians. If Mirowski had explained that Ron Paul is a follower of the Austrian school, it would have been no surprise to the reader that he opposed the Federal Reserve. But Mirowski just states that Bernanke sides with the neoliberal position of Milton Friedman. He simply fails to understand that Chicagoites and Austrians are diametrically opposed on fundamental questions and that it is a fallacy to consider them as ideologically and methodologically close.
The Origins of Mirowski’s ConfusionWhere does Mirowski’s confusion stem from? Why does he not clearly differentiate between the Chicago and the Austrian school?
There are basically three reasons that may have contributed to this confusion. First, the Austrian school and the Chicago school share many free market ideas. Members of both schools generally oppose price controls, product regulation, and the public provision of education services. Yet, as we have pointed out above, differences abound. The Chicago school supports central banking and antitrust, while the Austrian school does not. If Mirowski had looked into the libertarian positions many Austrians hold, he would have recognized that most Austrians are wide apart from the neoliberal positions of Chicago.
Second, Hayek became a professor at the Univeristy of Chicago in 1950. Yet, the location of Hayek at Chicago does not imply that he was close to Chicago school ideas. In fact, Hayek became professor at the Committee of Social Thought in Chicago, because Chicago economists had opposed his appointment at the economics department. This is understandable as Hayek was very critical of the positivistic approach that Chicago economists followed.
Third, the most likely cause of confusion stems from Mirowski’s treatment of the Mont Pelerin Society where Austrians and Chicagoites often meet together. From the very beginning, starting with the 1947 founding meeting of the Mont Pelerin Society, there were three main schools of thought that were represented: the Austrian school, the Ordoliberalism, and the Chicago school. Mises and Hayek from the Austrian school, Walter Eucken and Wilhelm Röpke were Ordoliberals, and George Stigler, Frank Knight, and Milton Friedman from the Chicago school.
Both the Chicago school and the Ordoliberal school can be classified as neoliberal. They oppose socialism, but also Manchesterism, i.e., they oppose the laissez-faire approach of classical liberalism. Both Ordoliberals, mainly located in German speaking countries, and the Chicago school favor a strong state to set the framework for the market and direct economic life in certain directions. They also want the state to provide some social security.
There has been tension from almost the very beginning between Austrians and neoliberals within the Mont Pelerin Society. As Mises wrote in the 1950s: “I have more and more doubts whether it is possible to cooperate with Ordo-interventionism in the Mont Pelerin Society.”
In retrospect and from the point of view of the Austrian school, it may be regarded indeed as a strategic error to found an alliance with the Chicago school and other neoliberals within the Mont Pelerin Society. As Austrians and neoliberals are united in the Mont Pelerin Society, authors like Mirowski tend to conflate neoliberalism with libertarianism and Chicago positions with Austrian ones. Instead of treating neoliberals as friends with a common cause, Austrians could have fared better by regarding neoliberals as enemies of their enemies; namely of full-blown socialism. Austrians could have made their ideological and methodological differences much clearer in a Mont Pelerin Society dominated by themselves and excluding Chicagoites and other neoliberals. Most of the attacks from Mirowski against the economics profession per se or against liberalism would have lost credibility. Then Mirowski would have had to direct his criticism only against the Chicago school and neoliberals.
This article was adapted from Philipp Bagus’s article “Why Mirowski Is Wrong About Neoliberlaism and the Austrian School.”
Merry Christmas and Happy Holidays from everyone here at the Mises Institute!
As an exciting year comes to a close, we want to thank all of our incredible members that allow us to do the work we do in advancing Austrian economics, freedom, and peace.
In honor of the season, John Denson joined Jeff Deist for a special episode of Mises Weekends to discuss the Christmas Truce. This incredible moment during World War I, often completely ignored by historians, is a wonderful celebration of the human spirit — even in the darkest of times. We hope you and yours will enjoy this extraordinary testament of the power of the Christmas season.
And in case you missed any of them, here are this week’s featured Mises Daily articles, some of our most popular articles at Mises Wire, and some holiday selections from the Mises archive:
Half of Britain Wants To Leave the EU by Ryan McMakenWhy Capitalists Are Repeatedly "Fooled" By Business Cycles by Frank ShostakGet More Bang for Your Buck by Jeff DeistThere's No Such Thing As a Neutral Government by David GordonPoland, Free Markets, and the Eurozone by Mateusz MachajA Will To Peace by John V. DensonIn Defense of Scrooge by Michael LevinA Capitalist Christmas by Dale SteinreichSimple Economic Truths for Entrepreneurs by Per Bylund
[This article appears in the November–December 2015 issue of The Austrian.]
Peter Simpson is a distinguished classicist and philosopher, known especially for his work on Aristotle’s ethics and politics. (He is also, by the way, a mordant critic of Leo Strauss and his followers.) In Political Illiberalism, he poses a fundamental challenge to philosophical justifications of modern liberalism, culminating in the vastly influential Political Liberalism (1993) of John Rawls. Though Simpson cannot be classed as a libertarian, his bold arguments will be of great use to all of us who, like Lew Rockwell, are Against the State.
According to a familiar tale, states before the inception of liberalism in the seventeenth and eighteenth centuries were fatally flawed. They sought to impose on their subject populations a political and religious orthodoxy. The Protestant Reformation brought some progress, but all too often, control by the monarch replaced dominance by the Catholic Church. Premodern illiberal states “taught and imposed on society a distinctive view of the good life. … Those who disagreed with this view of religion imposed by the state had to be resisted or expelled or incarcerated or killed.”
What was the distinctive contribution of liberalism? According to this view, the state must not rule on the basis of what Rawls calls a “conception of the good.” By this he means a comprehensive view of the good life for human beings. Religions are prime examples of conceptions of the good, but not the only ones. The all-embracing theory of life taught in Soviet Russia in the glory days of Lenin and Stalin would be a secular example of what liberalism deplores and seeks to eradicate.
Instead, liberals maintain, the state must remain neutral in the battle between such competing conceptions of the good. People must be allowed to work out their own salvation, religious or secular, as their own consciences dictate.
The recent Rawlsian account of liberalism rests itself on a notion of a neutral core of morality … which all such visions [of the good] are supposed to be able to accept and live by. … The core morality sets down conditions of respect and tolerance that, while permitting each person to pursue their vision as they wish, forbids them so to pursue it so they forcibly prevent others from pursuing other visions.
What is wrong with that? Is it not simple common sense? Who can reject freedom of conscience? Simpson exposes a crucial weakness in this seemingly impregnable argument for liberalism. The supposedly neutral state does not ensure freedom of conscience. It itself imposes its own ideology, namely liberalism, on everyone. The state is not an impartial umpire, standing above competing conceptions of the good: it is a powerful and malevolent force.
The paradox is that while liberalism claims to free people from the oppression of states that impose on everyone the one true doctrine espoused by the state, liberalism itself imposes on everyone such a doctrine: namely liberalism itself. … All those in professedly liberal states who, for whatever reason, do not accept the liberal doctrine, or are suspected of not doing so, become enemies of the state. … The liberal state has proved itself as ruthless against its opponents as any illiberal state is supposed to have done.
Even if Simpson’s argument is right, though, is there not an obvious objection he must confront? Is it not better to have a “neutral” state, which at least professes the ideal of freedom of conscience, than an avowedly ideological state that openly demands conformity?
Simpson has a brilliant response to this objection. The state is not necessary at all. To the contrary, he says, the state is an invention of the modern world. In what sense is this true? Simpson has in mind Max Weber’s famous definition of the state as an organization that claims a monopoly on the legitimate use of force.
Note, too, the novelty of this idea, for what Weber brings to our attention … is the difference between what existed before and what exists now. Before the modern emergence of the state, no institutional structure had a monopoly of coercive enforcement.
In past times, people to a large measure protected their persons and property by their own efforts.
One sign of the accuracy of Weber’s definition [of the modern state] is the absence of organized police forces in the pre-modern world. … The functions we now depute exclusively to the police were performed previously by the citizens, who relied on themselves and their relatives and friends for the enforcement of rights and for defense and protection.
In the face of the tyrannical contemporary state, Simpson places special emphasis on the private ownership of guns.
Weapons of self-defense … and nowadays primarily guns, belong naturally to the family. … By the situation of present times, the first defense is against the state. … Weapons, therefore, naturally belong in the hands of the people, and it is intrinsically unjust for any higher authority to confiscate or forbid them.
The monopoly state, supposedly needed to protect us, harms rather than benefits us. The record of the state is no better in foreign affairs. The modern liberal state has brought death and destruction, far more than it has protected us from foreign invaders.
One cannot even say that it was the totalitarian and not the liberal version of the state that caused total war. In the world wars of the twentieth century that were fought between liberal and totalitarian states, the liberal states caused at least as much death and destruction as the totalitarian ones, and these liberal states also pursued war when the totalitarian ones would have preferred peace. … So how, then, is liberalism better as regards war, since all systems will fight when they think they must? The only difference seems to be that liberalism will fight total wars, while most of these other systems will not be able to, which is an argument against liberalism and the state, not for them.
In his account of the rise of the state and the ideology that purports to justify it, Simpson brings to the fore the philosophy of Hegel, who remarked that the state “is the march of God in the world.” I would add to Simpson’s fine discussion that Hegel, incredibly, regarded the decline of the “divided conscience,” when the Church was an independent source of authority apart from the monarch, as a part of the growth of freedom. Now people were “free” to obey the state, without the distraction of a competing authority.
Simpson applies his anti-state perspective to American history. He does not view the Constitution with favor. Its adoption was a coup for centralizers and a blow against the dispersal of power.
The Constitution, therefore, makes two different changes [from the Articles of Confederation] at the same time: from a league to a national government and from a congress of delegates to a congress of individuals whose collective power, because it is the coercive power of the state and because in extremis it is unlimited, amounts to autocracy or despotism.
Simpson highlights to great effect the warnings of the Anti-Federalists against the potential for tyranny inherent in the Constitution.
The Anti-Federalists knew far more about political realities than the Federalists did, or at least that the Federalists admitted (for one may suspect that the actual results that the Ant-Federalists foresaw and feared were foreseen and perhaps in part welcomed by the Federalists).
As mentioned earlier, Simpson is no libertarian; and Austrians and libertarians will differ with some of his remarks about the economy. It is all the more remarkable, then, that Simpson’s views on the state converge so substantially with views that we at the Mises Institute have long defended. In our efforts to do so, we now have the help of the arguments of this original thinker and distinguished scholar.
We are now living in a post-ZIRP world. On Wednesday, Janet Yellen announced that the Federal Reserve will increase the target Federal Funds rate from 0.00-0.25 percent up to 0.25-0.5 percent. While Wall Street approved of the move, Ryan McMaken notes, “The fact that this is being labeled such a large change underscores just how fragile the current economic ‘recovery’ is.” Indeed, the new Fed target would itself have been unprecedentedly low if it had occurred prior to 2008. Bottom line, the Fed still hasn’t learned its lesson on interest rates.
What does this mean going forward? Well, while Austrians have long been calling for higher interest rates, the Austrian business cycle theory makes clear that any transition to what was once considered the monetary status quo is likely to cause economic pain. As Robert Murphy illustrates in his response to advocates of Market Monetarism:
[A]fter a credit-fueled boom, the precise timing of the crash will probably occur when the central bank “tightens. … Ultimately, the only way to prevent painful busts is to
Mises Weekends this week features a lecture from Dr. Murphy on what makes the Austrian approach to economics stand apart: its focus on human action.
It's this foundation in methodological individualism that has made Austrian economics an indispensable part of a consistent defense of liberty. If you’re interested in building upon your understanding of praxeology and the economic insights of Menger and Mises, this is an episode you won’t want to miss.
And in case you missed any of them, here are this week’s featured Mises Daily articles and some of our most popular articles at Mises Wire:
Why Doctors Are Entrepreneurs by Dr. Michel AccadThe Dreary Utopia of the Socialists by David GordonLudwig von Mises Is Winning by Tho BishopDid "Tight" Fed Policy Cause the Financial Crisis? by Robert MurphyTechnology and Government Shouldn't Mix by Benjamin M. WiegoldNo, There’s No Economic Case for the Minimum Wage by Per BylundAre Entrepreneurs Naturally Talented, or Just Hard Workers? by Matt McCaffreyThe Diabolical Side of ZIRP by Mark ThorntonMises Institute Ranked 9th Most Influential US Think TankMises Brasil Parabéns Pelo Trabalho Bem Feito! by Joseph SalernoTrue Money Supply Growth Rises Slightly to Eight Percent in November by Ryan McMakenLudwig von Mises is the Most Searched Economist in Brazil by Tho BishopThe Fed Still Hasn't Learned Its Lesson on Interest Rates by Troy VincentStudents Forget About Keynes In The Summer by Jonathan NewmanWith Few Gun Laws, New Hampshire Is Safer Than Canada by Ryan McMakenThe Stock Market Reacts to the Fed’s Interest Rate Hike by Randall G. HolcombeFed (Slightly) Raises Target Fed Funds Rate After Seven Years by Ryan McMakenSEC Approves Patrick Byrne’s Plan to Issue Stock Via Blockchain by Tho BishopThe Absurdity of Negative Interest Rates by Paul-Martin FossCato on the Basic Income by David GordonMartin Shkreli To Learn a Hard Lesson? by Ryan McMakenThe Bill of Rights: The Only Good Part of the Constitution by Ryan McMakenThe Fed Can Do Real Damage Without Even Trying by Jonathan NewmanSo Much for "Rules-Based" Policy at the IMF by Paul-Martin Foss
Jason Brennan, a remarkably prolific libertarian political philosopher, has a good eye for the essence of an argument. He puts this ability to effective use in Why Not Capitalism? In the book he challenges the defense of socialism in Why Not Socialism? by G.A. Cohen, whom Brennan rightly considers “the leading Marxist philosopher — and one of the leading political philosophers, period — of the past 100 years.”
At first, one might think that arguments in political philosophy over the merits of socialism and capitalism have no importance. If by socialism one means collective ownership or control of the means of production in a large-scale economy, there is nothing to debate. Mises and Hayek showed with the socialist calculation argument that socialist planning “cannot work, even if people were motivated to make it work, because planners do not have a workable substitute for prices.” If socialism cannot work, what is the point of comparing its ethical merits with its capitalist rival? Unless we desire economic chaos, socialism must be rejected and the free market affirmed.
Mises viewed matters in exactly this way. Before his calculation argument, the most effective challenge to socialism appealed to incentives. If people were not allowed to profit from their productive endeavors but were instead subjected to egalitarian imperatives, they would lack motivation to work. Socialism was incompatible with human nature. Mises thought that socialists could answer that the limits of current human nature might be overcome. They could not respond in this way, he thought, to the calculation argument. Once we grasp that socialism is impossible, there is no further room for philosophical discussion.
Cohen recognized the force of the economic argument that socialism cannot work, though he implausibly hoped that future developments in technology might alter the situation. He did not agree, though, that this renders otiose comparison of the ethical merits of socialism and capitalism. We can ask, “If socialism is unrealizable, is this a matter for regret? Is socialism ethically better than capitalism?” Cohen says that it is, and this is what in Why Not Socialism? he endeavors to show. Cohen believes that “even if socialism were infeasible, it would remain intrinsically desirable and the best way for us to live together.”
Cohen carried out his ambitious project by telling a story. It portrays people on a camping trip, who view their excursion as a common enterprise. They share in the work of the trip according to their abilities and do not demand extra benefits because of greater talent. Equality and community are their governing values. “The principle of socialist equality of opportunity eliminates all inequalities resulting from undeserved advantages or disadvantages … the campers also abide by a socialist principle of community. The campers care about one another, and care that they care about one another.”
Not so under capitalism. Here self-interest rules: people produce for the market in order to earn a profit, and the more profit the better. The drive to accumulate, not equality and community, governs society. Cohen would apply to capitalism Wordsworth’s familiar lines: “The world is too much with us, late and soon; Getting and spending, we lay waste our powers. … We have given our hearts away, a sordid boon!”
Brennan accepts the ground on which Cohen has laid out his challenge. Ideal theory, i.e., asking what is best without regard to feasibility, is indeed relevant, and Cohen’s question is a good one that does not go away when one accepts that socialism cannot be put into practice.
Precisely in the domain of ideal theory, though, Cohen has fallen into error. He compares socialism as an ideal with actually existing capitalism. Community and equality are more valuable than greed; hence the superiority of socialism to capitalism. This will not do, counters Brennan. Ideal socialism must be compared with ideal capitalism, not actually existing capitalism. “The problem is that Cohen is not comparing like to like. … It’s not that interesting if an idealized version of one type of regime ends up being better than a non-idealized, realistic version of another type of regime.”
To bring home the force of his objection, Brennan ingeniously parodies Cohen’s argument. He constructs a capitalist utopia, which he calls the Mickey Mouse Clubhouse Village. The residents of the village pursue creative projects, which often involve the use of private productive property, as they see fit. If, as a result of these projects, some are wealthier than others, this arouses no envy. The villagers are not selfish, but devoted to one another’s welfare. If someone is in need, his neighbors will rush to his assistance. He contrasts his utopia with actually existing socialism, characterized by mass murder and brutal dictatorship. Is not capitalism far better than socialism?
This, it needs to be said, is not Brennan’s actual argument for capitalism; it is, as already mentioned, a parody. It brings out very well the flaw in Cohen’s argument; to compare an ideal system with a non-ideal system is fallacious. Ideal must be compared with ideal, and real system with its counterpart real system.
What is the result of such comparison? Brennan holds that capitalism wins on both counts: its ideal is better than the ideal of socialism; and, to descend to the real world, the issue does not admit of doubt at all.
I think that Brennan is right: his village is indeed better than Cohen’s camping trip. But why should we think so? It may be that he wants us to take it as intuitively obvious that his ideal is better. One has only to consider the two ideals carefully to see which one gains the victory. If this is his line of thought, I should certainly assent to its conclusion; though Cohen would no doubt demur.
I suspect, though, that Brennan wishes to go beyond an appeal to moral intuitions; and, if I have correctly understood what he has in mind, I am not sure he is right. He may be arguing in this way: “My utopia includes the good features of Cohen’s and other goods as well. Just as in Cohen’s camping trip, the residents of my village care about one another and value community. But to altruism, creativity is added: the residents are devoted to their individual projects and pursue them without let or hindrance. On the principle that more goods are better than fewer, so long as the goods do not interfere with each other, is not my utopia better?”
Here Cohen would likely respond that Brennan’s utopia does not include all the values he deems of supreme importance. True enough, the residents of the village are devoted to each other; but they do not insist on equality. To the contrary, they willingly accept inequality, if such be the outcome of their various creative projects. For Cohen, though, the value of creative work is subordinate to the goods of equality and community, as he makes clear in his discussion of choice of jobs in his magnum opus, Rescuing Justice and Equality. If you are really committed to equality, he thinks, you may not always be able to engage in the work you like best. Again, I much prefer Brennan’s values to Cohen’s; but the argument from inclusion does not show that Brennan is right.
I suspect, though, that Brennan would give more weight to another argument. He has been much influenced by the third part of Robert Nozick’s great work Anarchy, State, and Utopia; and like Nozick, he stresses that the free market utopia is a “‘framework’ in which many different utopias could co-exist in peace and mutual respect.” Within this framework, groups of people are free to organize as they wish, so long as they commit no rights violations. If so, then a different version of the argument from inclusion shows the superiority of Brennan’s utopia. In it, those who agree with Cohen on the place of solidarity and equality in the hierarchy of values would be free to form a community as they deem best. Those who do not accept Cohen’s values would form communities of their own, in multifarious ways. Once more, then, does not the capitalist utopia include all the goods of Cohen’s, as well as others?
But again Cohen would not be satisfied. He does not think people should be forced to accept his egalitarian values; but, if they do not, he thinks that they will have chosen wrongly. Faced with the meta-utopia of Nozick and Brennan, he would say that all those not resident in an egalitarian community should forthwith join one.
Those of us who do not share Cohen’s intuitions will of course disagree; and I think that we can go further. Is Cohen’s ideal egalitarian system better than capitalism in the actual world? The latter should be characterized not as totally driven by the desire to accumulate, as Cohen’s Marxist myth has it, but rather by a mix of motives. The question will not here be pursued, but I am convinced the answer is that it is not. Cohen’s utopia strikes me as a most unpleasant place in which to live, with people constantly looking over their shoulders, lest they surpass others in wealth; but readers must judge for themselves.
Not content with one argument against Cohen, Brennan offers another; here he follows the political theorist Sharon Krause. Why should we think that the ideal system Cohen depicts has anything to do with socialism? In socialism, the means of production are centrally owned; but this tells us nothing about the values that prevail under this arrangement. In particular, socialism must not be equated with “moral virtue or community spirit.” (Brennan’s utopia escapes a parallel observation, because in it, individuals are explicitly allowed to own productive resources.) If so, Cohen has not succeeded in showing that, from the viewpoint of ideal theory, socialism is better than capitalism. He has not compared capitalism with an alternative economic system, whether ideal or actual. If this is right, Cohen has failed to show the moral superiority of socialism to its capitalist rival; but neither has Brennan shown, by his comparison of the Mickey Mouse Clubhouse Village to Cohen’s camping trip, that ideal capitalism is better than ideal socialism. Brennan has described an ideal capitalist system, but it has not been compared to a socialist alternative. On this construal, Brennan’s portrayal of the village is best taken as a challenge to practitioners of socialist ideal theory to construct an ideal that is both better than the village and recognizably socialist.
Finally, it is worth pointing out that Cohen has wrongly converted an advantage of capitalism into its prime defect. In a famous passage from The Wealth of Nations, quoted by Brennan, Adam Smith says that “It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest.” Smith’s point was that the free market does not depend on benevolent behavior. Altruism is a scarce resource, and the market can function well even if it is in short supply. In trying to make a profit, capitalists produce what people want. Cohen unfathomably is repelled by this, wrongly taking it to be an endorsement of greed.
Why Not Capitalism? is an outstanding contribution to political philosophy. It will delight libertarians and will instruct socialists willing to read it with an open mind, though I fear that their number will be few.
In the first volume (Economic Thought Before Adam Smith), Rothbard traces the history of economics from the ancient Greeks to Adam Smith; and in the second volume (Classical Economics), he discusses British classical economics, the French school of classical liberalism, and Marxism.
Narrated by Jeff Riggenbach. The full text is available online here.
Download the complete audio book (two volumes, 62 MP3 files) in one ZIP file here. This audiobook is also available on Apple Podcasts (Volume 1, Volume 2), Google Podcasts (Volume 1, Volume 2), and via RSS (Volume 1, Volume 2).
On Wednesday, the Federal Reserve once again reaffirmed its zero-interest rate policy. Amusingly, this commitment to the monetary status quo is being seen by some as “hawkish” which, as Ryan McMaken points out, “shows just how much the goal posts have been moved in recent years.” Unfortunately all the spin and promises of future rate hikes doesn’t change the fact that we are nearing the seven year anniversary of ZIRP with an economy Janet Yellen doesn’t think is strong enough to survive the reversal of the Fed’s monetary morphine. Hopefully our central bankers will one day realize their war on deflation is leaving us poorer, but in the meantime — at least we can laugh about it.
In this edition of the Mises Weekends, we have the third in our series on the current state of healthcare. Our first episode featured Charles Hugh Smith who discussed the consequences of a healthcare market taken over by government regulators and insurance lobbyists. Our second featured Dr. Michel Accad giving his perspective as a practicing doctor in a post-Obamacare world. This week, Robert Murphy discusses his new book, The Primal Prescription, which he co-wrote with Dr. Doug McGuff. Murphy not only applies his understanding of Austrian economics to highlight the problems plaguing us today, but offers advice on how to navigate through the current state of American healthcare.
In case you missed any of them, here are this week’s featured Mises Daily articles and some of our most popular posts at Mises Wire:
The Fed Can’t Raise Rates, But Must Pretend It Will by Thorsten PolleitRobert Shiller Imagines What Consumers Should Want, While Ignoring What They Do Want by G.P. ManishThe War on Cars Is a War on Workers and the Poor by Gary GallesToday's War Against Deflation Will Make Us Poorer by Frank ShostakThe World Bank Threatens Free Markets in Peru by Simon WilsonIf Sweden and Germany Became US States, They Would be Among the Poorest States by Ryan McMakenThere’s More to Money than Hyperinflation by Matt McCaffreyPew: Homicide Rates Cut in Half Over Past 20 Years (While New Gun Ownership Soared) by Ryan McMakenSpectre by Matt McCaffreySunday of the Blind, or the Failed Revolution by Carmen Elena DorobățUS Soldiers Are Paid Significantly More than Civilians with Similar Skills and Education by Ryan McMakenWith Interest Rates, "There Are Two, Opposite Causal Chains at Work" Murray RothbardFOMC: We'll Raise Rates Some Day; We're "Hawkish" Now by Ryan McMakenUnderwear Prices to Remain Near Zero by Peter KleinTextbook Definitions of Economics: An Informal Survey by Jonathan NewmanPoliticians Pander to an Anti-Fed Public by Tho BishopIn Sweden Cash Is Becoming Radioactive by Joseph SalernoFirst they came for the cash, then they came for the microwaves by David Howden
In a recent New York Times article, Robert Shiller takes aim at the idea that “an unregulated competitive economy is optimal for everyone.” While a defender of certain aspects of the free market, he has misgivings about the amount of manipulation and deceit that permeates it. A competitive economy, in his eyes, features numerous entrepreneurs preying on consumers making decisions that run counter to their best interests.
Too Many AssumptionsThis view of the free market is the result of a particular theoretical perspective that unfortunately pervades mainstream economics. In this view, which draws its inspiration primarily from Vilfredo Pareto and John Hicks, markets are optimal because they bring about a state of near-perfect rationality. Each consumer’s preferences are assumed to be error-free, reflecting the latest scientific knowledge. Thus, a consumer, when making decisions about what to eat, follows the advice of dietary experts. He never makes a “mistake” by consuming products that are deemed to be unhealthy. He never indulges himself in a candy bar or a box of chocolates.
Similarly, when making decisions which affect his health the consumer never runs afoul of his doctor’s instructions. Smoking cigarettes, excessive alcohol consumption or inadequate exercise are options that are off the table. Each consumer, moreover, has perfect knowledge regarding the state of the market and the prevailing prices. Therefore he never purchases a good and then finds out that it was available cheaper elsewhere. Such errors are ruled out by assumption.
The process of competition ensures that resources are allocated to best satisfy these rational consumer preferences, thereby bringing about a state of equilibrium that is optimal for everyone. In such a state each market participant is maximizing his or her welfare, allocating the scarce money income at his disposal to satisfy the most highly ranked wants that will truly contribute to it.
It should come as no surprise that the neoclassical economist, when turning his attention from such a defense of the free market, should gasp with horror at the irrationality pervading the real world. The consumers he meets in the supermarket are very different from those that pervade his theoretical model. They purchase candy, often in abundance, eat junk food, consume excessive alcohol, and make a host of other choices which experts in various fields would disapprove of. Why, they even happen to have a proclivity for gossip magazines, something that any rational being would surely see as nothing but a complete waste of time!
It is then a short jump to the conclusion that the entrepreneurs providing the consumers with the means to satisfy these irrational wants are mere manipulators and deceivers. Their desire to make profits in the face of competition forces them to exploit the human frailties of their customers, often finding ways to make them choose in a manner that is contrary to their true welfare. They take advantage of a consumer’s weak moments, when he fails to reason like a scientist or an expert and is inclined to give in to mere whims and fancies. In the process the entrepreneurs, far from ensuring the maximization of welfare, push consumers to make choices that leave them worse off.
Observing the Economy as it Is, Not as it Should BeEconomists working in the Austrian tradition provide a completely different defense of the benefits of the market that are immune to the criticisms advanced by Shiller. The heart of this defense lies in the concept of consumer sovereignty. The characteristic feature of a free, competitive economy is that the decisions of the entrepreneurs and the allocation of resources are always aligned to anticipated consumer preferences, however irrational they may be.
These preferences don’t have to stand up to rational scrutiny. They don’t have to be guided by the most up to date scientific knowledge. Instead, they reflect the momentary valuations of men as they are: erroneous, imperfect, and whimsical. As Mises notes, “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.”
Consumers, Not Producers, Direct the MarketThe prices that entrepreneurs bid for the factors of production merely reflect their expectations of these preferences. And those who are correct in their anticipations are rewarded with profits whereas those who are not are punished with losses. Thus, the real boss in the realm of the market, the true captain of the ship, is the consumer, irrational and ignorant as he is, and it is he who decides what should and should not be produced.
Any notion of welfare is inseparable from the satisfaction of these imperfect and irrational preferences. The market maximizes consumer welfare because it caters to the whims and fancies of consumers, not because it satisfies the wants of men guided by knowledge deemed to be perfectly rational by the economist.
Thus, when an Austrian economist walks into a supermarket he does not see irrationality, manipulation, and deceit. Instead he sees the miracle of the market at work; he sees the manifestation of the price system and its ability to ensure the satisfaction of the whims and fancies of consumers. When he notices candy bars and gossip magazines being sold in the checkout aisles he does not conclude that entrepreneurs are trying to manipulate consumers. Instead, he realizes that this allocation of resources merely mirrors the preferences of the vast majority of his fellow men. The ability of entrepreneurs to correctly anticipate these preferences and to cater to them enhances rather than diminishes consumer welfare.
Defending the free market is important but how one goes about doing it is equally important. Austrian economists defend the market not because it is perfect but because it allows us to prosper and thrive while letting us embrace our innate human frailties and limitations.
Quarterly Journal of Austrian Economics 18, no. 2 (Summer 2015)Symposium: Is There A Missing Element in Economics?
My first introduction to Austrian Economics came when I borrowed the well-thumbed copy of Ludwig von Mises’s Human Action from my boss, then-Congressman Jack Kemp, for whom I worked as speechwriter and congressional staff economist before and during both presidential administrations of Ronald Reagan. While I have a high regard for what Austrian economics gets right that other economic schools do not, I consider myself a “Neo-Scholastic” economist, a term which I will try to explain.
The Lou Church Memorial Lecture in Religion and EconomicsAustrian Economics Research ConferenceLudwig von Mises InstituteAuburn, AlabamaMarch 12, 2015
[First published in Inquiry, November 12, 1979.]
A half-century ago, America — and then the world — was rocked by a mighty stock-market crash that soon turned into the steepest and longest-lasting depression of all time.
It was not only the sharpness and depth of the depression that stunned the world and changed the face of modern history: it was the length, the chronic economic morass persisting throughout the 1930s, that caused intellectuals and the general public to despair of the market economy and the capitalist system.
Previous depressions, no matter how sharp, generally lasted no more than a year or two. But now, for over a decade, poverty, unemployment, and hopelessness led millions to seek some new economic system that would cure the depression and avoid a repetition of it.
Political solutions and panaceas differed. For some it was Marxian socialism — for others, one or another form of fascism. In the United States the accepted solution was a Keynesian mixed-economy or welfare-warfare state. Harvard was the focus of Keynesian economics in the United States, and Seymour Harris, a prominent Keynesian teaching there, titled one of his many books Saving American Capitalism. That title encapsulated the spirit of the New Deal reformers of the '30s and '40s. By the massive use of state power and government spending, capitalism was going to be saved from the challenges of communism and fascism.
One common guiding assumption characterized the Keynesians, socialists, and fascists of the 1930s: that laissez-faire, free-market capitalism had been the touchstone of the US economy during the 1920s, and that this old-fashioned form of capitalism had manifestly failed us by generating, or at least allowing, the most catastrophic depression in history to strike at the United States and the entire Western world.
Well, weren't the 1920s, with their burgeoning optimism, their speculation, their enshrinement of big business in politics, their Republican dominance, their individualism, their hedonistic cultural decadence, weren't these years indeed the heyday of laissez-faire? Certainly the decade looked that way to most observers, and hence it was natural that the free market should take the blame for the consequences of unbridled capitalism in 1929 and after.
Unfortunately for the course of history, the common interpretation was dead wrong: there was very little laissez-faire capitalism in the 1920s. Indeed the opposite was true: significant parts of the economy were infused with proto–New Deal statism, a statism that plunged us into the Great Depression and prolonged this miasma for more than a decade.
In the first place, everyone forgot that the Republicans had never been the laissez-faire party. On the contrary, it was the Democrats who had always championed free markets and minimal government, while the Republicans had crusaded for a protective tariff that would shield domestic industry from efficient competition, for huge land grants and other subsidies to railroads, and for inflation and cheap credit to stimulate purchasing power and apparent prosperity.
It was the Republicans who championed paternalistic big government and the partnership of business and government while the Democrats sought free trade and free competition, denounced the tariff as the "mother of trusts," and argued for the gold standard and the separation of government and banking as the only way to guard against inflation and the destruction of people's savings. At least that was the policy of the Democrats before Bryan and Wilson at the start of the 20th century, when the party shifted to a position not very far from its ancient Republican rivals.
The Republicans never shifted, and their reign in the 1920s brought the federal government to its greatest intensity of peacetime spending and hiked the tariff to new, stratospheric levels. A minority of old-fashioned "Cleveland" Democrats continued to hammer away at Republican extravagance and big government during the Coolidge and Hoover eras. Those included Governor Albert Ritchie of Maryland, Senator James Reed of Missouri, and former Solicitor General James M. Beck, who wrote two characteristic books in this era: The Vanishing Rights of the States and Our Wonderland of Bureaucracy.
But most important in terms of the depression was the new statism that the Republicans, following on the Wilson administration, brought to the vital but arcane field of money and banking. How many Americans know or care anything about banking? Yet it was in this neglected but crucial area that the seeds of 1929 were sown and cultivated by the American government.
The United States was the last major country to enjoy, or be saddled with, a central bank. All the major European countries had adopted central banks during the 18th and 19th centuries, which enabled governments to control and dominate commercial banks, to bail out banking firms whenever they got into trouble, and to inflate money and credit in ways controlled and regulated by the government. Only the United States, as a result of Democratic agitation during the Jacksonian era, had had the courage to extend the doctrine of classical liberalism to the banking system, thereby separating government from money and banking.
Having deposed the central bank in the 1830s, the United States enjoyed a freely competitive banking system — and hence a relatively "hard" and noninflated money — until the Civil War. During that catastrophe, the Republicans used their one-party dominance to push through their interventionist economic program. It included a protective tariff and land grants to railroads, as well as inflationary paper money and a "national banking system" that in effect crippled state-chartered banks and paved the way for the later central bank.
The United States adopted its central bank, the Federal Reserve System, in 1913, backed by a consensus of Democrats and Republicans. This virtual nationalization of the banking system was unopposed by the big banks; in fact, Wall Street and the other large banks had actively sought such a central system for many years. The result was the cartelization of banking under federal control, with the government standing ready to bail out banks in trouble, and also ready to inflate money and credit to whatever extent the banks felt was necessary.
Without a functioning Federal Reserve System available to inflate the money supply, the United States could not have financed its participation in World War I: that war was fueled by heavy government deficits and by the creation of new money to pay for swollen federal expenditures.
One point is undisputed: the autocratic ruler of the Federal Reserve System, from its inception in 1914 to his death in 1928, was Benjamin Strong, a New York banker who had been named governor of the Federal Reserve Bank of New York. Strong consistently and repeatedly used his power to force an inflationary increase of money and bank credit in the American economy, thereby driving prices higher than they would have been and stimulating disastrous booms in the stock and real-estate markets. In 1927, Strong gaily told a French central banker that he was going to give "a little coup de whiskey to the stock market." What was the point? Why did Strong pursue a policy that now can seem only heedless, dangerous, and recklessly extravagant?
Once the government has assumed absolute control of the money-creating machinery in society, it benefits — as would any other group — by using that power. Anyone would benefit, at least in the short run, by printing or creating new money for his own use or for the use of his economic or political allies.
Strong had several motives for supporting an inflationary boom in the 1920s. One was to stimulate foreign loans and foreign exports. The Republican party was committed to a policy of partnership of government and industry, and to subsidizing domestic and export firms. A protective tariff aided inefficient domestic producers by keeping out foreign competition. But if foreigners were shut out of our markets, how in the world were they going to buy our exports? The Republican administration thought it had solved this dilemma by stimulating American loans to foreigners so that they could buy our products.
A fine solution in the short run, but how were these loans to be kept up, and, more important, how were they to be repaid? The banking community was also confronted with the curious and ultimately self-defeating policy of preventing foreigners from selling us their products, and then lending them the money to keep buying ours. Benjamin Strong's inflationary policy meant repeated doses of cheap credit to stimulate this foreign lending. It should also be noted that this policy subsidized American investment banks in making foreign loans.
Among the exports stimulated by cheap credit and foreign loans were farm products. American agriculture, overstimulated by the swollen demands of warring European nations during World War I, was a chronically sick industry during the 1920s. It had awakened after the resumption of peace to find that farm prices had fallen and that European demand was down. Rather than adjusting to postwar realities, however, American farmers preferred to organize and agitate to force taxpayers and consumers to keep them in the style to which they had become accustomed during the palmy "parity" years of the war. One way for the federal government to bow to this political pressure was to stimulate foreign loans and hence to encourage foreign purchases of American farm products.
The "farm bloc," it should be noted, included not only farmers; more indirect and considerably less rustic interests were also busily at work. The postwar farm bloc gained strong support from George N. Peek and General Hugh S. Johnson; both, later prominent in the New Deal, were heads of the Moline Plow Company, a major manufacturer of farm machinery that stood to benefit handsomely from government subsidies to farmers. When Herbert Hoover, in one of his first acts as president — considerably before the crash — established the Federal Farm Board to raise farm prices, he installed as head of the FFB Alexander Legge, chairman of International Harvester, the nation's leading producer of farm machinery. Such was the Republican devotion to "laissez faire."
But a more indirect and ultimately more important motivation for Benjamin Strong's inflationary credit policies in the 1920s was his view that it was vitally important to "help England," even at American expense. Thus, in the spring of 1928, his assistant noted Strong's displeasure at the American public's outcry against the "speculative excesses" of the stock market.
The public didn't realize, Strong thought, that "we were now paying the penalty for the decision which was reached early in 1924 to help the rest of the world back to a sound financial and monetary basis." An unexceptionable statement, provided that we clear up some euphemisms. For the "decision" was taken by Strong in camera, without the knowledge or participation of the American people; the decision was to inflate money and credit, and it was done not to help the "rest of the world" but to help sustain Britain's unsound and inflationary policies.
Before the World War, all the major nations were on the gold standard, which meant that the various currencies — the dollar, pound, mark, franc, etc. — were redeemable in fixed weights of gold. This gold requirement ensured that governments were strictly limited in the amount of scrip they could print and pour into circulation, whether by spending to finance government deficits or by lending to favored economic or political groups. Consequently, inflation had been kept in check throughout the 19th century when this system was in force.
But world war ruptured all that, just as it destroyed so many other aspects of the classical-liberal polity. The major warring powers spent heavily on the war effort, creating new money in bushel baskets to pay the expense. Inflation was consequently rampant during and after World War I and, since there were far more pounds, marks, and francs in circulation than could possibly be redeemed in gold, the warring countries were forced to go off the gold standard and to fall back on paper currencies — all, that is, except for the United States, which was embroiled in the war for a relatively short time and could therefore afford to remain on the gold standard.
After the war, the nations faced a world currency breakdown with rampant inflation and chaotically falling exchange rates. What was to be done? There was a general consensus on the need to go back to gold, and thereby to eliminate inflation and frantically fluctuating exchange rates. But how to go back? That is, what should be the relations between gold and the various currencies?
Specifically, Britain had been the world's financial center for a century before the war, and the British pound and the dollar had been fixed all that time in terms of gold so that the pound would always be worth $4.86. But during and after the war the pound had been inflated relatively far more than the dollar, and thus had fallen to about $3.50 on the foreign-exchange market. But Britain was adamant about returning the pound, not to the realistic level of $3.50, but rather to the old prewar par of $4.86.
Why the stubborn insistence on going back to gold at the obsolete prewar par? Part of the reason was a stubborn and mindless concentration on saving face and British honor, on showing that the old lion was just as strong and tough as before the war. Partly, it was a shrewd realization by British bankers that if the pound were devalued from prewar levels England would lose its financial preeminence, perhaps to the United States, which had been able to retain its gold status.
So, under the spell of its bankers, England made the fateful decision to go back to gold at $4.86. But this meant that Britain's exports were now made artificially expensive and its imports cheaper, and since England lived by selling coal, textiles, and other products, while importing food, the resulting chronic depression in its export industries had serious consequences for the British economy. Unemployment remained high in Britain, especially in its export industries, throughout the boom of the 1920s.
To make this leap backward to $4.86 viable, Britain would have had to deflate its economy so as to bring about lower prices and wages and make its exports once again inexpensive abroad. But it wasn't willing to deflate since that would have meant a bitter confrontation with Britain's now-powerful unions. Ever since the imposition of an extensive unemployment-insurance system, wages in Britain were no longer flexible downward as they had been before the war. In fact, rather than deflate, the British government wanted the freedom to keep inflating, in order to raise prices, do an end run around union wage rates, and ensure cheap credit for business.
The British authorities had boxed themselves in: They insisted on several axioms. One was to go back to gold at the old prewar par of $4.86. This would have made deflation necessary, except that a second axiom was that the British continue to pursue a cheap credit, inflationary policy rather than deflation. How to square the circle? What the British tried was political pressure and arm-twisting on other countries, to try to induce or force them to inflate too. If other countries would also inflate, the pound would remain stable in relation to other currencies; Britain would not keep losing gold to other nations, which endangered its own jerry-built monetary structure.
On the defeated and small new countries of Europe, Britain's pressure was notably successful. Using their dominance in the League of Nations and especially in its Financial Committee, the British forced country after country not only to return to gold, but to do so at overvalued rates, thereby endangering those nations' exports and stimulating imports from Britain. And the British also flummoxed these countries into adopting a new form of gold "exchange" standard, in which they kept their reserves not in gold, as before, but in sterling balances in London.
In this way, the British could continue to inflate; and pounds, instead of being redeemed in gold, were used by other countries as reserves on which to pyramid their own paper inflation. The only stubborn resistance to the new order came from France, which had a hard-money policy into the late 1920s. It was French resistance to the new British monetary order that was ultimately fatal to the house of cards the British attempted to construct in the 1920s.
The United States was a different situation altogether. Britain could not coerce the United States into inflating in order to save the misbegotten pound, but it could cajole and persuade. In particular, it had a staunch ally in Benjamin Strong, who could always be relied on to be a willing servitor of British interests. By repeatedly agreeing to inflate the dollar at British urging, Benjamin Strong won the plaudits of the British financial press as the best friend of Great Britain since Ambassador Walter Hines Page, who had played a key role in inducing the United States to enter the war on the British side.
Why did Strong do it? We know that he formed a close friendship with British financial autocrat Montagu Norman, longtime head of the Bank of England. Norman would make secret visits to the United States, checking in at a Saratoga Springs resort under an assumed name, and Strong would join him there for the weekend, also incognito, there to agree on yet another inflationary coup de whiskey to the market.
Surely this Strong–Norman tie was crucial, but what was its basic nature? Some writers have improbably speculated on a homosexual liaison to explain the otherwise mysterious subservience of Strong to Norman's wishes. But there was another, and more concrete and provable, tie that bound these two financial autocrats together.
That tie involved the Morgan banking interests. Benjamin Strong had lived his life in the Morgan ambit. Before being named head of the Federal Reserve, Strong had risen to head of the Bankers Trust Company, a creature of the Morgan bank. When asked to be head of the Fed, he was persuaded to take the job by two of his best friends, Henry P. Davison and Dwight Morrow, both partners of J.P. Morgan & Co.
The Federal Reserve System arrived at a good time for the Morgans. It was needed to finance America's participation in World War I, a participation strongly supported by the Morgans, who played a major role in bringing the Wilson administration into the war. The Morgans, heavily invested in rail securities, had been caught short by the boom in industrial stocks that emerged at the turn of the century. Consequently, much of their position in investment-banking was being eroded by Kuhn, Loeb & Co., which had been faster off the mark on investment in industrial securities.
World War I meant economic boom or collapse for the Morgans. The House of Morgan was the fiscal agent for the Bank of England: it had the underwriting concession for all sales of British and French bonds in the United States during the war, and it helped finance US arms and munitions sales to Britain and France. The House of Morgan had a very heavy investment in an Anglo-French victory and a German-Austrian defeat. Kuhn, Loeb, on the other hand, was pro-German, and therefore was tied more to the fate of the Central Powers.
The cement binding Strong and Norman was the Morgan connection. Not only was the House of Morgan intimately wrapped up in British finance, but Norman himself — as well as his grandfather — in earlier days had worked in New York for the powerful investment banking firm of Brown Brothers, and hence had developed close personal ties with the New York banking community. For Benjamin Strong, helping Britain meant helping the House of Morgan to shore up the internally contradictory monetary structure it had constructed for the postwar world.
The result was inflationary credit, a speculative boom that could not last, and the Great Crash whose 50th anniversary we observe this year. After Strong's death in late 1928, the new Federal Reserve authorities, while confused on many issues, were no longer consistent servitors of Britain and the Morgans. The deliberate and consistent policy of inflation came to an end, and a corrective depression soon arrived.
There are two mysteries about the Great Depression, mysteries having two separate and distinct solutions. One is, why the crash? Why the sudden crash and depression in the midst of boom and seemingly permanent prosperity? We have seen the answer: inflationary credit expansion propelled by the Federal Reserve System in the service of various motives, including helping Britain and the House of Morgan.
But there is another vital and very different problem. Given the crash, why did the recovery take so long? Usually, when a crash or financial panic strikes, the economic and financial depression, be it slight or severe, is over in a few months or a year or two at the most. After that, economic recovery will have arrived. The crucial difference between earlier depressions and that of 1929 was that the 1929 crash became chronic and seemed permanent.
What is seldom realized is that depressions, despite their evident hardship on so many, perform an important corrective function. They serve to eliminate the distortions introduced into the economy by an inflationary boom. When the boom is over, the many distortions that have entered the system become clear: prices and wage rates have been driven too high, and much unsound investment has taken place, particularly in capital-goods industries.
The recession or depression serves to lower the swollen prices and to liquidate the unsound and uneconomic investments; it directs resources into those areas and industries that will most-effectively serve consumer demands — and were not allowed to do so during the artificial boom. Workers previously misdirected into uneconomic production, unstable at best, will, as the economy corrects itself, end up in more secure and productive employment.
The recession must be allowed to perform its work of liquidation and restoration as quickly as possible, so that the economy can be allowed to recover from boom and depression and get back to a healthy footing. Before 1929, this hands-off policy was precisely what all US governments had followed, and hence depressions, however sharp, would disappear after a year or so.
But when the Great Crash hit, America had recently elected a new kind of president. Until the past decade, historians have regarded Herbert Clark Hoover as the last of the laissez-faire presidents. Instead, he was the first New Dealer.
Hoover had his bipartisan aura, and was devoted to corporatist cartelization under the aegis of big government; indeed, he originated the New Deal farm-price-support program. His New Deal specifically centered on his program for fighting depressions. Before he assumed office, Hoover determined that should a depression strike during his term of office, he would use the massive powers of the federal government to combat it. No more would the government, as in the past, pursue a hands-off policy.
As Hoover himself recalled the crash and its aftermath,
The primary question at once arose as to whether the President and the federal government should undertake to investigate and remedy the evils. … No President before had ever believed that there was a governmental responsibility in such cases. … Presidents steadfastly had maintained that the federal government was apart from such eruptions … therefore, we had to pioneer a new field.
In his acceptance speech for the presidential renomination in 1932, Herbert Hoover summed it up:
We might have done nothing. … Instead, we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic. We put it into action. … No government in Washington has hitherto considered that it held so broad a responsibility for leadership in such times.
The massive Hoover program was, indeed, a characteristically New Deal one: vigorous action to keep up wage rates and prices, to expand public works and government deficits, to lend money to failing businesses to try to keep them afloat, and to inflate the supply of money and credit to try to stimulate purchasing power and recovery. Herbert Hoover during the 1920s had pioneered the proto-Keynesian idea that high wages are necessary to assure sufficient purchasing power and a healthy economy. The notion led him to artificially raising wages — and consequently to aggravating the unemployment problem — during the depression.
As soon as the stock market crashed, Hoover called in all the leading industrialists in the country for a series of White House conferences in which he successfully bludgeoned the industrialists, under the threat of coercive government action, into propping up wage rates — and hence causing massive unemployment — while prices were falling sharply. After Hoover's term, Franklin D. Roosevelt simply continued and expanded Hoover's policies across the board, adding considerably more coercion along the way. Between them, the two New Deal presidents managed the unprecedented feat of making the depression last a decade, until we were lifted out of it by our entry into World War II.
If Benjamin Strong got us into a depression and Herbert Hoover and Franklin D. Roosevelt kept us in it, what was the role in all this of the nation's economists, watchdogs of our economic health? Unsurprisingly, most economists, during the depression and ever since, have been much more part of the problem than of the solution. During the 1920s, establishment economists, led by Professor Irving Fisher of Yale, hailed the 20s as the start of a "New Era," one in which the new Federal Reserve System would ensure permanently stable prices, avoiding either booms or busts.
Unfortunately, the Fisherites, in their quest for stability, failed to realize that the trend of the free and unhampered market is always toward lower prices as productivity rises and mass markets develop for particular products. Keeping the price level stable in an era of rising productivity, as in the 1920s, requires a massive artificial expansion of money and credit. Focusing only on wholesale prices, Strong and the economists of the 1920s were willing to engender artificial booms in real estate and stocks, as well as malinvestments in capital goods, so long as the wholesale price level remained constant.
As a result, Irving Fisher and the leading economists of the 1920s failed to recognize that a dangerous inflationary boom was taking place. When the crash came, Fisher and his disciples of the Chicago School again pinned the blame on the wrong culprit. Instead of realizing that the depression process should be left alone to work itself out as rapidly as possible, Fisher and his colleagues laid the blame on the deflation after the crash and demanded a reinflation (or "reflation") back to 1929 levels.
In this way, even before Keynes, the leading economists of the day managed to miss the problem of inflation and cheap credit and to demand policies that only prolonged the depression and made it worse. After all, Keynesianism did not spring forth full-blown with the publication of Keynes's General Theory in 1936.
We are still pursuing the policies of the 1920s that led to eventual disaster. The Federal Reserve is still inflating the money supply and inflates it even further with the merest hint that a recession is in the offing. The Fed is still trying to fuel a perpetual boom while avoiding a correction on the one hand or a great deal of inflation on the other.
In a sense, things have gotten worse. For while the hard-money economists of the 1920s and 1930s wished to retain and tighten up the gold standard, the "hard-money" monetarists of today scorn gold, are happy to rely on paper currency, and feel that they are boldly courageous for proposing not to stop the inflation of money altogether, but to limit the expansion to a supposedly fixed amount.
Those who ignore the lessons of history are doomed to repeat it — except that now, with gold abandoned and each nation able to print currency ad lib, we are likely to wind up, not with a repeat of 1929, but with something far worse: the holocaust of runaway inflation that ravaged Germany in 1923 and many other countries during World War II. To avoid such a catastrophe we must have the resolve and the will to cease the inflationary expansion of credit, and to force the Federal Reserve System to stop purchasing assets, and thereby to stop its continued generation of chronic, accelerating inflation.
October 30, 1929. A brisk autumn’s day in Manhattan. The Savoy-Plaza Hotel’s thirty-three stories cast a long shadow over Central Park. At the base of the hotel a financier lies freshly fallen, motionless, while his last breath, wrenched from the lungs by force of impact, is now a red mist of gore in the air.
Sirens and uniforms. The suicide spot quickly becomes crowded by spectators, who form a vision-impairing ring-fence of backs, much to the annoyance of elbow-throwers at the periphery. Winston Churchill stands at his hotel window looking down on the mess. To nobody’s surprise, the police will find an empty wallet and five margin calls in the dead man's pockets.This is a dramatization of an event reported by Winston Churchill. Quoted on p. 7 of Robert P. Murphy’s Politically Incorrect Guide To The Great Depression and the New Deal.
Churchill’s curtains flutter shut, and we are left to wonder whether anyone — Churchill included — can yet see his clumsy, cigar-wielding hand in it all; whether anyone realizes that, had Churchill as Chancellor of the Exchequer only restored the gold standard at a lower exchange rate, as Keynes had recommended, the Wall Street Crash of 1929 could have been averted (or at least ameliorated).
Alas, by ignoring Keynes in 1925, Churchill triggered a calamity so severe that it not only inspired one man to kill himself beneath the British statesman’s very window but, more insidiously, also provided the impetus for the economics profession’s rejection of the “classical” axioms. As Keynes’s biographer Robert Skidelsky writes, Keynes “did not believe in the system of the ideas by which economists lived; he did not worship at the temple.” And while “in former times he would have been forced to recant, perhaps burnt at the stake, as it was ... the exigencies of his times enabled him to force himself on his church.”
1925: Britain’s Return to the Gold StandardThe pound sterling’s link to gold was severed at the start of WWI. After eleven years of unfettered inflation, Chancellor of the Exchequer Winston Churchill restored convertibility at the pre-war level of 4.25 pounds per ounce of gold.
Keynes, quite rightly, took exception to this particular detail: expecting Britain’s global customers to go on paying the same gold-price for the weakened pound was unrealistic. At this exchange rate the pound would be overvalued, and the only cure would be a sustained period of deflation — which was “certain to involve unemployment and industrial disputes.” Indeed, in 1926 a general strike crippled Britain for nine days.
What Keynes did not predict, however, was how Churchill’s blunder would later bring about an easing of monetary policy in America. And even supposing Keynes had predicted this side effect, would he have understood its implications for long-run sustainability? (Recall that both F.A. Hayek and Keynes predicted a crash would occur in 1929: Hayek because interest rates were too low, Keynes because they were too high!)
1927: At the Fed (With Cap in Hand)American sellers (in particular) were accepting British gold in exchange for goods, but were dissuaded from returning it due to the unfavorable rate of exchange. As a result, Britain’s gold supplies diminished at a rapid rate, which made the authorities understandably twitchy: how could they keep their pledge to convert pounds into gold if they had none?
In response, the Governor of the Bank of England, Montagu Norman, set off across the Atlantic and, with much pleading, persuaded the Federal Reserve to ease monetary policy. By lowering interest rates and raising inflation, the Fed stemmed gold flows into America, giving the British a much-needed respite from the ill-effects of Churchill’s costly pound.
With this episode of soft-hearted internationalism came an upswing in the Wall Street boom and “from that date,” wrote Lionel Robbins, “according to all the evidence, the situation got completely out of control.”
In The Great Crash, a very popular account of the lead up to the Great Depression, John Kenneth Galbraith writes:
the rediscount rate of the New York Federal Reserve was cut from 4 to 3.5 percent. Government securities were purchased in considerable volume with the mathematical consequence of leaving the banks and individuals who had sold them with money to spare. The funds that the Federal Reserve made available were either invested in common stocks or ... they became available to help finance the purchase of common stocks by others. So provided with funds, people rushed into the market.
Galbraith goes on to quote a member of the Federal Reserve Board who, with hindsight, called the operation “one of the most costly errors” committed by a banking system “in 75 years.”
Galbraith finishes: “the view that the action of the Federal Reserve in 1927 was responsible for the speculation and collapse which followed has never been seriously shaken.”
John Maynard Who?When Keynes wrote against returning to the gold standard at pre-war parity in 1925, he did so with the expectation that he might actually influence policy. As a younger, unknown man he had worked at the Treasury for a brief stint, leaving a legendary impression; and by 1925, six years after his best-seller The Economic Consequences of the Peace, he was a famous man whose words carried weight.
It is not outlandish then to imagine a world in which Keynes got his way. In such a world, the Wall Street crash and ensuing depression might never have happened — without the costly pound, the Fed would have had no impetus to inflate. Keynes would subsequently have found the economics profession less rattled, less willing to abandon its “classical” axioms in favor of his new-fangled approach. Keynes might have averted Keynesianism.
Our guest this week is uniquely qualified to discuss modern progressives from a libertarian perspective. Jim Ostrowski, whom Murray Rothbard called "one of the finest people in the libertarian movement," is a lawyer, writer, activist, and chronicler of progressive dysfunction in his native New York. He's the author of Progressivism: A Primer on the Idea Destroying America, which explains progressivism more as personal psychology than a coherent view of the world. If you're interested in how progressives managed to capture the 20th century, stay tuned.
Modern progressives believe the state should control, or at least involve itself, in nearly every aspect of human activity. They believe countless things about government and human nature that are manifestly not true. Deeply hostile to liberty, they never accept responsibility for the disasters caused by the political, economic, legal, cultural, and social policies they advocate.
But should libertarians engage with progressives? Should we attempt to match their long march through the West's great institutions? Or should we write them off as hopelessly statist products of the dominant culture?
Our show this weekend features William Boyes, Director of Arizona State University's Center for the Study of Economic Liberty. Boyes was in Auburn last week presenting a keynote speech at our Austrian Economics Research Conference. In his talk, Boyes gives the perspective of someone who has been a Keynesian in mainstream academia, but who is now a dedicated Austrian.
The Lou Church Memorial Lecture, sponsored by the Lou Church Foundation. Recorded at the Austrian Economics Research Conference at the Mises Institute in Auburn, Alabama, on 12 March 2015.
Recorded during the Authors' Forum at the 2015 Austrian Economics Research Conference, Jason Jewell discusses a recent book in which his writing is featured: Christian Faith and Social Justice: Five Views edited by Vic McCracken (Bloomsbury Academic, 2014).
This is the essay that overthrew the socialist paradigm in economics, and provided the foundation for modern Austrian price theory.
When it first appeared in 1920, Mises was alone in challenging the socialists to explain how their pricing system would actually work in practice. Mises proved that socialism could not work because it could not distinguish more or less valuable uses of social resources, and predicted the system would end in chaos. The result of his proof was the "socialist calculation" debate.
Narrated by Gennady Stolyarov II. The full text is available online here.
Download the complete audiobook (7 MP3 files) here. This audiobook is also available on Apple Podcasts, Google Podcasts, and via RSS.
Henry Hazlitt did the seemingly impossible, something that was and is a magnificent service to all people everywhere. He wrote a line-by-line commentary and refutation of one of the most destructive, fallacious, and convoluted books of the century. The target here is John Maynard Keynes's General Theory, the book that appeared in 1936 and swept all before it.
Far from being a dull read, this book has all the brightness and clarity we've come to expect from Hazlitt. He is a dazzling writer, and one can't but thrill to see him in the ring with the giant Keynes. By the time he delivers the knockout punch--taking on Keynes's suggestion that we nationalize investment--there is nothing left of his opponent.
Narrated by Josiah Schmidt.
Download the complete audiobook (33 MP3 files) here. This audiobook is also available on Apple Podcasts, Google Podcasts, and via RSS.
This essay is adapted from Murray Rothbard’s Austrian Perspective on the History of Ecopnomic Thought, Volume II.
While Ricardo formally admitted that supply and demand determine day-to-day market pricing, he tossed that aside as of no consequence. … Utility Ricardo brusquely disposed of as ultimately necessary to production but of no influence whatever on value or price; in the 'value paradox' he embraced exchange value and abandoned utility completely. Not only that: he frankly and boldly discarded any attempt to explain the prices of goods that are not reproducible, that could not be increased in supply by the employment of labor. Hence Ricardo simply gave up any attempt to explain the prices of such goods as paintings, which are fixed in supply and cannot be increased. In short, Ricardo abandoned any attempt at a general explanation of consumer prices. We have arrived at the full-fledged Ricardian — and Marxian — labor theory of value.
Ricardo’s Gloomy WorldThe Ricardian system is now complete. Prices of goods are determined by their costs, i.e., by the quantity of labour hours embodied in them, trivially plus the uniform rate of profit. Specifically, since the price of each good is uniform, it will equal the cost of production on the highest-cost (i.e., zero rent) or marginal land in cultivation. In short, price will be determined by cost, i.e., the quantity of labor hours on the zero-rent land used to work on the product. As time goes on, then, and population increases, poorer and poorer soils must be brought into use, so that the cost of producing corn continues to increase. It does so because the quantity of labor hours needed to produce corn keeps increasing, since labor must be employed on ever poorer soil. As a result, the price of corn keeps increasing. Since wage rates are always kept precisely at the subsistence level (the cost of growing corn) by population pressure, this means that money wage rates must continue to increase over time in order to keep real wage rates in pace with the ever rising price of corn. Wage rates must increase over time, and hence profits must keep falling until they are so low that the stationary state is reached.
Ricardo's system is both gloomy and rife with allegedly inherent class conflict on the free market. First, there is tautological conflict because, given the fixed total, the income shares of one macro-group can only increase at the expense of another. But the point of the free market in the real world is that generally production increases, so that the total pie tends to keep rising. And, second, if we focus on individual factors and on how much they earn, as does the later marginal productivity theory (and as did J.B. Say), then each factor tends to earn its marginal product, and we need not even concern ourselves with the alleged but non-existent laws and conflicts of macro-class income distribution. Ricardo kept his eye unerringly on the radically wrong problem — or rather, problems.
Ricardo Leads to MarxBut there is even more class conflict here than implied by Ricardo's tautological macro-approach. For if value is the product solely of labor hours, then it becomes easy for Marx, who was after all a neo-Ricardian, to call all returns to capital exploitative deductions from the whole of 'labor's' product. The Ricardian socialist call for turning over all of the product to labor follows directly from the Ricardian system — although Ricardo and the other orthodox Ricardians did not of course make that leap. Ricardo would have countered that capital represents embodied or frozen labor; but Marx accepted that point and simply riposted that all labor producers of capital, or frozen labor, should obtain their full return. In fact, neither was right; if we wish to consider capital goods as frozen anything, we would have to say, with the great Austrian Böhm-Bawerk, that capital is frozen labor and land and time. Labor, then, would be earning wages, land would earn rent, and interest (or long-run profits) would be the price of time.
Recent analysts, in an attempt to mitigate the crude fallacy of Ricardo's labor theory of value, have maintained, as in the case of Smith but even more so, that he was attempting not so much to explain the cause of value and price but to measure values over time, and labor was considered an invariable measure of value. But this hardly mitigates Ricardo's flaws; instead, it adds to the general fallacies and vagaries of the Ricardian system another important one: the vain search for a non-existent chimera of invariability.
The Chimera of Invariability of ValueFor values always fluctuate, and there is no invariable, fixed base of value from which other value changes can be measured. Thus, in rejecting Say's definition of the value of a good as its purchasing power of other goods in exchange, Ricardo sought the invariable entity, the unmoved power:
A franc is not a measure of value for any thing, but for a quantity of the same metal of which francs are made, unless francs, and the thing to be measured, can be referred to some other measure which is common to both. This, I think, they can be, for they are both the result of labour; and, therefore, labour is a common measure, by which their real as well as their relative value may be estimated.
It might be noted that both products are the result of capital, land, savings, and entrepreneurship, as well as labor, and that, in any case, their values are incommensurable except in terms of relative purchasing power, as Say had in fact maintained ...
The Class Struggle Implicit in Ricardo’s Theory of ValueAn even stronger and more direct class struggle than that implied by the labor theory of value stemmed from Ricardo's approach toward landlords and land rent. Landlords are simply obtaining payment for the powers of the soil, which, at least in the hands of many of Ricardo's followers, meant an unjust return. Furthermore, Ricardo's gloomy vision of the future held that labor must be kept at subsistence level, capitalists must see their profits inevitably falling — these two classes doing as badly as ever (labor) or always worse (capital) while the idle and useless landlords keep inexorably adding to their share of worldly goods. The productive classes suffer, while the idle landlords, charging for the powers of nature, benefit at the expense of the producers. If Ricardo implies Marx, he implies Henry George far more directly. The specter of land nationalization or the single tax absorbing all land rent follows straight from Ricardo.
Ricardo and the LandlordsOne of the greatest fallacies of the Ricardian theory of rent is that it ignores the fact that landlords do perform a vital economic function: they allocate land to its best and most productive use. Land does not allocate itself; it must be allocated, and only those who earn a return from such service have the incentive, or the ability, to allocate various parcels of land to their most profitable, and hence most productive and economic uses.
Ricardo himself did not go all the way to government expropriation of land rent. His short-run solution was to call for lowering of the tariff on corn, or even repeal of the Corn Laws entirely. The tariff on corn kept the price of corn high and ensured that inferior, high-cost domestic corn land would be cultivated. Repeal of the Corn Laws would enable England to import cheap corn, and thereby postpone for a time the use of inferior and high-cost land. Corn prices would for a while be lower, money wage rates would therefore immediately be lower, and profits would rise, adding to the accumulation of capital. The dread stationary state would be put further off on to the horizon. Ricardo's other anti-landlord action was political: by entering Parliament by joining Mill and the other Benthamite radicals in calling for democratic reform, Ricardo hoped to swing political power from the grip of the aristocracy, which meant in practice the landlord oligarchy, to the mass of the people.
The Logical Outcome of the Ricardian System: The Land TaxBut if Ricardo was too individualistic or too timorous to embrace the full logical consequence of the Ricardian system, James Mill characteristically was not. James Mill was the first prominent 'Georgist', calling frankly and enthusiastically for a single tax on land rent. In his high office in the East India Company, Mill felt able to influence Indian government policies.
Before obtaining this post, Mill had characteristically presumed to write and publish a massive History of British India (1817) without ever having been in that country or knowing any of the Indian languages. Steeped in the contemptuous view that India was thoroughly uncivilized, Mill advocated a 'scientific' single tax on land rent. Mill was convinced as a Ricardian that a tax on land rent was not a tax on cost and therefore would not reduce the incentive to supply any productive good or service. Hence a tax on land rent would have no bad effect on production — it would only have the effect of eliminating the ill-gotten gains of the landlords. In effect, a tax on land rent would be no tax at all! The land tax could be up to and including 100 percent of the social product caused by the differential fertility of the soil. The state, according to Mill, could then use this costless tax for public improvement, and largely for the function of maintaining law and order in India.
And Yet Ricardo Promoted Laissez-FaireWe see now the pernicious implications of the fallacious view that any part of the expense of production is in some way, from a holistic or social point of view, 'really' not a part of cost. For if an expense is not part of cost, it is in some sense not necessary to the factor's contribution to production. And therefore this income can be confiscated by the government with no ill effect. Despite the deep pessimism of Ricardo about the nature and consequences of the free market, he oddly enough cleaved strongly, and more firmly than Adam Smith, to laissez-faire. Probably the reason was his strong conviction that virtually any kind of government intervention could only make matters worse. Taxation should be at a minimum, for all of it cripples the accumulation of capital and diverts it from its best uses, as do tariffs on imports. Poor laws — welfare systems — only worsen the Malthusian population pressures on wage rates. And as an adherent of Say's law, he opposed government measures to stimulate consumption, as well as the national debt. In general, Ricardo declared that the best thing that government can do to stimulate the greatest development of industry was to remove the obstacles to growth which government itself created.
Image source: Portrait of David Ricardo by Thomas Phillips, public domain, wikimedia.
This weekend Jeff Deist welcomes Michael Oliver, and if you like debating Rothbard vs. Rand — or anarcho-capitalism vs. limited government — you’ll really enjoy our show. Michael witnessed the beginning of the modern anarcho-capitalism movement, meeting Rothbard in the early 1970s and writing a graduate thesis based on Murray’s provocative descriptive term for a libertarian society.
That thesis became a book entitled The New Libertarianism: Anarcho-Capitalism. But Oliver was also a dedicated Objectivist, and thus his book attempted to reconcile Rothbardian thought with the work of Ayn Rand — even in presumably thorny areas like natural law, private defense, and pure anarchism. The results are fascinating and provocative.
Economics Nobel Prize winner Jean Tirole still clings to the old neoclassical model "perfect competition" and monopoly, writes Frank Shostak. This audio Mises Daily is narrated by Robert Hale.
[This is a transcript from the September 22, 2014 episode of the Tom Woods Show, featuring Mateusz Machaj, former Summer Fellow at the Mises Institute, and founder of the Mises Institute of Poland.]
Thomas Woods: The Taylor rule has been cited for so long by so many people who describe themselves as free-market economists that it has become more or less the conventional wisdom that the Taylor rule is a good guide for the central bank in formulating monetary policy. Let’s start off by explaining who Taylor is and what the Taylor rule says, in a way that’s understandable to the layman.
Mateusz Machaj: Well, John Taylor started working on monetary policy in the early ’90s. He published a paper describing what the Federal Reserve System was doing in terms of monetary policy in the ’80s, and he apparently discovered that the Federal Reserve was following some version of the monetary policy rule, a sort of fixed rule. It was not probably fixed like the famous Friedman rule. It was short lived, but still it was a general rule for monetary policy. And it was a purely descriptive paper. And then after a few years, suddenly, from this purely descriptive paper in the literature we have a flourishing of the concept of the Taylor rule, based on this paper as if it were some normative proposition of how to conduct a correct monetary policy, whereas it was just a description of what was done in the ’80s. And that’s how we got into the whole Taylor rule thing.
Also, in the early 21st century, various versions of the Taylor rule were proposed for monetary policy. Unfortunately, they failed, but Taylor himself, in 2009, after the Great Recession started, published a paper arguing that the Federal Reserve System was not following his rule, and that was the reason for the real estate boom, and that was the main factor for the recession. And therefore, from his description of various, let’s say, mildly pro-market people with a sort of Friedmanite sentiment for having government rules that are supposed to constrain the government, we have the sentiment somehow about following the Taylor rule that is constraining government in some way by proposing a form of monetary constitution or something like that in order to stabilize the economy. But of course, the main problem is that this rule itself is vague, it’s unclear, and it actually opens the door for destructive monetary policy because it’s still a monetary policy performed by the government, by a government agency.
TW: Right, so that, of course, is going to be the ultimate problem with it. But one of the points you’re making in the paper is that even if we accept the idea that the Taylor rule is a good policy, even if we accept the idea that we should have some rule that overrides what would spontaneously occur on the market, nevertheless there are practical problems even with implementing the Taylor rule, one of them being the problem of figuring out which data ought to be used. Depending on which numbers you use, you wind up getting a different Taylor rule. Before we get into that, what exactly is the Taylor rule saying the central bank should do? He is saying, if you would listen to my Taylor rule, interest rates would have been higher, and you wouldn’t have had this housing bubble. So what does the rule tell the central bank it should do with interest rates?
MM: The Taylor rule itself is just an equation, and the equation can have many different forms. To make it as simple as possible to our listeners, the equation says that you are supposed to arrive at a certain level of interest rates set by the central bank based on two other main variables: price inflation and the so-called output gap. Apart from that, we have some additional coefficients that we put in the equation, and we arrive at the final number. The higher the inflation rate, of course, the higher the recommended interest rate by the central bank, and the bigger the output gap — that is, the further away we are from, let’s say, potential production, potential output — then the interest rates are supposed to be lower in order to boost spending and boost the economy and reach the potential level. Now, there are two main problems with this approach, one group with mainstream objections to the rule itself, and the other group employ Austrian objections — well, the mainstream objection would be that you have various problems with measurements, as you mentioned. That is, how you measure price inflation, and how you measure the so-called output gap. And there are lots of articles written in the mainstream literature actually arguing that there are serious problems with measuring the so-called potential output, the potential production. Some mainstream economists argue that we should get rid of it and forget it about it, because various ways of measuring this whole potential output are actually so vague that we should downplay it completely and forget about it.
TW: Well, actually, let me jump in on this issue of the output gap, because this is the term that I would think most normal people are not familiar with. The output gap is something that you’ll hear especially among Keynesian economists when there is a recession. They say that there’s an urgent need for stimulus programs because every day that we don’t engage in stimulus, we are losing potential output. Our factories are idle, our workers are idle. We have this potential to produce all of these goods because, look, we have the raw materials, we have the factories, we have the people, but none of these things are coming together, and stimulus can bring them together. In other words, every day that they don’t come together we lose potential output, because we could potentially be producing at this level up here, but because of the recession conditions and the unemployment of resources, we’re producing only down here. So there’s an output gap between where we would be producing if everything were gainfully employed as opposed to what we’re producing now when some things are not gainfully employed. That’s what’s meant by the output gap. Am I right about that?
MM: Yep, yep. Well, on the very, very general level, the term itself, potential output, makes some sense, of course, because every economist would tell you that when we are in the recession, our production possibilities are not fully utilized. They are not fully used because we have high unemployment. We have various scarce and idle factors of production that we could employ to increase our production. So on the very, very general level this is very correct, but the question is, how do we solve this problem? So how do we make sure that all of those various factors are employed in fact? Various stimulus programs, government programs that are being used often result in some form of employment of those factors, but this employment is at the expense of malinvestment created by that government spending or that government stimulus — that is, by capital consumption. So there is a famous paper by Austrian economist Fritz Machlup about capital consumption in Austria, where he describes various government policies that resulted in some stimulus for economic activity, but the final result after many years was that there was huge capital consumption, and a decrease in a general level of wealth in the country. So the question is, of course, when we are in the recession, real production is below some level of potential production, this is true. When we have high unemployment, of course, we could reach higher employment levels, but the question is how do we get there, and how do we make sure that an increase in employment and an increase in the usage of factors of production results in permanent growth, higher growth, and sustainable growth? That’s the key question.
TW: Right, exactly. It seems to me that the idea of the output gap takes for granted that the current configuration of the structure of production is optimal, and all we need to do is just rev it up again, start it up again. But what if in fact the employment of resources is incorrect in some sense? Then it’s a problem. In other words, as you say later in the paper, they’re thinking in terms of volumes instead of thinking in terms of patterns of capital.
MM: Exactly, that’s the basic Keynesian message. That’s the essence of Keynesian economics. Somewhere Keynes wrote in his General Theory, I believe, he said I am not concerned with the direction of employment; I am concerned about the volume of employment. So that’s why you have all those arguments about people digging the holes and then filling them up again with whatever, trash, or putting printed dollars in bottles and then putting bottles down between the surface and then digging them up again. All those arguments are based on various Keynesian — Keynesian arguments actually are based on this notion that we are focused on the volume, not the direction? Classical economics and especially Austrian economics is focused more on the direction of employment — that is, how we employ resources in various stages of production and in various places in the economy? So this is what matters for efficiency in the long run. It’s always easy to spend money on whatever and hire people, but the big question is, can we go on with this for a longer time, not just for a couple of months or two years?
TW: So what is the role that this idea of the output gap plays in Taylor? Is he saying that we have to look at the output gap — which is a difficult concept to begin with and certainly a difficult one to measure — and have that be one of the factors that decides where the central bank should target interest rates?
MM: Right. There are various ways of measuring output, and there is no reason to assume that one way is better than the other. Each of those ways can give us totally different results. And then we will have different recommendations for the interest rate. So using one concept of the output gap, the result may be 5 percent and using the other concept of potential output and the output gap, we will have interest rate recommendations at, for example, 2.5 percent. That’s a big difference between 5 and 2.5. That’s a huge difference. But in any case, whatever type of way we are using — originally, Taylor was using a very, very comfortable, let’s say, concept, he was focused on the trend. So he basically said, we just look at the long-term trend, and the long-term trend is showing us potential output, and we just focus on that. So this is one of the possible ways to do this. But whatever type of way you use, whether it’s the general trend or whether it’s based on some form of econometric models, or on some other ways, you arrive at a certain aggregate level of something, of potential output. That is to say we, for example, reach an observation that potential output is 3 percent higher than total production. The basic methodological problem with this is that it’s a totally aggregated and averaged out number. So it’s not telling you anything at all about the direction of employment. It’s not telling you anything at all about malinvestments. It just tells you that some number that we have gathered from the current data, that is, Gross Domestic Product, and some totally invented variable that we call potential output, is different by 3 percent. So it doesn’t tell you anything at all about the extent of malinvestments and problems in the direction of the employment of factors of production. That is to say, it connects in no way the interest rate with what is really going in the economy. And that’s the fundamental macroeconomic problem that I see in this rule.
TW: Getting back to the practical issues of the different ways you can measure these sorts of things, output gap or inflation, so that you could wind up with different Taylor rules — depending on which data you use you would get a different outcome and a different policy prescription — I found it interesting in your paper that an economist at the Atlanta Fed, a David Altig, apparently came up with a version of the Taylor rule using his version of the data that showed that the Fed did observe the Taylor rule during the housing bubble years.
MM: Yes, exactly.
TW: So how useful can this thing be if it can be used both to condemn and praise the Fed?
MM: Exactly. Exactly. That’s the thing. In my paper, I have Taylor’s presentation where he shows that the Fed should have followed his version of the rule. Therefore, interest rates would be higher, so there would be no real estate boom. I also gave the example of Altig from the Federal Reserve. Of course, he presented it during the boom years, and he showed we are following the Taylor rule, and it’s working. Of course, he used different sorts of data. And then I give my version of the rule, and I show that we can have a Taylor rule recommendation with even lower interest rates than the ones that were set by Alan Greenspan. So we would have even a higher real estate boom than actually was the case. So all those things about the ambiguity of the data are present in the mainstream literature. Also, there is this notion that we can mention that when we collect the data, that’s always a challenge, because the central bank, when it uses the data, it uses past data. But data is being constantly revised. For example, data about Gross Domestic Product can be revised, and the revisions are substantial.
[Economist Athanasios] Orphanides, who is famous in the literature for criticizing the Taylor rule, notes that we can only focus on past data, but this data can be revised within months, but we have to make a decision right now. So should we somehow deal with revised data after that, or should we be more focused on predicted data because, of course, we’re interested not in past inflation rates, we are interested in future inflation rates, that is, we’re interested in what will happen in the future.
So this complicates the issue even more, and this is all present in the mainstream literature, so we’re talking about the first group of arguments, that we have all those measurement problems about those variables that make the whole idea of the Taylor rule very, very difficult to be applied for a successful monetary policy. So it is kind of similar to problems with the so-called Friedman rule. You remember the famous Friedman rule, which is dead by now, about the money supply growth each year. Then it turned out that we have some problems because we are not sure how to measure the money supply. We have various ways of measuring that can be changed and so on. The Taylor rule is even more difficult because it’s not only the question of one variable called “money supply.” It’s the question of invented variables such as potential output, it’s the question of measured variables such as real production, which is being constantly revised, and it’s the problem, of course, of price inflation. We have various indexes of price inflation also, right? They can differ. We have core inflation. We have the personal consumption expenditures index. We have various ways of measuring price inflation. So which one do we choose for the equation to arrive at successful interest rates? That’s the challenge, and that’s the challenge even from the mainstream perspective. That’s one of the things in my paper that I tried to be focused on, that is, on mainstream objections to the rule itself because apart from that we have strong Austrian objections to the rule.
TW: Right, number one, the output gap concept itself, and secondly, the very idea of monetary policy. Of course, if we want to get into a really sweeping critique, we would start there.
When you and I shared an office for a week this summer at the Mises Institute, I showed you an article that David Stockman had written on the Taylor rule — David Stockman, the former Director of the Office of Management and Budget under Reagan — and I just want to share with people the paragraph that I pointed out to you in particular. He cites this lengthy passage from Taylor, and he says, “Only an academic power-seeker could come up with a Rube Goldberg contraption that ludicrous. Just re-read the policy rule in the second paragraph above. The four quarter rate of inflation, when there are 27 different versions published by the government statistical mills — all of which have been manipulated and deformed over the years, one half the deviation of national GDP from ‘potential’ GDP, which is unmeasurable in a dynamic global economy, and a magic constant named two. At least he has the good grace to name this gibberish after himself.” You can’t write that in an academic paper, unfortunately.
MM: That’s true. There is also one thing that we have to remember. Even putting aside the arguments about ambiguity of the data and uncertainty about the measurements, there is a Hayekian element that we have to remember when we criticize the Taylor rule. Because even if you assume that we have some sort of version of the rule where we have output gap measures, and we have price inflation, and there we go, we have policy recommendations for the interest rate. The thing is that we are, by using that level of the interest rates, we are only targeting those two variables. That is, we are targeting certain levels of inflation rates and a certain level of these supposed output gaps. But we just satisfy our macroeconomic goals that we have in our minds or in our government papers. What we are missing is that by pursuing this type of policy, we can still have malinvestment booms and financial bubbles, and that’s the thing.
Because even when you look at Taylor’s paper from 2009, where he demonstrates that the interest rates should have been higher, he gives no explanation how this equation, the Taylor equation, is supposed to relate to macroeconomic stability. He just assumes it. He just says, now look, interest rates could have been higher, and if they were higher, of course, there was no more investment boom. Well, that’s fine, but it’s not really a theoretical argument. Whereas the most important contribution by Hayek, in terms of macroeconomic issues, is the demonstration that even if we target some particular macroeconomic variable, we can still have malinvestment booms and financial bubbles. That is when we, for example, target the price inflation at 0 percent, we can still produce credit expansions that will result in malinvestments, and it is exactly the same thing with the Taylor rule. Even if we have assumed the Taylor rule, and we are targeting the so-called output gap to be zero, that is, to reach potential output, and even if we are targeting certain levels of price inflation at the same time, we still will produce credit expansion that may result in financial bubbles and more investment booms, and that’s the second part of the argument, which I find also very, very important aside from the mainstream arguments against the Taylor rule.
TW: Well, Matt, I appreciate your time today in taking us through this. As I say, this is a topic on which so many free-market economists go wrong to the point that a lot of people may just think without knowing much about it that the Taylor rule must somehow be a free-market principle, but of course, in the very nature of it, it can’t be. And then we see even the practical problems, quite apart from the theoretical ones with it, and we see that it just needs to be chucked along with the Friedman constant-rate-of-money-growth rule. Instead of trying to come up with all these rules, what about just letting the free market, that these people supposedly believe in, handle this question?
MM: That’s the thing. Well, the interest rate is just a price. It’s a price, and a price is supposed to reflect conditions in the market. That’s the thing. It’s not supposed to reflect the balance between general price inflation rate or the so-called output gap. The role and the function of the interest rate is to balance savings and investment in the financial markets. That’s the key issue. So it’s not supposed to be manipulated by the entity called the central bank in order to arrive at some macroeconomic goal of having an inflation rate at zero. Well, of course, it’s always 2 percent, right? Stable prices are defined in the mainstream literature at 2 percent inflation, of course, to leave some margin for extra printing for the government. But in any case, the interest rate is supposed to balance the demand side and the supply side in the financial market, in the savings market, in the loan markets, and so forth. It’s not supposed to satisfy our preferences for a particular macroeconomic variable to each reach its assumed goal. It’s a very, very different function, and that’s the rule.
I don’t know why people are so sentimental about the Taylor rule. Perhaps those pro-market, mildly pro-market economists, well, they think in terms of rules for the government, and some of them think that if we have short and simple rule s for government activities, then it somehow results in a greater amount of free market, but it’s not really the case. You can write a simple rule saying government owns everything. It doesn’t mean that we are closer to free market when we advocate that rule, right? So we have to always be careful about various real that they invent for the government. It’s not the question of having simple and clear rules. It’s also the question of having rules that result in lower government power. That’s the thing.
Image source: Marshall Astor, flickr, lifeontheedge
Christopher Westley reports from this year's National Association of Business Economists Convention. He finds that the mainstream's intellectual blinders are firmly in place, and that the “fatal conceit” Friedrich Hayek wrote about in 1988 is alive and well in 2014.
This audio Mises Daily is narrated by Robert Hale.
Early on in the most recent meeting of the National Association of Business Economists (NABE) in Chicago, Dan Ratner, one of President Obama's tech gurus for the 2012 election cycle and expert in the hip field of Big Data mining, stated to his audience that “there is no such thing as truth. There is only the most recent updated version of it.”
Little did I know this was to be a recurring theme at this conference.
Which is not to say that the conference was a wasted experience. Far from it. There were several excellent presentations and I enjoyed meeting some very smart people in economics, finance, and business, none of whom would attend NABE meetings if they didn’t provide value. But my take was that these individuals were in the minority as NABE’s overwhelming tone reinforced the central role of state policy intellectuals — connected somewhere between the revolving doors of the nation's leading universities, Federal Reserve district banks, crony corporations, and mostly DC-based lobbyists — to design top-down central planning schemes from Washington. Unstated but pregnant in perhaps every NABE session was the Keynesian dogmatic assumption that absent government supervision and force, markets fail miserably, but with benign and wise government intervention, markets will produce the prosperity required for the very survival of civilization.
Mr. Ratner’s statement about truth resonated when former Federal Reserve Chairman Ben Bernanke spoke via an interview format with the host of a business show on NPR, the government’s radio network. The exchange was not exactly what one witnessed when former Congressman Ron Paul used to grill Mr. Bernanke in those congressional hearings about real factors he and his compatriot Keynesian monetarists avoid by hiding them in the error terms of their mathematical models.
The interview began on a duplicitous note as Mr. Bernanke stated one of his first acts as Fed Chairman in 2006 was to inquire about Fed policies during a financial crisis, so concerned was he about the possibility of one emerging during his tenure. Two sensible follow-up questions to that self-serving and unproven statement — questions an interviewer less connected to state media would have asked — would be (1) if this was a concern, then why did you make statements regarding the stability of the housing market before the crash?, and, (2) who told you at the time Fed policy in a financial crisis would be to ensure men like Jamie Dimon see another payday?
But why ask at all when what matters is the most recent updated version of the truth?
After a humanizing exchange dealing with how the former Fed chairman shouldered the incredible weight of the global financial crisis during his time of public service — apparently, he blew off steam watching professional baseball players whose salaries he helped inflate — Bernanke stated current low global interest rates actually reflect what the Wicksellian natural rate would be in a free market, so there should be no worries about his low-interest policies or those of his successor. My jaw dropped. It was as if the New York City Housing Commissioner argued rent controls were not socially destructive because they were set at rents that would normally arise from supply and demand. I looked around my luncheon table to gauge the reaction of my co-conventioneers to find them whispering among themselves about who was this Knut Wicksell guy in the first place.
There was more in Mr. Bernanke’s apologia that rattled, but perhaps the most troubling aspect of it was the standing ovation he received. It reflects what should be a law of human nature, that those who live well on inflation will always honor the inflators. This surely applies to the average attendee of the NABE conference.
Other aspects of NABE 2014 were equally frustrating, if not also revealing. A pointless debate about fiscal policy between University of Chicago economists Austin Goolsbee (Democrat) and Randy Kroszner (Republican) occurred, with each often prefacing his response to the other with a version of, “I agree with that.” Not exactly a Firing Line experience from yesteryear, but it’s what one would expect between two interventionists more concerned with kinds, but not degrees, of the government's share of GDP. (Suggestion to future conference organizers: put David Stockman at a table with Dr. Kroszner.)
In other sessions, monetary discussions often focused on whether inflation should be 2 percent or 4, how bad, bad, falling prices would be, and why a muscular Fed can never be too aggressive in easing during downward shocks. Donald Kohn, the Fed’s second banana from 2006 to 2010, argued that when business cycles demand it, the Fed “cannot keep its powder dry,” and one could easily imagine him advising the Wizard of Oz to ramp up the fireworks when those Ozian animal spirits veered too close to the curtain. He was also lauded in his session, no doubt by representatives of firms who know all too well their revenues would plummet if they depended on real saving ironically kept low by Mr. Kohn himself.
Such biases serve the purpose of setting the terms of acceptable debate. During the break, I asked some fellow attendees about whether the market can correct without falling prices, and if hindering this process with money created out of thin air just might explain why the present recovery hardly feels like one for much of the country. How they responded indicated the degree that they suffered from apoplithorismosphobia and whether they also feared sales at the grocery store or inexpensive electronics at Best Buy.
Not all was bleak. I developed new respect for the labor economist Erik Hurst after hearing him speak in the flesh. Dr. Hurst's data-rich presentation broke down what groups (men, women, college, or high school graduates) recovered in labor markets since 2008, emphasizing that while official unemployment has been falling, the employment rate is not rising. The result is a labor market reflecting practically zero employment growth for high school graduates compared to growth in recoveries in the past. My question for him would be whether capital accumulation is really falling in a secular sense or whether capital confiscation is the real problem, motivated by post-9/11 expansions of war and welfare, of drones and disability payments.
Ed Clark, the soon-to-retire president of Canada’s TD Bank, gave a superlative speech demonstrating he clearly understands how the structure of the US banking system foments moral hazards and other agency problems which the Canadian system, whatever its faults, has been able to avoid. Northern Trust Chief Economist Carl Tannenbaum noted how compliance costs imposed on big banks are so high as to reduce the benefits of bigness in the future, although I wonder whether the such costs reflect regulatory capture serving to protect a banking cartel from potential competitors. His presentation reminded me of his quasi-Austrian predecessor at Northern Trust (and recommended economics blogger), Paul Kasriel, one of the few bank analysts whose newsletters became must-reads in their day. Harvey Rosenbloom, the former director of research at the Federal Reserve Bank of Dallas — which some free-market economists call “the good one” — spoke on how bad incentives created by the Dodd-Frank legislation are unlikely to address its intended problems associated with the TBTF banks. Messrs. Tannenbaum, Kasriel, and Rosenbloom all have had professional connections to the Fed, proving not all Fed-tinged research is a vale of tears. NABE’s program directors should be complimented for allowing their input.
Overall, I found NABE a mixed bag because it was not at all as mixed as it needed to be. Its intellectual blinders not only prove the “fatal conceit” Friedrich Hayek wrote about in 1988 is alive and well in 2014, it also explains why so many in my profession were dumbstruck by the financial crisis of the last decade. Government funding of research and, especially, central bank funding of monetary science, create an intellectual cocoon that justifies the funders’ place and power in society while benefiting parties attach to them. Loosening its ties implies dispensing with what historian (and popular interviewer) Thomas E. Woods often calls the “three-by-five card” of acceptable opinion, and is required for the emergence of stable, healthy economies of the future.
Contra Mr. Ratner, there is such a thing as truth, and we can know it in both an a priori and apodictic sense. We hurt ourselves when we focus on invented versions of it that serve not only our fancies, but also tax- and inflation-supported financiers.
Lesson learned: Chicago is beautiful in the fall. I would have saved myself time and heartburn had I avoided the Westin Michigan Avenue and instead stationed myself on a stool at one of the sports bars near Wrigley — remnants of a less-planned era — ordered a cold Goose Island draft, and reread economist and philosopher Hans-Hermann Hoppe’s important essay, “Natural Elites, Intellectuals, and the State.” An excerpt:
There are almost no economists, philosophers, historians, or social theorists of rank employed privately by members of the natural elite. And those few of the old elite who remain and who might have purchased their services can no longer afford intellectuals financially. Instead, intellectuals are now typically public employees, even if they work for nominally private institutions or foundations. Almost completely protected from the vagaries of consumer demand (“tenured”), their number has dramatically increased and their compensation is on average far above their genuine market value. At the same time the quality of their intellectual output has constantly fallen.
What you will discover is mostly irrelevance and incomprehensibility. Worse, insofar as today's intellectual output is at all relevant and comprehensible, it is viciously statist. There are exceptions, but if practically all intellectuals are employed in the multiple branches of the State, then it should hardly come as a surprise that most of their ever-more voluminous output will, either by commission or omission, be statist propaganda.
NABE claims its mission is “to provide leadership in the use and understanding of economics,” but it does so by asking the wrong, narrow set of questions. Specifically, it should annunciate what it means by “economics.” Methinks it defines the term divorced from concepts such as economic freedom, private property, and peace.
Image source: iStockphoto.
The Henry Hazlitt Memorial Lecture, sponsored by James M. Rodney, presented at the Austrian Economics Research Conference. Recorded 21 March 2013 at the Ludwig von Mises Institute. Includes an introduction by Joseph T. Salerno.
Ludwig von Mises, a mentor to Friedrich Hayek and a major figure in economics in his own right, set out his views on capitalism and inequality in a slender book (just 113 pages) called The Anti-Capitalistic Mentality. First published in 1954, and readily available online for less than $10, it is well worth reading today.
Mises’s treatise on why capitalism sits in the dock, falsely accused of various crimes against humanity, is a classic: bravely saying what still needs to be said. It offers a robust rebuttal to the jaundiced view of capitalism found (most recently and conspicuously) in Thomas Piketty’s Capital in the Twenty-First Century.
In The Anti-Capitalistic Mentality, Mises asks: Why do so many people “loathe” capitalism? He gives a threefold answer.
The first factor is simple ignorance. Few people credit capitalism for the fact that they “enjoy amenities that were denied to even the most prosperous people of earlier generations.” Telephones, cars, steel-making, and thousands of other advancements are all “an achievement of classical liberalism, free trade, laissez faire, and capital” — with the driving force being the profit motive and the deployment of capital used in the development of better tools and machines and the creation of new products. Take away capitalism and you wipe out most or all of the extraordinary progress that has been made in raising living standards and reducing poverty since the dawn of the Industrial Revolution.
The second factor is envy, the green-eyed monster, which causes many people to think they have gotten the short end of the stick. As Mises observes: “Capitalism grants to each the opportunity to attain the most desirable positions which, of course, can only be attained by the few … Whatever a man may have gained for himself, there are always before his eyes people who have outstripped him … Such is the attitude of the tramp against the man with the regular job, the factory hand against the foreman, the executive against the vice-president, the vice-president against the president, the man who is worth three hundred thousand dollars against the millionaire, and so on.”
And finally, the third factor is the unceasing vilification of capitalism by those who seek to constrain or destroy it. As Mises notes, the critics and anti-capitalists go on telling and re-telling the same story: saying that “capitalism is a system to make the masses suffer terribly and that the more capitalism progresses and approaches its full maturity, the more the immense majority becomes impoverished.”
Indeed, that is the story Piketty tells in his book, which has soared to the top of the New York Times and Amazon best-seller lists. Does inequality rank as the great defining issue of the twenty-first century? If you agree with Piketty, it does. He contends that disparities in income and wealth are spiraling out of control, setting the haves- against the have-nots. Without “confiscatory” taxes to create a new social and economic equilibrium, he warns, today’s democracies may ultimately collapse, taking capitalism and the capitalists down with them.
Piketty makes much of the seeming fact (some dispute his statistics) that those at the highest levels of income in the United States have claimed a sharply rising share of total U.S. national income over the past three or four decades. From there he leaps to the conclusion that the vast disparity in income between the top 1 percent and the bottom 90 percent will lead over time to the emergence of a new “patrimonial capitalism.” With nothing (save perhaps violent revolution) to worry about, the heirs to big fortunes will turn into a new class of rentiers, living off the rent they receive from owning land and other forms of capital.
In his analysis, it is set in stone that return on capital (r) outstrips economic growth (g), which means that the heirs to great fortunes stay on the fast track to even greater wealth — without even having to work — while the lower and middle class are condemned to economic stagnation or utter hopelessness. His little formula, r>g, is supposed to be one of the great takeaways from the book, but it points up one of the problems of presenting a far-too-static picture of how people behave in a competitive marketplace.
That would not have escaped Mises’s attention. Mises would have challenged Piketty’s assumption that the heirs to great fortunes would manage their money wisely, or that they would have the same success as others (more driven than they) in searching out the best investments. Mises maintained that “the dull and stolid progeny” of people who built business empires were likely to “fritter away” their heritage and “sink back into insignificance.”
Under a capitalist system worthy of the name (meaning, to Mises, a competitive market economy free of the crippling effects of state planning and controls); it is neither the powerful industrialist nor the rich investor who calls the shots; it is ordinary people in their capacity as consumers. Through their “buying or not buying,” consumers provide “a daily referendum on what is to be produced and who is to produce it.” They have the whip hand — the power to “make poor suppliers rich and rich suppliers poor.”
One may almost pity the poor capitalist portrayed by Mises. However hard he might work or fast he might run, someone is probably gaining on him. At all times, other suppliers are striving to unseat the incumbents by discovering new and better ways of serving their customers. In comes a Wal-Mart or Target and out goes a Sears or K-Mart. It is a battle fought with an unending supply of fresh recruits, and it is never the case (as Piketty claims) that “The past (i.e. wealth accumulated from previous success) devours the future.” Rather, it is the future (whatever the next big thing may be) that replaces the present with something better.
In The Anti-Capitalistic Mentality, Mises states unequivocally: “Nobody is needy in the market economy because of the fact that some people are rich. The riches of the rich are not the cause of the poverty of anybody.”
Look at the fastest-growing countries in today’s world. Is there not a natural compatibility — as opposed to an inherent contradiction — between major advances in the standard of living in some countries and the ability of their most enterprising citizens to make spectacular gains? That is what has happened in China as a result of economic liberalization: the number of Chinese billionaires has skyrocketed (and is now close to the number of U.S. billionaires), while hundreds of millions of people inside China have worked their way out of poverty.
Is it true — as Piketty contends — that we are witnessing a hyperconcentration of wealth inside the United States?
It might be true if the people with the highest incomes remained the same from one year to the next — over an extended period of time. But they are not the same people. Just as Mises would have expected, it is an ever-changing cast of characters. A recent report from the Tax Foundation data shows IRS data on people reporting a million dollars or more in income over a nine-year period. Fully half of these people made a one-time-only appearance. Only 15 percent of them reported at least a million in income two of the nine years and only 5.6 percent made it all nine years.
There is no danger of an oligarchy of the rich taking shape here to rival the power and permanence of the landed aristocracies in the pre-capitalistic France and Britain.This assumes that governments do not intervene, as they have been doing, to favor certain groups and enterprises. For more on how government increases income inequality, see Frank Hollenbeck’s article on income inequality, and Andreas Marquart’s work on this topic.
But there is something else to worry about — something that caused Mises to lose sleep. That is the thought that the natural tendency under capitalism “towards a continuous improvement in the average standard of living” will be stymied by a growing “absence of capitalism” due to “the effects of policies sabotaging the operation of capitalism.” Among those perverse policies, Mises pointed to credit expansion, gunning the money supply, and raising minimum wage rates. Still more, he railed against progressive policies that diminish individual choice and leave more and more economic decision-making in the hands the state. Mises’s greatest fear was that people would “renounce freedom and voluntarily surrender to the suzerainty of omnipotent government.”
Ironically, the most ardent proponents of big government are those who carry on the most about inequality. Do they want nothing more (to paraphrase Churchill) than an equal sharing of misery?
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Thomas Piketty, a neo-Marxist French professor, has written a near-700-page book, published by Harvard University Press. His book is titled Capital in the Twenty-First Century, in honor of Karl Marx’s nineteenth century Das Capital. It has been greeted with fervent applause from the left-wing intellectual establishment and has been on The New York Times’s and Amazon.com’s best-seller lists.
While his book is ostensibly devoted to the study of capital and its rate of return, Piketty comes to his subject apparently without having read a single page of Ludwig von Mises or Eugen von Böhm-Bawerk, the two leading theorists of the subject. There is not a single reference to either of these men in his book. There are, however, seventy references to Karl Marx.
In his book, Piketty argues that saving and capital accumulation by wealthy capitalists serves to reduce wages. The capital accumulated does nothing to increase production, he claims. All that it accomplishes is allegedly to increase the share of national income going to profits while equivalently reducing the share going to wages. Because there is no additional production, the effect of the change in shares is a corresponding change in absolute terms, i.e., real profits up, and real wages down.
In order to avoid such endless destructive capital accumulation and its accompanying “inegalitarian spiral,” Piketty advocates a progressive income tax as high as 80 percent “on incomes over $500,000 or $1 million a year,” accompanied by a progressive tax directly on capital itself, as high as 10 percent per year.
Now Piketty’s claims about the wage and profit shares are refuted simply by imagining an increase in saving and investment by capitalists and then observing the consequences both for wage payments and for the amount of profit in the economic system. It will be found that wage payments necessarily rise and the amount of profit necessarily falls, results in diametric opposition to Piketty’s claims.
Thus, assume that initially the total amount of profit in the economic system is 200 units of money. (Each unit can be conceived as representing as many tens of billions of dollars as may be necessary for 200 units to equal the actual current amount of aggregate profit.)
Assume also that accumulated capital in the economic system is initially 2,000 units of money. Thus the initial average rate of profit is 10 percent.
And, finally, assume that the capitalists, who have up to now been consuming their 200 of profit, decide to save and invest half of it. They now make an additional expenditure for capital goods and labor in the amount of 100.
Whatever portion of this 100 is wage payments necessarily increases the total of wages paid in the economic system. At the same time, the spending of an additional 100 on capital goods and labor must sooner or later add 100 to the aggregate costs of production of business that are deducted from sales revenues, thereby equivalently reducing aggregate profits.
The rise in costs can take place immediately or over many years, depending on what the 100 is spent for. At one extreme, if it were spent entirely on items that were not capitalized, such as, typically, selling, general, and administrative expenses, it would show up immediately as equivalent additional costs. At the other extreme, if it were spent entirely on the construction of buildings with a forty-year depreciable life, it would take forty years for it to show up as equivalent additional costs of production. But one way or the other, it will show up as equivalent additional costs and thus equivalently reduce the amount of profit in the economic system.
Thus, Piketty’s “findings,” as they are called, are reversed. The capitalists’ saving and investment that increases the ratio of accumulated capital to income, increases the wage share of national income and decreases the profit share.
Moreover, the larger supply of capital goods that results from the transition to a higher capital/income ratio serves to raise the productivity of labor and increase the total of what can be produced, including a still larger supply of capital goods. With technological progress to offset diminishing returns to a growing supply of capital goods, capital accumulation in physical terms can potentially go on indefinitely, without further increases in the ratio of capital to income. But a higher ratio would reinforce this process. This is because insofar as it represents a more abundant supply of savings, it makes it possible for the economic system to implement more costly technological advances, thereby increasing the contribution of technological progress to capital accumulation.
Piketty’s program is one of unmitigated economic destruction. America and the world, above all the wage earners of the world, need the abolition of taxes and regulations that stand in the way of capital accumulation and the increase in production. Capital accumulation and more production, not egalitarianism and its absurd theories and programs, are the foundation of rising living standards in general and rising real wages in particular.
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This article is also available as an Audio Mises Daily
The Federal Reserve System turned 100 years old last December and Fed supporters have been celebrating ever since. In recent months, the Dallas Fed opened an historical exhibit, the Kansas City Fed released a documentary, and the New York Fed even started a Facebook page, all to commemorate the date.
The mainstream media has also been vocal, as CNN posted a piece claiming Janet Yellen’s becoming the first female chair is an “apt way to mark the anniversary,” while National Review published an article of their own. Although the two outlets differ on politics, it seems nearly everyone agrees the Fed has fulfilled its purpose: grow the economy and prevent economic downturns.
Simon Jack of BBC news recorded a short video along these same lines. He refers to the Fed as “one of the most powerful institutions on earth” and to the boardroom specifically as “the nerve center of the global economy”; indeed, as the “most important room in the financial world.” One could be taken aback at his excessive praise, except that these statements are largely true: the Fed runs a counterfeiting monopoly, making it powerful beyond belief.
Jack alludes to this fact, yet overall he asserts that the Fed is divorced from politics. This is beneficial, he says, because it “allows them to do radical things when necessary,” such as Paul Volker raising interest rates in the 1970’s to combat price inflation. Thus he cites a supposedly prevalent expression among bankers, investors, and even presidents: don’t fight the Fed.
It’s curious then that Fed chairs are appointed by the president and approved by Congress. To claim neither has power over the happenings down the road is preposterous. And just as the Fed is staffed with former officials of the big banks, the banks themselves are influential in presidential elections (as Goldman Sachs, one of Bush’s largest donors, was one of Obama’s too).
Realistically, both the Fed and the president (not to mention the banking elite) possess extraordinary power which can be enhanced when working together. As Jack vaguely explains, the Federal Open Market Committee (FOMC) determines the money supply, interest rates, and how much “quantitative easing” there should be: decisions with implications around the world.
Of course this is true, but throughout the entire feel-good discussion (and others like it) a main feature of the Federal Reserve System is left conspicuously unmentioned: fractional reserve-banking.
People deposit money at a bank under agreement that whenever they so choose, they can withdraw their money in full. For the bank to be able to fulfill this obligation, it must keep as reserves the total balance deposited by its customers. Banks, then, are nothing more than warehouses for money, issuing receipts (money substitutes) in exchange for deposits. If depositors seek to withdraw their cash but the bank doesn’t have it on hand, the bank will be deemed insolvent – an event referred to as a “bank failure.”
Before the Federal Reserve Act, banks often held only a fraction of their liabilities as reserves because by loaning out a portion of it — even though it was their customers’ property – they could make serious dough through collecting interest. The only problem they encountered were bank runs, when they received more claims for redemption than they had cash available. This meant default and bankruptcy, save some sort of outside help.
Murray N. Rothbard demonstrated thirty years ago in his masterful essay Origins of the Federal Reserve that bankers and big business in the late 1800s began to call for a central bank as a “lender of last resort,” an institution that had the power to perform “bail outs” through printing money. After a massive propaganda campaign, they finally got their way in 1913.
Rather than risk default through fractional reserve banking, the Fed guarantees the banks have nothing to worry about. Today the reserve requirement is only 10%, meaning for every dollar deposited, the bank can lend out (i.e., “create”) an additional 90 cents.
“New” money enters circulation in competition with “old” money, bidding up prices for the first goods bought with it. But prices exist in relation to one another, so even though some prices will rise first, eventually all will rise as the market restores its desired proportions. For this reason, the total size of the money supply is irrelevant: only a change in this quantity matters because it causes a redistribution of wealth to the first receivers of the new money (government, bankers, big business, etc.) from the public at large.
Before the Fed, banks got away with this wholesale rip-off only insofar as the public placed confidence in their solvency. The last century has been distinct with the banks filling their own pockets practically without end. Since 1913, the dollar has lost over 95 percent of its exchange value.
The only limitation now is the stability of the currency itself and, as Jack said, the crash of 2008 was followed by an “unprecedented program of printing trillions of dollars to stimulate the economy.” If it weren’t for legal tender laws — requiring official debts, as well as taxes, to be paid in national currencies — and for inflationary central banks around the world, the US dollar would have already collapsed because investors would have switched to sounder money. So much for the Fed as “guardian of the U.S. dollar.”
Until holders of US dollars understand that they are being robbed by the very people who claim to be protecting their money, more of the same will follow. And until then, the intellectual army of economists employed by the Fed and the big banks will be eager to keep the lies going and the people in the dark.
Contrary to the popular notion that the Federal Reserve has the public welfare in mind, the sober observer would have to conclude that the Fed is all about special privileges for the few at the expense of the many. The last thing to be seen is who can blow out more birthday candles in one breath: former Fed chairman Ben Bernanke or the newly-appointed Janet Yellen.
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Editor’s note: this is a transcript of this interview, courtesy of The Tom Woods Show.
TOM WOODS: This book Against the State: An Anarcho-Capitalist Manifesto is getting plaudits from everybody. Charles Goyette likes it, Ron Paul likes it, I like it. Everybody who reads it seems to be thrilled with it. It’s readable in the sense that it’s got interesting, compelling, punchy prose. It’s packed with information, and it’s short enough that the length of it is not daunting. It doesn’t put people off. By the way, length of books does not always put people off. It amazes me how many people read The Creature from Jekyll Island. It amazes G. Edward Griffin how many people read that book. But all the more will read a book of this length. I am really pleased about it.
So I want to continue our conversation because we peeled away only a few layers of the onion last time, and I want to start off with a concept that we talked about on this program just a couple of weeks ago in connection with Teddy Roosevelt. We had the author of a little book called American Fascist talking about Teddy Roosevelt, and I wanted to give him a chance to show that his use of the word fascism was not just hyperbole. That even though we’re not necessarily talking about Hitler himself, there are ideas in fascism that are present to a greater or lesser extent in various regimes. What are you talking about when you say American fascism? What do you have in mind?
LEW ROCKWELL: Well, of course, as you and your interviewee pointed out, fascism comes from the Progressive Era. It’s not a coincidence that Teddy Roosevelt came to power in that time, and this is when Mussolini developed his ideas. This is before Hitler. So fascism antedates Hitler, and it’s not just an epithet. It is an actual, maybe not a very systematic, but it’s definitely an ideological system, a political system, and an economic system. Mussolini himself said really it’s better described as corporatism than fascism because they represented the melding of state power and corporate power, of course, under the politicians and applied against everybody else in society. So what is fascism? And I think the American system, certainly Teddy Roosevelt had his fascist impulses.
Franklin Roosevelt’s New Deal was entirely fascist. It really was ripped off from Mussolini, and it benefited the big companies that were in cahoots with the federal government—hurt all the companies and the consumers and everybody else who was not in cahoots, and it set out to change American capitalism, and they didn’t do it. So now I would say there have been many, many advances in fascism. The fact that we don’t have death camps is not a refutation that the American political and economic system is not fascist. So it’s the corporate state. It’s a combination of the welfare state, of massive regulation of business, of hatred of the other—in our case maybe it’s Muslims, Islamists and so forth who allegedly justify total surveillance and total control of the American population. It’s government that—in Mussolini’s case it was the labor unions, big business, and government in a combine. Thank goodness in our own country the labor unions are not a significant force anymore and are becoming less and less. But nevertheless, we have big corporations and big government cooperating together against the rest of us. It also involves militarism. Unfortunately most people accept as just the norm, the worship of the police and the military and the so-called first responders. That’s entirely a fascist impulse. The idea that we’re supposed to think that these are higher-level beings, they are far better and more significant people than just regular, what Will Grigg calls “the mundanes.” That it should be—and it’s perfectly plausible and really moral that it’s a far more serious crime to, say, touch your elbow to a cop who’s arresting you, and therefore you’re resisting arrest, than it would ever be to touch a regular person with your elbow by mistake. It’s the glorification. It’s the constant warfare system, the constant wars going on everywhere—Mussolini, Hitler, Teddy Roosevelt all believed that war was in some sense the highest result of civilization, that not only was the flowering of civilization—war—but that it advanced civilization. Well, it advances something, not of course civilization. So the constant wars, the constant militarism, military worship, and planning by the government and the big corporations of all of economic life, and then we have the total surveillance state, and we have unfortunately what is still, as compared to some other regimes, a soft fascism, but it’s becoming increasingly hard, and it’s more than slightly alarming.
On the other hand, I think there’s more and more, especially young people are becoming awakened to what the American system is, what it’s become, how their own lives are being stunted by it, their own economic possibilities in the future—and Ron Paul, of course, is the major factor in this.
All the ideas of the great libertarians and Austrians, Murray Rothbard and everybody else, they are, of course, the foundation for all of this. But Ron by all of his work has awakened the young people not only in this country but all around the world as to the importance of freedom, how it’s being attacked, and why we don’t want a corporate state, a fascist state. Why it goes against every value of decency, and religion, and the Golden Rule, and it just is an attack on, of course, private property, which is the real basis of civilization, of course, not war. You don’t actually have, for the most part, government ownership of the means of production, that is, you have the TVA. You have the VA single payer socialized medical system.
There are some aspects of the American economy that are classically socialist, but mostly private ownership remains in the hands of the private sector. Control is increasingly in the hands of the government, so that whatever government agency we look at, whether it’s the EPA, or the IRS, or OSHA, or the Treasury Department, the Interior Department, all of them, are massively increasing in power, and business people today have to worry first and foremost not what their customers are thinking and might want, but what is the government thinking and what might the government do to them. So they spend vast resources, vast amounts of time that should go into new products and services to attract the consumer and satisfy consumer wants, go into worrying about the government. Hans Hoppe met recently with, I won’t name him, but an important billionaire who’s interested in Hans’s ideas, and he had a lot of the businessmen associated with him, and Hans said all of them were terrified of the government. They were very, very concerned about what might happen to them. For example, if they spoke out, and I think this is what’s—this is the kind of country that we’ve developed. It is a fascist system. On the other hand, it’s sort of theglorification of falsehood so that there’s—and we do have the truth on our side, so that’s, of course, extremely important, and I actually think the future can be bright just because of young people resisting this system. They don’t like the surveillance. They don’t like the wars. Paulianism is spreading. Also, the ideas of anarcho-capitalism are spreading. There have been more attacks on private-property anarchism, libertarian anarchism, or as Murray Rothbard called it, anarcho-capitalism, than I think has ever, certainly in my lifetime, I have ever seen.
The media, whether it’s the New York Times down to Salon or up from Salon, or whatever, many of them, the New Republic, many of these publications and intellectuals, public intellectuals, are attacking our ideas. If they didn’t worry about us, of course, they wouldn’t bother to attack. They are worried about it. They are worried about its appeal to young people. They are worried about the fact that young people and Ron Paul made it possible for conservatives to be antiwar. Everybody had been brainwashed from the time of Bill Buckley that if you weren’t pro-war, you were pro-communist. You were just the worst kind of bad guy. We had to be at war everywhere all the time, and that’s the right way. Of course, it’s not the right way. It’s obviously not the right way. War is, I would argue, nothing but mass murder, and it’s not a good idea. Thank goodness most of us are not equipped to go kill people. It’s why veterans don’t ever want to talk about whatever happened to them. They don’t want to talk about what they were forced to do—what they saw. It’s so horrifying, and it affects them badly for the rest of their lives. It’s why we see so many suicides among veterans, suicides among troops. And then, of course, there’s all the people who are being killed. We’re only supposed to worry about American casualties. For example, I saw something on Drudgethe other day talking about, you know, was Iraq worth it, sorry I don’t have the figures exactly, but something like 4,800 Americans killed—68,000 wounded. But, of course, there probably have been a million people killed in Iraq. The British medical journal Lancet had a very, very good study of this. This is some years ago. It’s certainly hundreds and hundreds of thousands of innocents, people with their arms and legs blown off among the ones who are still surviving. People’s homes destroyed, businesses destroyed, and now, of course, in Iraq we see the alleged al Qaeda taking over and hilariously the Iraqi army just taking their uniforms off and getting out. They don’t want to kill. They don’t want to be killed.
So many, many interesting things happening in the world. The state is actually having trouble. They believe, of course, that everything can be solved by the gun at the head. So all of that takes care of everything. If they have the power to put a gun to your head, that will just solve everything. But of course, it doesn’t solve everything, even for the state. They require people’s active consent, or at least passive consent for what they are doing. That consent, I would argue, is evaporating, especially among young people. They are worried about the ideas of freedom. So I think, as Murray points out, all throughout human history there’s been the struggle between power and market. This is nothing new. It’s a struggle that will never be won this side of heaven, I’m afraid. But certainly we can make progress. We can reduce the amount of evil in the world, and the state, I would argue, is mankind’s greatest earthly enemy. There are spiritual enemies that are more important, but from the standpoint of human enemies, it’s the state, and so I think there’s every reason to look forward to the future because of young people—and also some of us older people are waking up, too, to what’s been done.
Fred Reed did a wonderful column the other day about how many veterans are waking up to the fact that they were used. They weren’t actually serving the country, protecting freedom, and all the rest of the lies that are told. They were misused, and they were misused for terrible and evil things. So I think people are waking up. The Internet continues to be very important as much as the government is trying to restrict it, and people are reading, people are learning. I think libertarianism is spreading, and I think it worries the bad guys, and that’s a good thing, because they should be worried.
WOODS: Lew, I had Bob Higgs on some months ago on the program, and he’s an example of somebody whose thought really did evolve over the years. He was always a limited-government libertarian, but I asked him: you’ve obviously really radicalized over the past five to ten years; what happened? And he said that it finally hit him — and I might add parenthetically, it’s very, very rare for an academic to really have second thoughts about anything. You just double down for your whole career. But he said that as he was doing scholarly work in the field of economics and sometimes economic history, he was describing the state in ways that he realized had no connection to reality at all. He was going along with the standard academic approach to the state, and he realized that this is not how the state is. These are not the state’s motivations. The state is not composed of the sorts of people that the theorists assume that it is. So he’s just abandoned it completely, and he’s entirely a Rockwellian at this point, entirely a Rothbardian in his outlook. And his Facebook updates are some of the best parts of my day, sometimes, even though they can be depressing.
On the military issue, sometimes you and I feel like we’re making a lot of progress, and we certainly are. But one thing that deflates me is the ubiquity of the military worship. It is everywhere. It’s in every sector of society. The military people get discounts on coffee. They get discounts on sandwiches. They get special consideration when they board a plane, and even the progressives, the ones who are supposed to be antiwar, will lamely clap for them on the airplane. And look, I’m sorry: I am just not clapping. And the conservatives, by the way, the conservatives will be against some regulatory agencies, and this regulatory agency is a bunch of thugs, and we don’t like these government employees, but this other branch of government employees can do no wrong. You’ve got to stand up and salute. You’ve got to applaud. They are sacrificing for our freedoms. These pieties are repeated even by people who ostensibly oppose the wars. Thanks for your service. What are you talking about? Am I living in an Orwell novel? What can we do about this?
ROCKWELL: You know, as Joe Sobran pointed out, conservatives are against government programs unless they involve killing people.
WOODS: Yeah. (laughs)
ROCKWELL: So this is what the state specializes in. In fact, I think people who are killers or who enjoy sending others to kill are attracted to the state. Maybe they become hit men for the mafia, but mostly they become politicians, and they actually enjoy starting wars. They enjoy having people killed. They are some people who feel that people like FDR or Bob Dole, who are themselves disabled, sometimes have an impulse. They don’t mind sending strong, young guys off to be mutilated. That they actually like it. So it’s very, very unfortunate. The military worship is, yes, I have never seen anything like it in my life. America’s always been a very militaristic country. It’s not true, for example, that veterans were spit upon when they came back from Vietnam. That’s all just a lie. I can tell you. I was there. The idea that hippies were being nasty to veterans who could beat them up—just, believe me, it didn’t happen. Even then the veterans were exempt, and the troops were exempt from people who always wanted to blame the government. Although, if we listen to Ron Paul’s favorite antiwar song, “The Universal Soldier,”it couldn’t happen without the soldiers. If the soldiers refuse to kill, the whole war operation comes to a halt. It doesn’t matter how big Lockheed-Martin or the rest of these munitions manufacturers are. It doesn’t matter how many people at the Pentagon. They need the soldiers.
So good for Bowe Bergdahl — the guy who apparently sought to change his job, or as they put it in militaryspeak, desert. And he didn’t want to kill anymore, and he didn’t want to be part of the killing, and of course, he didn’t want to be killed, either. They term that cowardice. Although it seems to me a perfectly healthy and normal reaction. So there’s a tremendous amount of propagandizing that goes on. The military training, in fact, as Fred Reed pointed out, consists largely in attempting to suppress the conscience. That’s the job of the chaplains in the military: to suppress the conscience. If we can think of the basic libertarian insight about government, it’s allowed to do everything that we know among ourselves in the private world are crimes. Say an escaped criminal is hiding in somebody’s apartment building. You can’t just bomb the apartment building to get the guy. The state calls it collateral damage. You can’t commit murder. Murder is a crime even if you’re wearing a government uniform. So maybe we have a hope of at least some of these soldiers realizing that they’re being sent out to commit crimes. And of course, they come back with all of these horrible mental problems, and obviously physical problems a lot of times, too. Then we see the government promoting the hiring of veterans from Iraq and Afghanistan as police because they will have the right attitude towards the people—which is, of course, not to protect and serve but to control. This is why they have the militarization, the uniforms, the military vehicles that they have, the military weapons—all designed against the people. So the state always fears its own people most. It doesn’t actually fear the Russkies or whoever is the enemy of the moment. It always fears the people, which is why all the propaganda is aimed at us, and of course, as in this military worship, it’s successful. But America, I am sorry to say, has always been a hotbed of military worship. It’s one of the faults of our country.
WOODS: Well Lew, in our society you don’t win any popularity contests by saying that maybe, just maybe, the troops might bear some moral responsibility here. I do understand that there is so much propaganda that it’s possible that somebody could really not know, not understand the moral significance of what he is doing. But that can go only so far. If you’re going to sign up for a job that you know involves killing people, you’ve got at least crack open a book. You’ve got to look at the history of the area that you’re going to bomb, have some remote sense of what’s going on there. I have distant relatives who have been in the military who have not got the first clue about anything in the world other than the U.S. is great and rah, rah, rah.
You mentioned “The Universal Soldier.” I am sure you will recall at Ron Paul’s Rally for the Republic in 2008 he had Aimee Allen sing that song because he has always appreciated that song. Then in his own remarks—I was really moved by this—he said that he sometimes looked back on his own time as a flight surgeon in the military and asked himself, “Was I the universal soldier?” That in my own small way, I enabled this. Maybe I should have just said no to the whole thing. And again, how unusual is it for somebody in his ’70s to look back and say, in public no less, maybe I did something that was seriously wrong, and I looked back on it, and I wish I had it to do over again.
ROCKWELL: And this, by the way, is a man who became a physician so he would never be called upon to kill people for the government. Ron was interested in many—he might have become another kind of scientist. He might have done many other things. He might have become a businessman, a successful businessman, too, but that’s why he became a doctor. So that was his—of course, this comes about through introspection. I don’t think you—of course, obviously I am for reading books—your book, my book, many of Rothbard’s. It’s essential. But can we also know from introspection? Isn’t this the Catholic doctrine of the natural law? Certain things are written on the human heart by God. One of them is, it’s not a good thing to kill people. Murder is a problem. It’s why these kids get brainwashed. A lot of times, because of the Fed and other government economic policies, they don’t have any kind of economic future in the private economy, or that’s what they feel, and so they joined for that reason. If something is in your economic interest, of course, it’s very easy to think it’s okay, and everybody is trained to believe that anybody who is resisting the U.S. is an untermensch who deserves to be killed, deserves to have his throat slit, and that’s true of his wife and children and his grandparents and so forth, too. They made the mistake of Leonard Peikoff, the horrible guy who is Ayn Rand’s successor as the head of the Ayn Rand Institute, who said you can kill everybody. He was for nuking all Arabs, and I guess he still is, but he was arguing for this. And he was asked the question about non-combatants. He said they are living in that country; therefore, they are responsible.
WOODS: Yeah, so he takes the leftist view that just by standing somewhere, you’ve consented to the regime. That’s the most totalitarian view of all, and also, from some of these official Randians — I don’t want to get complaints from ordinary Objectivists; I’m talking about the official mouthpieces of various Objectivist organizations — we hear repeatedly the use of the term “terrorist countries.” Now, these are the same people who call themselves individualists, and yet they speak in this horrifying collective about “terrorist countries.” And then, as you say, repeatedly you see Objectivist scholars saying we should not worry for a moment about collateral damage. And this is the school that portrays itself as the philosophy of reason. Heaven help us!
ROCKWELL: (laughs) No, of course, it’s true. And if we’re going to start to talk about terrorist countries, I don’t think you’re talking about the country, but terrorist regimes — why isn’t the U.S. right at the top of the list? If we think of the U.S.’s official definition of terrorism — and by the way, it has to be non-state. They start right off by saying it’s a non-state thing, terrorism. And it’s the use of violence or the threat of violence against civilian populations and civilian targets to attempt to bring about political change. Well, what’s the U.S. doing in all its wars? I mean, ordering all the drones and so forth, and when they bomb a wedding party, they feel that they can just give the surviving families a couple thousand dollars, and that’s fine. And everybody is trained to think it doesn’t matter. They are gooks. They are not really human. So it’s a horrendous—the National Socialists didn’t invent this sort of attitude. Maybe it’s always been present in the human heart, along with some other bad things.
WOODS: It’s intensified by the state.
ROCKWELL: Well, the state, of course, lives off it. This is the source of the state’s power. That and the drive towards egalitarianism is another one. But war, yes, it’s famously said war is the health of the state. War is sort of the foundation of the state. War is the essence of the state. I always find it interesting that there’s so many troops in Washington, D.C., that they are only allowed—they are ordered, in fact—that you must, of course, wear your uniform on Tuesday, but not the other days of the week, because if all the soldiers and Marines, and Navy guys, and Air Force guys wore their uniforms every day, the place would look like an armed camp. And of course it is an armed camp, and it’s engaged in what Jack Douglas calls the annihilation of nations. Look what they’ve done to Iraq and Afghanistan. We even hear rumors about a possible first strike using atomic weapons against Russia to eliminate them once and for all as one of the few countries that’s actually challenging the U.S. desire to rule the globe through global domination. Certainly, many, many political leaders and dictators have been accused of wanting to rule the globe, and maybe they all do, but very few of them have had the wherewithal. The U.S. government actually has the wherewithal and has pretty much achieved it, world domination and world rule, and I guess they want to rule the solar system and the universe, too. But the two countries that are giving them trouble and not obeying are China and Russia. So there are people who in the evil Herman Kahn’s neocon view think the unthinkable. That is this sort of routine use of atomic weapons against civilian populations as a way to control opposition in other countries.
Bob Higgs has said in a tremendous talk to the Mises University last summer at the Mises Institute —and you can see it online at Mises.org — he thought the U.S. state was actually capable of exterminating life on Earth. They were actually so crazy as well as evil with all their—just to take one aspect: in Fort Dietrich, Maryland there’s this vast government enterprise, and there are others in other parts of the country, too, that exist only to create deadly diseases. And there’s a bunch of government scientists right now who are engaging in attempting to restore the Spanish flu virus that came about as a result of World War I and that killed 50 million people. That’s sort of erased from history and from people’s memories because the whole thing was so unbelievably horrendous in this country, too, by the way. I had people from my family in those days died from this, too, and I think this was true of almost every American family. So these scientists funded by the government are attempting to bring this virus back. Only the government would do that. You can’t imagine a private company doing that. This is the government. So they produce biological weapons. They produce chemical weapons. There have even been efforts to bring about diseases and bacteria that would attack different ethnic groups like Arabs or whatever. So Dr. Evil doesn’t quite describe these people.
WOODS: Lew, early on, before they launched the war in Afghanistan, we know that there was a slide show that was shown to Condi Rice and Rumsfeld, and it was called “Thinking Outside the Box: Poison the Food Supply.” This was just considered a possible policy option that they might consider. As we’ve been talking it’s occurred to me that very often we hear people say, I believe in the free market, but the one issue where I just had trouble coming on board with you guys was foreign policy, was war. That was the last hurdle for me, and then when I finally saw it, then I joined with you guys. Isn’t it funny? And that was true for me, too, by the way. But isn’t it funny that it should be that way? That we’ve been so bamboozled by the state that the worst thing that it does is the thing we have the most difficulty letting go of. Why shouldn’t war be the first thing that we see as wrong? And then the minimum wage be the last one? Isn’t it funny that it goes the other way?
ROCKWELL: Yeah, it is funny, and I can remember one of the first acts of the Bush regime when it attacked Iraq was to bomb and destroy every single waste treatment facility in the country.
WOODS: Right.
ROCKWELL: In order to cause disease, in order to make sure that the water couldn’t be pure. It’s why, of course, long before there was a military attack, baby food, medicine, all kinds of things were banned from being exported to Iraq. So this is the fabled sanctions, which are also evil, which also violate the moral law. Another way to think of anarcho-capitalism or libertarianism is the state and its employees are not above the moral law. The moral law applies to them just as much as it does to the rest of us. This is very difficult for people to accept. Even clergymen have a difficult time. In fact, some of the worst defenders of the war system are some of the clergy.
WOODS: Oh, yeah. And that’s been true for a long time. Even the progressive Social Gospel clergy were so in favor of World War I, the rhetoric would shock you.
ROCKWELL: No, it’s true. Of course, they were all in favor of it, and they actually thought it would build the Kingdom of God on Earth. Rothbard writes a lot about this in his history of thought and otherwise. But they thought that building the Kingdom of God on Earth can be done by the state, and the most important and best thing the state did was to kill people. So that would bring the reign of God. Well, not quite. So it’s the reign of the devil or something that they’re actually promoting.
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Ninety-seven years ago, a small but ruthlessly determined band of revolutionaries set out to prove that it would be possible to achieve material happiness — and social justice — by replacing free markets with economic planning.
In his classic work Socialism, produced in 1922, just five years after the Bolshevik revolution of 1917, Ludwig von Mises predicted the failure of Soviet communism. He pointed out that the planners would be flying blind — lacking the vital information that comes from free-market pricing. In his words, the marketplace acts as “a daily referendum of what is to be produced and who is to produce it.”
“The problem of economic calculation is the fundamental problem of Socialism,” Mises wrote.
Socialist writers may continue to publish books about the decay of Capitalism and the coming of the socialist millennium; they may paint the evils of Capitalism in lurid colors and contrast them with an enticing picture of the blessing of a socialist society; their writings may continue to impress the thoughtless — but this cannot alter the fate of the Socialist idea. ... [They] cannot make Socialism workable.
Of course, Mises was right. The Soviet experiment produced human misery on a prodigious scale — resulting in the starvation and murder of tens of millions of people.
And he was no less right in his other prediction: saying that socialist writers would “continue to impress the thoughtless” with their belief in exalted government — despite all of the horrors and failures.
The whole debate about job creation here in the state of Missouri over the course of 2013 illustrates our continued susceptibility to what Mises called “the fundamental problem of Socialism” — the false idea that politicians and planners can pick economic winners and losers.
Trolling For Jobs (With Taxpayer Money)In the continuing evolution of this “unworkable” idea, we have passed from one form of statism to another: from communism to third-world economics (featuring mammoth projects such as Egypt’s Aswan Dam), and from third-world economics to what we will call third-grade economics — where everyone wants a shiny new object, at taxpayer expense.
Three years ago, the shiny new object of our lawmakers’ affection in Jefferson City was the proposed creation of an “Aerotropolis,” or “China Hub,” at Lambert-St. Louis International Airport, backed by hundreds of millions of dollars of state tax credits.
In 2013, the shiny object that Missouri Gov. Jay Nixon and political leaders of both parties sought was a brand-new plant for building large commercial airplanes.
In September, Nixon vetoed a bill that would have given some tax relief to all Missourians — both individuals and businesses. He said that tax relief was not needed because Missouri already is “a low-tax state.” Then in December, the governor turned around and urged Missouri legislators to approve a massive tax cut — an even bigger tax cut than the one he vetoed — for the exclusive use of one company.
How strange — and yet how typical!
The proponents of big government like to pooh-pooh the importance of taxes (thinking you can never tax and spend enough) ... until there is something they want — like a new plant. Then suddenly taxes matter; they matter a whole lot.
What happened between September and December was the Great Boeing Job Auction. When the 31,000-member International Association of Machinists (IAM) in the state of Washington voted two-to-one to reject Boeing’s offer of an eight-year contract, the company decided to put production of a new airliner, the 777X, in play — inviting proposals from other states.
Boeing initiated a bidding war that attracted governors of twenty-two states and about twice that number of local jurisdictions. It was nothing if not shamelessly frank in describing everything it wanted in the way of financial incentives and freebies. It wanted:
Site at no cost, or very low cost.
Facilities at no cost, or significantly reduced cost.
Infrastructure improvements provided on location.
Full support in worker training.
Entire applicable tax structure including corporate income tax, franchise tax, sales/use tax, business license/gross receipts tax and excise taxes to be significantly reduced.
It is hard to think of a better wish list for corporate welfare, or crony capitalism.
At Nixon’s urging, the Missouri Legislature and the Saint Louis County Council quickly put together a joint package that offered Boeing $3.5 billion in tax cuts and tax credits, mostly over a ten-year period. That comes to almost $600 for every man, woman, and child in Missouri. A substantial portion of the state tax credits on offer were transferrable — meaning that Boeing could sell them for cash to other companies wanting to shelter income in Missouri.
But it was not enough.
The Washington legislature upped the ante — approving tax breaks and other benefits valued at close to $9 billion over sixteen years. In a second vote in early January of 2014, the Seattle chapter of the IAM approved Boeing’s offer of a long-term contract. With that, Boeing announced it would keep 777X production at its massive plant in Everett, Wash.
Taxes Matter — For EveryoneAt the end of this saga, Nixon and other enthusiastic advocates of the Boeing aid package (including the Saint Louis Regional Chamber) did not complain that they had been used as a stalking horse in an elaborate game of rent-seeking and corporate politics. Instead, they heaped praise upon themselves. It was, they said, a worthy effort proving that our state can play in the big leagues of economic development — winning the attention and respect of one of America’s biggest and most respected corporations.
To which we ask — what about every other employer in the state of Missouri? Do they not enter into your thinking? Does it not occur to you that the great engine of job creation in this country over the past several decades has been small business, not big business?
Show-Me Institute Policy Analyst Patrick Ishmael zeroed in on this point in an op-ed in the St. Louis Business Journal on Jan. 24, 2014. He wrote:
If, as we often are told, Missouri is a “low-tax state,” why was it necessary to make Boeing’s taxes even lower? And why should the state support corporate handouts to one company, but actively deny them to family businesses in our community?
Channeled in a different direction, the incentives that the state of Missouri offered to Boeing would make it possible to cut Missouri’s 6.25 percent tax on business income in half.
Think of what that would mean to thousands of Missouri businesses.
Who is to say that substantial tax relief for all businesses would not create many more jobs than the addition of a single Boeing plant?
Missouri has been among the most generous of states (or, to be more accurate, among the most wasteful of states) in doling out commercial tax credits to politically favored businesses. It has also trailed all but a handful of other states in economic growth and job creation.
Every year, the state of Missouri hands out about $400 million in targeted tax credits earmarked for economic development. That is money that supposedly goes to promising business ventures and commercial developments. But the return on this investment of taxpayer money is not just bad, it is appalling. Again and again, the would-be great success stories have turned into disappointments.
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“Every man,” argued the philosopher William Godwin, “has a certain sphere of discretion, which he has a right to expect shall not be infringed by his neighbours. This right flows from the very nature of man.” Market anarchists agree with Godwin and thus oppose the state simply as one specific example of invasion or aggression against peaceful individuals. After all, by definition, governments must aggress against innocents just to exist. As soon as we subject government to the same moral rules and standards to which we subject every other individual or group, we see at once that government is the foremost lawbreaker and evildoer acting in society. As Murray Rothbard argued in his classic libertarian manifesto For a New Liberty, since we “make no exceptions” to general morality for the state, we must “simply think of the State as a criminal band,” an organization of plunder seizing tribute from peaceful, productive society. The state presents us with no good or compelling reason why it ought to enjoy the prerogative of killing, stealing, and doling out special privileges to its courtiers at the expense of legitimate free market actors. Presented with a nation blighted by the sequelæ of past state misdeeds, our overlords nevertheless assure us that the only way forward is to entrust the political elite with more power still.
The glaringly contradictory logic of such a course of action was percipiently noted by the British historian Thomas Babington Macaulay when he wrote, “The calamities arising from the collection of wealth in the hands of a few capitalists are to be remedied by collecting it in the hands of one great capitalist, who has no conceivable motive to use it better than other capitalists, the all-devouring state.” Macaulay, anticipating the public choice theory of politics, understood that the state is a human institution, that the individuals who make it up and brandish its enormous power are motivated by all the same impulses and incentives that drive the rest of us. If, for good reason, we generally distrust the concentrated power wielded by coercive monopolies, we ought to avoid at all costs placing more power in the state, the ultimate embodiment of monopoly — indeed the source of all monopoly power. When statists of all stripes — progressives, socialists, “liberals,” etc., — propose to empower the state further, clamoring for more laws and regulations, they aggravate the problem that they propose to remedy, short-circuiting more and more of the competitive pressures that are in point of fact the only effective safeguard against the abuse and concentration of power. Anarchists instead propose an economic system of pure voluntary exchange, a real free market within which the one and only way to amass any economic power is to serve consumers consistently and responsively. Contrast such a system to the American fascism which governs the United States today. In his new book, Against the State, Lew Rockwell writes, “Fascism is the system of government that cartelizes the private sector, centrally plans the economy to subsidize producers, exalts the police State as the source of order, denies fundamental rights and liberties to individuals, and makes the executive State the unlimited master of society.” There is no denying that the foregoing definition of fascism provides an accurate description of conditions now prevalent in the United States.
The anarchist, having established that the state is a war on and the principal obstacle to a free and peaceful society, suggests the “utopian” notion of simply not permitting a glorified mafia to prey on the innocent. Anarchism, therefore, is hardly a provocative, pie in the sky notion, and is hardly the straw man put up by its statist opponents. Neither is it advocacy for chaos and lawlessness, which much better describe a system in which justice is meted out arbitrarily and unevenly, in which American citizens can be murdered without due process, and constitutional protections reveal themselves as the impotent parchment guarantees they are. Because it undermines the fascist, Washington, DC-instituted status quo, the free-market anarchism that we espouse will be fighting an uphill battle for as far as the eye can see. As Rothbard wrote, “[S]pecial interests and ruling elites will not surrender their ill-gotten gains so readily. They will fight like hell to keep it. Libertarianism is not a message of treacle and Camelot: it is a message of struggle.” Lacking the money, power, or connections of the ruling power elite, anarchists must be content to approach that struggle with the strength of our ideas — propitiously, when it comes to those, we have the upper hand.
Image source: iStockphoto.
This article is also available as an Audio Mises Daily Today, many Christians feel it natural to adopt a brand of social conservatism when it comes to politics and public policy. Not only do we see them hold public demonstrations against what they view as social vices, they also usually call for legislation to regulate, control, and ban these activities. The same religious zeal (which is not a problem per se), which brought alcohol prohibition in the 1920s is still here today. Numerous governments around the world have laws that criminalize peaceful and consensual sexual activities between those of the same sex. Christian leaders and movements have policies.
Norman Horn “these Christians have no means of harmonizing these thoughts in a political and cultural climate that presents us with seemingly only one option. The disconnect is their theology of the State and of law. It causes them to make a mistake in reasoning that the State needs to solve this problem (with more legislation, more regulation) and the church just needs to fall in line.”Norman Horn (2013, March). How the Church can reasonably respond to same-sex marriage Simply put, in the face of social vices, they are drawn to whatever government-initiated public policies that are being perpetuated to curb them.
This assumes a rather optimistic view of the ability and authority of the State to combat sin and its effects. Ironically, this stands in stark contrast to that of St. Augustine, the renowned Christian theologian and philosopher, who takes a prominent place in Church and Western history. His influence as a thinker was arguably unrivalled in the early history of the Church.Brian Tierney (1988). The Crisis of Church and State, 1050–1300. Toronto: University of Toronto Press.
In the City of God, Augustine explains that humankind is divided into two groups: one belonging to the City of God, the other to the earthly city. The City of God is made up of those who love God above all else, but the earthly city is constituted of those who love themselves and, is animated by the lust for power:
The two cities were created by two kinds of love: the earthly city was created by self-love reaching the point of contempt for God, the Heavenly City by the love of God carried as far as contempt for self. ... In the former [the earthly city] the lust for domination lords it over its princes as over the nations it subjugates; in the other, both those put in authority and those subject to them serve one another in love, the rulers by their counsel, the subjects by obedience. [14: 28]
Following this distinction, he argues that true justice, which is to “love serving God only, and therefore ruling well all else,” is simply not present on earth, due to the sinful nature of mankind populating the earthly city. All political states as they exist on earth are therefore devoid of true justice.
With this in mind, Augustine likened the State to a criminal band of thieves and robbers:
Justice being taken away, then, what are kingdoms but great robberies? For what are robberies themselves, but little kingdoms? The band itself is made up of men; it is ruled by the authority of a prince, it is knit together by the pact of the confederacy; the booty is divided by the law agreed on. If, by the admittance of abandoned men, this evil increases to such a degree that it holds places, fixes abodes, takes possession of cities, and subdues peoples, it assumes the more plainly the name of a kingdom, because the reality is now manifestly conferred on it, not by the removal of covetousness, but by the addition of impunity. Indeed, that was an apt and true reply which was given to Alexander the Great by a pirate who had been seized. For when that king had asked the man what he meant by keeping hostile possession of the sea, he answered with bold pride, “What thou meanest by seizing the whole earth; but because I do it with a petty ship, I am called a robber, whilst thou who dost it with a great fleet art styled emperor.” [4:4]
Of course, St. Augustine was no anarchist. Though political states are imperfect and lack true justice, they still, for Augustine, have a divine purpose to fulfill. Their basic function is to ensure a modicum of civil peace on earth to prevent a Hobbesian “war of all against all.”R.W. Dyson (2003). "The Political Theology of St. Augustine of Hippo." In Normative Theories of Society and Government. Lewiston: Edwin Mellon.
Even though Augustine did not seem to follow through with his damning critique of the State, which aligns very well with Murray Rothbard’s description of the State as “a gang of thieves writ large,” he still argued clearly that the State was not a moral institution in and of itself.
Dyson concludes therefore,
the State, then, is a result of sin and an expression of sin. Like sickness, death and all the tribulations of this world, it is an outcome or product of the Fall. More strictly, it is a result of the change wrought in human nature and on the human will by the Fall. The State is not, as it had been for Plato and Aristotle, a natural part of human life or a natural forum for the development and expression of the human character and potential. It is an unnatural supervention upon the created order.Ibid., p. 27.
This should be a sobering reminder to Christian statists who so uncritically accord the State some semblance of moral authority. It makes no sense to combat sin with an inherently flawed institution that is itself borne of sin. We must look beyond the mystical aura the State has hidden itself behind and realize that the “emperor” has no clothes. Religious zeal devoid of knowledge of the truth is damaging and costly.
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Just as Professor Bernanke exits center stage at the end of Act I of the monetary comedy he created, the scene shifts to Frankfurt. The star of Act II is European Central Bank (ECB) chief Mario Draghi. As we pick up the story, Mr. Draghi has been launching a defense against a phantom threat of deflation.
Meanwhile, our retired star is busy collecting top fees from appreciative “fans,” especially from Wall Street, an area where he once admitted “he had to hold his nose.” What are these fans hoping to gain from their fawning of ex-superstar Bernanke in this new world of monetary transparency, which he proudly claims to have created? Is it the privileged insights that come from networking and knowing how the replacement actor will handle the Fed’s machinery for manipulating long-term interest rates? It has been said that the new chief, rising star Janet Yellen, is “joined at the hip” to her predecessor.
Mario Draghi has yet to acknowledge how much the success of Act II depends on the quantitative easing from Act I, as written and choreographed by Professor Bernanke. The ECB illusionist scored his first big ovation from center stage by proclaiming he would do “whatever it takes to save the euro.” The global asset price inflation plague created by the Bernanke Fed turned those words into immediate virtual reality. Irrationally exuberant investors in their search for yield have been chasing any half-plausible story. Europe with its onetime array of high-yielding markets has been fertile ground for such speculative hypotheses, including Draghi’s boast.
The ECB president is impervious to the critics who say his new strategy of injecting an added strain of asset price inflation into the veins of the European economy, though bolstering the European Monetary Union (EMU) in the short-term, could be fatal in the longer term. That is no laughing matter, because the collapse of EMU in the next great asset price deflation in global markets could bring a monetary revolution.
The essence of comedy is inflexibility, not the volume of the laughter. Don Juan is comic because even when granted a last chance of repentance, or else face death by fire, he cannot change his ways. In the present Bernanke authored comedy, the central bank actors cannot stop trembling for fear of deflation. Yet there has been no actual or threatened monetary deflation during all the years of this long-running show (and well before then).
Under a hypothetical regime of monetary stability the invisible hand of market forces would cause there to be periods of falling and rising prices. The determination of the Federal Reserve to fight those natural down-waves in prices such as occur in business contractions, or under the influence of technological change, has been the source of outbreaks of asset price inflation culminating in great recession and in long-run diminution of economic dynamism.
The Bernanke-ite comedic characters, though, remain convinced that any episode of falling prices would mean economic catastrophe and they have conjured a whole folklore, spanning from the Great Depression to Japan’s Lost Decade, to demonstrate this misleading assertion. ECB chief Mario Draghi cites the fight against deflation as the principal reason for introducing negative interest rates on deposits at the ECB, and a further package of below market cost loans to weak banks.
Yes, prices, and even some wages have been falling in Spain and Italy. But this is simply a result of the unsustainable high levels that resulted from the asset and credit inflation of the last decade, and are now falling slowly in line with real equilibrium tendencies. In Germany, goods-and-services inflation is running at over 1 percent per annum and real estate price inflation is at 10 percent-plus in many cities.
Understandably the German media is voicing complaints by savers being penalized for the camouflaged purpose of aiding crony-capitalist bankers in southern Europe. Mario Draghi gives the standard response of the deflation phobic central banker: Non-conventional policy tools will stimulate a strong recovery which should ultimately benefit the rentier. Who is he kidding?
It appears he is kidding many. The boom in carry trade (the assumption of currency, credit, or maturity risk in the pursuit of higher yields), a key symptom of the asset price inflation disease which ECB and Fed deflation fighting created, now features 10-year yields on Spanish government bonds, below those on US bonds.
Many in the marketplace now question whether there ever really was a crisis in the European Monetary Union. The David Low cartoon comes to mind, John Bull rubs his eyes on March 13, 1939, asking whether the Munich crisis of the previous November was just a bad dream. No wonder the euro stays at high levels.
Back on stage, the Bernanke-ite comedians are now puppeteers, pulling the strings of their puppets, donning their Emperor’s new clothes (in the form of rate manipulation machinery the effectiveness of which depends on market irrationality), and waving their wands. The question of whether the comedians are themselves puppets does not cloud the minds of those in the audience mesmerized by the show, and expecting to cash their profits before speculative temperatures drop. The retired actor and author, in the twilight of his career, knows his appearance fees depend on the show’s continued power to mesmerize the crowd.
Image source: iStockphoto.
This article is also available as an Audio Mises Daily
Progressives have a way with words that is truly impressive. Perhaps it started when they stole the word liberal from libertarians and since has snowballed out of control. From “social justice” to “pro-choice” (except with light bulbs) to various “isms” to describe their opponents, progressives are experts at such linguistic feats. And while conservatives and even libertarians unfortunately use many trite phrases in place of an argument as well, progressives are the all-time champions. The best proof of this is the term progressive and their excessive use of it when referring to everything they support as being progressive and everything they oppose as more or less reactionary. This simple dichotomy is a pleasant fiction for those who like their politics boiled down to the most unsophisticated, partisan blather. However, the idea of progress coming on some gradient between reactionary conservative or libertarian and progressive liberal is blatantly fallacious.
Assuming progress is one way and reaction the other is a kind of two-dimensional thinking that breaks down very quickly. For example, the progressives of the early twentieth century generally believed things that would abhor progressives of today. Those progressives were the ones who rammed through Prohibition against those “economic conservatives who ... pushed so hard for repeal”Daniel Okrent, Last Call : The Rise and Fall of Prohibition (New York: Scribner, 2010), p. 361. as historian Daniel Okrent put it. The famous progressive William Jennings Bryan was a staunch supporter of Prohibition. As his biographer Paolo Coletta noted,
Bryan epitomized the prohibitionist viewpoint: Protestant and nativist, hostile to the corporation and the evils of urban civilization, devoted to personal regeneration and the social gospel, he sincerely believed that prohibition would contribute to the physical health and moral improvement of the individual, stimulate civic progress, and end the notorious abuses connected with the liquor traffic.Paolo Coletta, William Jennings Bryan (Lincoln: University of Nebraska Press, 1969), vol. 2, p. 8.
Sounds like a modern day drug warrior, to whom progressives are often quite suspect (unless they are fighting Four Loko, of course). Speaking of which, the progressives of old also passed the Harrison Narcotics Tax Act, the first federal drug law. Meanwhile, the presumably reactionary libertarian H.L. Mencken described supporters of Prohibition as being moved by the “psychological aberration called sadism.”
It should also be noted that Coletta described Bryan as a “nativist.” Nativism is usually associated with the right, but that shouldn’t be the case for these progressives. The AFL supported the 1882 and 1924 immigration restriction acts against the Chinese. In fact, many “progressive” labor unions were very racist, nativist, and nationalist. Even the second incarnation of the Ku Klux Klan in the early twentieth century, aside from being quite racist, was also in favor of many progressive reforms. Abortion-advocate and progressive hero Margaret Sanger even gave a speech at one of the KKK’s rallies.
Margaret Sanger was also an avowed supporter of eugenics, as were many other progressives of the time (something modern day progressives seem less enthusiastic about). As Steven Pinker observed,
Contrary to the popular belief spread by the radical scientists, eugenics for much of the twentieth century was a favorite cause of the left, not the right. It was championed by many progressives, liberals, and socialists, including Theodore Roosevelt, H.G. Wells, Emma Goldman, George Bernard Shaw, Harold Laski, John Maynard Keynes, Sidney and Beatrice Webb, Margaret Sanger and the Marxist biologists J.B.S. Haldane and Hermann Muller. It’s not hard to see why the sides lined up this way. Conservative Catholics and Bible Belt Protestants hated eugenics because it was an attempt by intellectual and scientific elites to play God. Progressives loved eugenics because it was on the side of reform rather than the status quo, activism rather than laissez-faire, and social responsibility rather than selfishness.Steven Pinker, The Blank Slate (New York: Penguin Books, 2003), p. 153.
It’s almost absurd that conservatives and libertarians get blamed for eugenics, even if it’s typically in a roundabout way through the muddled and all but apocryphal term of “Social Darwinism.” After all, why would conservatives, who are often skeptical of evolution, support a “science” based on evolution? And why would libertarians support government trying to regulate people biologically when they oppose the government trying to regulate lemonade stands. Given that, it is unsurprising that the Catholic conservative G.K. Chesterton wrote Eugenics and Other Evils. And the great libertarian economist Ludwig von Mises complained about socialist meddling in that “... [a man] becomes a pawn in the hands of the supreme social engineer. Even his freedom to rear progeny will be taken away by eugenics.”Ludwig von Mises, Two Essays by Ludwig von Mises (Auburn, Ala.: Mises Institute, 1991), p. 27.
But the National Socialists (i.e., “Nazis”) were the biggest proponents of eugenics and they weren’t progressive, right? After all, their 25 point platform demanded all sorts of libertarian things such as “the nationalization of all trusts ... profit sharing in large industries ... [and] a generous increase in old-age pensions.” Hugh Johnson, a key member of Franklin Roosevelt’s Brain Trust during the New Deal, even refered to Benito Mussolini as a “shining example of the twentieth century.”Quoted in Thaddeus Russell, A Renegade History of the United States (New York: Free Press, 2011), p. 252. Still, the National Socialists certainly weren’t antecedents of modern left-wing social justice warriors. Of course, it’s hard not to conclude such fascists were also close to the polar opposite of libertarians.
This history should prove that progress in terms of moving toward something better is, in a political sense, extremely subjective. For example, progressives in Denmark made prostitution legal and progressives in Sweden made it illegal. Can both be progressive? Now, progress surely exists in economic, scientific, and technologic terms. Or at least one would think. Some very progressive folks believe the Luddites were a “heroic movement for working-class rights.” So destroying technology equals progress? What about the Industrival Revolution? After all — despite its many difficulties — per capita income did skyrocket afterward. But some progressives seem unsure about the Industrial Revolution’s overall positive qualities. Or let’s go back further and ignore the ridiculously high levels of violence among tribal societies by undoing the Agricultural Revolution, which Jared Diamond calls “The Worst Mistake in the History of the Human Race.” Or forget that, let’s just get rid of human beings all together with the hyper-progressive voluntary human extinction movement. Progress!
What progress is and what reaction is depend very much on where you start and where you want to go. If equality is the goal — as many self-described progressives say it is — then any progress toward equality should be considered, well, progress. If that is the case, shouldn’t communism be the most progressive cause of all? Communism was certainly considered as such by many intellectuals in the past. Indeed, Karl Marx saw history as a sort of march of progress: primitive communism to slave society to feudalism to mercantilism to capitalism to socialism and finally to communism. And the Soviet Union certainly executed its fair share of reactionaries and counter-revolutionaries.
Fortunately, communism has been politically dead for over two decades. You may have a few radicals like Maoist Rebel News toasting his now dearly departed Kim Jung Ill with a shot of Hennessey or making a whole series of videos describing the greatness of North Korea by recycling North Korean propaganda videos and talking points. But that’s abnormal. Most modern progressives despise communism and would never show even the meekest support for such a blood-soaked system. Would they?
Well, over at Salon, Jesse Myerson wants to tell you “Why you’re wrong about communism” and Sean Mcelwee at The Rolling Stone highlights why “Marx was Right” because he foresaw the horror of iphones. Whoopi Goldberg thinks that at least “it’s a great concept.” Former Obama White House Communications Director Anita Dunn referred to Mao Zedong as one of her “favorite political philosophers” whom Howard Zinn lauded for creating “... the closest thing, in the long history of [China], to a people’s government ...”Howard Zinn, A People’s History of the United States (HarperCollins Publishers, 2005), p. 399. Back in 1984, Jesse Jackson gave a speech in Havana titled “Viva Fidel,” Robert Redford went scuba diving with said dictator and Steven Spielberg described the time he spent with Castro as “the most important eight hours of [my] life.” Hollywood even made a four-and-half- hour, two-part propaganda film about Che Guevara back in 2008. The left’s mushy and ambivalent view toward communism may best be summed up by Daniel Singer, when writing for The Nation back in 1999, wanted to highlight both sides, the “enthusiasm, construction, the spread of education and social advancement” along with the less pleasant things, such as mass murder.
Refutations of such nonsense can be found elsewhere. What’s important to this discussion is that one would suspect that dusting-off things which had been left in the ash heap of history would be, well, reactionary.
Image source: iStockphoto
This article is also available as an Audio Mises Daily
One of the worst effects of modern Keynesian economics is that its total spending (“aggregate demand”) approach to output and employment provides a pseudo-scientific justification for the central error of mercantilism — an error that dates back to the sixteenth century. According to this ancient fallacy, a deficit in a nation's balance of payments results in a loss of demand, income, and jobs. This doctrine has been demolished time and again by economists during the past two-and-a-half centuries. Yet like the mythical Phoenix the mercantilist myth continually rises from its own ashes.
A few weeks ago the Commerce Department reported that the US trade deficit increased to $47.2 billion in April from $44.2 billion the previous month.US Department of Commerce, “US International Trade In Goods And Services April 2014” (June 4, 2014). This $3 billion increase brought forth the usual dire warnings of economic doom from Keynesian neo-mercantilists. Dean Baker co-director of the Center for Economic Policy Research, for example, wrote:
To remind folks who never suffered through a [Keynesian] intro course or forgot their suffering, a trade deficit means that demand generated in the United States is going overseas. Money spent by businesses or consumers is going for goods and services produced in Europe, Mexico, and China rather than in the United States. ... A larger trade deficit has the same implications for the economy as a sudden cutback in consumer spending or business investment. It means less demand and fewer jobs.Dean Baker, “Why Do Coal Mining Jobs Matter So Much More Than Jobs Lost to Trade?” Truthout (June 9, 2014).
Baker seizes on this small blip in monthly trade balance figures as an opportunity to regurgitate the discredited mercantilist dogma for the billionth time. Using some statistical legerdemain, he projects dire effects of the trade deficit on the US labor market:
Data from a single month are erratic, but the average trade deficit over the three months from February to April was running at an $85 billion higher annual rate than the trade deficit of the prior three months. This means, other things equal, $85 billion more of the demand generated in the United States would be creating growth and jobs in other countries rather than in the United States. ... This loss of demand would translate into roughly 700,000 jobs. This is the result of having consumers and businesses switch their spending from domestically produced items to goods and services that we get from other countries.Ibid.
Now there are a few problems with Baker’s argument. First, by annualizing and averaging the three monthly data points, Baker obscures two facts: (1) the trade deficit for February-April actually averaged only $21.25 billion higher than the previous three months; and (2) his claim of an $85 billion increase in the deficit is based on arbitrarily extrapolating these data nine months into the future. Furthermore, by comparing the size of the deficit during these three months to the immediately prior three months, Baker is cherry picking the periods he is comparing to make a projection that is at odds with the recent historical movement in the trade deficit. In fact if we take the two-year period from the end of 2011 to the end of 2013, we get a very different picture: the trade deficit has fallen continually with one slight interruption, from a quarterly rate of over $140 billion to under $120 billion, meaning that over the past two calendar years the average annual trade deficit has actually declined by over $40 billion.Federal Reserve Bank of St. Louis, National Economic Trends (June 2014), p. 18. Baker’s disingenuous appeal to statistics is even clearer when we consider the raw data, which show that the trade deficits for the years 2011–2013 were, respectively, $559.880 billion, $537.605 billion, and $476.392, a clear downward trend.“US International Trade In Goods And Services April 2014,” p. 1 (see note 1 above for url); and US Department of Commerce, “US International Trade In Goods And Services November 2013” (January 2014). (As Murray Rothbard always emphasized, the raw data are always closer to reality than “data” that have been subjected to fancy statistical techniques such as seasonal adjustment, three-month moving averages, chain-weighting, etc.)
Second, even if the trend projected by Baker is realized, other things equal, it would not cause any net loss in jobs at all. What Baker and his fellow neo-mercantilists fail to realize is that every dollar in excess of US exports that is spent by US residents on imports of goods and services from abroad is either spent by foreigners on the purchase of US assets, i.e., invested in US stocks, bonds, bank deposits, real estate, physical capital or are used by foreigners to pay interest and dividends owed to US residents who own foreign assets. In other words, not a single dollar leaves the US as a result of the trade deficit. Checking deposits in US banks are merely transferred from US importers to foreign exporters, who may or may not sell them on the foreign exchange market. In either case, these dollar deposits are ultimately transferred back to US residents by foreigners who wish to invest in US assets or who owe debts to US residents.
Let us take our trade deficit with China as an example. Chinese exporters to the US are not interested in earning and holding dollars which are neither used as payments media in their own country nor yield a return. If they do not wish to use these dollars to buy American products (or to sell them on the foreign exchange market to others who do), then they will use them to invest in US assets that are expected to yield interest payments or profits. Thus, in the last year Chinese investors have used China’s net export earnings to buy up golf courses across the US from California to North Carolina. They have also purchased Sheraton hotels and residential real estate on the West Coast as well as the AMC Theatres chain. Last year alone major Chinese investments in US businesses doubled to $14 billion and are estimated to have reached $8 billion in the first three months of this year.E. Scott Reckard, “Chinese Investors Buying Up US Golf Courses,” Los Angeles Times (June 14, 2014) In addition, of course, the Chinese continue to invest dollars in accumulating US financial assets yielding interest and dividends.
The neo-mercantilist responds to this by arguing that foreign purchases of US financial assets and (existing) real assets do not replace the decreased spending on currently produced US goods and services that “leaked out” through the trade deficit. But this is based on the discredited Keynesian doctrine that purchasing financial assets is not necessarily equivalent to spending on “real” capital goods. However, the dollars that are invested by foreigners in US stocks, bonds, and financial intermediaries like banks and mutual funds are ultimately lent to or invested in US business firms. These firms then “spend” these dollars on paying wages and buying real capital goods like raw materials, plants and equipment, and software. But what about foreign purchases of real assets like golf courses or hotels that already exist? All other things equal, including domestic “time” or saving preferences, these purchases provide the funds for the US sellers of these assets to invest in starting new projects and enterprises that they forecast to be more profitable and which involves spending on wages and new capital goods.
In short, the so-called trade deficit is exactly equal in dollar terms to net foreign investment in US-based business firms (plus net investment income received by US residents from their foreign asset holdings). The flow of spending in the US economy is not diminished one cent by a negative trade balance but merely re-routed. Accordingly, the “real” effect on the US economy of a trade deficit is a redirection of labor and capital out of its export industries into industries producing consumer and capital goods for domestic use, with no net loss of jobs.
Unfortunately, Baker does not betray the slightest recognition of this analysis. He is trapped in the Keynesian framework in which total spending mechanically drives production and employment and interest rates are always stuck above the level necessary to coordinate the decisions of household to “save” by purchasing financial assets and the separate decisions of business firms to “invest” by purchasing currently produced capital goods. Thus for Baker the trade deficit is a malady to be cured by government rather than a necessary stage of a continuous process in which capital is reallocated to its most highly valued uses in the global economy.
Third, as a neo-mercantilist enlightened by Keynesian economics, Baker shies away from advocating tariffs, quotas, and other crude barriers to trade to remedy the trade deficit. He considers adding spending to the economy via government budget deficits to offset the leakage of spending abroad through the trade deficit, but dismisses the idea: “Government deficits would do the trick but our politicians don’t like budget deficits.” Instead, he argues:
The trick to getting the trade deficit down is a lower valued dollar. This makes our exports cheaper to foreigners, meaning we export more. And it makes imports more expensive, so we buy domestically produced goods rather than imports. ... The way to lower the dollar is simple, we negotiate it.Baker, “Why Do Coal Mining Jobs Matter So Much More Than Jobs Lost to Trade?” (see note 2 above for url).
In other words Baker is proposing that the US government deliberately engineer a cheapening of the dollar in collusion with foreign governments. Needless to say there are profound problems with this policy. First it involves increasing the rate of growth of the US money supply relative to the rates of monetary growth in foreign countries, especially China and OECD countries. Second, the dollar depreciation can only succeed in shrinking the trade deficit in the short run. Since exchange rates typically respond much more quickly than the prices of goods and services to monetary expansion, dollar depreciation would temporarily lower the prices of US products relative to those of foreign products. This would cause US exports to increase and imports to decline. But once the rate of price inflation in the US finally adjusted to the elevated rate of monetary expansion, the effect of the cheaper dollar would be entirely offset by higher US prices. US products and services would no longer enjoy a price advantage in global markets and the trade deficit would reappear, other things equal, unless the Fed once again ratcheted up the rate of monetary growth.
Furthermore, deliberately cheapening the dollar would wreak havoc with the US economy and reduce living standards of ordinary Americans. In the short run, which could last a year or two, the policy would impoverish most US households by raising the prices they have to pay for imported goods, like those that stock the shelves of Walmart and Best Buy, while lining the pockets of the unionized laborers and crony capitalists who operate in the export industries. In the long run, these same households would suffer the effects of an inflationary boom, asset bubbles in financial and real estate markets, and the inevitable financial crisis and recession.
The real problem is not the trade deficit and the corresponding inflow of foreign capital to the US. In fact this would enhance labor productivity and living standards in the US if these funds were invested in the production of additional capital goods and the creation of new enterprises. The problem is the Federal budget deficit which diverts foreign — as well as domestic — capital flows from productive investment in the US economy to politicians who use these funds to finance wars, corporate welfare programs, crony capitalist bank bailouts, and the expansion of wasteful and destructive government agencies. This deficit suppresses current US living standards and leaves future taxpayers to foot the bill.
Image source: iStockphoto
This article is also available as an Audio Mises DailyEarlier this year Chris Kjorness described the importance of entrepreneurship in the rise of the Beatles. The Beatles became a global phenomenon when they arrived in the US fifty years ago, thanks to the entrepreneurial alertness and imagination of Brian Epstein. 1964 was also the year of the start of what became John Lennon’s most admired and respected contribution to modern music: “Imagine.”
Several poems in Yoko Ono’s 1964 book Grapefruit inspired Lennon to compose “Imagine.” According to Lennon “Imagine ... should be credited as a Lennon/Ono song. A lot of it — the lyric and the concept — came from Yoko, but in those days I was a bit more selfish, a bit more macho, and I sort of omitted her contribution, but it was right out of Grapefruit.”
The lyrics of “Imagine” are blatantly socialist. Lennon stated that the song is a political statement, and “is virtually The Communist Manifesto.” Lennon rejected socialism as practiced in Russian and China, but favored “nice British socialism.”
The idea that socialism can be British instead of brutish is based on unclear thinking. There is no doubt that the lyrics of “Imagine” have evoked strong feelings, but this is why its vision for socialism is unworkable. Lennon stated that the “no-religion too” part of “Imagine” aimed at ending the “my God is bigger than your God thing.” If we eliminated national borders, religion, possessions, all the things that at least appear to divide people, then we can supposedly achieve global harmony.
The problem is that Lennon’s vision is incredibly vague and undetailed; it allows each person to imagine his or her own personal utopia. This is one of the key defects of socialism: there is no one objective notion of a good society or social justice.
The proposed ending of possessions means ending private property rights. Ending private property rights would not end division among all people, it would maximize division. Instead of the “my God is bigger than your God thing” socialism must result in the “my social justice is better than your social justice” thing.
Lennon claimed to oppose the type of socialism practiced by “some daft Russian,” but the reality is that all socialist societies naturally produce rival factions that each try to impose their own plan for all society, based on their own special notion of social justice. It is the utter lack of any objective notion of what socialism should be, combined with the powers of human imagination, which makes harmony in socialism impossible.
The entrepreneurial type of imagination and insight exercised by Brian Epstein is what produces the greatest feasible level of social harmony. Epstein accurately perceived the potential of the Beatles to entertain vast numbers of people around the world. The commercial success of the Beatles stemmed from peaceful transactions for records and tickets, and all this commerce resulted in gainful employment for many people, some of whom may not have actually appreciated Beatles music.
The kind of world described in “Imagine” by John Lennon and Yoko Ono is a source of tragic division and destruction (though Lennon and Ono can’t be blamed for any specific example of utopia-inspired disasters). A daft Russian named Stalin murdered millions to impose his vision of socialism instead of Trotsky’s vision of socialism. Then there is that daft Chinese Mao, that daft Cambodian Pol Pot, that daft Vietnamese Ho Chi Minh ...
Hayek noted that if he had to live in a socialist society he would prefer to have it run by Americans or by English, but in the end American or British socialism would “not prove so very different or much less intolerable” than the Nazi and Soviet prototypes. Hayek was right. Neither Marx nor Lennon, nor any other socialist, has been able to create anything more than a vague vision or a strictly personal plan for socialism. It would likely take many years for British or American socialism to become truly tyrannical, but the fact of the matter is that we have already witnessed a failure of rival factions in US politics to agree on any common vision for the federal welfare state.
It is a great irony that visions of socialist harmony necessarily result in rancorous and destructive struggles among groups with contradictory visions of the good society. It is perhaps equally ironic that profit-driven competition in markets results in the highest attainable degree of social harmony. Yet, this is how the world really works.
Image source: iStockphoto.
Volume 7, No.1 (Spring 2004)Short of state implosion, what those who wish to promote free markets most need is an unevasive, contemporary, socialist theory. Cockshott and Cottrell have come as close to developing a serious, up-to-date version of a neo-Marxist political economy as we are likely to see.
Volume 9, No. 4 (Winter 2006)
Thomas Sowell is probably best known for his studies of ethnic relations and economics and for his policy oriented works, aimed at a wide popular audience, e.g., Conquests and Cultures: An International History (1998) and Basic Economics: A Citizen’s Guide to the Economy (2004). His Knowledge and Decisions (1980), which earned the praise of F.A. Hayek, showed him to be a gifted theorist as well; and, in On Classical Economics , this versatile author makes a valuable contribution to the history of economics.
Sowell begins with a definition of classical economics:
Since the authoritative tradition that built upon The Wealth of Nations underwent a major change with the marginalist revolution of the 1870s, the end points of classical economics can be reasonably well established, about a hundred years apart. Within that span, there were three men who were clearly classical in every sense: Adam Smith, David Ricardo, and John Stuart Mill.
Others, such as James Mill and J.R. McCulloch, were “fully part of the same tradition, though not of equal stature”; yet others, such as Say and Malthus, “contributed key concepts to classical economics without sharing all its methods and conclusions.” A further group, which includes Marx and Torrens, made less important contributions but still falls within the “larger penumbra” of classical economics.
Volume 8, No. 2 (Spring 2005)Symposium: On the Occasion of the Eighteenth Edition of Paul Samuelson's Economics
Paul A. Samuelson's legendary textbook, straightforwardly titled Economics, most famously exemplifies Samuelsom the writer. To mark the release of the eighteenth edition in July 2004, this paper briefly considers the textbook, and celebrity (and criticism) it attracted.
Volume 9, No. 1 (Spring 2006)The book distinguishes seven different schools of macroeconomic thought: orthodox Keynesianism, orthodox monetarism, the New Classical School, real business cycle theory, new Keynesianism, Post Keynesianism, and the Austrian School. As the authors themselves acknowledge, their classification differs slightly from some of those made by other scholars, but it should not prove to be particularly controversial. Each school of thought receives one chapter, and most chapters conclude with an interview by the authors with a leading representative of the school (e.g., Milton Friedman on orthodox monetarism, Robert E. Lucas, Jr. on the New Classical School, Edward Prescott on real business cycle theory, N. Gregory Mankiw on new Keynesianism). The chapters on Post Keynesianism and on Austrian economics do not include such interviews, because they have been contributed by leading scholars of those schools (Paul Davidson and Roger W. Garrison, respectively) rather than by Snowdon and Vane.
Volume 8, No. 2 (Summer 2005)Symposium: On the Occasion of the Eighteenth Edition of Paul Samuelson's Economics
It is no wonder that the vast majority of Americans do not know whom, if anyone, they should believe regarding economic pronouncements. Much of the credit for this intellectual legacy can be laid at the feet of Paul A. Samuelson, the Nobel Prize-winning economist, who took the public mind by storm with his phenomenally popular textbook, Economics: An Introductory Analysis.
Samuelson, through the popularity of his brew of historicist, Walrasian, and Keynesian analysis, paved the way for the current dismal reputation of the dismal science, Rothbard, by developing his theory within the praxeological tradition of Menger, Böhm-Bawerk, and Mises, established an economic edifice that is both thoroughly realistic and universal, providing both students and professional scholars a consistent antidote for the contemporary interventionist mish-mash of free-market rhetoric and statist economic policy.
Volume 9, No. 4 (Winter 2006)
For those who know little or nothing about the subject the book is likely to be informative but also to be a source of misinformation, particularly for those who know something about one school and are seeking enlightenment on the other. So Chicagoans seeking knowledge about the Austrians will get a lot of useful information about the history of the Austrian School and its development, but nothing about the subtleties of its investigative method or misgivings toward the mainstream way of doing things. In particular the Chicagoan is likely to come away from the book having his prejudices about the Austrian School as being “scientifically soft” reinforced. On the other hand, the Austrian seeking guidance into the Chicago School is also likely to get a lot of useful historical information, but to have his prejudice of the Chicago School as a bunch of naïve, technically proficient philistines reinforced. Neither view is, of course, the truth. Given that few Chicago-types, or any “mainstream”-types are likely to read this book, I imagine that it will be mostly Austrians (and other heterodox-types) who will read it, and they are unlikely to really learn much about the subtleties of the Chicago-method from it.
Volume 5, No. 2 (Summer 2002)Here we discuss briefly Mankiw’s ten principles of economics and offer a critique of these principles à la the Austrian School of economics. A textbook in economics completely based on principles of modern Austrian economics is yet to be written. When such a textbook is written, perhaps this discussion will help the author design the text. We would strongly recommend to the author that the first chapter of the yet-to-be-written textbook be devoted to the ten or so basic principles of economics, with the rest of the book simply enhancing the explanation and application of these principles.
Volume 7, No.1 (Spring 2004)For the usual readers of free market books, Naked Economics promises exciting reading. Charles Wheelan, an American correspondent of London’s Economist and a lecturer at Northwestern University, promises to “undress the dismal science.” Undressing in this sense means “stripping away all of the diagrams, equations, and jargon” and making it the science of real life. “Dismal” means that misunderstanding of the science that equates it with boredom, vagueness, and sheer dullness that Thomas Carlyle forever smeared economics with. In the Foreword, Burton Malkiel calls the book “truly unique,” because Wheelan succeeds in giving us “a delightfully readable guide to economic literacy.”
Volume 13, Number 3 (Fall 2010)
This paper contrasts mainstream analysis of the recent boom/bust episode and its massive interventions with Austrian business cycle theory (ABCT). Mainstream economists remain lost in the Keynesian jungle, and economists in the vein of Irving Fisher, Milton Friedman and Martin Feldstein have not helped. The blinkered approach favored by the economics profession ignores the business cycle theory pioneered by Ludwig von Mises and deepened by successors like Murray Rothbard and Jesús Huerta De Soto. Defying standard economic theory, economists implicitly believe that artificially low interest rates (wrong prices) and debt piled on debt unbacked by real savings do no harm to resource allocation and employment. Attempts to hasten economic growth via monetary policy must prove self-defeating by seducing businesses to over invest in higher stages of production and under invest in lower stages. The recession is the realignment of the production structure with consumer wants. “Without a sound capital theory, macroeconomics is incomprehensible,” as Larry J. Sechrest wrote.
I would like to thank Joe Salerno for his kind invitation to present the Ludwig von Mises lecture for 2010, in this way giving me the opportunity to present these views on the classical theory of the cycle and Say’s Law to a wider audience. I would also like to thank my good friend, Peter Smith, who provided excellent and sympathetic advice on an earlier draft of this paper.
Ludwig von Mises LectureAustrian Scholars ConferenceLudwig von Mises InstituteAuburn, AlabamaMarch 13, 2010
It is a great honor for me to have been asked to present the Ludwig von Mises lecture here at the Austrian Scholars Conference.
Let me begin with a story. When I came to select my list of the ten most influential economists of the twentieth century in an article published in the Canberra Times on December 1999, an article which can still be found on the Societies for the History of Economics website, the economist I chose as the most influential—not the best nor the greatest, mind you, but as the most influential—was John Maynard Keynes. No one, I regret to say, has had more influence than Keynes.
Then, second on my list, was Friedrich Hayek, placed there because of his recognized relevance for the economies of Eastern Europe that were then emerging from beneath the horrors of their communist regimes.
But third was Ludwig von Mises, who might have just as easily been second, about whom I wrote these words:
Ludwig von Mises took the fight up to the socialist dogmas of the early twentieth century and showed on paper that no economy could ever solve the problem of allocating resources without a price mechanism, free markets and private property. Who doesn’t know it now? He knew it eighty years ago.
Ludwig von Mises is an economist for whom I have had the greatest imaginable regard which is why having been given this opportunity to speak to you today means as much to me as it does.
And in beginning this address, I would like to mention something that Mises and I have in common. He had been for twenty-four years the economist for the Austrian Chamber of Commerce. Well, as it happens, I had myself been, also for twenty-four years, the economist for the Australian Chamber of Commerce.
And while to some extent this is mere coincidence, I believe that for both of us, as the economic representative of the business communities in both of our countries, even though more than two generations apart, it was this experience that allowed us to understand the workings of an economy with certain kinds of insights that may generally not be appreciated by others.
But it was one aspect of my work that ended up having an immensely large impact on my life, and that is the discovery of Say’s Law for myself. It is because I reinvented this principle that I believe I understand it so well.
And what happened was this. As part of the way in which the Australian economy is managed, we have what was once known as the National Wage Case. It is a court case in front of a panel of industrial relations judges who at the time determined the level of wages for something like ninety percent of the working population.
And as part of the union claim for higher wages, it was always argued that increased incomes would be good for the economy because it would increase demand. I would counter this by pointing out how useless it would be for businesses to find their revenues increased through first increasing their costs by an equivalent amount. And then, a year after I had formulated this argument, I came across the identical argument in a passage in an essay by John Stuart Mill, published as long ago as 1844. This is what Mill wrote:
The utility of a large government expenditure, for the purpose of encouraging industry, is no longer maintained.... It is no longer supposed that you benefit the producer by taking his money, provided you give it to him again in exchange for his goods. There is nothing which impresses a person of reflection with a stronger sense of the shallowness of the political reasonings of the last two centuries, than the general reception so long given to a doctrine which, if it proves anything, proves … that the man who steals money out of a shop, provided he expends it all again at the same shop, is a benefactor to the tradesman whom he robs, and that the same operation, repeated sufficiently often, would make the tradesman’s fortune. (Mill, 1874 [1974])
Although it would be years before I would work this out, what Mill wrote is based on a proper understanding of Say’s Law. High levels of public spending do not encourage industry. Spending does not of itself create growth and employment. You cannot make an economy prosper through expenditure but only through value adding production. Demand does not drive an economy forward, nor does demand deficiency cause recessions.
It was this most fundamental of all economic propositions that Keynes deliberately and willfully destroyed. Say’s Law has, for all practical purposes, now disappeared from economic discourse and policy. And until it returns, the ability for the economics profession to provide sound and sensible advice during recession will remain sharply constrained. But to understand what Say’s Law means one must first understand the role Say’s Law played in the Keynesian Revolution.
UNDERSTANDING THE KEYNESIAN REVOLUTION The Keynesian Revolution, and therefore the origins of virtually all macroeconomic theory today, can only be understood in relation to Keynes’ coming across Malthus’ economic writings in 1932. In particular, it was his reading of the Malthus side of the Malthus-Ricardo correspondence, which had been unearthed in 1930 by his close associate Piero Sraffa, that turned Keynes’ mind to the possibility of demand deficiency as a cause of recession. Until that time, economists had been near unanimous in arguing that insufficient demand as a cause of recession was fallacious.
There has been universal recognition amongst historians of thought that something does happen in late 1932 to turn Keynes in a new direction. Yet not one of the works devoted either to understanding the nature of the Keynesian revolution nor to examining the road between the Treatise on Money published in 1930 and the General Theory published in 1936, has suggested that the reason for this change in direction occurs specifically because Keynes was at that time updating his essay on Malthus.Keynes was at the time completing the essay for inclusion in his Essays in Biography which would be published the following year. Indeed, there is no reason given of any kind why at that particular moment Keynes came to the conclusion that demand deficiency was the missing link in the theory of the cycle. Yet it is as close to a certainty as one can have in such reconstructions that Keynes would never have written the General Theory as he did, focusing on demand deficiency, had he not become deeply interested at the end of 1932 in Malthus’ economic writings. It was Malthus, of course, who had been the leading advocate in the nineteenth century of demand deficiency as a cause of recession and of increased levels of unproductive spending as the cure. Reading Malthus’ letters to Ricardo, and then the text of Chapter VII of Malthus’ Principles, ought to be recognized as the single most important reason why Keynes was to write what he wrote in the way he did.
Recognizing that this was the inspiration should make it easier to understand what the intent of the General Theory was and to understand the nature of the change in economic theory that occurs as a result. In the General Theory Keynes is very clear about what he has learned from reading Malthus.
The idea that we can safely neglect the aggregate demand function is fundamental to the Ricardian economics, which underlie what we have been taught for more than a century. Malthus, indeed, had vehemently opposed Ricardo’s doctrine that it was impossible for effective demand to be deficient; but vainly. For, since Malthus was unable to explain clearly (apart from an appeal to the facts of common observation) how and why effective demand could be deficient or excessive, he failed to furnish an alternative construction; and Ricardo conquered England as completely as the Holy Inquisition conquered Spain. Not only was his theory accepted by the city, by statesmen and by the academic world. But controversy ceased; the other point of view completely disappeared; it ceased to be discussed. The great puzzle of Effective Demand with which Malthus had wrestled vanished from the economic literature. (Keynes, 1936, p. 32, emphasis added.)
It was the “great puzzle of Effective Demand” that Malthus had been wrestling with which had disappeared and it was this that Keynes was intent on restoring to economic theory.
Nor was Keynes wrong on the implications of Say’s Law to his contemporaries. It was precisely this issue that is the dividing line between pre-Keynesian economics and the economics that has dominated theory ever since. Mainstream economists before 1936 had actively denied any role for aggregate demand in understanding the business cycle. Although there had been some attempts to overturn the law of markets, demand deficiency as an explanation for recession was until then almost entirely the province of cranks.Keynes discussed a number of these in the General Theory, referring to them as his “brave army of heretics” (Keynes, 1936, p. 371), a band of brothers that included Bernard Mandeville, Malthus, Major Douglas, Silvio Gesell and J.A. Hobson. The two most important diagrammatic innovations of the 1930s were the IS-LM curves published by Hicks in 1937 and the Keynesian cross diagram first published by Paul Samuelson in 1939 (see Schneider 2010). Both were developed in response to Keynes’ General Theory, and both feature in economics texts to this day.
The problem of recession as conceived in the General Theory was that an economy, once it has passed a certain level of production, will run out of demands for the goods and services it produces.
This is not excess supply for individual goods and services, the “particular glut” whose existence no one had ever denied, but an actual excess supply of all goods taken together, that is, a “general glut.” Keynes made the possibility of demand failure the culminating point at the end of the introductory chapters of the General Theory.
The celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. (Keynes, 1936, p. 33)
The possibility of a failure of effective demand is the very point behind the Keynesian-cross diagram, IS-LM curves or the AD-AS relationship. It is taught to undergraduate economists worldwide, and is embedded almost universally in our present policies designed to pull economies out of recession. And while other possible explanations for recession are now usually discussed as well, demand failure remains the single most important concept most economists are taught in relation to the causes of recession and involuntary unemployment. It is the argument that recessions can best be understood as occurring because of a fall in aggregate demand that continues to mark economic theory to this day, along with the implication that stimulating demand through deficit spending is the optimal approach to take in dealing with recessions when and where they occur.
Aggregate demand is intrinsic to the modern understanding of the level of economic activity. The implication is that it is the level of aggregate demand that is responsible for the level of output, the rate of economic growth and the number of persons employed. An insufficient level of aggregate demand is held generally responsible for high levels of unemployment and it is almost universally accepted that deficit financed public spending can permanently raise the level of output and thereby lower the rate of unemployment. There is an aggregate supply curve associated with aggregate demand, but its principal role is the determination of the rate of inflation. Production levels are not determined by supply capabilities but by the willingness of individuals to buy what has been produced with the incomes they have received.
Indeed, the issue went farther than this. Keynes argued that if Say’s Law were valid, continuing and persistent unemployment simply could not occur and this was unrecognized by classical economists whom he was about to correct. As he wrote:
Say’s law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment. If, however, this is not the true law relating the aggregate demand and supply functions, there is a vitally important chapter of economic theory which remains to be written and without which all discussions concerning the volume of aggregate employment are futile. (Keynes, 1936, p. 26, emphasis added.)
For the vast majority of the economics profession even now, this is the way in which Say’s Law and its implications are understood. It is the very meaning of the Keynesian Revolution. Mises made the same point in 1950:
Lord 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. (Mises, 1950 [1980])
It is precisely here that we find the division between the economics of the classics and virtually all modern economic theory, especially of the mainstream variety. As was recognized at the time, and as Mises clearly notes, Keynesian economics, that is all of modern macroeconomics with its focus on aggregate demand, must collapse if the attack on Say’s Law turns out to be wrong.
It is only to be regretted that Mises did not recognize how singularly important it was to hammer home this point. He treated Say’s Law as so obviously valid, beyond any possibility of argument, that I suspect he found it impossible to understand how anyone who called themselves an economist could accept Keynesian theory. All he ever directly wrote on Say’s Law he contained in a brief article in a collection of essays. But as for the validity of Say’s Law, he could not have been more clear:
The 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. (Mises, 1950 [1980])
Mises accepted Say’s Law as unquestionably valid, as part of the “perennial laws” of economics. But because he found rejection of Say’s Law inconceivable he did not do what he might otherwise have done, which was to explain why it must remain an integral part of the bedrock foundation of economic theory if that theory is to provide us with the guidance needed when recessions and high unemployment occur.
UNDERSTANDING SAY’S LAW—MALTHUS AND THE “GENERAL GLUT” DEBATE What is relevant about Say’s Law cannot be contained within a single statement. Say’s Law, if it is to be understood in full, must be understood as a series of related propositions which when taken together constitute the basic ingredients of the classical theory of the cycle. The most extraordinary of the many ironies that have surrounded this issue since Keynes first pronounced on it in 1936 is that Say’s Law was the foundation stone within classical theory for understanding why a cycle exists at all. Keynes’ argument was that belief in Say’s Law meant that classical economists assumed there was never at any stage an obstacle to full employment. The reality is that Say’s Law was an integral part of the explanation of why in fact unemployment actually occurred.
Keynes, in attacking “Say’s Law” in 1936 was not attacking some one-sentence statement of principle. In attacking Say’s Law, he was attacking the entire classical theory of the cycle. Unless this is understood, it is impossible to understand in full exactly what Keynes was able to do. The propositions associated with Say’s Law need to be seen as the constituent elements of the classical theory of the cycle and to understand why this was so, it is necessary to enter into some of the early history of economic theory itself.
What became the classical theory of the cycle was formed during what is now known as the “General Glut” debate that lasted from the publication of Malthus’ Principles of Political Economy in 1820 through until John Stuart Mill published his own Principles of Political Economy in 1848. Malthus was, in 1820, the single most famous economist in the world. His 1798 publication, On Population, had been an international sensation. As a result, when he published his text on economic theory, it was not just another text but a work that would instantly attract the widest attention.As an interesting parallel, Keynes, too, was the most famous economist of his time after having written his Economic Consequences of the Peace at the end of World War I. It had also been a worldwide sensation in its time.
What in particular distinguished Malthus’ arguments from virtually all other writings on economic issues at the time was his belief that the recessions experienced by England at the end of the Napoleonic Wars had been caused by oversaving and demand deficiency. And so a debate was commenced across the whole of the economics community of the time, with a raft of books on economic theory published over the next few years in which much of the argument centered on a discussion of what Malthus had written. All agreed it was possible to have an excess supply of individual goods and services. The question was whether there could be an excess supply of all goods and services taken together.
Importantly, it was not a debate over whether recessions and large-scale unemployment were possible. On this there was obviously unanimity. The only question was whether recessions, when they occurred, were the result of too much saving and too little effective demand. That this could never be a realistic explanation was ultimately accepted by the whole of the mainstream of the economics community.
Moreover, during classical times there was no economic principle known as “Say’s Law.” The term would not be coined until the twentieth century or enter economic discourse until the 1920s (see Kates, 1998, pp. 148–149). There was Jean-Baptiste Say’s théorie des débouchés, known in English as the “law of markets,” which stated that demand was constituted by supply. It was the law of markets that was employed as part of the response to Malthus’ views but as only one strand in a far more complex series of counter arguments. It was a crucially important part of the argument, but it was only one of the arguments in a longer chain of reasoning. It was the entire set of counter arguments that when taken together became the related propositions that formed the classical theory of the cycle. Leaving Say’s Law in Keynes’ desiccated form of words—“supply creates its own demand”—not only reverses the point that classical economists had tried to make—that demand in real terms can only be derived through the production of value adding goods and services—but ignores every other related aspect that was central to an understanding of the classical theory of the cycle.
By discrediting the crucially central idea that demand is formed on the supply side of the economy, the related propositions that had emerged from the debate over Malthus lost their coherence. The publication of the General Theory caused the entire classical perspective on the business cycle to disappear. The propositions presented below are therefore intended to reassemble the arguments that were at the core of pre-Keynesian business cycle theory and need to be seen as the full meaning of Say’s Law as it emerged during the General Glut debate.For historical accuracy I will note that these arguments had been first brought together by James Mill in 1808 where he, too, specifically invoked the théorie des debouches to explain why demand deficiency is a fallacious explanation for recession. It is for this reason that in my view James Mill had been the first to properly state “Say’s Law” (see Kates, 1998, pp. 24–29). They are also put in a form so that the entire argument can be seen as a full and complete response not just to Keynes and the arguments of the General Theory, but also as a reply to modern macroeconomics to the extent that it continues to rely on demand deficiency to explain why recessions occur.
THE RELATED PROPOSITIONS OF SAY’S LAW The related propositions that make up Say’s Law are discussed below, along with concrete examples from the pre-Keynesian literature to demonstrate their importance as integral components of classical thought.
Proposition 1: Recessions are never due to demand deficiency. An economy can never produce more than its members would be willing or able to buy. A general glut (i.e. general overproduction) is impossible. Neither high levels of saving nor the redirection of resources into higher levels of capital formation cause recessions to occur.
This is the starting point for any understanding of the pre-Keynesian theory of recession and Say’s Law. Four examples of how this statement was an integral part of economic theory across the entire classical period will help put the law of markets into its proper context.
First Adam Smith. He specifically denies that there is any danger from oversaving and that a community has anything to fear from the saving of its more provident members. It was this argument that Keynes specifically set out to deny.
What is annually saved is as regularly consumed as what is annually spent, and nearly in the same time too; but it is consumed by a different set of people. That portion of his revenue which a rich man annually spends, is in most cases consumed by idle guests, and menial servants, who leave nothing behind them in return for their consumption. That portion which he annually saves, as for the sake of the profit it is immediately employed as a capital, is consumed in the same manner, and nearly in the same time too, but by a different set of people, by laborers, manufacturers, and artificers, who reproduce with a profit the value of their annual consumption. His revenue we shall suppose, is paid him in money. Had he spent the whole, the food, clothing, and lodging, which the whole could have purchased, would have been distributed among the former set of people. By saving a part of it, as that part is for the sake of profit immediately employed as capital either by himself or by some other person, the food, clothing and lodging, which may be purchased with it, are necessarily reserved for the latter. The consumption is the same, but the consumers are different. (Smith, 1776 [1976], p. 359)
A second example is Alfred Marshall writing in a publication co-authored with his wife, Mary Paley Marshall, in 1879. Here it is made abundantly clear that deficient aggregate demand is not the proper explanation for depression.
After every crisis, in every period of commercial depression, it is said that supply is in excess of demand. Of course there may easily be an excessive supply of some particular commodities; so much cloth and furniture and cutlery may have been made that they cannot be sold at a remunerative price. But something more than this is meant. For after a crisis the ware-houses are overstocked with goods in almost every important trade; scarcely any trade can continue undiminished production so as to afford a good rate of profits to capital and a good rate of wages to labour. And it is thought that this state of things is one of general over-production. We shall however find that it really is nothing but a state of commercial disorganisation. (Marshall and Marshall, 1879 [1881], p. 154)
And lest it be thought that this is the early Alfred Marshall which was later subsumed by a different point of view, in a section introduced into the fifth edition of the Principles in 1907 he emphatically made the point again. Note that problems on the demand side are seen only to exacerbate a problem that has been due to other causes.
It is true that in times of depression the disorganization of consumption is a contributory cause to the continuance of the disorganization of credit and of production. But a remedy is not to be got by a study of consumption, as has been alleged by some hasty writers. (Marshall, 1907 [1961], p. 711n)
Finally, Friedrich Hayek. His 1931 article, “The ‘Paradox’ of Saving,” is a full-scale discussion, more than 40 pages in length, on the arguments of Catchings and Foster who during the 1920s and 1930s had argued that over-saving was the cause of recessions. Hayek’s opening paragraph is not only an attack on the belief that excess saving is a cause of recession, but he also specifically refers to the théorie des débouchés as providing the appropriate position. And while Hayek had his own theory of the cycle, the article is not in the least dependent on such views. It is nothing other than a straightforward statement of the classical position. Hayek wrote:
The assertion that saving renders the purchasing power of the consumer insufficient to take up the volume of current production although made more often by members of the lay public than by professional economists, is almost as old as the science of political economy itself. The question of the utility of ‘unproductive’ expenditure was first raised by the Mercantilists, who were thinking chiefly of luxury expenditure. The idea recurs in those writings of Lauderdale and Malthus which gave rise to the celebrated Théorie des Débouchés of James Mill and J.B. Say, and in spite of many attempts to refute it, permeates the main doctrines of socialist economics right up to Tugan-Baranovsky, Thorstein Veblen and J.A. Hobson. But while in this way the idea has found a greater popularity in quasi-scientific and propagandist literature than perhaps any other economic doctrine hitherto, fortunately it has not succeeded as yet in depriving saving of its general respectability. (Hayek, 1931, pp. 74–75, bolding added)
It is highly noteworthy that it was only five years later that the General Theory would in fact do what Hayek had feared, and “deprive saving of its general respectability.”The existence of this critique of Catchings and Foster may also help explain why Hayek, having invested the time and effort in dealing with their arguments, almost completely ignored Keynes’ attempt to achieve the same result. By the time Keynes wrote, Hayek may well have found trying to explain the fallacies in such reasoning completely stale. To have bothered responding to Keynes in the detail required would have for him involved going over old ground.
Proposition 2: Demand is constituted by supply. Aggregate demand is not independent of aggregate production but is identical with it. A community’s purchasing power is constituted by its value added. Aggregate demand can only increase when the value of the goods and services produced is greater than the value of the inputs used up in the production process.
This proposition is a restatement of Jean-Baptiste Say’s original théorie des debouches, wrongly characterized by Keynes as “supply creates its own demand.” Moreover, the statement that “demand is constituted by supply” may be the most important concept in coming to grips with the classical theory of the cycle, but because it is so foreign to modern macroeconomic thought, it may also be the most difficult. Yet it was fully accepted by pre-Keynesian economists.
Here is James Mill, in the first presentation of what would become the classical theory of the cycle, explaining the significance of this principle. He could not be more emphatic nor does he leave any doubt about just how crucial he believes this principle to be.
No proposition however in political economy seems to be more certain than this which I am going to announce, how paradoxical soever it may at first sight appear; and if it is true, none undoubtedly can be deemed of more importance. The production of commodities creates, and is the one universal cause which creates a market for the commodities produced. (Mill, 1808 [1966], p. 135)
Moving forward a century, the same concept is found in the following passage from one of the most widely used economic texts ever published, in which this principle is stated in very clear terms:
It is only because our exchanges are made through money that we have any difficulty in perceiving that an increase in supply is (not “causes”) an increase in demand…. An increase in the supply of cloth is an increase in the demand for other things; and vice versa, an increase in the supply of anything else may constitute a demand for cloth. What is divided among the members of society is the goods and services produced to satisfy its wants; and the same goods and services are both Supply and Demand. (Clay, 1916, p. 242)
The notion of aggregate demand separate from aggregate supply was foreign to pre-Keynesian economic thought. Aggregate demand grows at the same rate and by the same amount as aggregate supply, and will not grow unless supply has grown. It is not, however, just any production that will lead to an increase in aggregate demand. What creates demand is the production of forms of output for which enough buyers can be found to cover in aggregate the entire costs of production. Only if the goods and services produced can be sold for more than was paid for the inputs that went into their production can it be said with certainty that value has been added during the production process. Conversely, if the goods and services produced do not create more value than is used up in the production process, there can be no increase in aggregate demand because there has been no increase in aggregate supply in any relevant sense.
Proposition 3: The process involved in purchase and sale is the conversion of one’s own goods or services into money and then the re-conversion of the money one has received back into other goods and services. There is no implication of a barter economy. Money is intrinsic to the processes involved.
At the very core of the classical propositions surrounding Say’s Law is an appreciation that money is infused with value only by being received in exchange for value adding production. The process is one that may be characterized in the formula C–M–C’ where the set of goods or services in one’s own possession (C) is converted into a different set of goods or services (C’) by the sale of what one owns for money (M) and then the reconversion of the money received into what one wishes to buy.This is the formula used by Marx to explain the classical mechanisms associatedwith the law of markets but was used by him as a criticism. Keynes had accused classical economists of confusing a barter economy with the operation of a money economy, but from the first statements on Say’s Law by Say himself that had never been the case. Here is J.B. Say, in the fourth edition of his Treatise,It is the fourth edition that has been the one translated into English because that was the latest edition available when Malthus published his Principles in 1820. There would be a fifth edition in French that has not been translated. trying to explain the obvious.
Should a tradesman say, “I do not want other products for my woollens, I want money,” there could be little difficulty in convincing him that his customers could not pay him in money, without having first procured it by the sale of some other commodities of their own. … You say, you only want money; I say, you want other commodities, and not money…. To say that sales are dull, owing to the scarcity of money, is to mistake the means for the cause; an error that proceeds from the circumstance, that almost all produce is in the first instance exchanged for money, before it is ultimately converted into other produce. (Say, 1821, pp. 163–165)
But more importantly, the process lay in ensuring that those who produced made sure that they created value in the process. Demand was only constituted by the value added that arose from the sale of goods or services to others. If output could not be sold at prices that repaid the costs of production, then no value added had occurred. That this frequently did take place provided the core insight into the classical theory of the cycle. That demand was built on productive activities was also pointed out by Mises, who was explicitly following Say in making this point:
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. (Mises, 1950 [1980])
To understand demand being constituted by supply, it is necessary to recognize that in a properly functioning economy, purchases are effected with the revenue from the previous sale of goods and services or with money borrowed from others who have earned incomes by producing. For those who earned their incomes from the sale of goods and services, the process is direct. The creation of value and the sale of what had been produced provided the income for the purchase of other goods and services. For businesses investing borrowed funds, the purchases are effected through the transfer of funds through a saving-investment process. For governments, purchases are effected through revenues raised through taxation of the incomes of those who had sold goods or services to the market.
Proposition 4: Recessions are common and result in high levels of involuntary unemployment.
It really ought to be unnecessary to point out that this proposition ought to be completely non-controversial. It really ought to have been inconceivable to have suggested, as Keynes did in 1936, that economists until then had had no explicit theory of involuntary unemployment and recession. Yet one of the consequences of the publication of the General Theory was the belief that classical economists had no theories to account for recessions and involuntary unemployment. It is therefore necessary to make the explicit statement that classical economists did indeed have such theories of recession and they most assuredly did understand that involuntary unemployment was a frequent feature of economic life. The theory of the business cycle had been developing for over a century by that stage, so that for Keynes to have stated of his fellow economists that they had no theory of involuntary unemployment was absurd.
A compendium of all of the theories of the cycle is found in a League of Nations publication by Gottfried Haberler, titled Prosperity and Depression whose first edition was published in 1937, the year following the publication of the General Theory. The first words of the preface ought to make it absolutely plain that recession and unemployment were amongst the most important questions under examination by the economics community of the world during the 1930s, and had been for generations:
This book has its origin in a resolution adopted by the Assembly of the League of Nations in September 1930 by which it was decided that an attempt should be made to co-ordinate the analytical work then being done on the problem of the recurrence of periods of economic depression. The literature concerning economic depressions and what is currently and somewhat loosely described as the trade cycle is abundant…. It is apparent from the persistence with which depressions occur, from the gravity of their economic and social effects, and from the growing consciousness of that gravity, that – however abundant the literature on the subject, however elaborate and specious the theories – our knowledge of the causes of depressions has not yet reached a stage at which measures can be designed to avert them. (Haberler, 1937, p. iii)
That what ought to have been seen as absurdly improbable was nevertheless accepted from the moment it was first published is an issue that demands the attention of historians of ideas. Here we merely note that Keynes’ statement, that economists before him had no theories to explain recessions and unemployment, is false as a moment’s reflection ought to have led anyone to recognize at the time, just as it ought to be recognized today.
Proposition 5: Recessions are due to structural problems of one kind or another. In particular, recessions occur where the structure of supply does not match the structure of demand. Recessions occur when the pattern of demand is different from the actual composition of output so that a significant proportion of the goods and services put up for sale remains unsold.
For anyone basing their understanding of these issues on Keynes’ writings, it is something of a surprise to discover that the law of markets was at the very centre of the classical theory of the recession and, in fact, provided the foundation for the theory of the cycle as understood by classical economists. Because demand was constituted by supply, cyclical activity was understood to be the result of individuals and businesses producing what could not be sold at prices which covered costs. Why this might happen was the underlying issue, but that it frequently did happen, of this no one had the slightest doubt. The more than one hundred year classical literature on the nature and causes of the business cycle is a testament to the recognition that pre-Keynesian economists gave to unemployment and recession.
Torrens, writing in 1821 in a direct response to the arguments presented by Malthus, makes the point as explicitly as it is possible to make it. The classical theory of the cycle was built on these very concepts. Demand is constituted by supply but only so long as supply consists of what those with incomes to spend want to buy. Keeping demand and supply properly proportioned was the imperative, but once that had been achieved all went well. It was when the proportions were not maintained that recessions would occur. Torrens firstly notes that there is no possibility that supply will ever outrun demand.
So long as the proportion is preserved, every article which the industrious classes have the will and power to produce, will find a ready and profitable vend. No conceivable increase of production can lead to an overstocking of the market…. Increased production will create a proportionally increased demand [sound familiar?] …. (Torrens, 1821 [1965], pp. 370–372)
What is particularly notable is that Torrens uses almost the very words Keynes would use to summarize Say’s Law. “Increased production will create a proportionately increased demand” is the lineal ancestor of “supply creates its own demand.” Torrens is invoking Say’s law of markets to show that demand deficiency is never a problem. But he does not conclude from this that economies cannot therefore go into recession or that there are no obstacles to full employment. He instead uses this very principle to explain why recessions occur. Following on from the above passage, Torrens immediately sets out the consequences should something happen to disturb the balance between the structure of production and the structure of demand.
This happy and prosperous state of things is immediately interrupted when the proportions in which commodities are produced are such as to disturb the equality between effectual demand and supply…. Then gluts and regorgements are experienced. (Torrens, 1821 [1965], pp. 370–372)
Torrens was not the first to make this point, but he made it very well. A lack of proportion between supply and demand is the cause of a descent into recession. The problems of recession are due to structural problems in an economy, not because of a failure of demand. And it required an understanding of the law of markets to understand that recessions occur when what has been produced does not coincide with what those with incomes want to buy.
In these passages, Torrens captured the theory that became during the following century the common ground amongst the economics community in discussing the business cycle. Recessions and depressions were due to structural problems. Haberler, in his Prosperity and Depression, provided a synopsis of the theory of the cycle as it had been understood until then. In summarizing the views of the economic profession of his time, he wrote:
An expansion or contraction may be interrupted on the one hand by an accident…or it may on the other hand itself give rise to maladjustments in the economic system…. Most cycle theorists have tried to prove that the second type of restraining force is all-important. (Haberler, 1937, p. 245)
This is Torrens once again. It is this maladjustment in the structure of production, where demand and supply are out of proportion with each other, that was the fundamental explanation for recession. Demand deficiency played no part in the process within orthodox theory.There was, however, an under-consumptionist literature which argued that too little demand from consumers was the systematic cause of economic recession. This was at the time almost entirely the province of economic cranks, as Keynes’ reference to the “brave army of heretics” plainly shows. Hobson was seen as the leading exponent of this view as both Keynes (Keynes, 1936, pp. 364–370) and Haberler (1937, p. 115) make clear.
Where demand was crucial was in relation to the structure of demand relative to supply, that is, in situations where what buyers would have been willing to pay the full costs of production for did not match what suppliers had actually put on the market. Starting from the proposition that demand is constituted by properly proportioned supply, recessions are caused by events that mislead producers into producing goods and services that cannot be sold at cost covering prices.
Proposition 6: Partial overproduction of individual goods and services occurs continuously within economies and can lead to a general downturn in an economy. The transmission mechanism is from a reduction in earnings in some sectors of the economy where sales have been below expectations to a fall in demand in other sectors and therefore to a wholesale downturn in activity.
Walter Bagehot, as editor of The Economist, wrote one of the most influential nineteenth century works on the operation of the money market. As part of this work, he included a chapter on the nature of the business cycle, in which he described the evolution of a general downturn built out of a downturn in one part of the economy. Given Keynes’ accusation that classical economists had ignored monetary factors and their effects on economic activity, it should not go unnoticed that the following is from Bagehot’s Lombard Street which had as its subtitle, A Description of the Money Market. What Bagehot wrote was this:
No single large industry can be depressed without injury to other industries; still less can any great group of industries. Each industry when prosperous buys and consumes the produce probably of most (certainly of very many) other industries, and if industry A fail and is in difficulty, industries B, and C, and D, which used to sell to it, will not be able to sell that which they had produced in reliance on A’s demand, and in future they will stand idle till industry A recovers, because in default of A there will be no one to buy the commodities which they create. (Bagehot, 1873, 121–122)
The essence of this process is the creation of an economic downturn built upon the systematic failure of producers to sell what they have produced in their own markets. This is not a description of a Keynesian multiplier but a trail of purchase and sale between different producers. It accepts that when the recovery comes there may be different firms and industries in different proportions. But the conception that lies behind it is that the pieces in the economy must interlock as firms provide a market for each other with the entire structure ultimately aimed at producing goods and services for final home consumption.
Proposition 7: Monetary factors, most notably structural imbalances in the market for credit, can also be and often are an important cause of recession. Even where monetary instability has not been the originating cause of recession, monetary factors will often deepen a recession brought on for other reasons.
It is because Keynes argued that classical economists thought only in terms of real variables that such an obvious statement even needs to be made. It was, in fact, the specific conclusion reached by Becker and Baumol that ought to have put this issue to rest for all time, and also have raised some questions about the foundations of the Keynesian economic theory that had been built on the rejection of so flimsy a straw man. Becker and Baumol could not have been more explicit in dealing with this caricature of classical theory, which they labeled “Say’s Identity.” In discussing what they term “the clearest statement on the point”—Mill’s second essay in his Essays on Some Unsettled Questions of Political Economy—they wrote:
It is all there and explicitly—Walras’ Law, Say’s Identity which Mill points out holds only for a barter economy, the “utility of money” which consists in permitting purchases to be made when convenient, the possibility of (temporary) oversupply of commodities when money is in excess demand, and Say’s Equality which makes this only a temporary possibility. Indeed, in reading it one is led to wonder why so much of the subsequent literature (this paper included) had to be written at all. (Becker and Baumol, 1952, p. 374.)
Monetary factors can and do cause recession. It is stating nothing but what ought to be obvious, that classical economists were fully aware that monetary factors were often part of the process even when not the initiating factor in causing recessions to occur.
The approach to economic policy becomes very different if one begins from a classical perspective rather than from one built that commences with demand deficiency. These different perspectives are part of the matrix of ideas that were part of the structure of understanding that existed under a theory of the cycle built on classical foundations.
Proposition 8: Because recessions are not due to a failure of demand, practical solutions to recession do not encompass increased levels of public spending. While such expenditure may provide some limited benefit if spending is concentrated on value adding goods and services, such expenditure is merely a palliative rather than a cure.
The policy consequences of Keynesian theory have over the years provided ample evidence that on this matter classical economists were correct. There has been no instance of a peacetime increase in public spending during recession that has led to recovery. Reductions in taxation have a different effect on economic outcomes, and can be consistent with classical principles in generating economic growth. Increases in public spending, however, are not. John Stuart Mill’s statement, found at the start of this paper, is about as clear-cut as one could find.
The utility of a large government expenditure, for the purpose of encouraging industry, is no longer maintained.... It is no longer supposed that you benefit the producer by taking his money, provided you give it to him again in exchange for his goods. (Mill, 1874 [1974])
The stimulus packages that have been associated with attempts to revive economies internationally following the onset of the Global Financial Crisis, especially in the US and UK, have been failures. The absence of signs of success and the growing problems related to the rising levels of public debt are indications that these Keynesian policies did not work as their advocates suggested they would. The outcomes of these stimulus packages ought to be recognized as the major test of Keynesian theory and policy that they have been. Based on this experience, the macroeconomics that is almost universally taught should be recognized as of no theoretical or practical value. Ridding economic theory of the aggregate demand curve should be the single most important theoretical issue of our time.The downturn in activity, because the cycle is cyclical, will end at some stage with an upturn. What is evident already, however, is that the spending programs which have been introduced have not been factors in generating recovery. Indeed, not only have they been of virtually no use in creating a net addition to employment they have also coincided with deteriorations in economic conditions generally that have been unexpected by those who introduced the stimulus programs. The argument has been made that economic conditions would have been even worse than they were had these programs not been introduced even though at the time of their introduction, the expectation was that there would be a generally rapid upturn in activity and the labor market. None of this has occurred, as anyone looking at these programs from a classical perspective would have expected.
If public spending and deficit finance are recognized to have failed, just as they failed in Japan during the 1990s and in the United States during the Great Depression, support for Keynesian theory and policy should erode and a search for an alternative theoretical approach should commence. The proper place to begin such as investigation is amongst the long-forgotten theories of the cycle, which were discarded after the publication of the General Theory. There should be a newfound recognition that perhaps, after all is said and done, that so far as Say’s Law is concerned, Keynes was wrong and the classical economists were right.
MEN ERR IN THEIR PRODUCTIONS, THERE IS NO DEFICIENCY OF DEMAND It was Keynes himself who made it clear that the economics of the General Theory was to be seen as a refutation of Say’s Law. Recessions, he wrote, were caused by a deficiency of aggregate demand.
This was utterly contrary to mainstream classical thought. Classical economists understood that economies are not driven by demand but by value adding production, which is what they referred to as “supply.” They understood perfectly well that raising demand without an increase in the level of value adding output cannot be an answer to recession and unemployment.
This was summarized by classical economists in various ways: demand is constituted by supply, there is no such thing as a general glut, overproduction is an impossibility. However, the most remarkable short statement, not just on the nature of aggregate demand but also on the related issue of how recessions occur, can be found in Ricardo’s reply to Malthus in a personal letter written on October 9, 1820. Ricardo was writing a few months after Malthus’ Principles had been published: “Men err in their productions, there is no deficiency of demand.” (Ricardo, 1951–73, p. 277)
This is, first of all, a statement on the causes of recession: “men err in their productions,” that is, there is some kind of market disequilibrium which has occurred across the economy. And beyond that, it is a statement of what does not cause recessions: “there is no deficiency of demand.” Whatever might have caused the recession, it is not due to a lack of demand. What is found in Ricardo’s short statement is in summary form the entire classical theory of recession with its explicit rejection of demand factors as their cause. To understand what Say’s Law really means and why it matters, this is what you need to know.
What if Ricardo’s short and to-the-point statement were at the core of modern macroeconomics in the way it was at the core of the classical theory of the cycle? Here there is no ambiguity of meaning, none of the uncertainty that currently exists over what “supply creates its own demand” does or does not mean. Ricardo’s brief statement of classical principle means that when recessions occur, they cannot be understood as a consequence of too little demand but should be understood as some sort of derangement within the
market process. Were this understanding at the core of modern macroeconomics, policy makers would have no excuse for the levels of deficit spending that occurred after the commencement of the Global Financial Crisis but would understand that far different measures are needed to get markets and an economy back on track.
My book, Say’s Law and the Keynesian Revolution, which covers in far more detail all that has been discussed in this paper, has as its subtitle, How Macroeconomic Theory Lost Its Way. Macroeconomics replaced the classical theory of the cycle in the 1930s and has been Keynesian ever since. No metaphorical statement on the death of Keynes or of Keynesian economics can be true so long as aggregate demand maintains its presence at the core of macroeconomic theory and policy. Macroeconomics, with its focus on aggregate demand, has been systematically misleading economists since the 1930s. Because of the near universal acceptance of Keynesian theory within the mainstream, economists have repeatedly formulated policies around the need to stimulate demand during periods of high unemployment. Keynesian economics has, however, not had a single peacetime success but has recorded many, many failures to which one more can now be added. It is the very concept of aggregate demand that must be removed from economic theory. Its pervasive presence has caused a blackout curtain to fall across the whole of macroeconomic theory making it all but impossible to understand the underlying workings of an economy or to provide useful advice when recessions occur.
The use of public spending and deficit finance to deal with the Global Financial Crisis has been massive and worldwide. This ought to be recognized as having been a decisive test of the validity of Keynesian theory and policy. These policies have been tried to their utmost limits in the United States and elsewhere and should be recognized as having been an abject failure. A return to an economic theory based around a proper understanding of Say’s Law and the classical theory of the cycle should be the direction in which economic theory now moves.
Volume 2, No. 4 (Winter 1999)Caplan arrives at the startling conclusion that the Austrian approach, despite the efforts, is less realistic than the neoclassical approach that flourished in the age of benign neglect for realism. A discussion of these views is highly useful given the growing interest in economic realism. In this article, we will show that Caplan fails to identify the important differences between Austrian and neoclassical economics. Caplan's errors seem all to be rooted in his failure to grasp that Austrian economics is a theory of action (praxeology) rather than some kind of applied psychology. We will therefore briefly characterize the praxeological approach toward the explanation of human behavior and then discuss Caplan's main tenets in some detail.
Volume 3, No. 4 (Winter 2000)This article reviews and assesses the trilogy Castells entitles The Information Age: Society Economy, and Culture. Despite the adulation and attention the books have drawn, their ideas are strikingly similar to those sociology has proffered for the past 150 years, conceptual frameworks that more often resemble ideological interpretations than a scientific sociological theory and analysis actually proves to be little more than an expression of the sociologist's own preferred vision of the world—in Castells's case, a "social democratic" one.
Volume 1, No. 1 (Spring 1998)A noteworthy feature of Murray Rothbard’s monumental history of economic thought is his vigorous denunciation of Adam Smith and the Wealth of Nations. Smith was “an inveterate plagiarist,” but one who “plagiarized badly, adding new fallacies to the truths he lifted.” Smith’s “economics was a grave deterioration from his predecessors, from Cantillon, from Turgot, from his teacher Hutcheson, from the Spanish scholastics, even . . . from his own previous works” (Rothbard, pp. 435–36). Smith’s book distracted people away from these meritorious earlier works. The “Wealth of Nations is a huge, sprawling, inchoate, confused tome, rife with vagueness, ambiguity and deep inner contradictions” (Rothbard, p. 436).In the following, we will review Rothbard’s principal criticisms and add some that he overlooked. However, he has failed to take note of some of the positive virtues of The Wealth of Nations. We will also refer to relevant aspects of the works of Cantillon and Turgot, whom Rothbard praised highly.Rothbard’s commentary follows the sequence of The Wealth of Nations, and we will do the same.
Division of Labor“It is appropriate to begin . . . with the division of labor, since Smith himself begins there” (Rothbard, p. 441). Not quite. Smith’s initial point is that the wealth of the nation is its output of goods and services, and division of labor is analyzed as a major contributor to national productivity (Smith, p. lvii). In Rothbard’s view, “for Smith the division of labor took on swollen and gigantic importance” (Rothbard, p. 441). In Smith’s Book 1, “division of labor alone accounts for the affluence of civilized society” (Rothbard, p. 442). However, Smith soon makes it clear that division of labor depends critically on capital, and that capital is the engine of growth. In Smith’s eyes, division of labor creates the basic problems of information and motivation, which in turn require an explanation of how a market economy works to guide economic activity. Smith also expects growth of capital to generate technological progress (Smith, p. 260). But Rothbard is entirely correct in noting that Smith was totally oblivious to the technological changes going on around him.[1] We might particularly have expected him to be aware of James Watt and the steam engine.Rothbard claims that Smith “failed to apply his analysis of the division of labor to international trade” (Rothbard, p. 442). But international exchange is present in Smith’s very first sentence, where he notes that economic well-being arises from “the immediate produce of labor . . . or . . . what is purchased with that produce from other nations” (Smith, p. lvii). It enters Smith’s panegyric on “the accommodation of the most common artificer or day-laborer in a civilized and thriving country,” which involves, among many other things, recognizing
how much commerce and navigation in particular, how many ship-builders, sailors, sail-makers, rope-makers, must have been employed in order to bring together the different drugs made use of by the dyer, which often come from the remotest corners of the world. (Smith, p. 11)
And division of labor figures prominently in Smith’s defense of free international trade.[2]Rothbard also contends that Smith neglected “the more significant division of labor among industries” (Rothbard, p. 442). However, numerous industries and occupations are cited in introducing the topic (Smith, pp. 11–12, also, 14, 17–18, 86).Moreover, Smith highlights the role of the market mechanism in directing people into occupations:
If in the same neighborhood, there was any employment evidently either more or less advantageous than the rest, so many people would crowd into it in the one case, and so many would desert in the other, that its advantages would soon return to the level of other employments. (Smith, p. 99)
Productive and Unproductive LaborRothbard has an easy time showing the semantic defects of Smith’s analysis of productive and unproductive labor.[3] When the topic is fully developed, in chapter 3 of book 2, the context has been clearly set forth—it is the accumulation of physical capital. Smith makes it clear that “unproductive” labor can have both public and private value.[4] I find no support for Rothbard’s claim (undocumented) that “Smith . . . excludes all production of immaterial services from the annual product” (Rothbard, p. 445; contrary evidence appears at p. 448, quoting Smith, p. 30). What Smith does say over and over is that increase in the national product results primarily from saving, investment, and productive labor (Smith, pp. 320–23, 464, 574, 577, 640–41). The harm done by mercantilism results partly from reduction of investment and misallocation of what remains (Smith, pp. 325, 562, 570–73, 594–95, 637–38).
Rothbard documents more persuasively his view that Smith had a “Calvinistic scorn of consumption” (Rothbard, p. 447), but this can be tempered by passages in The Wealth of Nations (pp. 325–29, 459, 569, 726–27, and 748.)[5]Rothbard’s claim that Smith “was not content to abide by free-market choices between growth . . . and consumption” would be difficult to prove and diverts our attention from Smith’s emphasis on the harmful deviations from free-market outcomes arising from government.[6] Rothbard accuses Smith of a bias against durable consumer goods, but this seems clearly contradicted by The Wealth of Nations (pp. 329–32).Ultimately, of course, Rothbard is criticizing Smith because his distinction between productive and unproductive labor, and his materialistic analysis of development, easily led to the perversions developed by Marx. From these origins can be traced the Stalinist neglect of services and the helter-skelter pursuit of growth through forced investment undertaken with little regard to cost or allocation.
The Theory of ValueAccording to Rothbard, “Smith’s doctrine on value was an unmitigated disaster” (p. 448). In particular, The Wealth of Nations was inferior to Smith’s earlier expositions in his lectures. In The Wealth of Nations value in use is distinguished from value in exchange; whereas, in the lectures, Smith had easily explained the diamond-water paradox by reference to relative scarcity.
And with scarcity gone. . ., subjective utility virtually drops out of economics as well as does consumption and consumer demand. Utility can no longer explain value and price, and the two sundered concepts will reappear in later generations as left-wingers and socialists happily prate about the crucial difference between “production for profit” and “production for use.” (Rothbard, p. 449)
As if this were not bad enough, Smith “was almost solely responsible for the injection into economics of the labor theory of value” (Rothbard, p. 453)—that is, the argument that products exchange in proportion to the labor (direct and indirect) embodied in each.[7] Rothbard exaggerates the degree to which Smith viewed labor input as the determinant of value. Most secondary treatments more plausibly note that Smith tried (not very successfully) to use labor command as a measure of value. But it is still broadly true that Smith set the stage for Ricardo and Marx by passages which presuppose that labor is the source of all value, and that property incomes are somehow diversions which may be morally and functionally dubious. While Smith does indicate why payments for the use of physical or money capital are appropriate, he never indicates that landowners perform any useful activity that would warrant their rent incomes.Rothbard clearly acknowledges that Smith’s primary theory is that products tend, in the long run to exchange at values equal to the factor costs (direct and indirect) of each, where those factor costs reflect the “normal” values for services of land, labor, and capital.[8] Although this is now (with appropriate elaborations) standard doctrine in undergraduate textbooks, Rothbard does not think highly of it: “Value and price theory shifts, because of Adam Smith’s unfortunate and drastic change of focus . . . , from prices in the real world to a mystical non-existent price in the never-never land of long-run ‘equilibrium’” (Rothbard, p. 450).Rothbard acknowledges that “The long-run normal price is important but only for explaining the directional tendencies and the underlying architectonic structure of this economy” (Rothbard, pp. 450–51).“But only” indeed! Smith’s theory of value is in reality his vision of the determination of the composition of output and the allocation of resources in a self-correcting market economy. This general-equilibrium point of view is effectively developed in many sections of The Wealth of Nations.[9]Both Cantillon and Turgot had earlier presented theories of long-run normal price. Cantillon’s referred to “intrinsic value” of a product, which is “the measure of the quantity of land and of labor entering into its production.” But he devoted a lot of attention to the determination of market prices by supply and demand.[10] Turgot argued that the “fundamental value” of a product was its unit cost (specifically allotted to wages, profits, and raw materials) (Groenewegen, p. 181).Smith repeatedly stresses the adjustment process underlying resource allocation. Moreover, although subjective utility is indeed neglected, the pattern of resource allocation is demand-driven: “The quantity of every commodity brought to market naturally suits itself to the effectual demand” (Smith, p. 57).[11]Rothbard grudgingly acknowledges these passages (Rothbard, p. 451), but maintains that “only the market price is the real price” (Rothbard, p. 450). His judgment is clouded by his fixation on price determination, whereas Smith’s real concern is with quantities.Smith returns the reader to this general-equilibrium perspective at many points. He reiterated the tendency for the price of any factor of production to become equalized in its various uses as each resource owner shops around for the most advantageous employment.[12] This is the point of departure for the famous chapter 10 of book 1, which examines “equalizing differences” in reward which tend to persist (Smith, pp. 99–143). Here also Smith uses his general-equilibrium approach as a basis for denouncing the “policy of Europe,” by which rent-seeking behavior leads to interventions that create unfair monopoly rents and misallocate resources (Smith, pp. 118ff.). This criticism resumes, with emphasis on the misallocation of capital among sectors, in chapter 5 of book 2 (see esp. pp. 352–53) and the little-read book 3. Profit-seeking in a free market will lead each individual to employ his capital “in the support of that industry of which the produce is likely to be of the greatest value, or to exchange for the greatest quantity either of money or of other goods” (Smith, p. 423). A sophisticated perception of demand underlies Smith’s brilliant “Digression Concerning the Corn Trade and Corn Laws,” where he explains the rationing function of high prices during a period of shortage, with particular attention to spreading out consumption over time (Smith, pp. 491–510).
The Theory of DistributionThe pricing of the factors of production is critical to the pricing of products. Rothbard believes that “Smith’s theory of distribution was fully as disastrous as his theory of value” (Rothbard, p. 458). Here much of Rothbard’s criticism is well warranted.[13] Smith indeed had no adequate theory of the rate of return on capital (though he talked sensibly, if not very originally, about the close link between that rate of return and the market interest rate). His analysis of rent is muddled.However, Rothbard misrepresents both the content and merit of Smith’s wage theory.[14] Smith reminds the reader at many points that the basis of wages is the productivity of labor.[15] Chapter 8, book 1, “Of the Wages of Labor,” begins with the blunt assertion that “The produce of labor constitutes the natural recompense or wages of labor” (Smith, p. 64). We are briefly informed that labor productivity depends in part on human capital (pp. 265–66, 641), but Smith mainly emphasizes the role of growth of capital in raising demand for labor. Increase in the capital stock raises labor productivity, and there are also hints of a primitive kind of Keynesian macroeconomic multiplier (esp. Smith, pp. 69–74).Wages also depend on the supply of labor, reflecting the size of the population. Wages cannot remain below subsistence, since labor supply will be impaired. On the other hand, high wages will reduce death rates and thus spur population growth. Rothbard attributes to Smith the view that “wages tend to settle at the minimum subsistence level for the existing population” (Rothbard, p. 458). This is a serious misrepresentation, losing as it does the entire thrust of Smith’s optimistic view concerning economic growth (below). Smith demonstrated that wages in Britain were well above the biological subsistence level (Smith, pp. 74–81). To be sure, high wages encourage population growth. But this is no bad thing. Smith had a far more sensible view of these matters than had Malthus and Ricardo. Labor supply adjusts very slowly, so the (minimum) subsistence wage will come about only in countries where “wealth . . . has been long stationary,” where “long” means “several centuries” (Smith, p. 71; also pp. 94–95). And food output should have no difficulty in keeping pace with population (p. 187).Smith’s chapter on colonies brilliantly sketches the manner in which abundance of land in newly settled areas affects relative wages (high), land values (low), and social relationships (egalitarian) (Smith, pp. 532–33, 551–53).
The Theory of MoneyRothbard is on sound ground in finding Smith’s discussions of money very defective. In particular, Smith failed to transmit the essence of Cantillon’s and Hume’s specie-flow models of price-level and international-trade adjustment, although his lectures show he was familiar with these.Part of Rothbard’s criticism of Smith stems from Rothbard’s antipathy toward fractional reserve banking, reflecting the Hayek-Mises theory of business cycles. In truth, fractional reserve banking is one more example of a spontaneous social development that has enhanced economic productivity by creating a more efficient system of payments and credit.
Risk and EntrepreneurshipRothbard is appropriately critical of Smith’s neglect of the special qualities of entrepreneurship. Cantillon had dealt with this at length, stressing the nature of market risks and the importance of “undertakers” operating in a world of uncertain information.[16] Smith simply credits progress and prosperity to the “effort of every man to better his condition” (p. 326; see also pp. 594–95). When merchants and manufacturers come in for separate discussion, it is usually a criticism of their political role (Smith, pp. 128, 249–50, 429, 438, 460).
Smith and Laissez-FaireRothbard finds that “in The Wealth of Nations . . . laissez-faire becomes only a qualified presumption rather than a hard-and-fast rule, and the natural order becomes imperfect and to be followed only ‘in most cases’” (Rothbard, p. 465). Rothbard criticizes Smith’s concessions regarding national defense, education, and usury laws.[17] Further, Smith’s twelve-year career as customs commissioner does not reveal him as a practical champion of free trade.[18]There is here a sense that Rothbard is displeased because Smith has denounced only 90 percent of harmful government interventions rather than 100 percent.[19] Let us remember that it is the virtues of free markets and limited government that receive the emphasis in the beginning sections of The Wealth of Nations—the sections of a nine-hundred-page work most likely to influence readers. Remember, too, the double-barrelled nature of Smith’s argument. One element is that the system of “perfect liberty” leads to good economic and social outcomes.[20] The other is an oft-repeated analysis of “government failure.” Paranoid nationalism, national rivalries and oppression of colonial domains are part of this failure.[21] Stylistically, some of Smith’s finest rhetoric is employed in exercising this double-barrelled weapon.[22]
According to Rothbard, Smith’s “devotion to the militarism of the nation-state . . . induced him to take the lead[!] in the pernicious modern view of excusing any government intervention that might plausibly be labelled for ‘the national defense’” (Rothbard, p. 465). Smith referred to “the art of war” as “certainly the noblest of all arts” (Smith, p. 658). He argued that “It is only by means of a standing army . . . that the civilization of any country can be perpetuated, or even preserved for any considerable time” against invasions from the Tartars or other barbarous hordes (p. 667).
However, Smith was hardly a militarist. He saw that military force was essential for the protection of trade and commerce, a lesson which Thomas Jefferson was soon to learn the hard way. Britain had no conscript military and relied primarily on a volunteer navy for its defense. Smith’s support of “martial spirit” should be seen as an implicit defense of a volunteer military service (Smith, pp. 735, 738–39). Smith’s concession that “defense . . . is of much more importance than opulence” (p. 431) concluded a two-page discussion of the navigation acts (aimed at supporting that volunteer navy), in which Smith noted their economic disadvantages. Those disadvantages were the principal thrust of his subsequent discussion of the navigation acts in the context of colonial policy (Smith, esp. pp. 562–65).[23]According to Smith, government has a duty “of erecting and maintaining those public institutions and those public works, which, though they may be in the highest degree advantageous to a great society, are, however, of such a nature, that the profit could never repay the expence to any individual or small number of individuals” (Smith, p. 681). These would include projects to facilitate commerce: “good roads, bridges, navigable canals, harbours” (p. 682). But how do we know which ones are “in the highest degree advantageous?” Smith advocates relying on user charges as much as possible, recognizing that through this use of the market mechanism, “they can be made only where the commerce requires them, and consequently where it is proper to make them” (p. 683).Smith also felt that government should supply some educational services, but again stressed the importance of user charges in motivating the teachers (pp. 716–21). Smith clearly expected that market forces would provide the society with most of the needed education. His affirmative mandate for government’s role in education appears to embrace two different concerns. The first anticipates the lofty goals of liberal education as often encountered in college catalogues (Smith, pp. 734–35, 740).[24] The second involves “the most essential parts of education . . .[:] to read, write, and account.” He does not directly recommend compulsory school attendance, but suggests a kind of qualifying examination before a man “can obtain the freedom in any corporation, or be allowed to set up any trade either in a village or town corporate” (Smith, pp. 738, 748).While Smith’s agenda for government actions involving commerce and education may appear extensive, his qualifications regarding user charges were strong and consistent, reflecting his concern for “incentive-compatible” outcomes (see also Smith, p. 767). In neither area does he appear to contemplate government monopoly.Taken in its entirety, The Wealth of Nations enumerates a vast array of government measures that Smith disliked. Restrictions (or artificial preferences) on imports and exports are probably the chief target. Others include special privileges of guilds and corporations, systems of apprenticeship, limits on geographic and occupational mobility, wage controls, and currency debasement. Governments are condemned for condoning slavery and systems of primogeniture and entail. We are told that government employment can have morally degrading effects and that government extravagance diverts resources from saving and investment. Smith denounced government interventions in grain markets, such as price controls, discrimination against middlemen and restrictions against “engrossing.” While extolling benefits from the discovery of America, Smith condemned at great length the abusive treatment of colonies. These specific references are intermixed with analytical principles that support the optimality of economic activity constrained by competition and by protection of public order, property, and contracts. On numerous occasions, the reader is reminded of the limitations and incapacities of government. Rothbard’s commentaries do not communicate this quality to the reader.
An Inspiration for MarxRothbard justifiably argues that Smith provided much ammunition for Marx and other socialists. Smith helped promote the labor theory of value, even if on balance he did not believe in it. His discussions of rent, interest, and profits failed to provide a functional defense for property incomes. Smith’s strictures on government anticipated many elements of the modern theory of public choice, but they also presented a rather stark social-class interest-group analysis of political action. From his erroneous notion that profit rates decline with economic growth, Smith argued that the self-interest of capitalists was thus opposed to progress. He tended to equate the functional shares of income going to land, labor, and capital, with separable social classes. Many of his references to businessmen were extremely hostile (see Ginzberg 1934). His characterization of productive and unproductive labor paved the way for the Marxian neglect of services. Marx’s muddled view, which identified the flow of wage payments with “capital,” bears some resemblance to Smith’s early version of the wage fund theory.The chief contrary argument would be, of course, that Smith consistently argued that the growth of capital raises real wages and operates to the benefit of the working class, which is protected by competition in the labor market. It was Malthus and Ricardo who turned economics into a dismal science by their gross exaggeration of diminishing returns and resource constraints.
Intrinsic Advantage in Capital AllocationSurprisingly, Rothbard neglects one of Smith’s most serious analytical defects. Smith’s analysis of capital often holds that there are intrinsic advantages in using capital in some sectors rather than others. Most obvious is his contention (clearly derived from the Physiocrats) that investment in agriculture is always preferable to commerce or manufacturing.[25] He claims that
the capital employed in agriculture . . . not only puts into motion a greater quantity of productive labor than any equal capital employed in manufactures, but in proportion too to the quantity of productive labor which it employs, it adds a much greater value to the annual produce. . . . Of all the ways in which a capital can be employed, it is by far the most advantageous to the society. (Smith, p. 345)
In a similar manner, Smith went on to differentiate between home trade, foreign trade of consumption, and carrying trade.This mode of discourse is not a mere aside, but provides a major part of Smith’s critique of mercantilism and the “policy of Europe” in books 3 and 4 (pp. 343–55, 421–23, 566–73, 593–94). To be sure, Smith’s underlying argument is against deviations from the free-market allocation of capital. But the exposition is hardly felicitous.
Smith’s Analysis of Economic GrowthRothbard’s assessment of Smith neglects the fact that The Wealth of Nations is in large measure a book about economic growth and development. As noted, Smith’s wage theory is presented in the context of economic growth. Capital formation is the engine of growth, helping in turn to improve division of labor and (occasionally) to promote technological improvement. The process is benign; it raises wages and thus benefits the common people. Higher wages will of course tend to speed up population growth, but Smith sees no real problem with this. Smith clearly recognized the phenomenon that came to be called diminishing returns, viewed in a dynamic context with reasonable technological improvement (Smith, pp. 60–61, 154–57, 175, 217, 235). But he explicitly argued that corn, the basic subsistence food, would not be subject to diminishing returns (p. 187). Thus, Smith avoided the near-paranoid concern with food shortage and resource constraint that marred the work of his successors.Smith also found important benign aspects to the process of economic development. Smith argued that
commerce and manufactures gradually introduced order and good government, and with them, the liberty and security of individuals, among the inhabitants of the country, who had before lived almost in a continual state of war with their neighbors, and of servile dependency upon their superiors. (Smith, pp. 384–92 at 385)
And he dwelt at length on the beneficial effects of the discovery of America in extending division of labor and introducing new products.In contrast, neither Cantillon nor Turgot dealt with economic growth. According to Murphy (1986), “Cantillon had a static interpretation of economic processes” (pp. 8, 279). Aspromourgos (1996) concluded that
whatever the extent of the Quesnay-Turgot influences upon Smith, his integration of distribution, value, and capital accumulation in a quite comprehensive treatment of capitalist economic development better captured the essentials of the prevailing trend of historical development than had any of his predecessors. (p. 157)
ConclusionsRothbard’s forty-page chapter on Smith focuses on the latter’s deficiencies so much so that there is no pretense of giving a systematic overview of The Wealth of Nations. Rothbard cites Schumpeter as one of the first to mount an authoritative deflation of Smith’s exaggerated reputation. But Schumpeter also said that The Wealth of Nations “is a great performance all the same and fully deserved its success” (1954, p. 185).
Rothbard’s treatment of Smith’s work is unfair and inaccurate. His treatment of Cantillon is distorted in the opposite direction. Ironically, many of Rothbard’s specific criticisms of Smith would also apply to Cantillon and Turgot.While it is not difficult now to find “origins” for many of Smith’s ideas, his work is far superior to that of the predecessors. Often this superiority lies in making explicit what was only implicit, and in explaining rather than merely asserting. There are two major analytical achievements of The Wealth of Nations. The first is the comprehensive depiction of a self-adjusting general-equilibrium system embracing product markets and factor markets and extending to international as well as domestic activities. The second is a representation of benign economic growth. These analytical devices then form the basis for a comprehensive criticism of government economic interventions, supplemented with a powerful analysis of “government failure.” The analysis is conducted with a consistently humanitarian viewpoint and presented in numerous passages of superb rhetoric which reflect moral passion, humor, sarcasm, and simple explanatory patience and clarity.ReferencesAspromourgos, Tony. 1996. On the Origins of Classical Economics: Distribution and Value from William Petty to Adam Smith. New York: Routledge.Brems, Hans. 1978. “Cantillon versus Marx: The Land Theory and the Labor Theory of Value.” History of Political Economy 10, no. 4 (Winter): 669–78.Cantillon, Richard. [1755] 1959. Essai sur la Nature du Commerce en General. Edited with an English translation by Henry Higgs. London: Frank Cass.Ginzberg, Eli. 1934. The House of Adam Smith. New York: Columbia University Press.Groenewegen, Peter. 1970. “A Reappraisal of Turgot’s Theory of Value, Exchange and Price Determination.” History of Political Economy 2, no. 1 (Spring): 177–96.Hollander, Samuel. 1973. The Economics of Adam Smith. Toronto: University of Toronto Press.Murphy, Antoin E. 1986. Richard Cantillon, Entrepreneur and Economist. Oxford: Clarendon Press.Rothbard, Murray. 1995. Economic Thought before Adam Smith: An Austrian Perspective on the History of Economic Thought. Vol. 1. Brookfield, Vt.: Edward Elgar.Schumpeter, Joseph A. 1954. History of Economic Analysis. New York: Oxford University Press.Smith, Adam. [1776] 1937. An Inquiry into the Nature and Causes of the Wealth of Nations. New York: Modern Library.Trescott, Paul B. 1997. “The General-Equilibrium Perspective of The Wealth of Nations.” Paper presented to the History of Economics Society, Charleston, South Carolina. Unpublished manuscript.Paul B. Trescott is professor of economics at Southern Illinois University at Carbondale.[1] Equally true, though perhaps more defensible, for Cantillon and Turgot.[2] International division of labor is particularly celebrated in Smith’s assessment of the impact of the discovery of America: “By opening a new and inexhaustible market to all the commodities of Europe, it gave occasion to new divisions of labor and improvements of art, which in the narrow circle of the ancient commerce, could never have taken place” (Smith, p. 416; see also pp. 424, 590).[3] Somehow Rothbard glossed over (Rothbard, p. 393) Turgot’s similar but even less fruitful claim that only agricultural workers were productive.[4] Speaking of “menial servants,” Smith remarks “The labor of the latter, however, has its value and deserves its reward” (p. 314). Speaking of government employees, he notes, “Their service, how[ever] honourable, how[ever] useful, or how[ever] necessary . . . produces nothing for which an equal quantity of service can afterwards be procured” (p. 315). See also his favorable remarks on people who “amuse and divert the people by painting, poetry, music, dancing; by all sorts of dramatic representations and exhibitions” (p. 748).[5] Rothbard does not comment on the fervent denunciations of “luxury” that appear in Cantillon (pp. 193–99).[6] “It is the highest impertinence and presumption . . . in kings and ministers, to pretend to watch over the economy of private people, and to restrain their expense, either by sumptuary laws, or by prohibiting the importation of foreign luxuries. . . . If their own extravagance does not ruin the state, that of their subjects never will” (Smith, p. 329).[7] Although Cantillon did not advance a labor theory of value as such, he was clearly on the same track, basing “intrinsic value” on “the quantity of land and labor entering into the production” (Cantillon, p. 29). Note this was a theory based on input quantities, not values or costs (see Brems 1978).[8] By implication, Rothbard criticizes Smith’s theory because it cannot account for the values of items “which have no cost because they are not produced” (Rothbard, p. 452). Smith does briefly look at the pricing of items “which it is scarce in the power of human industry to multiply at all,” and clearly identifies demand as the determinant (Smith, p. 218).Hollander (1973) notes that important parts of Smith’s theory of value are presented later in the book (Smith, pp. 217–47) mainly in a context of economic growth. Here appear clear precursors of historical increasing returns or decreasing returns.[9] The point is strongly stated in Hollander (1973) and amplified in Trescott (1997).[10] Rothbard’s discussion of Cantillon, while somewhat lopsided, at least acknowledges both elements (Rothbard, pp. 349–51). Murphy asserts that Cantillon “considered intrinsic value to comprise the costs of the factors of production plus normal profit” (Murphy, p. 252). Aspromourgos has a similar view (pp. 81, 95). However, this is never clearly developed in the Essai (see Cantillon, pp. 29–31). It appears Cantillon intended his intrinsic-cost analysis to be a guide to mercantilistic regulations (see Essai, p. 233).[11] The general notion of a demand-driven general equilibrium recurs with regard to labor (Smith, p. 80) and precious metals (Smith, pp. 403–6). Rothbard might appropriately reply that the optimality of a demand-driven allocation can only be established with explicit reference to subjective utility, as in discussions of Pareto optimality. However, much of the “production for use instead of for profit” literature came from people like Veblen, who were thoroughly familiar with, but disdained, the role of subjective value. Cantillon does not indicate that free-market outcomes are optimal (see Cantillon, pp. 87–93).[12] There are hints of a general-equilibrium perspective in both Cantillon and Turgot (see Aspromourgos 1996, p. 156). But the principles are evident to a modern reader who already understands the concept; eighteenth-century readers would hardly have learned them from these remarks.[13] Cantillon’s analysis of factor prices is even less impressive. Aspromourgos (1996) attributes to him the assumption of an exogenous real wage (p. 82). Cantillon has numerous passages involving labor-market disequilibrium, but these never entail equilibrating movements of wages (see pp. 61–65, 73, 87, 91–93).[14] An especially outrageous assertion is that “Richard Cantillon’s theory of wages is dependent on population in a way that was copied almost word for word by Adam Smith” (Rothbard, p. 352). While Cantillon’s discussion of population is impressive (Rothbard, pp. 352–53) the link with wages is quite unclear. At most, Cantillon simply asserts that wages tend to subsistence, where the latter term is clearly conventional and customary rather than biological (pp. 31–41). Smith acknowledged Cantillon’s argument that wages could not be below the subsistence level. Beyond that, Smith’s discussion has no counterpart in Cantillon. In particular, Smith’s analysis linking capital, growth, and wages appears quite original.[15] This is clear in the discussion of professional incomes at p. 717.[16] However, Aspromourgos argues that Cantillon’s vision of entrepreneurship is “pre-capitalist” and gives no real analysis of profit as a distributive share nor of capitalists as a social class (pp. 82, 121). Smith occasionally salutes creative entrepreneurship (see pp. 115, 384–85, 491–510). But contrast his negative view of “prodigals and projectors” (pp. 339–40).[17] Rothbard’s list of Smith’s exceptions to laissez-faire (Rothbard, p. 466) could be even longer. In addition to favoring government suppression of small bank notes, Smith also approved the Dutch practices of requiring commercial settlements in banknotes and relying on municipal guarantee of bank reserves (Smith, pp. 447–48, 453–55). He approved of “premiums given . . . to artists and manufacturers who excel in their particular occupations” (p. 489). He was willing to countenance temporary grants of monopoly to joint stock companies in “remote and barbarous” areas, as well as similar monopoly privilege to inventors and authors (p. 712).[18] In contrast, “When Turgot became finance minister in France in 1774, his first act was to decree freedom of import and export of grain” (Rothbard, p. 367).[19] It is especially illuminating to compare Rothbard’s treatment of Cantillon, whose Essai is shot full of the crudest kind of mercantilist fallacies, including bullionism. Rothbard claims that “the entire thrust of Cantillion’s work was in a free trade, laissez-faire direction” (Rothbard, p. 359). Quite the contrary. Cantillon clearly felt that his real-cost analysis provided guidance for state controls of trade to gain maximum advantage over foreigners. He states that It is by examining the results of each branch of commerce singularly that foreign trade can be usefully regulated. It cannot be distinctly apprehended by abstract reasons. It will always be found . . . that the exportation of all manufactured articles is advantageous to the state . . . [and] that the best returns or payments imported are specie. (p. 233)[20] Smith states that Without any intervention of law. . . the private interests and passions of men naturally lead them to divide and distribute the stock of every society, among all the different employments carried on in it, as nearly as possible in the proportion which is most agreeable to the interest of the whole society. (pp. 594–95. See also pp. 353, 424–25, 456, 466, 471, 473, 483, 489, 497, 506, 529, 570, 572, 597, 637–38)[21] “Commerce, which ought naturally to be, among nations, as among individuals, a bond of union and friendship, has become the most fertile source of discord and animosity” (Smith, p. 460; see also pp. 580–82, 590–606). In contrast, Cantillon “perceived international trade as a zero sum game in which one country could grow only at the expense of another” (Murphy, pp. 8, 279).[22] Smith states that The statesman, who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to use it. (p. 423; also p. 651)Smith had a clear perception of what we now call rent-seeking behavior, and warned that interventions tend to create vested interests which block their removal (Smith, pp. 438–9, 571).[23] Rothbard does not mention the fact that Cantillon also strongly supported the navigation acts (see Cantillon, pp. 239–43).[24] Rothbard notes that one of Smith’s educational goals was to inculcate obedience to government (Rothbard, p. 466). Considering that Smith has just presented several hundred pages of strong criticism of many government policies, one might better interpret his remarks as a preference for peaceful and orderly methods of political action.[25] Cantillon had presented an extreme argument that most economic magnitudes “depend on” the actions of the landowners. For Turgot, only agricultural activity was “productive.”
Volume 1, No. 1 (Spring 1998)This article argues that Murray Rothbard does indeed have scathing criticisms of Adam Smith in Rothbard’s recent work on the history of economic thought. It points out, though, that Rothbard had quite harsh words for many eminent economists. Moreover, in terms of methodology, Rothbard basically felt that he possessed certain key economic truths. People who did not share these truths were, in Rothbard’s eyes, quite simply wrong.Following Rothbard’s lead, the article then summarizes key areas in which Smith indeed held views quite different from those of Rothbard. Moreover, the article argues that the situation is possibly even worse than Rothbard himself realized. Drawing upon lesser known parts of Smith’s work, including Essays on Philosophical Subjects, Lectures on Rhetoric and Belles Lettres, Lectures on Jurisprudence, and Correspondence, the article claims that Smith seems to have been an epistemological skeptic, and that he had a proto-Marxist dialectical theory of socioeconomic development. For Smith, the state necessarily arises with the development of private property and inequality in wealth, and it exists to protect the rich from the poor. Hence, the differences between the thought of Rothbard and Smith were possibly even greater than Rothbard himself recognized. Nonetheless, the article concludes that Rothbard was essentially astute, correct, and honest in recognizing and emphasizing the distance between his thought and that of the iconic Adam Smith.Rothbard’s two-volume text on the history of economic thought[1] contains surprisingly strong statements against Adam Smith. For example, according to Rothbard, Smith “originated nothing that was true” (Rothbard 1995a, p. 435); Smith “contributed nothing of value to economic thought” (ibid., p. 463); his doctrine of value was an “unmitigated disaster” (ibid., p. 448); his theory of distribution was “disastrous” (ibid., p. 458); his emphasis on the long run was a “tragic detour” (ibid., p. 451); and Smith’s putative “sins” (ibid., p. 452) included introduction into economics of the labor theory of value.At first reading, Rothbard’s criticisms of Smith seem unduly severe; it is, arguably, one of the harshest attacks ever made upon Smith’s work by a non-Marxist (or indeed, any) economist. Yet, consideration of Rothbard’s rhetoric and methodology sheds light on Rothbard’s style. From Rothbard’s point of view, his lambasting of Smith certainly makes sense. Indeed, had Rothbard been more familiar with some of the lesser known parts of Smith’s oeuvre, his thrashing of Smith might have been still more severe.First, in terms of rhetoric, Rothbard has rough stuff to say about most everyone with whom he disagrees. Rothbard was a man of unusually strong views and clear convictions of what is right and wrong, correct and incorrect. He did not mince words. So, for example, the Tableau Économique of Quesnay is judged to be “irritating,” “elaborate frippery,” “false,” “mischief-making,” “deceptive,” and in no sense did it “do anything but detract and divert attention from genuine economic analysis and insight” (Rothbard 1995a, p. 376). Ricardo had “a deductive system built on deep fallacy and incorrect macro-models” (Rothbard 1995b, p. 82). Marx was a “sponger” and a “cadger” with a corrupt attitude toward money (ibid., p. 340) whose economics was a “tissue of fallacies. Every single nodal point of the theory is wrong and fallacious” (ibid., p. 433). The conservative economist Thomas Sowell is chastised for having written “the most spectacularly overrated work on Marxism” (ibid., p. 497); “a remarkably frenetic and unconvincing whirl of Marxian apologetics” (ibid., p. 436, n. 36). On John Stuart Mill: “It is difficult to think of anyone in the history of thought who has been more egregiously and systematically overestimated as an economist, as a political philosopher, as an overall thinker, or [even!] as a man” (ibid., p. 491). At least Rothbard did not attack Adam Smith’s reputation as a male.[2]Second, in considering Rothbard’s rough handling of Smith, one needs to take into account Rothbard’s methodological strategy in writing his Economic Thought before Adam Smith, volume 1. Essentially, Rothbard asks: How does a historical theorist compare with his own views on such crucial topics as the subjective theory of value, laissez-faire, the fractional reserve banking system, and scientific methodology (i.e., praxeology)? When Rothbard disagrees with the theorist, that theorist is basically wrong. In Rothbard’s view, there is generally not room for another completely different theory or viewpoint. For Rothbard, “knowledge can be and is lost as well as gained . . . paradigms and basic truths get lost, and economists . . . can get worse” (Rothbard 1995a, p. 438). Rothbard assumes that he knows truth and can recognize scientific progress. He has “a vision of the historical process as a permanent struggle between truth and falsehood, economic wisdom and blundering” (Hoppe, p. 250). Truth can be discovered and distinguished from falsehood; there is one truth; general principles can be known with certainty. For Rothbard, economics does not so much approach truth. Rather, economists tend to get, grasp, or understand truth; and then other economists tend to lose it. This is why, for Rothbard, there can be retrogression as well as progress in the history of economic thought.When Rothbard comes to Smith’s work, he finds that there is indeed a wide gulf between what Rothbard holds to be the truth and Smith’s own views. Hence the ensuing harsh criticisms; and, from Rothbard’s perspective, these criticisms are essentially correct.As Rothbard correctly stresses, Smith does not believe in a subjective theory of value, nor does he follow any kind of utility theory of value. Causality for Smith runs from costs of production to consumer goods prices; it does not run from consumer valuation to consumer goods prices to the pricing of productive factors (i.e., the costs of production). Smith writes about alienated labor, and he tries to distinguish between unproductive and productive labor. Smith advocated usury laws and he “favored low and criticized high profits because high profits induce capitalists to engage in excessive consumption” (Rothbard 1995a, p. 447). Scarcity plays virtually no role in The Wealth of Nations. Smith emphasized long-run “natural” price. He did not use the concept of the entrepreneur (or one might say that he severely minimized the role of the entrepreneur). Smith discarded the entrepreneur as an admirable risk-bearer and forecaster; instead, Smith generally deprecated “projectors” whom he felt squandered resources through dubious ventures and excessive risk-taking.Cost for Smith is somehow determined objectively and largely exogenously from the market. Smith does have a cost-of-production analysis which, in turn, rests insecurely upon some sort of labor theory of value. As Rothbard correctly states, “Marx was, in this matter, simply a Smithian-Ricardian trying to work out the theory of his masters” (Rothbard 1995a, p. 455).[3] For Smith, rent and profit can be viewed as deductions from the produce of labor. This indeed leaves “the door open for later socialists who would call for restructuring institutions so as to enable workers to capture their whole produce” (ibid., p. 456).Smith indeed thought little of landlords, writing that they “like to reap where they never sowed and demand a rent even for its natural produce” (Rothbard 1995a, p. 456). For Smith, wages in the short run are “determined by the relative ‘bargaining power’ of employers and workers” (ibid., p. 459). As Rothbard points out, Smith’s theory of rent is indeed a befuddled mess.In terms of economic policy, Smith does introduce numerous “waffles” in laissez-faire policies; his championing of laissez-faire was not consistent. As Rothbard correctly notes, Smith supported the British navigation acts in the name of national defense; he was for government involvement in education; Smith was for the regulation of bank paper, including outlawing small denomination notes; Smith favored some public works; and government coinage; and government control of the post office; and he was for the compulsory building of fire walls; and the compulsory registration of mortgages; and the outlawing of the practice of paying employees in kind; and other government involvements in the economy (Pack 1991, pp. 51–72; Viner, pp. 116–55; Rosenberg, pp. 19–34).There were numerous taxes advocated by Smith. He urged higher taxes on uncultivated land, and heavy taxes on luxurious consumption to tax the indolence and vanity of the rich. Smith appeared to be for progressive income taxation. He spent the last twelve years of his life as a commissioner of Scottish customs. He was for the compulsory automatic warehousing of all imports to hurt smugglers. Smith felt that there should be a government, and the government needed taxes to support it.As far as banking policy is concerned, Smith embraced the institution of fractional reserve banking. He praised the expansion of bank credit and money within a specie-standard framework. From Rothbard’s point of view, all of the above views are serious errors, fallacies, and deviations from the truth.Let us now consider Rothbard’s methodology in a bit more detail, since that too is so different from Smith’s methodology. For Rothbard, the praxeological method “is the only one that bases theory on broadly known and deeply empirical—indeed universally true—premises! Being universally true, the praxeological method provides complete and general laws” (Rothbard 1995b, p. 152). Praxeology “arrives at truths about the world and about human life that are absolute, universal and eternal—at least while the world and humanity last. It arrives, in short, at a system of natural laws.” Economic theory penetrates “truths about human action which are absolute, unchanging, and eternal, which are unaffected by changes of time and place. Economic thought, at least correct economic thought, is itself a subset of natural laws.” Hence,
the existence of human action, the eternal pursuit of goals by employing scarce means, the diversity and inequality among men, ... apply to all of human life, at any time and place. Once articulated and set forth, they impel assent to their truth by a shock of recognition; once articulated, they become evident to the human mind. (Rothbard 1995a, p. 19)
For Rothbard, praxeological theory is “grounded on deductions from fundamental axioms so broadly empirical as to be virtually self-evident” (Rothbard 1995a, p. 19). Hence, “eternal natural truths about economic aspects of politics may be and have been arrived at” (ibid., p. 20).In contradistinction to Rothbard, Smith himself seems to have been a thoroughgoing skeptic. As the philosopher Charles Griswold points out in a perceptive essay on Smith’s Theory of Moral Sentiments, “in theorizing about ethics Smith enacts Skeptism. He may therefore be interpreted as following out Hume’s skeptical program to its limit, and perhaps as doing so more consistently than Hume did” (Griswold, p. 228). Rothbard, of course, recognizes that David Hume was a skeptic, and states that Hume’s Treatise “was pivotal in its corrosive and destructive skepticism” (Rothbard 1995a, p. 425). For Rothbard, skepticism is the worst groundwork for individual liberty (ibid.; also p. 201). While Rothbard is aware that Smith and Hume were friends, he seems to be insufficiently cognizant of the depth of Hume’s influence upon Smith’s methodology.[4]Smith treated Newton’s physics as a “mere invention of the imagination.”[5] In Smith’s view, science does not necessarily disclose truth, nor approximate reality (Pack 1993). Science for Smith seems to be largely successful stories designed to calm humans; hence, the importance of rhetoric for Smith.[6] Scientific theories for Smith are products of and appeal to the imagination. Unlike Rothbard, for Smith humans do not discover theories; rather, humans imagine and create them (Pack 1995, 1996b).Rothbard is wrong in believing that “Smith retreated from the absolutist, natural-law position that he had set forth in his ethical work The Theory of Moral Sentiments” (Rothbard 1995a, p. 465). Again, largely following Hume, Smith basically did not utilize a natural-law or natural-rights framework. His book on The Theory of Moral Sentiments was an elaborate argument for why humans can get along in society and why they do indeed have morals, wrapped around his theory of “sympathy.” Although a case can be made that Smith’s theory of justice was partly grounded in a natural-law position—after all, Smith did write that “the rules of justice are the only rules of morality which are precise and accurate” (Smith 1976, p. 327)—Smith for the most part never used natural-rights and natural-law theory.[7]Indeed, it is when we get to Smith’s position on justice and jurisprudence that the differences between Smith and Rothbard become most striking. Recall that for Rothbard, “the truth, of course is . . . the state, through history, has been the main despoiler and plunderer of private property” (Rothbard 1995b, p. 334). Also, for Rothbard, “all classes live in harmony through the voluntary exchange of goods and services that mutually benefits them all” (ibid., p. 380). Rothbard feels that “modern anthropological research . . . has demonstrated that most primitive and tribal societies were based on private property, money, and market economies” (ibid., p. 312, n. 1).In contradistinction to Rothbard, Smith’s lectures on jurisprudence, particularly in the more extensive lecture notes that were first published in 1978,[8] display an almost Marxist quality. There Smith presents a dialectical interplay between the level of economic development of a society, which he divides into the age of hunters, shepherds, farmers and the commercial age, and a society’s legal and political institutions.[9] Smith is barely able to say a thing about a law or legal right without first specifying the level of socioeconomic development of that society. For Smith, rights, laws, and government are all dependent upon the level of the material development of society. As the Marxist Meek (and one of the editors of the Glasgow Edition of Smith’s Lectures on Jurisprudence, p. 16) perceptively points out, “it could very plausibly be argued, indeed, that it is in Smith’s numerous remarks about the influence exerted upon the character of individuals, social classes and nations by the manner in which the people concerned get their living, about the relativity of manners and morals to time and place, and about the socio-economic determinants of political attitudes, literary styles, consumption patterns, etc., that the main similarities between his approach and Marx’s are to be found.”Smith’s Lectures on Jurisprudence are organized around a proto-Marxist four-stage theory of socioeconomic development. These lectures hold that the law and government of a society are basically dependent upon the level of economic development of that particular society. As the socioeconomic level of a society changes, its rules, regulations and governmental system will also change. This dialectical interplay between history, the economy, and cultural institutions is perhaps most clearly evinced in Smith’s handling of marital relations and women, (Nyland 1933) as well as his analysis of slavery (Pack 1996a). From these jurisprudence lectures, it is clear that for Smith his Wealth of Nations is socially specific to what he calls the commercial stage of society (Pack 1991, pp. 119–37).For Smith the state arises with the rise of private property and shepherd society: “The appropriation of herds and flocks, which introduced an inequality of fortune, was that which first gave rise to regular government. Till there be property there can be no government, the very end of which is to secure wealth, and to defend the rich from the poor” (Jurisprudence, p. 404). According to Smith, “Property and civil government very much depend on one another. The preservation of property and the inequality of possession first formed it, and the state of property must always vary with the form of government” (ibid., p. 401). Smith is quite candid that “laws and government may be considered in this and indeed in every case as a combination of the rich to oppress the poor, and preserve to themselves the inequality of the goods which would otherwise be soon destroyed by the attacks of the poor” (ibid., p. 208).Hence, Smith approves of a certain amount of social stratification as necessary to any sort of post-primitive society. He approves of the role of the state, which exists largely to protect the rich from the poor. The commercial state depends upon taxation, and consequently it is not too surprising that Smith chose to spend the last years of his life working for the Scottish customs. By Smith’s thought, commercial society needs the state which in turn needs tax revenues, and Smith endeavored to be a good citizen of the state. Smith was no libertarian.It has been held that “Rothbard ranks among the great social thinkers. A system-builder, he is the architect of a rigorously consistent social philosophy” (Hoppe, p. 249). People who largely agree with Rothbard’s views may want to reread their Smith. There is indeed a wide gulf between the thought of Smith and Rothbard. In my opinion, Rothbard is essentially correct, astute, and honest in recognizing and emphasizing the size of the distance separating his thought from that of the iconic Adam Smith.
ReferencesBrown, Maurice. 1988. Adam Smith’s Economies: Its Place in the Development of Economic Thought. London and New York: Croom Helm.Griswold, Charles L., Jr. 1991. “Rhetoric and Ethics: Adam Smith on Theorizing about the Moral Sentiments,” Philosophy and Rhetoric 24, no. 3: 213–37.Haakonssen, Knud. 1996. Natural Law and Moral Philosophy. Cambridge: Cambridge University Press.Hoppe, Hans-Hermann. 1990. “Review of Walter Block and Llewellyn H. Rockwell, Jr., ed. Man, Economy, and Liberty: Essays in Honor of Murray N. Rothbard.” Review of Austrian Economics 4: 249–63.Justman, Stewart 1993. The Autonomous MALE of Adam Smith. Norman: University of Oklahoma Press.Marx, Karl. 1973. Grundrisse: Foundations of the Critique of Political Economy. New York: Vintage Books.Meek, Ronald. 1997. Smith, Marx, and After. New York: John Wiley and Sons.Nyland, Chris. 1993. “Adam Smith, Stage Theory, and the Status of Women.” History of Political Economy 25, no. 4: 617–40.Pack, Spencer J. 1991. Capitalism as a Moral System: Adam Smith’s Critique of the Free Market Economy. Brookfield, Vt.: Edward Elgar.———. 1993. “Adam Smith on the Limits to Human Reason.” In Perspectives on the History of Economic Thought, Vol. 9: Themes on Economic Discourse, Method, Money and Trade. Robert F. Hébert, ed. Brookfield, Vt.: Edward Elgar.———. 1995. “Theological (and Hence Economic) Implications of Adam Smith’s ‘Principles which Lead and Direct Philosophical Enquiries.’” History of Political Economy 27, no. 2: 289–307.———. 1996a. “Slavery, Adam Smith’s Economic Vision and the Invisible Hand.” History of Economic Ideas 3, nos. 2–3.———. 1996b. “Adam Smith’s Invisible/Visible Hand/Chain/Chaos.” In Joseph A. Schumpeter: Historian of Economics, Perspectives in the History of Economic Thought. Laurence S. Moss, ed. New York: Routledge.Rosenberg, Nathan. 1979. “Adam Smith and Laissez-Faire Revisited.” In Adam Smith and Modern Political Economy. Gerald O’Driscoll, ed. Ames: Iowa State University Press.Rothbard, Murray N. 1995a. Economic Thought before Adam Smith: An Austrian Perspective on the History of Economic Thought, Vol. 1. Brookfield, Vt.: Edward Elgar.———. 1995b. Classical Economics: An Austrian Perspective on the History of Economic Thought, Vol. 2. Brookfield, Vt.: Edward Elgar.Smith, Adam E. 1976. Theory of Moral Sentiments. The Glasgow Edition of the Works and Correspondence of Adam Smith. Vol. 1. A.L. Macfie and D.D. Raphael, eds. Oxford: Oxford University Press.———. 1977. The Correspondence of Adam Smith. The Glasgow Edition of the Works and Correspondence of Adam Smith. Vol. 6. E.C. Mossner and I.S. Ross, eds. Oxford: Oxford University Press.———. 1978. Lectures on Jurisprudence. The Glasgow Edition of the Works and Correspondence of Adam Smith. Vol. 5. R.L. Meek, D.D. Raphael, and P.G. Stein, eds. Oxford: Oxford University Press.———. 1980. Essays on Philosophical Subjects. The Glasgow Edition of the Works and Correspondence of Adam Smith. Vol. 3. W.P.D. Wightman and J.C. Bryce, eds. Oxford: Oxford University Press.———. 1983. Lectures on Rhetoric and Belles Lettres. The Glasgow Edition of the Works and Correspondence of Adam Smith, Vol. 4. J.C. Bryce, ed. Oxford: Oxford University Press.Viner, Jacob. 1928. “Adam Smith and Laissez-Faire.” In Adam Smith 1776–1926. John Maurice Clark et al. Chicago: University of Chicago Press.Spencer J. Pack is professor of economics at Connecticut College.[1] The books referenced in this article are Economic Thought before Adam Smith: An Austrian Perspective on the History of Economic Thought, Vol. 1 and Classical Economics: An Austrian Perspective on the History of Economic Thought, Vol. 2. References will appear in the text as (Rothbard 1995a) and (Rothbard 1995b) respectively.[2] This has been done, and rather successfully too. See Justman’s (1993) entertaining book.[3] Marx (p. 104): It was an immense step forward for Adam Smith to throw out every limiting specification of wealth-creating activity—not only manufacturing, or commercial or agricultural labor, but one as well as the others, labor in general. With the abstract universality of wealth-creating activity we now have the universality of the object defined as wealth, the product as such or again labor as such, but labor as past, objectified labor. How difficult and great was this transition may be seen from how Adam Smith himself from time to time still falls back into the Physiocratic system.[4] To acquire a real feel for the intimate closeness of the relationship between Smith and Hume, consult the relevant letters (Smith 1977).[5] See his “The Principles which Lead and Direct Philosophical Enquiries; Illustrated by the History of Astronomy”; also his so-called “History of the Ancient Physics” and “History of the Ancient Logics and Metaphysics” as well. These latter two essays are also prefaced by the same significant title “The Principles Which Lead and Direct Philosophical Enquiries.” These three essays are actually all part of one unfinished work written by the young Adam Smith. They are a key source for understanding Smith’s methodology (Smith 1980).[6] See Smith’s Lectures on Rhetoric and Belles Lettres (1983).[7] See the chapters on Hume, Smith, and John Millar in Haakonssen (1996).[8] It is significant that Smith was originally hired at Glasgow as a professor of logic and that he gave these lectures in the logic course. He continued to teach this course as an “elective” even after he transferred to the chair of moral philosophy.[9] For a study that stresses the dialectical nature of Smith’s work in general, see Brown (1988).
Volume 12, Number 2 (Winter/Spring 1991)Jeffrey M. Herbener discusses fallacies of Philip Mirowski's book More Heat than Light.
Volume 1, No. 1 (Spring 1998)From Adam Smith's day to our own, economists have tended to treat the intertemporal trade-off as something quite different from other trade-offs that market participants face. Whether based on the impartial spectator or on a perceived consensus among economists or on a supposed magic of compounding, their thinking is biased in favor of the future. They write as if they believe the prospect of a more-than-doubled real income forty years hence should have a greater effect on our current willingness to save than it actually has. On this idea, whether offered by Smith himself or modern mainstream, Rothbard has expressed dissent.
In his new book, Capital In the Twenty-First Century, Piketty fails to understand how savings and investment work, writes George Reisman This audio Mises Daily is narrated by Keith Hocker.
In socialist countries of old, it was easy to find cookies and candies in state-owned stores while fresh meat and bread was rare, writes Jim Fedako. This audio Mises Daily is narrated by Joe Kohlhaas.
Interviewed by host Tom Woods, Bob Murphy demonstrates that the author of a book on capital doesn't seem to know any capital theory.
Interviewed by host Redmond Weissenberger, Mark Thornton discusses markets, Keynes, Keynesians, and general economic craziness.
This article is also available as an Audio Mises DailyMartin Wolf is the chief economics commentator at the influential Financial Times. He has received numerous honorary awards, positions, and degrees. My first knowledge of him came from a friend who had attended a lecture where Mr. Wolf mentioned that the best research on real estate economics was being done in Auburn, Alabama. I was quite shocked that Mr. Wolf was following our work here at the Mises Institute.
However, Mr. Wolf has only deteriorated in my estimation over time. He has reached an all time low with his recent editorial (“Wipe out Rentiers with Cheap Money,” 5/6/14), where he argues that the cheap money policy used by central banks was here to stay, so get used to it. What makes his conclusion so tainted is that he understands the consequences of this policy. He even invokes the famous remark of Keynes regarding the “euthanasia of the rentier” where he supported the ruination of people who earn interest on their savings.
He sees the problem as insufficient aggregate demand. Wolf considers the pre-2007 unsustainable credit boom a temporary fix, rather than the cause of the crisis brought about by central banks. His argument is that low interest rates and quantitative easing policy has been an insufficient policy response. His preferred solution is some type of massive public works program financed by government deficits. However, he believes that governments will refuse to borrow in order to build “productive assets.”
This is classic Keynesian logic: solve the problems of debt and monetary expansion by engaging in more debt and monetary expansion. With governments reluctant to expand spending further he concludes that we are stuck with the second-best solution of a cheap money policy consisting of ultra low interest rates and quantitative easing. Besides, he notes, the “cautious rentier no longer serves a useful purpose.”
Wolf is the unabashed mouthpiece for the ruling power elite. He clearly and correctly describes what this policy actually accomplishes — cheap monetary policy hurts most people in the economy, particularly workers and savers and redistributes wealth to the ruling elites. The losers from easy credit policy include the broad categories of insurance, pensions, and households. This long known result was recently confirmed in a study, referenced by Wolf, by the McKinsey Global Institute.
Insurance is far more important than most people think. Insurance protects us against the loss of life (life insurance), our health (medical insurance), our homes (home, flood, and fire insurance), and our vehicles (car insurance). There is also general liability insurance and various types of business insurance. Insurance companies even offer incentives to be better drivers, to maintain safer homes, and to live healthier lifestyles, and they strive to eliminate moral hazard. Insurance companies are hurt by cheap money policies because their interest return on investments are now lower than required to meet their payout obligations. This hurts the companies and their policyholders because it requires higher premiums and raises the possibility of bankrupting insurance companies.
Pensions and retirement savings accounts are also hurt by easy credit policies. These institutions arose to address the problems associated with increased longevity brought about by increased prosperity. By saving during your working career you provide income for your retirement. Cheap money policy and low interest rates discourage saving and also makes it more difficult for pensions to earn returns on their investments necessary to make future payouts to retirees. The same is true for individuals who have retirement savings accounts.
In order to achieve higher returns, pension funds and people saving for retirement have been forced into more risky investments. Savings accounts, money market mutual funds, certificates of deposit, and short-term government bonds earn less than 1 percent, and after taxes and inflation they are losing purchasing power. Hence, central banks have been forcing these people to invest in the stock markets and junk bonds and the possibility of large loses in the future.
The class labeled “households” is basically everyone except the small number of people who benefit from cheap money policy. Households are harmed in a variety of ways, including the weak job market, declining real wages, and the negative impact on savings. It has also harmed them by encouraging households to take on extremely high amounts of debt, much of which comes with much higher interest rates.
The winners from cheap money policy are the government, large corporations, and large banks in the US. Low interest rates clearly benefit borrowers with lower interest rates and governments, banks, and corporations are the biggest borrowers. In general, artificially low interest rates benefit capital and hurt labor. Cheap money policy by central banks helps banks, like subsidized flour policies would help bakeries. Banks are also helped by most forms of government bailouts.
The easy money policy makes it easy for large corporations to borrow large amounts of credit at very low interest rates. It also forces stock prices up as alternative forms of savings, such as certificates of deposits, yield a real negative return. It has also made it very cheap for corporations to buy back their stock and to leverage their balance sheets. The stock market bubble is the direct effect of the cheap money policy of the central bank.
Mr. Wolf and central bankers around the world have the idea that cheap money policies can increase stock prices and that this will lead to sustainable increases in investment, consumer spending, and increased aggregate demand. In reality, cheap money policies cause economic bubbles that are inherently unstable and subject to crash. It should be obvious that harming the workers and savers of society to benefit the wealthy ruling class is no way to get the economy back on track. Therefore, cheap money policy is a scam of gigantic global proportions.
Achieving economic recovery and growth requires first knowing what caused the problem in the first place. A lack of aggregate demand is the effect, not the cause. A lack of aggregate demand is the crisis, not the cause of it. The cause of the crisis is easy money policy and runaway government spending and debt. Continued easy money policy and government spending will only make the negative consequences of the crisis even worse.
The solution consists of: 1. Central banks should have no monetary policy and they should not interfere with interest rates. 2. Government budgets should be balanced and reduced over time. 3. Government regulations, subsidies, and taxes should be eliminated. 4. Land, labor, and capital should be transferred from the public sector to the private sector. And, 5. Programs that burden future generations should be ended.
The horrible irony here is that when Keynes wrote approvingly of the euthanasia of the rentier class, he was speaking of a powerful class of monopoly capitalists and aristocrats. When Mr. Wolf speaks of the euthanasia of the rentier he is actually targeting “insurance, pensions, and households,” with a policy that has enormous financial benefits to the class of people that Keynes was targeting for extinction!
In 1789 Marie Antoinette said “let them eat cake.” In 2014, Mr. Martin Wolf tells us to eat “cheap money.”