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Introduction • 5,300 Words
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Knowledge of the principles of the free society is not something that everyone is born with or something that we just catch like the common cold. The principles of liberty must be carefully passed on from one generation to the next if they are to survive, let alone flourish. Each generation must learn anew from their predecessors the virtues of private property and the consequences of statism. It is even more crucial today, in our contemporary intellectual environment, to have something to offer besides empty platitudes about how we can all “just get along.” Today’s citizen who is interested in things economic, can do no better than to turn to Ludwig von Mises. In his life and work Mises provides the intelligent person a vision for the importance of truth, economics, liberty, and scholarship that continually inspires to greatness.[1]For a good and accessible overview of Mises’s thought see The Essential von Mises and Ludwig von Mises: Scholar, Creator, Hero(Auburn, Ala.: Mises Institute, 2009), both by Murray N. Rothbard. They are combined in one volume in Rothbard (2009). A more extensive biography of Mises can be found in Israel Kirzner’s Ludwig von Mises: The Man and His Economics (Wilmington, Del.: ISI Book, 2001). Jörg Guido Hülsmann’s massive Mises: The Last Knight of Liberalism (Auburn, Ala.: Mises Institute, 2007) is the most extensive biography and the standard-bearer on Mises’s life and work.

The reason Mises is so important can be understood by looking at our halls of learning. It is no secret that state-run elementary and secondary schools are failing their charges. Year after year we hear the all-too-familiar reports telling us again and again how test scores are falling. Such dismal performance sows the seeds for a meager harvest reaped by these same students as they enter college. Fewer and fewer of them graduate high school with a basic knowledge about history, literature, science, and math. It should not surprise us that 20 percent of all college freshmen in the United States need remedial classes.[2]A. Lu, States Reform Remedial College Education (2013). Available at: http://www.pewstates.org/projects/stateline/headlin...492704 It is particularly disheartening to observe the decayed condition of modern American higher education. Not so very long ago, the college was seen as a most important institution charged with transmitting Western civilization from one generation to the next. It was here that students had the luxury of critically examining what different voices throughout time have answered when considering the big questions regarding man, life, death, and God. The goal was not an endless pursuit for pursuit’s sake, but was indeed pursuit for true answers to these questions.

Most people, I am sure, recognize that this is no longer the case. Most college faculties are now dominated, especially in the humanities, by one manifestation or another of deconstructionism. Everything is up for grabs and, at worst, the intellectual sees his chief end as the destruction of the foundations of Western civilization so that we can all dance on its ruins.

On the economic front, things are not much better. Several years ago a college near mine was having a political debate of sorts and evidently could not find anyone on their campus to defend the free market position, so they asked some of my students if they would participate. The report back from my students was by turns outrageous and depressing. From their opponents, there were numerous serious calls for stronger anti-trust regulation, energy regulation, increased state funding of education, subsidization of business, increased welfare, socialized health care, state urban planning, increased environmental regulation, an $11/hour living wage, regulations forcing insurance companies to cover abortions, and increased gun ownership restrictions.

This is what happens when intellectuals, teachers, and college professors see themselves as destroyers instead of cultivators. If we want to preserve our noble cultural inheritance, we cannot think that it will happen automatically. It is always easier to destroy than to maintain and build up. If civilization is not to descend into barbarism, we must teach each generation the importance of truth, liberty, and private property. It is not called culture for nothing. We must cultivate civilization. A former colleague of mine reminds me from time to time that as professors we are indeed the thin tweed line separating civilization from barbarism. Recently, however, the barbarians have been winning because the troops charged with manning the thin tweed line have been either absent without leave or actually fighting for the enemy.

What makes the fight more difficult is that to preserve society, it is not enough merely to oppose destructive philosophies, although oppose them we must. We also must offer a positive and real alternative. As Mises warns us at the end of his book, The Anti-capitalist Mentality,

An “anti-something” movement displays a purely negative attitude. It has no chance whatever to succeed. Its passionate diatribes virtually advertise the program they attack. People must fight for something they want to achieve, not simply reject an evil, no matter how bad it may be. They must, without any reservations, endorse the program of the market economy.[3]Ludwig von Mises, The Anti-capitalist Mentality (New York: D. Van Nostrand, 1956), p. 112.

In this, Mises was, perhaps unwittingly, in agreement with the Apostle Paul who told us many years ago to hate indeed that which is evil, but also to cling to that which is good. In order to maintain our cultural inheritance, we must not only oppose statism but also teach our students to cultivate and nurture the roots of civilization: the free society of voluntary exchange built on private property.

In today’s intellectual vacuum, students need someone to whom they can look for an example of sound scholarship that provides true answers to the important economic and political questions of the day. They could do no better than to turn to the writings of Ludwig von Mises. The life and work of Mises provides students with a magnificent example of what an economist, a scholar, and, in many ways, what a person should be.

This is certainly true in my own experience. As a freshman at a Christian liberal arts college in Northwest Iowa, I was instinctively conservative. I thought, for instance, that low taxes were better than high taxes, low inflation was better than high inflation, and communism was a bad economic and political system. However, I could not satisfactorily explain why.

That same year I joined the Conservative Book Club. As a member I agreed to buy four books from the Club over the course of three years. One month the Club was offering this book Human Action by some Austrian economist I had never heard of as its featured alternative. Because of its price, it was allowed to count for two of my required purchases. I thought, “hey, pretty economical,” and upon encouragement from my economics professor, I went ahead and bought it. The book changed my life. In Mises’s own memoirs, he recounts how near Christmas in 1903 he read Carl Menger’s Principles of Economics and that book made him an economist.[4]Ludwig von Mises, Memoirs (Auburn, Ala.: Mises Institute, 2009), p. 25.Well, Human Action did the same for me.

I found the book at once inspiring and intimidating. I plowed into it with an eager mind and immediately was impressed with Mises’s intellect and his rigorous logic. What also impressed me was the density of Mises’s arguments. He did not waste words that did not advance his theories. As such, Human Action can be rather daunting for readers relatively new to economics. On the one hand, I had several eureka! moments as Mises unpacked the logic demonstrating another economic truth. A number of times I also found some of it rather slow-going. Many times I read and re-read pages to gain a sense of understanding. I would start at the top of a page and by the time I had worked my way down to the bottom, I forgot what the main point was, so I had to start again. Some of it is quite technical, so I had to slow way down to grasp material. I would read passages, sections, and chapters and need to set the book aside for a bit while I thought about, puzzled over, evaluated, and, finally, achieved understanding. It took me five years of off-and-on reading in the midst of my other studies and then work to complete reading it the first time through. Now all of this work was definitely worth it. The benefit from reading and re-reading Human Action is incalculable. Still, I began to look for a less taxing way of becoming acquainted with Mises’s ideas.

During my time in college, while I was still working through Human Action, I sought out other more accessible books by Mises. This was years before the advent of the internet and mises.org. I had to turn to that ancient institution called the library and I discovered that our college library had a collection of shorter essays by Mises published by Libertarian Press in a collection entitled Planning for Freedom and Sixteen Other Essays. This book proved to be a more accessible introduction to Mises’s thought. I began reading it during my free time and did not stop until I had come to the end. Planning for Freedom turned out to be the first book by Mises that I read completely. As I read, I began to put together an economic and political philosophy that revolved around private property. It was the writings of Mises that provided me the intellectual foundation to evaluate and integrate what I was being taught in school. Looking back on those years, I have grown to appreciate the wisdom expressed in the sentiment by Mark Thornton that one of the best ways to become introduced to the work of Ludwig von Mises is through some of his shorter, more popular works.[5]Mark Thornton, from a Mises Wire post “How to Read Mises,” October 8, 2013. https://mises.org/blog/how-read-mises While sacrificing nothing in the way of sound economic theory, they are more accessible and in any event are not as intimidating as Mises’s 881-page magnum opus.

In this anthology, I have sought to bring you the best of both worlds. An attempt has been made to acquaint the reader with the broad spectrum of Mises’s ideas and analyses in a way that is more accessible and less daunting. The selections include, therefore, several shorter, more popular works side-by-side with excerpts from longer, more scholarly and technically difficult works. A special feature of this collection is the inclusion of an appreciation of Eugen von Böhm-Bawerk, available for the first time in English, translated from the French by Karl-Friederich Israel. It is my hope that this book will provide a user-friendly gateway into the brilliance of Mises, because we desperately need his wisdom as much now as in any other time in our history.

The work of Ludwig von Mises is an important guide for thoughtful citizens because he strongly, yet matter-of-factly sets forth economics as the pursuit of truth. Not the truth of the passing fancy, nor the so-called “small t-truth” that is always in danger of being refuted by the latest bit of empirical data; but economic truth that will stand for all ages. Misesian economic theory is a triumphant response to the epistemological relativism of today because it is economics developed in light of reality.

Upon reading the works of Mises, one is immediately set forth on the right road, because Mises begins where economics must begin — human action. All of his economic theorems and corollaries are deduced from the non-controversial axiom that people engage in purposeful behavior. This immediately sets his theories on intellectual bedrock.

As I read the opening chapters of Human Action during my sophomore year, I had a sort of epiphany as all of the conclusions I had learned in my economics classes began to fall into logical place. The law of demand was not merely a plausible sounding notion that is true only in an unrealizable ideal world. It was not the necessary implication of arbitrary assumptions that must be tested again and again. Mises showed that economics is logically whole and that demand is rooted in the law of marginal utility which itself is deduced from the premise that human beings act purposefully. Readers of Mises are not left walking on the shifting sand of empiricism, but on the solid ground of true axioms and sound logic.

A former student of mine who received his J.D. at Harvard Law School had a similar reaction. He once told me that while he appreciated the insights that economics in general gives him in the field of law and economics, what sets Mises above all others in his mind is Mises’s focus on individual human action. The modern focus on bell curves and treating people as rats in mazes, he said, makes it difficult to imagine the practical implication of economic theory relating to a contract case between Joe and Bob. Mises’s framework starts with people like Joe and Bob.

In arguing for economic truth, Mises explicitly rejects relativism. A much-too-large segment of our intellectual culture is under the spell of post-modernism. One root of such thinking is what Mises termed polylogism, the idea that different groups of people have different mental categories and systems of logic. Marxists, for instance, argue that there is an inseparable gulf between the proletariat mind and the bourgeois mind. Not that they have different opinions on things, but that they have entirely different laws of logic and ways of thinking. The same notions are found in feminist academic circles and in all brands of multiculturalism. These theories attempt to shield their subscribers from criticism made by those outside of their particular cults. Mises refutes such illogic by stressing that truth is truth no matter who says it. He writes,

A theory is either correct or incorrect. … But a theory can never be valid for a bourgeois or an American if it is invalid for a proletarian or a Chinese.[6]Ludwig von Mises, Human Action (Auburn, Ala.:Mises Institute [1949] 1998), p. 91.

Mises’s demolition of polylogism provides students a basis from which they can reply to the Marxist, feminist, and racist theories of criticism that have been running amok within the humanities for some time.

The work of Mises is also important for today because Mises provides a clear understanding of why economics is important by asking the right and important questions and providing correct answers. His books and essays are not consumed with inquiries regarding what the stock market will do in the next six months, or will a federal funds rate of 0.25 percent achieve full employment or should it be 0.5 percent.

While Mises does help us speak to such questions, he focuses on the larger, more fundamental issues. A key theme that runs throughout the work of Mises, for instance, is the consideration of the survival of civilization. Mises warns that social progress is not automatic. In Human Action he explains that our

civilization was able to spring into existence because the peoples were dominated by ideas which were the application of the teachings of economics to the problems of economic policy. It will and must perish if the nations continue to pursue the course which they entered upon under the spell of doctrines rejecting economic thinking.[7]Mises, Human Action, p. 10.

The work of Mises is important to the survival of civilization because it helps pass along knowledge to a new generation of students. And this knowledge helps answer one of the most pressing dilemmas of our human existence — a dilemma that has been with us since the beginning of time. How do we deal with the fundamental condition of scarcity? As we are reminded by that eminent modern philosopher and former student of the London School of Economics Mick Jagger, “You can’t always get what you want.” We are presented with the question: How do we go about our business in this world of scarcity without descending into a barbaric struggle for survival?

Because of the relative material comfort we possess in the West, it is natural for this question to never have occurred to most people. The brilliance of Mises, however, lies in the fact that he invites us to ponder this very real question and then sets out the right answer. He explains that in order to escape starvation and a barbaric struggle for survival, it is crucial that we take advantage of social cooperation through the division of labor. Without the division of labor, everyone would have to produce all that he or she consumes. Each person would have to produce his own food, plus his own house, plus his own clothes, plus all the other goods that make his life better. Without the division of labor, no one would be able to specialize in that thing he does relatively better than everyone else. Our total wealth would be greatly reduced and we would be left living largely from hand to mouth.

By reading Mises, however, students clearly see that as the result of our ability to exchange goods with one another, we can specialize in producing only those things at which we are most efficient and then trade the surplus we don’t need for other things we want. As we specialize, our productivity goes up individually and the total wealth of our community increases. The division of labor through voluntary exchange allows us to rise above a barbaric struggle for existence in which we hope that we are one of the fittest that will survive. The division of labor allows us to build civilization.

However the expansion of the division of labor has challenges of its own. And it is here that Mises is really in his element. An economy that has taken advantage of an extensive division of labor is very complex and yet, decentralized. Such an economy features a multitude of different markets in which the participants must coordinate their activities if we want to avoid recessions and depressions. The biggest problem for this decentralized economy to work is that all of the various producers have to know what to produce, how much to produce, and how to produce it.

This can only be done if some method of calculation exists. No other economist of his day stressed this point more than Mises. Indeed in the 1920s Mises demonstrated that the lack of economic calculation is the Achilles heel of socialism. Alternatives must be compared to one another if producers are to know how best to fulfill the desires of consumers for goods and services. Even if they know what consumers want they must be able to compare alternative ways to produce it. Should we build this house with wooden studs or metal? Blown or rolled insulation? Air or coil heating? This can be known only if there is a common denominator we can use to assess the relative value of each alternative. We cannot simply use physical units of goods for the comparison. Saying that ten two-by-fours are worth less than fifty nails because ten is less than fifty is like saying I’m taller than you because I’m 5 foot 8 and you are 98.6 degrees Fahrenheit.

Mises recognizes that what makes such comparisons even harder is that we all value goods subjectively, according to our personal preferences. We cannot, therefore, measure value because there are no objective units of value measurement.

Again it was Mises who demonstrated that voluntary exchange in a monetary economy opens the door to a solution. In a monetary economy, every good is exchanged against money, so every price is expressed in terms of the monetary unit — in our case dollars and cents. Even though value is subjective, in a free market, people manifest their values by voluntarily deciding what they will pay for particular products and services. These objective prices, therefore, are reflections of subjective values. Entrepreneurs are able to use these objective prices to calculate expected profit and loss and act accordingly. In a free market, Mises shows, entrepreneurs are able to plan for the future and consumers will receive what they most want.

Socialism, on the other hand, is doomed because there is no way for the central planner to efficiently allocate factors of production because there is no way to calculate profit and loss. In a completely socialistic economy all of the means of production are owned by the state. There is, therefore, no actual exchange of goods, and hence no actual prices that reflect the actual subjective values of human beings. Producers, then, have no way to calculate whether their actions are productive or wasteful from the point of view of society. What is called a planned economy is, instead, as Mises so eloquently put it, “groping about in the dark.”

I once had a student from China who cited Human Action as the book that finally turned him away from socialism. He had read all of Human Action, praising it for its readability. He told me that reading Human Actionhelped him realize that Communism was an impossible utopia. Mises’s explanation of the devastating economic consequences of war also attracted this student to read further works by Mises.

The moral of the story is that voluntary exchange in a monetary economy allows us to have the civilization we enjoy. In order to engage in voluntary exchange using money, however, Mises stresses that it is necessary for people to own private property. You cannot exchange what you do not own. If there is no ownership of private property, there is no actual exchange. If there is no exchange, there is no division of labor and there is no money so there are neither money prices, nor economic calculation. We would be left with chaos, not civilization. For civilization to survive, consequently, Mises teaches us that society must be a private property order. If people are able to own and trade their property as they see fit, wealth increases and civilization prospers.

The insights of Mises do not stop with his critique of socialism, however. From his 1929 collection of essays A Critique of Interventionism through the rest of his career, he continually explained to whomever would listen that even if the state does not fully socialize the economy, but intervenes only here and there, this too hinders the workings of the price system. To the extent that the state intervenes and curbs the free actions of individuals through price controls, monetary inflation, product restrictions, taxation, and subsidization, to that extent will prices for goods not accurately reflect the values of the people in that society. Such intervention will make it that much harder for entrepreneurs to do their job and one should expect to see shortages in some industries and surpluses in another.

You can see, then, that Mises builds his economic theory into a massive, logically integrated edifice of truth. More than any other economist of his day, Mises demonstrates that laws of economics are indeed laws every bit as universal and irrevocable as the laws of chemistry and physics, and we violate them at our peril. It is this fact that enables the study of economics to be a noble endeavor for everyone. In Human Action, Mises comments on the role of the economist by likening him to a chemist warning people against poisoning themselves. He writes,

A man who chooses between drinking a glass of milk and a glass of a solution of potassium cyanide does not choose between two beverages; he chooses between life and death. A society that chooses between capitalism and socialism does not choose between two social systems; it chooses between social cooperation and the disintegration of society. Socialism is not an alternative to capitalism; it is an alternative to any system under which men can live as human beings. To stress this point is the task of economics as it is the task of biology and chemistry to teach that potassium cyanide is not a nutriment but a deadly poison.[8]Mises, Human Action, p. 676.

Indeed, one of the most important benefits received from reading Mises is the ability to critically evaluate public policy.

When assigned in a college class long ago to research the viability of the social security system, the first place I turned to was Human Action. The passage I read then I have never forgotten. It is a passage that is as timely as today’s headlines. Mises writes,

One may try to justify [social security] by declaring that the wage earners lack the insight and the moral strength to provide spontaneously for their own future. But then it is not easy to silence the voices of those who ask whether it is not paradoxical to entrust the nation’s welfare to the decisions of voters whom the law itself considers incapable of managing their own affairs.[9]Ibid., p. 613.
(Mises, Human Action, p. 676.)

This is dynamite for the intelligent person who wants to truly understand the nature of hydra-headed interventionism that pushes a myriad of statist policies including inflationism, the welfare-warfare state, Keynesian fiscal management, socialized medicine, and countless business regulations that serve only to hamper mutually beneficial exchange.

Today people are increasingly urged to support this or that political program advertised as solving a vexing social problem with no understanding of economics and hence no frame of reference from which to evaluate different policies. All that is mustered in justification for interventionism are feelings that make people want to “do something.” The economics of Mises is the crucial antidote for the current interventionist ideology supporting the progressive march to economic fascism. Citizens acquainted with Mises quickly understand that any sort of middle-of-the-road economic policy does indeed lead to socialism.

Ludwig von Mises does not only provide us a vision of economic truth, however. He also inspires us to greatness by presenting the student an example of what an outstanding scholar should be. It does not take the reader of Mises’s work very long to see what a breadth of knowledge Mises had. Murray Rothbard once recounted how, when someone first recommended Human Action to him, he asked, “What is it about?” The response to Rothbard was “Everything.” A student in one of my managerial economics courses was impressed with the same observation. I had assigned from Human Action a brief section about the distinction between the manager and the entrepreneur. He liked what was assigned, so he began to read through the first part of the book. He was greatly impressed and told me, “He doesn’t write just about economics. It’s all there, of course, but he also writes about everything else.” This student now has a standard for real scholarship.

Throughout Mises’s works are insightful discussions about history, philosophy, political science, sociology, and even aesthetics. He makes not only references to, but thoughtful comments on the likes of Aristotle, Bentham, Bismark, Comte, Locke, Kant, Marx, Mill, Napoleon, Tacitus, Saint Francis of Assisi, and Spinoza. As he once explained in his New York University Seminar,

One of the indispensable prerequisites of a master of economics is a perfect knowledge of history, the history of ideas and of civilization, and of social, economic, and political history. To know one field well, one must also know other fields.[10]John Chamberlain, “My Years with Ludwig von Mises,” The Freeman 27, no. 2 (February 1977): 126–27.

In another instance Mises cited a number of authors in French and German. One student spoke up, asking, “Why are you giving these citations, Professor? I can’t read French and German.” Mises replied simply, “Learn it. You are engaged in scholarly activities.”[11]Margit von Mises, My Years with Ludwig von Mises (New Rochelle, New York: Arlington Press, 1976), pp. 135–36. He also encouraged his students not only to read authors with which they agreed, but to read about an issue from all sides. A student who reads Mises is inspired to be such a scholar.

Looking at Mises the scholar, the contemporary student learns a valuable lesson in integrity. His life was a never-ending fight for economic truth, liberty, scholarly excellence, and the principles of the free market. As he notes in his autobiography, at a particularly depressing time in his life when it appeared that he had become merely “an historian of decline,” he remembered his personal motto adopted from a line out of Virgil: “Do not give in to the evil, but proceed ever the more against it.” Throughout his life, he did just that.

His research and logical analysis convinced him of the negative consequences of socialism and interventionism. He never wavered from those convictions and his steadfastness cost him plenty. He did without a salaried academic appointment because he was not willing to be a court intellectual. However, he never grew bitter about this. In his autobiography he writes,

I was sometimes accused of representing my viewpoint in a manner too abrupt and intransigent. It was also claimed that I could have accomplished more had I displayed a greater willingness to compromise. … When I look back at my work … my only regret is my willingness to compromise, and not my intransigence.[12]Mises, Memoirs, p. 60.

The reason for his uncompromising attitude is that he took his work as a scholar seriously. Mises thought, “In science, compromise is a betrayal of truth.”[13]Ibid., p. 61.
(Mises, Memoirs, p. 60.)
Would that more contemporary economists had the same convictions.

Ludwig von Mises truly was an intellectual giant among men and, as Murray Rothbard[14]Murray N. Rothbard, “Ludwig von Mises and the Paradigm for our Age,” Modern Age (Fall 1971): 370–79. saw, his thought and causal-realist framework is the best alternative to the economic paradigm of our age. In the contemporary fog of the modern academy, Mises serves as a lighthouse, warning unsuspecting students of the perils of bad economics and statist economic policies, while illuminating students to the principles of the free society.

The book in your hands is intended to give a taste of the many facets of Mises’s thought in a way that accessibly communicates most of his key contributions to the social sciences. It therefore includes excerpts from his larger and more technically demanding works side-by-side with shorter, more introductory articles and lectures. The finished product is sort of an intelligent person’s guide to the work of Ludwig von Mises. It is especially suitable for those with an interest in Mises, but find jumping right into Human Action, Socialism, or The Theory of Money and Credit rather daunting. The hope is to give the reader a survey of Mises’s insights in a format that nourishes his intellectual soul, while also whetting the appetite for his larger corpus of work. Those ready to dive into deeper Misesian waters are encouraged to pick up The Mises Reader Unabridged which contains all of the material in The Mises Reader plus over 125 pages of additional material, primarily from his more scholarly works. It is hoped that together these two volumes will foster a rising generation of citizens more thoroughly acquainted with sound economics and the principles of the free society.

If we want to preserve our civilization from the cultural destroyers, post-modern relativists, and enemies of freedom, we must provide our generation of inquisitive minds with a sound alternative. We must direct our fellow sojourners to a literature that defends truth and property and inspires us to greatness. Fortunately we have such a literature to turn to — a literature of freedom. Those desiring to beat back the barbarians at the gate, would do well to begin with the works of Ludwig von Mises. In him, the reader will find, as Murray Rothbard found, a scholar, creator, and hero. Shawn Ritenour Grove City College

BOOK INFORMATION

The Mises Reader Unabridged
Shawn Ritenour, editor

Published 2016 by the Mises Institute. This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivs 4.0 International License.

http://creativecommons.org/licenses/by-nc-nd/4.0/

Mises Institute
518 West Magnolia Avenue
Auburn, Alabama 36832
mises.org

ISBN: 978-1-61016-667-6

Footnotes

[1] For a good and accessible overview of Mises’s thought see The Essential von Mises and Ludwig von Mises: Scholar, Creator, Hero(Auburn, Ala.: Mises Institute, 2009), both by Murray N. Rothbard. They are combined in one volume in Rothbard (2009). A more extensive biography of Mises can be found in Israel Kirzner’s Ludwig von Mises: The Man and His Economics (Wilmington, Del.: ISI Book, 2001). Jörg Guido Hülsmann’s massive Mises: The Last Knight of Liberalism (Auburn, Ala.: Mises Institute, 2007) is the most extensive biography and the standard-bearer on Mises’s life and work.

[2] A. Lu, States Reform Remedial College Education (2013). Available at: http://www.pewstates.org/projects/stateline/headlines/states-reform-college-remedial-education-85899492704

[3] Ludwig von Mises, The Anti-capitalist Mentality (New York: D. Van Nostrand, 1956), p. 112.

[4] Ludwig von Mises, Memoirs (Auburn, Ala.: Mises Institute, 2009), p. 25.

[5] Mark Thornton, from a Mises Wire post “How to Read Mises,” October 8, 2013. https://mises.org/blog/how-read-mises

[6] Ludwig von Mises, Human Action (Auburn, Ala.:Mises Institute [1949] 1998), p. 91.

[7] Mises, Human Action, p. 10.

[8] Mises, Human Action, p. 676.

[9] Ibid., p. 613.

[10] John Chamberlain, “My Years with Ludwig von Mises,” The Freeman 27, no. 2 (February 1977): 126–27.

[11] Margit von Mises, My Years with Ludwig von Mises (New Rochelle, New York: Arlington Press, 1976), pp. 135–36.

[12] Mises, Memoirs, p. 60.

[13] Ibid., p. 61.

[14] Murray N. Rothbard, “Ludwig von Mises and the Paradigm for our Age,” Modern Age (Fall 1971): 370–79.

Chapter 1 • Human Action • 5,200 Words

1. The Basic Concept of Action and its Categorial Conditions

The starting point of our reasoning is not behavior, but action, or, as it is redundantly designated, rational action. Human action is conscious behavior on the part of a human being. Conceptually it can be sharply and clearly distinguished from unconscious activity, even though in some cases it is perhaps not easy to determine whether given behavior is to be assigned to one or the other category.

As thinking and acting men, we grasp the concept of action. In grasping this concept we simultaneously grasp the closely correlated concepts of value, wealth, exchange, price, and cost. They are all necessarily implied in the concept of action, and together with them the concepts of valuing, scale of value and importance, scarcity and abundance, advantage and disadvantage, success, profit, and loss. The logical unfolding of all these concepts and categories in systematic derivation from the fundamental category of action and the demonstration of the necessary relations among them constitutes the first task of our science. The part that deals with the elementary theory of value and price serves as the starting point in its exposition. There can be no doubt whatever concerning the aprioristic character of these disciplines.

The most general prerequisite of action is a state of dissatisfaction, on the one hand, and, on the other, the possibility of removing or alleviating it by taking action. (Perfect satisfaction and its concomitant, the absence of any stimulus to change and action, belong properly to the concept of a perfect being. This, however, is beyond the power of the human mind to conceive. A perfect being would not act.) Only this most general condition is necessarily implied in the concept of action. The other categorial conditions of action are independent of the basic concept; they are not necessary prerequisites of concrete action. Whether or not they are present in a particular case can be shown by experience only. But where they are present, the action necessarily falls under definite laws that flow from the categorial determinacy of these further conditions.

It is an empirical fact that man grows old and dies and that therefore he cannot be indifferent to the passage of time. That this has been man’s experience thus far without exception, that we do not have the slightest evidence to the contrary, and that scarcely any other experience points more obviously to its foundation in a law of nature — all this in no way changes its empirical character. The fact that the passage of time is one of the conditions under which action takes place is established empirically and not a priori. We can without contradiction conceive of action on the part of immortal beings who would never age. But in so far as we take into consideration the action of men who are not indifferent to the passage of time and who therefore economize time because it is important to them whether they attain a desired end sooner or later, we must attribute to their action everything that necessarily follows from the categorial nature of time. The empirical character of our knowledge that the passage of time is a condition of any given action in no way affects the aprioristic character of the conclusions that necessarily follow from the introduction of the category of time. Whatever follows necessarily from empirical knowledge — e.g., the propositions of the agio theory of interest — lies outside the scope of empiricism.

Whether the exchange of economic goods (in the broadest sense, which also includes services) occurs directly, as in barter, or indirectly, through a medium of exchange, can be established only empirically. However, where and in so far as media of exchange are employed, all the propositions that are essentially valid with regard to indirect exchange must hold true. Everything asserted by the quantity theory of money, the theory of the relation between the quantity of money and interest, the theory of fiduciary media, and the circulation-credit theory of the business cycle, then becomes inseparably connected with action. All these theorems would still be meaningful even if there had never been any indirect exchange; only their practical significance for our action and for the science that explains it would then have to be appraised differently. However, the heuristic importance of experience for the analysis of action is not to be disregarded. Perhaps if there had never been indirect exchange, we would not have been able to conceive of it as a possible form of action and to study it in all its ramifications. But this in no way alters the aprioristic character of our science.

These considerations enable us to assess critically the thesis that all or most of the doctrines of economics hold only for a limited period of history and that, consequently, theorems whose validity is thus limited historically or geographically should replace, or at least supplement, those of the universally valid theory. All the propositions established by the universally valid theory hold to the extent that the conditions that they presuppose and precisely delimit are given. Where these conditions are present, the propositions hold without exception. This means that these propositions concern action as such; that is, that they presuppose only the existence of a state of dissatisfaction, on the one hand, and the recognized possibility, on the other, of relieving this dissatisfaction by conscious behavior, and that, therefore, the elementary laws of value are valid without exception for all human action. When an isolated person acts, his action occurs in accordance with the laws of value. Where, in addition, goods of higher order are introduced into action, all the laws of the theory of imputation are valid. Where indirect exchange takes place, all the laws of monetary theory are valid. Where fiduciary media are created, all the laws of the theory of fiduciary media (the theory of credit) are valid. There would be no point in expressing this fact by saying that the doctrines of the theory of money are true only in those periods of history in which indirect exchange takes place. …

4. The Distinction Between Means and Ends: The “Irrational”

Most of the objections raised against the science of action stem from a misconception of the distinction between means and ends. In the strict sense, the end is always the removal of a dissatisfaction. However, we can doubtless also designate as an end the attainment of that condition of the external world which brings about our state of satisfaction either directly or indirectly, or which enables us to perform, without further difficulties, the act through which satisfaction is to be obtained. If the removal of the feeling of hunger is the end sought, the procuring of food and its preparation for eating can also be considered as ends; if one seeks the removal of the feeling of cold as an end, the heating of one’s quarters can just as well be called an end. If additional measures are needed for the removal of dissatisfaction, then the attainment of any particular step along the way toward the desired final condition is also designated as an end. In this sense the acquisition of money in the market economy and, proximately, the division of labor are designated as ends of action; in this sense too the attainment of all things that indirectly promote the end of want-satisfaction appear as proximate or intermediate ends.

In the course of attaining the primary end, secondary ends are attained. A man walks from A to B. He would choose the shortest route if other, secondary ends did not demand satisfaction. He makes a detour if he can walk in the shade a little longer; if he can include in his walk another place, C, which he wants to look for; if, by doing so, he can avoid dangers that may be lying in wait for him on the shortest route; or if he just happens to like the longer route. If he decides on a detour, we must infer that at the moment of decision the attainment of such secondary ends was of greater importance in his judgment than the saving of distance. Consequently, for him the “detour” was no detour at all, since his walk brought him greater satisfaction or — at least from the point of view that he took of his situation at the moment of decision — was expected to bring greater satisfaction than the attainment of his destination by the shorter route. Only one who does not have these secondary ends in mind can call the longer way a detour. As far as our stroller was concerned, it was the correct route, that is, the route that promised the greatest satisfactions.[2]Cf. Lionel Robbins, An Essay on the Nature and Significance of Economic Science (London, 1932), p. 23.

Since satisfaction and dissatisfaction depend only on the subjective view of the individual, there is no room for argument on this question in a science that does not presume to establish a scale of values or to make judgments of value. Its conception of an end, in the strict sense, is more deductive than empirical: ends are determined by the wishes and the desires of the individual. Whenever reference is made to the greater or lesser appropriateness of means, this can only be from the point of view of the acting individual.

We must next deal with the objection of those who never weary of asserting that man does not act rationally at all. It has never been disputed that man does not always act correctly from the objective point of view; that is, that either from ignorance of causal relations or because of an erroneous judgment of the given situation, in order to realize his ends he acts differently from the way in which he would act if he had correct information. In 1833 the method of healing wounds was different from that used in 1933, and in 2033 still another way will presumably be thought suitable. Statesmen, field marshals, and stock-market speculators act differently at present from the way in which they would act if they knew exactly all the data needed for an accurate judgment of conditions. Only a perfect being, whose omniscience and omnipresence would enable him to survey all the data and every causal relationship, could know how each erring human being would have to act at every moment if he wanted to possess the divine attribute of omniscience. If we were to attempt to distinguish rational action from irrational action, we should not only be setting ourselves up as a judge over the scales of value of our fellow men, but we should also be declaring our own knowledge to be the only correct, objective standard of knowledge. We should be arrogating to ourselves the position that only an all-knowing being has the power to occupy.

The assertion that there is irrational action is always rooted in an evaluation of a scale of values different from our own. Whoever says that irrationality plays a role in human action is merely saying, that his fellow men behave in a way that he does not consider correct. If we do not wish to pass judgment on the ends and the scales of value of other people and to claim omniscience for ourselves, the statement, “He acts irrationally,” is meaningless, because it is not compatible with the concept of action. The “seeking to attain an end” and the “striving after a goal” cannot be eliminated from the concept of action. Whatever does not strive after goals or seek the attainment of ends reacts with absolute passivity to an external stimulus and is without a will of its own, like an automaton or a stone. To be sure, man too is as far outside the effective range of his action as a reed in the wind. But in so far as he is able to do anything, he always acts: even negligence and passivity are action if another course of conduct could have been chosen. And the conduct that is determined by the unconscious, in the Freudian sense, or by the subconscious, is also action in so far as conscious behavior could prevent it but neglects to do so. Even in the unconscious and apparently senseless behavior of the neurotic and the psychopath there is meaning, i.e., there is striving after ends and goals.[3]Cf. Sigmund Freud, Lectures on the Introduction to Psychoanalysis, 17th lecture.

Everything that we say about action is independent of the motives that cause it and of the goals toward which it strives in the individual case. It makes no difference whether action springs from altruistic or from egoistic motives, from a noble or from a base disposition; whether it is directed toward the attainment of materialistic or idealistic ends; whether it arises from exhaustive and painstaking deliberation or follows fleeting impulses and passions. The laws of catallactics that economics expounds are valid for every exchange regardless of whether those involved in it have acted wisely or unwisely or whether they were actuated by economic or noneconomic motives. The causes of action and the goals toward which it strives are data for the theory of action: upon their concrete configuration depends the course of action taken in the individual case, but the nature of action as such is not thereby affected.

These considerations have an evident bearing on the widespread tendency of the present age to appeal to the irrational. The concepts rational and irrational are not applicable to ends at all. Whoever wishes to pass judgment on ends may praise or condemn them as good or evil, fine or vulgar, etc. When the expressions “rational” and “irrational” are applied to the means employed for the attainment of an end, such a usage has significance only from the standpoint of a definite technology. However, the use of means other than those prescribed as “rational” by this technology can be accounted for in only two possible ways: either the “rational” means were not known to the actor, or he did not employ them because he wished to attain still other ends — perhaps very foolish ones from the point of view of the observer. In neither of these two cases is one justified in speaking of “irrational” action.

Action is, by definition, always rational. One is unwarranted in calling goals of action irrational simply because they are not worth striving for from the point of view of one’s own valuations. Such a mode of expressions leads to gross misunderstandings. Instead of saying that irrationality plays a role in action, one should accustom oneself to saying merely: There are people who aim at different ends from those that I aim at, and people who employ different means from those I would employ in their situation.

1. Purposeful Action and Animal Reaction

Human action is purposeful behavior. Or we may say: Action is will put into operation and transformed into an agency, is aiming at ends and goals, is the ego’s meaningful response to stimuli and to the conditions of its environment, is a person’s conscious adjustment to the state of the universe that determines his life. Such paraphrases may clarify the definition given and prevent possible misinterpretations. But the definition itself is adequate and does not need complement or commentary.

Conscious or purposeful behavior is in sharp contrast to unconscious behavior, i.e., the reflexes and the involuntary responses of the body’s cells and nerves to stimuli. People are sometimes prepared to believe that the boundaries between conscious behavior and the involuntary reaction of the forces operating within man’s body are more or less indefinite. This is correct only as far as it is sometimes not easy to establish whether concrete behavior is to be considered voluntary or involuntary. But the distinction between consciousness and unconsciousness is nonetheless sharp and can be clearly determined.

The unconscious behavior of the bodily organs and cells is for the acting ego no less a datum than any other fact of the external world. Acting man must take into account all that goes on within his own body as well as other data, e.g., the weather or the attitudes of his neighbors. There is, of course, a margin within which purposeful behavior has the power to neutralize the working of bodily factors. It is feasible within certain limits to get the body under control. Man can sometimes succeed through the power of his will in overcoming sickness, in compensating for the innate or acquired insufficiency of his physical constitution, or in suppressing reflexes. As far as this is possible, the field of purposeful action is extended. If a man abstains from controlling the involuntary reaction of cells and nerve centers, although he would be in a position to do so, his behavior is from our point of view purposeful.

The field of our science is human action, not the psychological events which result in an action. It is precisely this which distinguishes the general theory of human action, praxeology, from psychology. The theme of psychology is the internal events that result or can result in a definite action. The theme of praxeology is action as such. This also settles the relation of praxeology to the psychoanalytical concept of the subconscious. Psychoanalysis too is psychology and does not investigate action but the forces and factors that impel a man toward a definite action. The psychoanalytical subconscious is a psychological and not a praxeological category. Whether an action stems from clear deliberation, or from forgotten memories and suppressed desires which from submerged regions, as it were, direct the will, does not influence the nature of the action. The murderer whom a subconscious urge (the Id) drives toward his crime and the neurotic whose aberrant behavior seems to be simply meaningless to an untrained observer both act; they like anybody else are aiming at certain ends. It is the merit of psychoanalysis that it has demonstrated that even the behavior of neurotics and psychopaths is meaningful, that they too act and aim at ends, although we who consider ourselves normal and sane call the reasoning determining their choice of ends nonsensical and the means they choose for the attainment of these ends contrary to purpose.

The term “unconscious” as used by praxeology and the term “subconscious” as applied by psychoanalysis belong to two different systems of thought and research. Praxeology no less than other branches of knowledge owes much to psychoanalysis. The more necessary is it then to become aware of the line which separates praxeology from psychoanalysis.

Action is not simply giving preference. Man also shows preference in situations in which things and events are unavoidable or are believed to be so. Thus a man may prefer sunshine to rain and may wish that the sun would dispel the clouds. He who only wishes and hopes does not interfere actively with the course of events and with the shaping of his own destiny. But acting man chooses, determines, and tries to reach an end. Of two things both of which he cannot have together he selects one and gives up the other. Action therefore always involves both taking and renunciation.

To express wishes and hopes and to announce planned action may be forms of action in so far as they aim in themselves at the realization of a certain purpose. But they must not be confused with the actions to which they refer. They are not identical with the actions they announce, recommend, or reject. Action is a real thing. What counts is a man’s total behavior, and not his talk about planned but not realized acts. On the other hand action must be clearly distinguished from the application of labor. Action means the employment of means for the attainment of ends. As a rule one of the means employed is the acting man’s labor. But this is not always the case. Under special conditions a word is all that is needed. He who gives orders or interdictions may act without any expenditure of labor. To talk or not to talk, to smile or to remain serious, may be action. To consume and to enjoy are no less action than to abstain from accessible consumption and enjoyment.

Praxeology consequently does not distinguish between “active” or energetic and “passive” or indolent man. The vigorous man industriously striving for the improvement of his condition acts neither more nor less than the lethargic man who sluggishly takes things as they come. For to do nothing and to be idle are also action, they too determine the course of events. Wherever the conditions for human interference are present, man acts no matter whether he interferes or refrains from interfering. He who endures what he could change acts no less than he who interferes in order to attain another result. A man who abstains from influencing the operation of physiological and instinctive factors which he could influence also acts. Action is not only doing but no less omitting to do what possibly could be done.

We may say that action is the manifestation of a man’s will. But this would not add anything to our knowledge. For the term will means nothing else than man’s faculty to choose between different states of affairs, to prefer one, to set aside the other, and to behave according to the decision made in aiming at the chosen state and forsaking the other.

2. The Prerequisites of Human Action

We call contentment or satisfaction that state of a human being which does not and cannot result in any action. Acting man is eager to substitute a more satisfactory state of affairs for a less satisfactory. His mind imagines conditions which suit him better, and his action aims at bringing about this desired state. The incentive that impels a man to act is always some uneasiness.[6]Cf. [John] Lock, An Essay Concerning Human Understanding, ed. Fraser (Oxford, 1894), vol. I, pp. 331–333; [Gottfried Wilhelm] Leibniz, Nouveaux essais sur l’entendement humain, ed. Flammarion, p. 119. A man perfectly content with the state of his affairs would have no incentive to change things. He would have neither wishes nor desires; he would be perfectly happy. He would not act; he would simply live free from care.

But to make a man act, uneasiness and the image of a more satisfactory state alone are not sufficient. A third condition is required: the expectation that purposeful behavior has the power to remove or at least to alleviate the felt uneasiness. In the absence of this condition no action is feasible. Man must yield to the inevitable. He must submit to destiny.

These are the general conditions of human action. Man is the being that lives under these conditions. He is not only homo sapiens, but no less homo agens. Beings of human descent who either from birth or from acquired defects are unchangeably unfit for any action (in the strict sense of the term and not merely in the legal sense) are practically not human. Although the statutes and biology consider them to be men, they lack the essential feature of humanity. The newborn child too is not an acting being. It has not yet gone the whole way from conception to the full development of its human qualities. But at the end of this evolution it becomes an acting being.

On Happiness

In colloquial speech we call a man “happy” who has succeeded in attaining his ends. A more adequate description of his state would be that he is happier than he was before. There is however no valid objection to a usage that defines human action as the striving for happiness.

But we must avoid current misunderstandings. The ultimate goal of human action is always the satisfaction of the acting man’s desire. There is no standard of greater or lesser satisfaction other than individual judgments of value, different for various people and for the same people at various times. What makes a man feel uneasy and less uneasy is established by him from the standard of his own will and judgment, from his personal and subjective valuation. Nobody is in a position to decree what should make a fellow man happier.

To establish this fact does not refer in any way to the antitheses of egoism and altruism, of materialism and idealism, of individualism and collectivism, of atheism and religion. There are people whose only aim is to improve the condition of their own ego. There are other people with whom awareness of the troubles of their fellow men causes as much uneasiness as or even more uneasiness than their own wants. There are people who desire nothing else than the satisfaction of their appetites for sexual intercourse, food, drinks, fine homes, and other material things. But other men care more for the satisfactions commonly called “higher” and “ideal.” There are individuals eager to adjust their actions to the requirements of social cooperation; there are, on the other hand, refractory people who defy the rules of social life. There are people for whom the ultimate goal of the earthly pilgrimage is the preparation for a life of bliss. There are other people who do not believe in the teachings of any religion and do not allow their actions to be influenced by them.

Praxeology is indifferent to the ultimate goals of action. Its findings are valid for all kinds of action irrespective of the ends aimed at. It is a science of means, not of ends. It applies the term happiness in a purely formal sense. In the praxeological terminology the proposition: man’s unique aim is to attain happiness, is tautological. It does not imply any statement about the state of affairs from which man expects happiness.

The idea that the incentive of human activity is always some uneasiness and its aim always to remove such uneasiness as far as possible, that is, to make the acting men feel happier, is the essence of the teachings of Eudaemonism and Hedonism. Epicurean

is that state of perfect happiness and contentment at which all human activity aims without ever wholly attaining it. In the face of the grandeur of this cognition it is of little avail only that many representatives of this philosophy failed to recognize the purely formal character of the notions pain and pleasure and gave them a material and carnal meaning. The theological, mystical, and other schools of a heteronomous ethic did not shake the core of Epicureanism because they could not raise any other objection than its neglect of the “higher” and “nobler” pleasures. It is true that the writings of many earlier champions of Eudaemonism, Hedonism, and Utilitarianism are in some points open to misinterpretation. But the language of modern philosophers and still more that of the modern economists is so precise and straightforward that no misinterpretation can possibly occur.

On Instincts and Impulses

One does not further the comprehension of the fundamental problem of human action by the methods of instinct-sociology. This school classifies the various concrete goals of human action and assigns to each class a special instinct as its motive. Man appears as a being driven by various innate instincts and dispositions. It is assumed that this explanation demolishes once for all the odious teachings of economics and utilitarian ethics. However, Feuerbach has already justly observed that every instinct is an instinct to happiness.[7]Cf. [Ludwig] Feuerbach, Sämmtliche Werke, ed. Bolin and Jodl (Stuttgart, 1907), vol. 10, p. 231. The method of instinct-psychology and instinct-sociology consists in an arbitrary classification of the immediate goals of action and in a hypostasis of each. Whereas praxeology says that the goal of an action is to remove a certain uneasiness, instinct-psychology says it is the satisfaction of an instinctive urge.

Many champions of the instinct school are convinced that they have proved that action is not determined by reason, but stems from the profound depths of innate forces, impulses, instincts, and dispositions which are not open to any rational elucidation. They are certain they have succeeded in exposing the shallowness of rationalism and disparage economics as “a tissue of false conclusions drawn from false psychological assumptions.”[8]Cf. William McDougall, An Introduction to Social Psychology, 14th ed. (Boston, 1921), p. 11. Yet rationalism, praxeology, and economics do not deal with the ultimate springs and goals of action, but with the means applied for the attainment of an end sought. However unfathomable the depths may be from which an impulse or instinct emerges, the means which man chooses for its satisfaction are determined by a rational consideration of expense and success.

He who acts under an emotional impulse also acts. What distinguishes an emotional action from other actions is the valuation of input and output. Emotions disarrange valuations. Inflamed with passion, man sees the goal as more desirable and the price he has to pay for it as less burdensome than he would in cool deliberation. Men have never doubted that even in the state of emotion means and ends are pondered and that it is possible to influence the outcome of this deliberation by rendering more costly the yielding to the passionate impulse. To punish criminal offenses committed in a state of emotional excitement or intoxication more mildly than other offenses is tantamount to encouraging such excesses. The threat of severe retaliation does not fail to deter even people driven by seemingly irresistible passion.

We interpret animal behavior on the assumption that the animal yields to the impulse which prevails at the moment. As we observe that the animal feeds, cohabits, and attacks other animals or men, we speak of its instincts of nourishment, of reproduction, and of aggression. We assume that such instincts are innate and peremptorily ask for satisfaction.

But is it different with man. Man is not a being who cannot help yielding to the impulse that most urgently asks for satisfaction. Man is a being capable of subduing his instincts, emotions, and impulses; he can rationalize his behavior. He renounces the satisfaction of a burning impulse in order to satisfy other desires. He is not a puppet of his appetites. A man does not ravish every female that stirs his senses; he does not devour every piece of food that entices him; he does not knock down every fellow he would like to kill. He arranges his wishes and desires into a scale, he chooses; in short, he acts. What distinguishes man from beasts is precisely that he adjusts his behavior deliberatively. Man is the being that has inhibitions, that can master his impulses and desires, that has the power to suppress instinctive desires and impulses.

It may happen that an impulse emerges with such vehemence that no disadvantage which its satisfaction may cause appears great enough to prevent the individual from satisfying it. In this case too there is choosing. Man decides in favor of yielding to the desire concerned.[9]In such cases a great role is played by the circumstances that the two satisfactions concerned — that expected from yielding to the impulse and that expected from the avoidance of its undesirable consequences — are not simultaneous.

References • 200 Words

[1] [Ludwig von Mises, Epistemological Problems of Economics, 3rd ed. (1933; Auburn, Ala.: Mises Institute, 2003), chap. 1, sec. 2: “The Scope and Meaning of the System of A Priori Theorems,” pp. 24–27, 33–37.]

[2] Cf. Lionel Robbins, An Essay on the Nature and Significance of Economic Science (London, 1932), p. 23.

[3] Cf. Sigmund Freud, Lectures on the Introduction to Psychoanalysis, 17th lecture.

[5] [Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 1: “Acting Man,” pp. 11–16.]

[6] Cf. [John] Lock, An Essay Concerning Human Understanding, ed. Fraser (Oxford, 1894), vol. I, pp. 331–333; [Gottfried Wilhelm] Leibniz, Nouveaux essais sur l’entendement humain, ed. Flammarion, p. 119.

[7] Cf. [Ludwig] Feuerbach, Sämmtliche Werke, ed. Bolin and Jodl (Stuttgart, 1907), vol. 10, p. 231.

[8] Cf. William McDougall, An Introduction to Social Psychology, 14th ed. (Boston, 1921), p. 11.

[9] In such cases a great role is played by the circumstances that the two satisfactions concerned — that expected from yielding to the impulse and that expected from the avoidance of its undesirable consequences — are not simultaneous.

Chapter 2 • Action and Value • 6,700 Words

1. The Delimitation of the “Economic”

Investigations concerning the money prices of goods and services constituted the historical starting point of the reflections that led to the development of economic theory. What first opened the way to success in these inquiries was the observation that money plays “merely” an intermediary role and that through its interposition goods and services are, in the last analysis, exchanged against goods and services. This discovery led to the further realization that the theory of direct exchange, which makes use of the fiction that all acts of exchange are conducted without the intervention of any medium, must be given logical priority over the theory of money and credit, i.e., the theory of indirect exchange, which is effected by means of money.

Still further possibilities were disclosed when it was realized that acts of interpersonal exchange are not essentially different from those which the individual makes within his own household without reaching beyond it into the social sphere. Hence, every allocation of goods — even those in the processes of production — is an exchange, and consequently the basic law of economic action can be comprehended also in the conduct of the isolated farmer. Thus, the foundation was laid for the first correct formulation and satisfactory solution of the problem of the delimitation of “economic” action from “noneconomic” action.

This problem had been approached previously in two different ways, each of which necessarily rendered its solution considerably more difficult. Classical economics had not succeeded in overcoming the difficulties posed by the apparent paradox of value. It had to construct its theory of value and price formation on the basis of exchange value and to start from the action of the businessman, because it was not able to base its system on the valuations of the marginal consumers. The specific conduct of the businessman is directed toward the attainment of the greatest possible monetary profit. Since the classical economists beheld in this phenomenon the essence of economic conduct, they had to distinguish accordingly between “economic” and “noneconomic” action. As soon as the transition was made to the subjective theory of value, this distinction, because it contradicts the basic thought of the whole system, could not but prove totally unserviceable and indeed nothing short of absurd. Of course, it took a long time before it was recognized as such.

If the distinction between the “economic” and the “noneconomic” proved untenable when formulated in terms of the motives and immediate goals of the actor, the attempt to base it on differences among the objects of action fared no better. Material things of the external world are exchanged not only against other things of this kind; they are exchanged also against other — “immaterial” — goods like honor, fame, and recognition. If one wishes to remove these actions from the province of the “economic,” then a new difficulty arises. For a great many of the acts in which material goods are exchanged serve one or both parties to the transaction merely as a preliminary means for the attainment of such “immaterial” satisfactions. However, every attempt to draw a sharp distinction here necessarily led to barren scholastic discussions which entangled themselves in immanent contradictions — discussions such as the successors of the classical economists devoted to the related endeavors to delimit the concepts of a “good” and “productivity.” But even if one wished to disregard this problem completely, one could not ignore the fact that human action exhibits an indissoluble homogeneity and that action involving the exchange of material goods against immaterial goods differs in no significant respect from action involving the exchange of material goods alone.

Two propositions follow from the subjective theory of value that make a precise separation between the “economic” and the “noneconomic,” such as the older economics sought, appear impracticable. First, there is the realization that the economic principle is the fundamental principle of all rational action, and not just a particular feature of a certain kind of rational action. All rational action is therefore an act of economizing. Secondly, there is the realization that every conscious, i.e., meaningful, action is rational. Only the ultimate goals — the values or ends — at which action aims are beyond rationality and, indeed, always and without exception must be. It was no longer compatible with subjectivism to equate “rational” and “irrational” with “objectively practical” and “objectively impractical.” It was no longer permissible to contrast “correct” action as “rational” to “incorrect” action, i.e., action diverted through misunderstanding ignorance, or negligence from employing the best means available to attain the ends sought. Nor was it henceforth possible to call an action irrational in which values like honor, piety, or political goals are taken into consideration. Max Weber’s attempt to separate rational action from other action on the basis of such distinctions was the last of its kind. It was necessarily doomed to failure.

If, however, all conscious conduct is an act of rational economizing, then one must be able to exhibit the fundamental economic categories involved in every action, even in action that is called “noneconomic” in popular usage. And, in fact, it is not difficult to point out in every conceivable human — that is, conscious — action the fundamental categories of catallactics, namely, value, good, exchange, price, and costs. Not only does the science of ethics show this, but even everyday popular usage gives us ample demonstrations of it. One has only to consider, for example, how, outside the domain customarily designated as that of science, terms and phrases are used that have these categories as their specific denotation.

2. Preferring as the Basic Element in Human Conduct

All conscious conduct on the part of men involves preferring an A to a B. It is an act of choice between two alternative possibilities that offer themselves. Only these acts of choice, these inner decisions that operate upon the external world, are our data. We comprehend their meaning by constructing the concept of importance. If an individual prefers A to B, we say that, at the moment of the act of choice, A appeared more important to him (more valuable, more desirable) than B.

We are also wont to say that the need for A was more urgent than the need for B. This is a mode of expression that, under certain circumstances, may be quite expedient. But as an hypostatization of what was to be explained, it became a source of serious misunderstandings. It was forgotten that we are able to infer the need only from the action. Hence, the idea of an action not in conformity with needs is absurd. As soon as one attempts to distinguish between the need and the action and makes the need the criterion for judging the action, one leaves the domain of theoretical science, with its neutrality in regard to value judgments. It is necessary to recall here that we are dealing with the theory of action, not with psychology, and certainly not with a system of norms, which has the task of differentiating between good and evil or between value and worthlessness. Our data are actions and conduct. It may be left undecided how far and in what way our science needs to concern itself with what lies behind them, that is, with actual valuations and volitions. For there can be no doubt that its subject matter is given action and only given action. Action that ought to be, but is not, does not come within its purview.

This best becomes clear to us if we consider the task of catallactics. Catallactics has to explain how market prices arise from the action of parties to the exchange of goods. It has to explain market prices as they are, not as they should be. If one wishes to do justice to this task, then in no way may one distinguish between “economic” and “noneconomic” grounds of price determination or limit oneself to constructing a theory that would apply only to a world that does not exist. In Böhm-Bawerk’s famous example of the planter’s five sacks of grain, there is no question of a rank order of objective correctness, but of a rank order of subjective desires.

The boundary that separates the economic from the noneconomic is not to be sought within the compass of rational action. It coincides with the line that separates action from nonaction. Action takes place only where decisions are to be made, where the necessity exists of choosing between possible goals, because all goals either cannot be achieved at all or not at the same time. Men act because they are affected by the flux of time. They are therefore not indifferent to the passage of time. They act because they are not fully satisfied and satiated and because by acting they are able to enhance the degree of their satisfaction. Where these conditions are not present — as in the case of “free” goods, for example — action does not take place.

3. Eudaemonism and the Theory of Value

The most troublesome misunderstandings with which the history of philosophical thought has been plagued concern the terms “pleasure” and “pain.” These misconceptions have been carried over into the literature of sociology and economics and have caused harm there too.

Before the introduction of this pair of concepts, ethics was a doctrine of what ought to be. It sought to establish the goals that man should adopt. The realization that man seeks satisfaction by acts both of commission and of omission opened the only path that can lead to a science of human action. If Epicurus sees in

the final goal of action, we can behold in it, if we wish, the state of complete satisfaction and freedom from desire at which human action aims without ever being able to attain it. Crude materialistic thinking seeks to circumscribe it in visions of Paradise and Cockaigne. Whether this construction may, in fact, be placed on Epicurus’ words remains, of course, uncertain, in view of the paucity of what has been handed down of his writings.

Doubtless it did not happen altogether without the fault of Epicurus and his school that the concepts of pleasure and pain were taken in the narrowest and coarsely materialistic sense when one wanted to misconstrue the ideas of hedonism and eudaemonism. And they were not only misconstrued; they were deliberately misrepresented, caricatured, derided, and ridiculed. Not until the seventeenth century did appreciation of the teachings of Epicurus again begin to be shown. On the foundations provided by it arose modern utilitarianism, which for its part soon had to contend anew with the same misrepresentations on the part of its opponents that had confronted its ancient forerunner. Hedonism, eudaemonism, and utilitarianism were condemned and outlawed, and whoever did not wish to run the risk of making the whole world his enemy had to be scrupulously intent upon avoiding the suspicion that he inclined toward these heretical doctrines. This must be kept in mind if one wants to understand why many economists went to great pains to deny the connection between their teachings and those of utilitarianism.

Even Böhm-Bawerk thought that he had to defend himself against the reproach of hedonism. The heart of this defense consists in his statement that he had expressly called attention already in the first exposition of his theory of value to his use of the word “well-being” in its broadest sense, in which it “embraces not only the self-centered interests of a Subject, but everything that seems to him worth aiming at.”[2]Cf. [Eugen von] Böhm-Bawerk, Kapital und Kapitalzins, Part II, vol. 1, p. 236, footnote. Böhm-Bawerk did not see that in saying this he was adopting the same purely formal view of the character of the basic eudaemonistic concepts of pleasure and pain — treating them as indifferent to content — that all advanced utilitarians have held. One need only compare with the words quoted from Böhm-Bawerk the following dictum of Jacobi:

We originally want or desire an object not because it is agreeable or good, but we call it agreeable or good because we want or desire it; and we do this because our sensuous or supersensuous nature so requires. There is, thus, no basis for recognizing what is good and worth wishing for outside of the faculty of desiring — i.e., the original desire and the wish themselves.[3]According to Fr. A. Schmid, quoted by Jodl, Geschichte der Ethik (2nd ed.), vol. 2, p. 661.

We need not go further into the fact that every ethic, no matter how strict an opponent of eudaemonism it may at first appear to be, must somehow clandestinely smuggle the idea of happiness into its system. As Böhm-Bawerk has shown, the case is no different with “ethical” economics.[4]Cf. Böhm-Bawerk’s comments on Schmoller, Kapital und Kapitalzins, p. 239, footnote. That the concepts of pleasure and pain contain no reference to the content of what is aimed at, ought, indeed, scarcely to be still open to misunderstanding.

Once this fact is established, the ground is removed from all the objections advanced by “ethical” economics and related schools. There may be men who aim at different ends from those of the men we know, but as long as there are men — that is, as long as they do not merely graze like animals or vegetate like plants, but act because they seek to attain goals — they will necessarily always be subject to the logic of action, the investigation of which is the task of our science. In this sense that science is universally human, and not limited by nationality, bound to a particular time, or contingent upon any social class. In this sense too it is logically prior to all historical and descriptive research.

1. Ends and Means

The result sought by an action is called its end, goal, or aim. One uses these terms in ordinary speech also to signify intermediate ends, goals, or aims; these are points which acting man wants to attain only because he believes that he will reach his ultimate end, goal, or aim in passing beyond them. Strictly speaking the end, goal, or aim of any action is always the relief from a felt uneasiness.

A means is what serves to the attainment of any end, goal, or aim. Means are not in the given universe; in this universe there exist only things. A thing becomes a means when human reason plans to employ it for the attainment of some end and human action really employs it for this purpose. Thinking man sees the serviceableness of things, i.e., their ability to minister to his ends, and acting man makes them means. It is of primary importance to realize that parts of the external world become means only through the operation of the human mind and its offshoot, human action. External objects are as such only phenomena of the physical universe and the subject matter of the natural sciences. It is human meaning and action which transform them into means. Praxeology does not deal with the external world, but with man’s conduct with regard to it. Praxeological reality is not the physical universe, but man’s conscious reaction to the given state of this universe. Economics is not about things and tangible material objects; it is about men, their meanings and actions. Goods, commodities, and wealth and all the other notions of conduct are not elements of nature; they are elements of human meaning and conduct. He who wants to deal with them must not look at the external world; he must search for them in the meaning of acting men.

Praxeology and economics do not deal with human meaning and action as they should be or would be if all men were inspired by an absolutely valid philosophy and equipped with a perfect knowledge of technology. For such notions as absolute validity and omniscience there is no room in the frame of a science whose subject matter is erring man. An end is everything which men aim at. A means is everything which acting men consider as such.

It is the task of scientific technology and therapeutics to explode errors in their respective fields. It is the task of economics to expose erroneous doctrines in the field of social action. But if men do not follow the advice of science, but cling to their fallacious prejudices, these errors are reality and must be dealt with as such. Economists consider foreign exchange control as inappropriate to attain the ends aimed at by those who take recourse to it. However, if public opinion does not abandon its delusions and governments consequently resort to foreign exchange control, the course of events is determined by this attitude. Present-day medicine considers the doctrine of the therapeutic effects of mandrake as a fable. But as long as people took this fable as truth, mandrake was an economic good and prices were paid for its acquisition. In dealing with prices economics does not ask what things are in the eyes of other people, but only what they are in the meaning of those intent upon getting them. For it deals with real prices, paid and received in real transactions, not with prices as they would be if men were different from what they really are.

Means are necessarily always limited, i.e., scarce with regard to the services for which man wants to use them. If this were not the case, there would not be any action with regard to them. Where man is not restrained by the insufficient quantity of things available, there is no need for any action.

It is customary to call the end the ultimate good and the means goods. In applying this terminology economists mainly used to think as technologists and not as praxeologists. They differentiated between free goods and economic goods. They called free goods things available in superfluous abundance which man does not need to be economize. Such goods are, however, not the object of any action. They are general conditions of human welfare; they are parts of the natural environment in which man lives and acts. Only the economic goods are the substratum of action. They alone are dealt with in economics.

Economic goods which in themselves are fitted to satisfy human wants directly and whose serviceableness does not depend on the cooperation of other economic goods, are called consumers’ goods or goods of the first order. Means which can satisfy wants only indirectly when complemented by cooperation of other goods are called producers’ goods or factors of production or goods of a remoter or higher order. The services rendered by a producers’ good consist in bringing about, by the cooperation of complementary producers’ goods, a product. This product may be a consumers’ good; it may be a producers’ good which when combined with other producers’ goods will finally bring about a consumers’ good. It is possible to think of the producers’ goods as arranged in orders according to their proximity to the consumers’ good for whose production they can be used. Those producers’ goods which are nearest to the production of a consumers’ good are ranged in the second order, and accordingly those which are used for the production of goods of the second order in the third order and so on.

The purpose of such an arrangement of goods in orders is to provide a basis for the theory of value and prices of the factors of production. It will be shown later how the valuation and the prices of the goods of higher orders are dependent on the valuation and the prices of the goods of lower orders produced by their expenditure. The first and ultimate valuation of external things refers only to consumers’ goods. All other things are valued according to the part they play in the production of consumers’ goods.

It is therefore not necessary actually to arrange producers’ goods in various orders from the second to the nth. It is no less superfluous to enter into pedantic discussions of whether a concrete good has to be called a good of the lowest order or should rather be attributed to one of the higher orders. Whether raw coffee beans or roast coffee beans or ground coffee or coffee prepared for drinking or only coffee prepared and mixed with cream and sugar are to be called a consumers’ good ready for consumption is of no importance. It is immaterial which manner of speech we adopt. For with regard to the problem of valuation, all that we say about a consumers’ good can be applied to any good of a higher order (except those of the highest order) if we consider it as a product.

An economic good does not necessarily have to be embodied in a tangible thing. Nonmaterial economic goods are called services.

2. The Scale of Value

Acting man chooses between various opportunities offered for choice. He prefers one alternative to others.

It is customary to say that acting man has a scale of wants or values in his mind when he arranges his actions. On the basis of such a scale he satisfies what is of higher value, i.e., his more urgent wants, and leaves unsatisfied what is of lower value, i.e., what is a less urgent want. There is no objection to such a presentation of the state of affairs. However, one must not forget that the scale of values or wants manifests itself only in the reality of action. These scales have no independent existence apart from the actual behavior of individuals. The only source from which our knowledge concerning these scales is derived is the observation of a man’s actions. Every action is always in perfect agreement with the scale of values or wants because these scales are nothing but an instrument for the interpretation of a man’s acting.

Ethical doctrines are intent upon establishing scales of value according to which man should act but does not necessarily always act. They claim for themselves the vocation of telling right from wrong and of advising man concerning what he should aim at as the supreme good. They are normative disciplines aiming at the cognition of what ought to be. They are not neutral with regard to facts; they judge them from the point of view of freely adopted standards.

This is not the attitude of praxeology and economics. They are fully aware of the fact that the ultimate ends of human action are not open to examination from any absolute standard. Ultimate ends are ultimately given, they are purely subjective, they differ with various people and with the same people at various moments in their lives. Praxeology and economics deal with the means for the attainment of ends chosen by the acting individuals. They do not express any opinion with regard to such problems as whether or not sybaritism is better than asceticism. They apply to the means only one yardstick, viz., whether or not they are suitable to attain the ends at which the acting individuals aim.

The notions of abnormality and perversity therefore have no place in economics. It does not say that a man is perverse because he prefers the disagreeable, the detrimental, and the painful to the agreeable, the beneficial, and the pleasant. It says only that he is different from other people; that he likes what others detest; that he considers useful what others want to avoid; that he takes pleasure in enduring pain which others avoid because it hurts them. The polar notions normal and perverse can be used anthropologically for the distinction between those who behave as most people do and outsiders and atypical exceptions; they can be applied biologically for the distinction between those whose behavior preserves the vital forces and those whose behavior is self-destructive; they can be applied in an ethical sense for the distinction between those who behave correctly and those who act otherwise than they should. However, in the frame of a theoretical science of human action, there is no room for such a distinction. Any examination of ultimate ends turns out to be purely subjective and therefore arbitrary.

Value is the importance that acting man attaches to ultimate ends. Only to ultimate ends is primary and original value assigned. Means are valued derivatively according to their serviceableness in contributing to the attainment of ultimate ends. Their valuation is derived from the valuation of the respective ends. They are important for man only as far as they make it possible for him to attain some ends.

Value is not intrinsic, it is not in things. It is within us; it is the way in which man reacts to the conditions of his environment.

Neither is value in words and in doctrines. It is reflected in human conduct. It is not what a man or groups of men say about value that counts, but how they act. The bombastic oratory of moralists and the inflated pompousness of party programs are significant as such. But they influence the course of human events only as far as they really determine the actions of men.

3. The Scale of Needs

Notwithstanding all declarations to the contrary, the immense majority of men aim first of all at an improvement of the material conditions of well-being. They want more and better food, better homes and clothes, and a thousand other amenities. They strive after abundance and health. Taking these goals as given, applied physiology tries to determine what means are best suited to provide as much satisfaction as possible. It distinguishes, from this point of view, between man’s “real” needs and imaginary and spurious appetites. It teaches people how they should act and what they should aim at as a means.

The importance of such doctrines is obvious. From his point of view the physiologist is right in distinguishing between sensible action and action contrary to purpose. He is right in contrasting judicious methods of nourishment from unwise methods. He may condemn certain modes of behavior as absurd and opposed to “real” needs. However, such judgments are beside the point for a science dealing with the reality of human action. Not what a man should do, but what he does, counts for praxeology and economics. Hygiene may be right or wrong in calling alcohol and nicotine poisons. But economics must explain the prices of tobacco and liquor as they are, not as they would be under different conditions.

There is no room left in the field of economics for a scale of needs different from the scale of values as reflected in man’s actual behavior. Economics deals with real man, weak and subject to error as he is, not with ideal beings, omniscient and perfect as only gods could be.

4. Action as an Exchange

Action is an attempt to substitute a more satisfactory state of affairs for a less satisfactory one. We call such a willfully induced alteration an exchange. A less desirable condition is bartered for a more desirable. What gratifies less is abandoned in order to attain something that pleases more. That which is abandoned is called the price paid for the attainment of the end sought. The value of the price paid is called costs. Costs are equal to the value attached to the satisfaction which one must forego in order to attain the end aimed at.

The difference between the value of the price paid (the costs incurred) and that of the goal attained is called gain or profit or net yield. Profit in this primary sense is purely subjective, it is an increase in the acting man’s happiness, it is a psychical phenomenon that can be neither measured nor weighed. There is a more and a less in the removal of uneasiness felt; but how much one satisfaction surpasses another one can only be felt; it cannot be established and determined in an objective way. A judgment of value does not measure, it arranges in a scale of degrees, it grades. It is expressive of an order of preference and sequence, but not expressive of measure and weight. Only the ordinal numbers can be applied to it, but not the cardinal numbers.

It is vain to speak of any calculation of values. Calculation is possible only with cardinal numbers. The difference between the valuation of two states of affairs is entirely psychical and personal. It is not open to any projection into the external world. It can be sensed only by the individual. It cannot be communicated or imparted to any fellow man. It is an intensive magnitude.

Physiology and psychology have developed various methods by means of which they pretend to have attained a substitute for the unfeasible measurement of intensive magnitudes. There is no need for economics to enter into an examination of these rather questionable makeshifts. Their supporters themselves realize that they are not applicable to value judgments. But even if they were, they would not have any bearing on economic problems. For economics deals with action as such, and not with the psychical facts that result in definite actions.

It happens again and again that an action does not attain the end sought. Sometimes the result, although inferior to the end aimed at, is still an improvement when compared with the previous state of affairs; then there is still a profit, although a smaller one than that expected. But it can happen that the action produces a state of affairs less desirable than the previous state it was intended to alter. Then the difference between the valuation of the result and the costs incurred is called loss.

1. Judgments of Value and Propositions of Existence

Propositions asserting existence (affirmative existential propositions) or nonexistence (negative existential propositions) are descriptive. They assert something about the state of the whole universe or of parts of the universe. With regard to them questions of truth and falsity are significant. They must not be confounded with judgments of value.

Judgments of value are voluntaristic. They express feelings, tastes, or preferences of the individual who utters them. With regard to them there cannot be any question of truth and falsity. They are ultimate and not subject to any proof or evidence.

Judgments of value are mental acts of the individual concerned. As such they must be sharply distinguished from the sentences by means of which an individual tries to inform other people about the content of his judgments of value. A man may have some reason to lie about his valuations. We may describe this state of affairs in the following way: Every judgment of value is in itself also a fact of the actual state of the universe and as such may be the topic of existential propositions. The sentence “I prefer Beethoven to Lehar” refers to a judgment of value. If looked upon as an existential proposition, it is true if I really prefer Beethoven and act accordingly and false if I in fact prefer Lehar and for some reasons lie about my real feelings, taste, or preferences. In an analogous way the existential proposition “Paul prefers Beethoven to Lehar” may be true or false. In declaring that with regard to a judgment of value there cannot be any question of truth or falsity, we refer to the judgment as such and not to the sentences communicating the content of such a judgment of value to other people.

2. Valuation and Action

A judgment of value is purely academic if it does not impel the man who utters it to any action. There are judgments which must remain academic because it is beyond the power of the individual to embark upon any action directed by them. A man may prefer a starry sky to the starless sky, but he cannot attempt to substitute the former state which he likes better for the latter he likes less.

The significance of value judgments consists precisely in the fact that they are the springs of human action. Guided by his valuations, man is intent upon substituting conditions that please him better for conditions which he deems less satisfactory. He employs means in order to attain ends sought.

Hence the history of human affairs has to deal with the judgments of value that impelled men to act and directed their conduct. What happened in history cannot be discovered and narrated without referring to the various valuations of the acting individuals. It is not the task of the historian qua historian to pass judgments of value on the individuals whose conduct is the theme of his inquiries. As a branch of knowledge history utters existential propositions only. But these existential propositions often refer to the presence or absence of definite judgments of value in the minds of the acting individuals. It is one of the tasks of the specific understanding of the historical sciences to establish what content the value judgments of the acting individuals had.

It is a task of history, for example, to trace back the origin of India’s caste system to the values which prompted the conduct of the generations who developed, perfected, and preserved it. It is its further task to discover what the consequences of this system were and how these effects influenced the value judgments of later generations. But it is not the business of the historian to pass judgments of value on the system as such, to praise or to condemn it. He has to deal with its relevance for the course of affairs, he has to compare it with the designs and intentions of its authors and supporters and to depict its effects and consequences. He has to ask whether or not the means employed were fit to attain the ends the acting individuals sought.

It is a fact that hardly any historian has fully avoided passing judgments of value. But such judgments are always merely incidental to the genuine tasks of history. In uttering them the author speaks as an individual judging from the point of view of his personal valuations, not as a historian.

3. The Subjectivity of Valuation

All judgments of value are personal and subjective. There are no judgments of value other than those asserting I prefer, I like better, I wish.

It cannot be denied by anybody that various individuals disagree widely with regard to their feelings, tastes, and preferences and that even the same individuals at various instants of their lives value the same things in a different way. In view of this fact it is useless to talk about absolute and eternal values.

This does not mean that every individual draws his valuations from his own mind. The immense majority of people take their valuations from the social environment into which they were born, in which they grew up, that moulded their personality and educated them. Few men have the power to deviate from the traditional set of values and to establish their own scale of what appears to be better and what appears to be worse.

What the theorem of the subjectivity of valuation means is that there is no standard available which would enable us to reject any ultimate judgment of value as wrong, false, or erroneous in the way we can reject an existential proposition as manifestly false. It is vain to argue about ultimate judgments of value as we argue about the truth or falsity of an existential proposition. As soon as we start to refute by arguments an ultimate judgment of value, we look upon it as a means to attain definite ends. But then we merely shift the discussion to another plane. We no longer view the principle concerned as an ultimate value but as a means to attain an ultimate value, and we are again faced with the same problem. We may, for instance, try to show a Buddhist that to act in conformity with the teachings of his creed results in effects which we consider disastrous. But we are silenced if he replies that these effects are in his opinion lesser evils or no evils at all compared to what would result from nonobservance of his rules of conduct. His ideas about the supreme good, happiness, and eternal bliss are different from ours. He does not care for those values his critics are concerned with, and seeks for satisfaction in other things than they do.

4. The Logical and Syntactical Structure of Judgments of Value

A judgment of value looks upon things from the point of view of the man who utters it. It does not assert anything about things as they are. It manifests a man’s affective response to definite conditions of the universe as compared with other definite conditions.

Value is not intrinsic. It is not in things and conditions but in the valuing subject. It is impossible to ascribe value to one thing or state of affairs only. Valuation invariably compares one thing or condition with another thing or condition. It grades various states of the external world. It contrasts one thing or state, whether real or imagined, with another thing or state, whether real or imagined, and arranges both in a scale of what the author of the judgment likes better and what less.

It may happen that the judging individual considers both things or conditions envisaged as equal. He is not concerned whether there is A or B. Then his judgment of value expresses indifference. No action can result from such a neutral disposition.

Sometimes the utterance of a judgment of value is elliptical and makes sense only if appropriately completed by the hearer. “I don’t like measles” means “I prefer the absence of measles to its presence.” Such incompleteness is the mark of all references to freedom. Freedom invariably means freedom from (absence of) something referred to expressly or implicitly. The grammatical form of such judgments may be qualified as negative. But it is vain to deduce from this idiomatic attire of a class of judgments of value any statements about their content and to blame them for an alleged negativism. Every judgment of value allows of a formulation in which the more highly valued thing or state is logically expressed in both a positive and a negative way, although sometimes a language may not have developed the appropriate term. Freedom of the press implies the rejection or negation of censorship. But, stated explicitly, it means a state of affairs in which the author alone determines the content of his publication as distinct from a state in which the police has a right to interfere in the matter.

Action necessarily involves the renunciation of something to which a lower value is assigned in order to attain or to preserve something to which a higher value is assigned. Thus, for instance, a definite amount of leisure is renounced in order to reap the product of a definite amount of labor. The renunciation of leisure is the means to attain a more highly valued thing or state.

There are men whose nerves are so sensitive that they cannot endure an unvarnished account of many facts about the physiological nature of the human body and the praxeological character of human action. Such people take offense at the statement that man must choose between the most sublime things, the loftiest human ideals, on the one hand, and the wants of his body on the other. They feel that such statements detract from the nobility of the higher things. They refuse to notice the fact that there arise in the life of man situations in which he is forced to choose between fidelity to lofty ideals and such animal urges as feeding.

Whenever man is faced with the necessity of choosing between two things or states, his decision is a judgment of value no matter whether or not it is uttered in the grammatical form commonly employed in expressing such judgments.

References • 100 Words

[1] [Ludwig von Mises, Epistemological Problems of Economics, 3rd ed. (1933; Auburn, Ala.: Mises Institute, 2003), chap. 4: “On the Development of the Subjective Theory of Value,” pp. 155–61.]

[2] Cf. [Eugen von] Böhm-Bawerk, Kapital und Kapitalzins, Part II, vol. 1, p. 236, footnote.

[3] According to Fr. A. Schmid, quoted by Jodl, Geschichte der Ethik (2nd ed.), vol. 2, p. 661.

[4] Cf. Böhm-Bawerk’s comments on Schmoller, Kapital und Kapitalzins, p. 239, footnote.

[5] [Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 4: “A First Analysis of the Category of Analysis,” pp. 92–98.]

[6] [Ludwig von Mises, Theory and History (1957; Auburn, Ala.: Mises Institute, 1985), chap. 1: “Judgments of Value,” pp. 19–25.]

Chapter 3 • Action in Time • 7,200 Words

1. The Temporal Character of Praxeology

The notion of change implies the notion of temporal sequence. A rigid, eternally immutable universe would be out of time, but it would be dead. The concepts of change and of time are inseparably linked together. Action aims at change and is therefore in the temporal order. Human reason is even incapable of conceiving the ideas of timeless existence and of timeless action.

He who acts distinguishes between the time before the action, the time absorbed by the action, and the time after the action has been finished. He cannot be neutral with regard to the lapse of time.

Logic and mathematics deal with an ideal system of thought. The relations and implications of their system are coexistent and interdependent. We may say as well that they are synchronous or that they are out of time. A perfect mind could grasp them all in one thought. Man’s inability to accomplish this makes thinking itself an action, proceeding step by step from the less satisfactory state of insufficient cognition to the more satisfactory state of better insight. But the temporal order in which knowledge is acquired must not be confused with the logical simultaneity of all parts of this aprioristic deductive system. Within this system the notions of anteriority and consequence are metaphorical only. They do not refer to the system, but to our action in grasping it. The system itself implies neither the category of time nor that of causality. There is functional correspondence between elements, but there is neither cause nor effect.

What distinguishes epistemologically the praxeological system from the logical system epistemologically is precisely that it implies the categories both of time and of causality. The praxeological system too is aprioristic and deductive. As a system it is out of time. But change is one of its elements. The notions of sooner and later and of cause and effect are among its constituents. Anteriority and consequence are essential concepts of praxeological reasoning. So is the irreversibility of events. In the frame of the praxeological system any reference to functional correspondence is no less metaphorical and misleading than is the reference to anteriority and consequence in the frame of the logical system.[2]In a treatise on economics there is no need to enter into a discussion of the endeavors to construct mechanics as an axiomatic system in which the concept of function is substituted for that of cause and effect. It will be shown later that axiomatic mechanics cannot serve as a model for the treatment of the economic system.

2. Past, Present, and Future

It is acting that provides man with the notion of time and makes him aware of the flux of time. The idea of time is a praxeological category. Action is always directed toward the future; it is essentially and necessarily always a planning and acting for a better future. Its aim is always to render future conditions more satisfactory than they would be without the interference of action. The uneasiness that impels a man to act is caused by a dissatisfaction with expected future conditions as they would probably develop if nothing were done to alter them. In any case action can influence only the future, never the present that with every infinitesimal fraction of a second sinks down into the past. Man becomes conscious of time when he plans to convert a less satisfactory present state into a more satisfactory future state.

For contemplative meditation time is merely duration, “la durée pure, dont l’écoulement est continu, et où l’on passe, par gradations insensibles, d’un état à l’autre: Continuité réellement vécue.”[3]Henri Bergson, Matière et mémoire (7th ed. Paris, 1911), p. 205. The “now” of the present is continually shifted to the past and is retained in the memory only. Reflecting about the past, say the philosophers, man becomes aware of time.[4]Edmund Husserl, “Vorlesungen zur Phänomenologie des inneren Zeitbewusstseins,” Jahrbuch für Philosophie und Phänomenologische Forschung (1928), vol. 9, pp. 391ff.; Alfred Schütz, Der sinnhafte Aufbau der sozialen Welt (Vienna, 1932), pp. 45 ff. However, it is not recollection that conveys to man the categories of change and of time, but the will to improve the conditions of his life.

Time as we measure it by various mechanical devices is always past, and time as the philosophers use this concept is always either past or future. The present is, from these aspects, nothing but an ideal boundary line separating the past from the future. But from the praxeological aspect there is between the past and the future a real extended present. Action is as such in the real present because it utilizes the instant and thus embodies its reality.[5]“Ce que j’appelle mon présent, c’est mon attitude vis-à-vis de l’avenir immédiat, c’est nom action imminente.” Bergson, Matière et mémoire, p. 152. Later retrospective reflection discerns in the instant passed away first of all the action and the conditions which it offered to action. That which can no longer be done or consumed because the opportunity for it has passed away, contrasts the past with the present. That which cannot yet be done or consumed, because the conditions for undertaking it or the time for its ripening have not yet come, contrasts the future with the past. The present offers to acting opportunities and tasks for which it was hitherto too early and for which it will be hereafter too late.

The present qua duration is the continuation of the conditions and opportunities given for acting. Every kind of action requires special conditions to which it must be adjusted with regard to the aims sought. The concept of the present is therefore different for various fields of action. It has no reference whatever to the various methods of measuring the passing of time by spatial movements. The present encloses as much of the time passed away as still is actual, i.e., of importance for acting. The present contrasts itself, according to the various actions one has in view, with the Middle Ages, with the nineteenth century, with the past year, month, or day, but no less with the hour, minute, or second just passed away. If a man says: Nowadays Zeus is no longer worshiped, he has a present in mind other than that the motorcar driver who thinks: Now it is still too early to turn.

As the future is uncertain it always remains undecided and vague how much of it we can consider as now and present. If a man had said in 1913: At present — now — in Europe freedom of thought is undisputed, he would have not foreseen that this present would very soon be a past.

3. The Economization of Time

Man is subject to the passing of time. He comes into existence, grows, becomes old, and passes away. His time is scarce. He must economize it as he does other scarce factors.

The economization of time has a peculiar character because of the uniqueness and irreversibility of the temporal order. The importance of these facts manifests itself in every part of the theory of action.

Only one fact must be stressed at this point. The economization of time is independent of the economization of economic goods and services. Even in the land of Cockaigne man would be forced to economize time, provided he were not immortal and not endowed with eternal youth and indestructible health and vigor. Although all his appetites could be satisfied immediately without any expenditure of labor, he would have to arrange his time schedule, as there are states of satisfaction which are incompatible and cannot be consummated at the same time. For this man, too, time would be scarce and subject to the aspect of sooner and later.

4. The Temporal Relation Between Actions

Two actions of an individual are never synchronous; their temporal relation is that of sooner and later. Actions of various individuals can be considered as synchronous only in the light of the physical methods for the measurement of time. Synchronism is a praxeological notion only with regard to the concerted efforts of various acting men.[6]In order to avoid any possible misunderstanding it may well be expedient to emphasize that this theorem has nothing at all to do with Einstein’s theorem concerning the temporal relation of spatially distant events.

A man’s individual actions succeed one another. They can never be effected at the same instant; they can only follow one another in more or less rapid succession. There are actions which serve several purposes at one blow. It would be misleading to refer to them as a coincidence of various actions.

People have often failed to recognize the meaning of the term “scale of value” and have disregarded the obstacles preventing the assumption of synchronism in the various actions of an individual. They have interpreted a man’s various acts as the outcome of a scale of value, independent of these acts and preceding them, and of a previously devised plan whose realization they aim at. The scale of value and the plan to which duration and immutability for a certain period of time were attributed, were hypostasized into the cause and motive of the various individual actions. Synchronism which could not be asserted with regard to various acts was then easily discovered in the scale of value and in the plan. But this overlooks the fact that the scale of value is nothing but a constructed tool of thought. The scale of value manifests itself only in real acting; it can be discerned only from the observation of real acting. It is therefore impermissible to contrast it with real acting and to use it as a yardstick for the appraisal of real actions.

It is no less impermissible to differentiate between rational and allegedly irrational acting on the basis of a comparison of real acting with earlier drafts and plans for future actions. It may be very interesting that yesterday goals were set for today’s acting other than those really aimed at today. But yesterday’s plans do not provide us with any more objective and nonarbitrary standard for the appraisal of today’s real acting than any other ideas and norms.

The attempt has been made to attain the notion of a nonrational action by this reasoning: If a is preferred to band b to c, logically a should be preferred to c. But if actually c is preferred to a, we are faced with a mode of acting to which we cannot ascribe consistency and rationality.[7]Cf. Felix Kaufmann, “On the Subject-Matter of Economic Science,” Economica 13: 390. This reasoning disregards the fact that two acts of an individual can never be synchronous. If in one action a is preferred to b and in another action b to c, it is, however short the interval between the two actions may be, not permissible to construct a uniform scale of value in which a precedes b and b precedes c. Nor is it permissible to consider a later third action as coincident with the two previous actions. All that the example proves is that value judgments are not immutable and that therefore a scale of value, which is abstracted from various, necessarily nonsynchronous actions of an individual, may be self-contradictory.[8]Cf. [Philip H.] Wicksteed, The Common Sense of Political Economy, ed. Robbins (London, 1933), vol. 1, pp. 32 ff.; [Lionel] Robbins, An Essay on the Nature and Significance of Economic Science, 2d ed. (London, 1935), pp. 91 ff.

One must not confuse the logical concept of consistency (viz., absence of contradiction) and the praxeological concept of consistency (viz., constancy or clinging to the same principles). Logical consistency has its place only in thinking, constancy has its place only in acting.

Constancy and rationality are entirely different notions. If one’s valuations have changed, unremitting faithfulness to the once espoused principles of action merely for the sake of constancy would not be rational but simply stubborn. Only in one respect can acting be constant: in preferring the more valuable to the less valuable. If the valuations change, acting must change also. Faithfulness, under changed conditions, to an old plan would be nonsensical. A logical system must be consistent and free of contradictions because it implies the coexistence of all its parts and theorems. In acting, which is necessarily in the temporal order, there cannot be any question of such consistency. Acting must be suited to purpose, and purposefulness requires adjustment to changing conditions.

Presence of mind is considered a virtue in acting man. A man has presence of mind if he has the ability to think and to adjust his acting so quickly that the interval between the emergence of new conditions and the adaptation of his actions to them becomes as short as possible. If constancy is viewed as faithfulness to a plan once designed without regard to changes in conditions, then presence of mind and quick reaction are the very opposite of constancy.

When the speculator goes to the stock exchange, he may sketch a definite plan for his operations. Whether or not he clings to this plan, his actions are rational also in the sense which those eager to distinguish rational acting from irrational attribute to the term “rational.” This speculator in the course of the day may embark upon transactions which an observer, not taking into account the changes occurring in market conditions, will not be able to interpret as the outcome of constant behavior. But the speculator is firm in his intention to make profits and to avoid losses. Accordingly he must adjust his conduct to the change in market conditions and in his own judgment concerning the future development of prices.[9]Plans too, of course, may be self-contradictory. Sometimes their contradictions may be the effect of mistaken judgment. But sometimes such contradictions may be intentional and serve a definite purpose. If, for instance, a publicized program of a government or a political party promises high prices to the producers and at the same time low prices to the consumers, the purpose of such an espousal of incompatible goals may be demagogic. Then the program, the publicized plan, is self-contradictory; but the plan of its authors who wanted to attain a definite end through the endorsement of incompatible aims and their public announcement is free of any contradiction.

However one twists things, one will never succeed in formulating the notion of “irrational” action whose “irrationality” is not founded upon an arbitrary judgment of value. Let us suppose that somebody has chosen to act inconstantly for no other purpose than for the sake of refuting the praxeological assertion that there is no irrational action. What happens here is that a man aims at a peculiar goal, viz., the refutation of a praxeological theorem, and that he accordingly acts differently from what he would have done otherwise. He has chosen an unsuitable means for the refutation of praxeology, that is all. …

1. Uncertainty and Acting[10][Mises, Human Action, chap. 6: “Uncertainty,” pp. 105–15.]

The uncertainty of the future is already implied in the very notion of action. That man acts and that the future is uncertain are by no means two independent matters. They are only two different modes of establishing one thing.

We may assume that the outcome of all events and changes is uniquely determined by eternal unchangeable laws governing becoming and development in the whole universe. We may consider the necessary connection and interdependence of all phenomena, i.e., their causal concatenation, as the fundamental and ultimate fact. We may entirely discard the notion of undetermined chance. But however that may be, or appear to the mind of a perfect intelligence, the fact remains that to acting man the future is hidden. If man knew the future, he would not have to choose and would not act. He would be like an automaton, reacting to stimuli without any will of his own.

Some philosophers are prepared to explode the notion of man’s will as an illusion and self-deception because man must unwittingly behave according to the inevitable laws of causality. They may be right or wrong from the point of view of the prime mover or the cause of itself. However, from the human point of view action is the ultimate thing. We do not assert that man is “free” in choosing and acting. We merely establish the fact that he chooses and acts and that we are at a loss to use the methods of the natural sciences for answering the question why he acts this way and not otherwise.

Natural science does not render the future predictable. It makes it possible to foretell the results to be obtained by definite actions. But it leaves impredictable two spheres: that of insufficiently known natural phenomena and that of human acts of choice. Our ignorance with regard to these two spheres taints all human actions with uncertainty. Apodictic certainty is only within the orbit of the deductive system of aprioristic theory. The most that can be attained with regard to reality is probability.

It is not the task of praxeology to investigate whether or not it is permissible to consider as certain some of the theorems of the empirical natural sciences. This problem is without practical importance for praxeological considerations. At any rate, the theorems of physics and chemistry have such a high degree of probability that we are entitled to call them certain for all practical purposes. We can practically forecast the working of a machine constructed according to the rules of scientific technology. But the construction of a machine is only a part in a broader program that aims at supplying the consumers with the machine’s products. Whether this was or was not the most appropriate plan depends on the development of future conditions which at the time of the plan’s execution cannot be forecast with certainty. Thus the degree of certainty with regard to the technological outcome of the machine’s construction, whatever it may be, does not remove the uncertainty inherent in the whole action. Future needs and valuations, the reaction of men to changes in conditions, future scientific and technological knowledge, future ideologies and policies can never be foretold with more than a greater or smaller degree of probability. Every action refers to an unknown future. It is in this sense always a risky speculation.

The problems of truth and certainty concern the general theory of human knowledge. The problem of probability, on the other hand, is a primary concern of praxeology.

2. The Meaning of Probability

The treatment of probability has been confused by the mathematicians. From the beginning there was an ambiguity in dealing with the calculus of probability. When the Chevalier de Méré consulted Pascal on the problems involved in the games of dice, the great mathematician should have frankly told his friend the truth, namely, that mathematics cannot be of any use to the gambler in a game of pure chance. Instead he wrapped his answer in the symbolic language of mathematics. What could easily be explained in a few sentences of mundane speech was expressed in a terminology which is unfamiliar to the immense majority and therefore regarded with reverential awe. People suspected that the puzzling formulas contain some important revelations, hidden to the uninitiated; they got the impression that a scientific method of gambling exists and that the esoteric teachings of mathematics provide a key for winning. The heavenly mystic Pascal unintentionally became the patron saint of gambling. The textbooks of the calculus of probability gratuitously propagandize for the gambling casinos precisely because they are sealed books to the layman.

No less havoc was spread by the equivocations of the calculus of probability in the field of scientific research. The history of every branch of knowledge records instances of the misapplication of the calculus of probability which, as John Stuart Mill observed, made it “the real opprobrium of mathematics.”[11]John Stuart Mill, A System of Logic Ratiocinative and Inductive (new impression; London, 1936), p. 353. Some of the worst errors have arisen in our day in the interpretation of the methods of physics.

The problem of probable inference is much bigger than those problems which constitute the field of the calculus of probability. Only preoccupation with the mathematical treatment could result in the prejudice that probability always means frequency.

A further error confused the problem of probability with the problem of inductive reasoning as applied by the natural sciences. The attempt to substitute a universal theory of probability for the category of causality characterizes an abortive mode of philosophizing, very fashionable only a few years ago.

A statement is probable if our knowledge concerning its content is deficient. We do not know everything which would be required for a definite decision between true and not true. But, on the other hand, we do know something about it; we are in a position to say more than simply non liquet or ignoramus.

There are two entirely different instances of probability; we may call them class probability (or frequency probability) and case probability (or the specific understanding of the sciences of human action). The field for the application of the former is the field of the natural sciences, entirely ruled by causality; the field for the application of the latter is the field of the sciences of human action, entirely ruled by teleology.

3. Class Probability

Class probability means: We know or assume to know, with regard to the problem concerned, everything about the behavior of a whole class of events or phenomena; but about the actual singular events or phenomena we know nothing but that they are elements of this class.

We know, for instance, that there are ninety tickets in a lottery and that five of them will be drawn. Thus we know all about the behavior of the whole class of tickets. But with regard to the singular tickets we do not know anything but that they are elements of this class of tickets.

We have a complete table of mortality for a definite period of the past in a definite area. If we assume that with regard to mortality no changes will occur, we may say that we know everything about the mortality of the whole population in question. But with regard to the life expectancy of the individuals we do not know anything but that they are members of this class of people.

For this defective knowledge the calculus of probability provides a presentation in symbols of the mathematical terminology. It neither expands nor deepens nor complements our knowledge. It translates it into mathematical language. Its calculations repeat in algebraic formulas what we knew beforehand. They do not lead to results that would tell us anything about the actual singular events. And, of course, they do not add anything to our knowledge concerning the behavior of the whole class, as this knowledge was already perfect — or was considered perfect — at the very outset of our consideration of the matter.

It is a serious mistake to believe that the calculus of probability provides the gambler with any information which could remove or lessen the risk of gambling. It is, contrary to popular fallacies, quite useless for the gambler, as is any other mode of logical or mathematical reasoning. It is the characteristic mark of gambling that it deals with the unknown, with pure chance. The gambler’s hopes for success are not based on substantial considerations. The nonsuperstitious gambler thinks: “There is a slight chance [or, in other words: ‘it is not impossible’] that I may win; I am ready to put up the stake required. I know very well that in putting it up I am behaving like a fool. But the biggest fools have the most luck. Anyway!”

Cool reasoning must show the gambler that he does not improve his chances by buying two tickets instead of one of a lottery in which the total amount of the winnings is smaller than the proceeds from the sale of all tickets. If he were to buy all the tickets, he would certainly lose a part of his outlay. Yet every lottery customer is firmly convinced that it is better to buy more tickets than less. The habitués of the casinos and slot machines never stop. They do not give a thought to the fact that, because the ruling odds favor the banker over the player, the outcome will the more certainly result in a loss for them the longer they continue to play. The lure of gambling consists precisely in its unpredictability and its adventurous vicissitudes. Let us assume that ten tickets, each bearing the name of a different man, are put into a box. One ticket will be drawn, and the man whose name it bears will be liable to pay 100 dollars. Then an insurer can promise to the loser full indemnification if he is in a position to insure each of the ten for a premium of ten dollars. He will collect 100 dollars and will have to pay the same amount to one of the ten. But if he were to insure one only of them at a rate fixed by the calculus, he would embark not upon an insurance business, but upon gambling. He would substitute himself for the insured. He would collect ten dollars and would get the chance either of keeping it or of losing that ten dollars and ninety dollars more.

If a man promises to pay at the death of another man a definite sum and charges for this promise the amount adequate to the life expectancy as determined by the calculus of probability, he is not an insurer but a gambler. Insurance, whether conducted according to business principles or according to the principle of mutuality, requires the insurance of a whole class or what can reasonably be considered as such. Its basic idea is pooling and distribution of risks, not the calculus of probability. The mathematical operations that it requires are the four elementary operations of arithmetic. The calculus of probability is mere by-play.

This is clearly evidenced by the fact that the elimination of hazardous risk by pooling can also be effected without any recourse to actuarial methods. Everybody practices it in his daily life. Every businessman includes in his normal cost accounting the compensation for losses which regularly occur in the conduct of affairs. “Regularly” means in this context: The amount of these losses is known as far as the whole class of the various items is concerned. The fruit dealer may know, for instance, that one of every fifty apples will rot in this stock; but he does not know to which individual apple this will happen. He deals with such losses as with any other item in the bill of costs.

The definition of the essence of class probability as given above is the only logically satisfactory one. It avoids the crude circularity implied in all definitions referring to the equiprobability of possible events. In stating that we know nothing about actual singular events except that they are elements of a class the behavior of which is fully known, this vicious circle is disposed of. Moreover, it is superfluous to add a further condition called the absence of any regularity in the sequence of the singular events.

The characteristic mark of insurance is that it deals with the whole class of events. As we pretend to know everything about the behavior of the whole class, there seems to be no specific risk involved in the conduct of the business.

Neither is there any specific risk in the business of the keeper of a gambling bank or in the enterprise of a lottery. From the point of view of the lottery enterprise the outcome is predictable, provided that all tickets have been sold. If some tickets remain unsold, the enterpriser is in the same position with regard to them as every buyer of a ticket is with regard to the tickets he bought.

4. Case Probability

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.

Case probability has nothing in common with class probability but the incompleteness of our knowledge. In every other regard the two are entirely different.

There are, of course, many instances in which men try to forecast a particular future event on the basis of their knowledge about the behavior of the class. A doctor may determine the chances for the full recovery of his patient if he knows that 70 per cent of those afflicted with the same disease recover. If he expresses his judgment correctly, he will not say more than that the probability of recovery is 0.7, that is, that out of ten patients not more than three on the average die. All such predictions about external events, i.e., events in the field of the natural sciences, are of this character. They are in fact not forecasts about the issue of the case in question, but statements about the frequency of the various possible outcomes. They are based either on statistical information or simply on the rough estimate of the frequency derived from nonstatistical experience.

So far as such types of probable statements are concerned, we are not faced with case probability. In fact we do not know anything about the case in question except that it is an instance of a class the behavior of which we know or think we know.

A surgeon tells a patient who considers submitting himself to an operation that thirty out of every hundred undergoing such an operation die. If the patient asks whether this number of deaths is already full, he has misunderstood the sense of the doctor’s statement. He has fallen prey to the error known as the “gambler’s fallacy.” Like the roulette player who concludes from a run of ten red in succession that the probability of the next turn being black is now greater than it was before the run, he confuses case probability with class probability.

All medical prognoses, when based only on physiological knowledge, deal with class probability. A doctor who hears that a man he does not know has been seized by a definite illness will, on the basis of his general medical experience, say: His chances for recovery are 7 to 3. If the doctor himself treats the patient, he may have a different opinion. The patient is a young, vigorous man; he was in good health before he was taken with the illness. In such cases, the doctor may think, the mortality figures are lower; the chances for this patient are not 7:3, but 9:1. The logical approach remains the same, although it may be based not on a collection of statistical data, but simply on a more or less exact résumé of the doctor’s own experience with previous cases. What the doctor knows is always only the behavior of classes. In our instance the class is the class of young, vigorous men seized by the illness in question.

Case probability is a particular feature of our dealing with problems of human action. Here any reference to frequency is inappropriate, as our statements always deal with unique events which as such — i.e., with regard to the problem in question — are not members of any class. We can form a class “American presidential elections.” This class concept may prove useful or even necessary for various kinds of reasoning, as, for instance, for a treatment of the matter from the viewpoint of constitutional law. But if we are dealing with the election of 1944 — either, before the election, with its future outcome or, after the election, with an analysis of the factors which determined the outcome — we are grappling with an individual, unique, and nonrepeatable case. The case is characterized by its unique merits, it is a class by itself. All the marks which make it permissible to subsume it under any class are irrelevant for the problem in question.

Two football teams, the Blues and the Yellows, will play tomorrow. In the past the Blues have always defeated the Yellows. This knowledge is not knowledge about a class of events. If we were to consider it as such, we would have to conclude that the Blues are always victorious and that the Yellows are always defeated. We would not be uncertain with regard to the outcome of the game. We would know for certain that the Blues will win again. The mere fact that we consider our forecast about tomorrow’s game as only probable shows that we do not argue this way.

On the other hand, we believe that the fact that the Blues were victorious in the past is not immaterial with regard to the outcome of tomorrow’s game. We consider it as a favorable prognosis for the repeated success of the Blues. If we were to argue correctly according to the reasoning appropriate to class probability, we would not attach any importance to this fact. If we were not to resist the erroneous conclusion of the “gambler’s fallacy,” we would, on the contrary, argue that tomorrow’s game will result in the success of the Yellows.

If we risk some money on the chance of one team’s victory, the lawyers would qualify our action as a bet. They would call it gambling if class probability were involved.

Everything that outside the field of class probability is commonly implied in the term probability refers to the peculiar mode of reasoning involved in dealing with historical uniqueness or individuality, the specific understanding of the historical sciences.

Understanding is always based on incomplete knowledge. We may know the motives of the acting men, the ends they are aiming at, and the means they plan to apply for the attainment of these ends. We have a definite opinion with regard to the effects to be expected from the operation of these factors. But this knowledge is defective. We cannot exclude beforehand the possibility that we have erred in the appraisal of their influence or have failed to take into consideration some factors whose interference we did not foresee at all, or not in a correct way.

Gambling, engineering, and speculating are three different modes of dealing with the future.

The gambler knows nothing about the event on which the outcome of his gambling depends. All that he knows is the frequency of a favorable outcome of a series of such events, knowledge which is useless for his undertaking. He trusts to good luck, that is his only plan.

Life itself is exposed to many risks. At any moment it is endangered by disastrous accidents which cannot be controlled, or at least not sufficiently. Every man banks on good luck. He counts upon not being struck by lightning and not being bitten by a viper. There is an element of gambling in human life. Man can remove some of the chrematistic consequences of such disasters and accidents by taking out insurance policies. In doing so he banks upon the opposite chances. On the part of the insured the insurance is gambling. His premiums were spent in vain if the disaster does not occur.[12]In life insurance the insured’s stake spent in vain consists only in the difference between the amount collected and the amount he could have accumulated by saving. With regard to noncontrollable natural events man is always in the position of a gambler.

The engineer, on the other hand, knows everything that is needed for a technologically satisfactory solution of his problem, the construction of a machine. As far as some fringes of uncertainty are left in his power to control, he tries to eliminate them by taking safety margins. The engineer knows only soluble problems and problems which cannot be solved under the present state of knowledge. He may sometimes discover from adverse experience that his knowledge was less complete than he had assumed and that he failed to recognize the indeterminateness of some issues which he thought he was able to control. Then he will try to render his knowledge more complete. Of course he can never eliminate altogether the element of gambling present in human life. But it is his principle to operate only within an orbit of certainty. He aims at full control of the elements of his action.

It is customary nowadays to speak of “social engineering.” Like planning, this term is a synonym for dictatorship and totalitarian tyranny. The idea is to treat human beings in the same way in which the engineer treats the stuff out of which he builds his bridges, roads, and machines. The social engineer’s will is to be substituted for the will of the various people he plans to use for the construction of his utopia. Mankind is to be divided into two classes: the almighty dictator, on the one hand, and the underlings who are to be reduced to the status of mere pawns in his plans and cogs in his machinery, on the other. If this were feasible, then of course the social engineer would not have to bother about understanding other people’s actions. He would be free to deal with them as technology deals with lumber and iron.

In the real world acting man is faced with the fact that there are fellow men acting on their own behalf as he himself acts. The necessity to adjust his actions to other people’s actions makes him a speculator for whom success and failure depend on his greater or lesser ability to understand the future. Every investment is a form of speculation. There is in the course of human events no stability and consequently no safety.

5. Numerical Evaluation of Case Probability

Case probability is not open to any kind of numerical evaluation. What is commonly considered as such exhibits, when more closely scrutinized, a different character.

On the eve of the 1944 presidential election people could have said:

(a) I am ready to bet three dollars against one that Roosevelt will be elected.

(b) I guess that out of the total amount of electors 45 million will exercise their franchise, 25 millions of whom will vote for Roosevelt.

(c) I estimate Roosevelt’s chances as 9 to 1.

(d) I am certain that Roosevelt will be elected. Statement (d) is obviously inexact. If asked under oath on the witness stand whether he is as certain about Roosevelt’s future victory as about the fact that a block of ice will melt when exposed to a temperature of 150 degrees, our man would have answered no. He would have rectified his statement and would have declared: I am personally fully convinced that Roosevelt will carry on. That is my opinion. But, of course, this is not certainty, only the way I understand the conditions involved.

The case of statement (a) is similar. This man believed that he risked very little when laying such a wager. The relation 3:1 is the outcome of the interplay of two factors: the opinion that Roosevelt will be elected and the man’s propensity for betting.

Statement (b) is an evaluation of the outcome of the impending event. Its figures refer not to a greater or smaller degree of probability, but to the expected result of the voting. Such a statement may be based on a systematic investigation like the Gallup poll or simply on estimates.

It is different with statement (c). This is a proposition about the expected outcome couched in arithmetical terms. It certainly does not mean that out of ten cases of the same type nine are favorable for Roosevelt and one unfavorable. It cannot have any reference to class probability. But what else can it mean?

It is a metaphorical expression. Most of the metaphors used in daily speech imaginatively identify an abstract object with another object that can be apprehended directly by the senses. Yet this is not a necessary feature of metaphorical language, but merely a consequence of the fact that the concrete is as a rule more familiar to us than the abstract. As metaphors aim at an explanation of something which is less well known by comparing it with something better known, they consist for the most part in identifying something abstract with a better-known concrete. The specific mark of our case is that it is an attempt to elucidate a complicated state of affairs by resorting to an analogy borrowed from a branch of higher mathematics, the calculus of probability. As it happens, this mathematical discipline is more popular than the analysis of the epistemological nature of understanding.

There is no use in applying the yardstick of logic to a critique of metaphorical language. Analogies and metaphors are always defective and logically unsatisfactory. It is usual to search for the underlying tertium comparationis. But even this is not permissible with regard to the metaphor we are dealing with. For the comparison is based on a conception which is in itself faulty in the very frame of the calculus of probability, namely the gambler’s fallacy. In asserting that Roosevelt’s chances are 9:1, the idea is that Roosevelt is in regard to the impending election in the position of a man who owns 90 per cent of all tickets of a lottery in regard to the first prize. It is implied that this ratio 9:1 tells us something substantial about the outcome of the unique case in which we are interested. There is no need to repeat that this is a mistaken idea.

No less impermissible is the recourse to the calculus of probability in dealing with hypotheses in the field of the natural sciences. Hypotheses are tentative explanations consciously based on logically insufficient arguments. With regard to them all that can be asserted is: The hypothesis does or does not contradict either logical principles or the facts as experimentally established and considered as true. In the first case it is untenable, in the second case it is — under the present state of our experimental knowledge — not untenable. (The intensity of personal conviction is purely subjective.) Neither frequency probability nor historical understanding enters into the matter.

The term hypothesis, applied to definite modes of understanding historical events, is a misnomer. If a historian asserts that in the fall of the Romanoff dynasty the fact that this house was of German background played a relevant role, he does not advance a hypothesis. The facts on which his understanding is founded are beyond question. There was a widespread animosity against Germans in Russia, and the ruling line of the Romanoffs, having for 200 years intermarried exclusively with scions of families of German descent, was viewed by many Russians as a Germanized family, even by those who assumed that Tsar Paul was not the son of Peter III. But the question remains what the relevance of these facts was in the chain of events which brought about the dethronement of this dynasty. Such problems are not open to any elucidation other than that provided by understanding.

Footnotes

[1] [Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 5: “Time,” pp. 99–104.]

[2] In a treatise on economics there is no need to enter into a discussion of the endeavors to construct mechanics as an axiomatic system in which the concept of function is substituted for that of cause and effect. It will be shown later that axiomatic mechanics cannot serve as a model for the treatment of the economic system.

[3] Henri Bergson, Matière et mémoire (7th ed. Paris, 1911), p. 205.

[4] Edmund Husserl, “Vorlesungen zur Phänomenologie des inneren Zeitbewusstseins,” Jahrbuch für Philosophie und Phänomenologische Forschung (1928), vol. 9, pp. 391ff.; Alfred Schütz, Der sinnhafte Aufbau der sozialen Welt (Vienna, 1932), pp. 45 ff.

[5] “Ce que j’appelle mon présent, c’est mon attitude vis-à-vis de l’avenir immédiat, c’est nom action imminente.” Bergson, Matière et mémoire, p. 152.

[6] In order to avoid any possible misunderstanding it may well be expedient to emphasize that this theorem has nothing at all to do with Einstein’s theorem concerning the temporal relation of spatially distant events.

[7] Cf. Felix Kaufmann, “On the Subject-Matter of Economic Science,” Economica 13: 390.

[8] Cf. [Philip H.] Wicksteed, The Common Sense of Political Economy, ed. Robbins (London, 1933), vol. 1, pp. 32 ff.; [Lionel] Robbins, An Essay on the Nature and Significance of Economic Science, 2d ed. (London, 1935), pp. 91 ff.

[9] Plans too, of course, may be self-contradictory. Sometimes their contradictions may be the effect of mistaken judgment. But sometimes such contradictions may be intentional and serve a definite purpose. If, for instance, a publicized program of a government or a political party promises high prices to the producers and at the same time low prices to the consumers, the purpose of such an espousal of incompatible goals may be demagogic. Then the program, the publicized plan, is self-contradictory; but the plan of its authors who wanted to attain a definite end through the endorsement of incompatible aims and their public announcement is free of any contradiction.

[10] [Mises, Human Action, chap. 6: “Uncertainty,” pp. 105–15.]

[11] John Stuart Mill, A System of Logic Ratiocinative and Inductive (new impression; London, 1936), p. 353.

[12] In life insurance the insured’s stake spent in vain consists only in the difference between the amount collected and the amount he could have accumulated by saving.

Chapter 4 • Society, Exchange, and the Division of Labor • 17,800 Words

1. Autistic Exchange and Interpersonal Exchange

Action always is essentially the exchange of one state of affairs for another state of affairs. If the action is performed by an individual without any reference to cooperation with other individuals, we may call it autistic exchange. An instance: the isolated hunter who kills an animal for his own consumption; he exchanges leisure and a cartridge for food.

Within society cooperation substitutes interpersonal or social exchange for autistic exchanges. Man gives to other men in order to receive from them. Mutuality emerges. Man serves in order to be served.

The exchange relation is the fundamental social relation. Interpersonal exchange of goods and services weaves the bond which unites men into society. The societal formula is: do ut des. Where there is no intentional mutuality, where an action is performed without any design of being benefited by a concomitant action of other men, there is no interpersonal exchange, but autistic exchange. It does not matter whether the autistic action is beneficial or detrimental to other people or whether it does not concern them at all. A genius may perform his task for himself, not for the crowd; however, he is an outstanding benefactor of mankind. The robber kills the victim for his own advantage; the murdered man is by no means a partner in this crime, he is merely its object; what is done, is done against him.

Hostile aggression was a practice common to man’s nonhuman forebears. Conscious and purposeful cooperation is the outcome of a long evolutionary process. Ethnology and history have provided us with interesting information concerning the beginning and the primitive patterns of interpersonal exchange. Some consider the custom of mutual giving and returning of presents and stipulating a certain return present in advance as a precursory pattern of interpersonal exchange.[2]Gustav Cassel, The Theory of Social Economy, trans. S.L. Banon (new ed; London, 1932), p. 371. Others consider dumb barter as the primitive mode of trade. However, to make presents in the expectation of being rewarded by the receiver’s return present or in order to acquire the favor of a man whose animosity could be disastrous, is already tantamount to interpersonal exchange. The same applies to dumb barter which is distinguished from other modes of bartering and trading only through the absence of oral discussion.

It is the essential characteristic of the categories of human action that they are apodictic and absolute and do not admit of any gradation. There is action or nonaction, there is exchange or nonexchange; everything which applies to action and exchange as such is given or not given in every individual instance according to whether there is or there is not action and exchange. In the same way the boundaries between autistic exchange and interpersonal exchange are sharply distinct. Making one-sided presents without the aim of being rewarded by any conduct on the part of the receiver or of third persons is autistic exchange. The donor acquires the satisfaction which the better condition of the receiver gives to him. The receiver gets the present as a God-sent gift. But if presents are given in order to influence some people’s conduct, they are no longer one-sided, but a variety of interpersonal exchange between the donor and the man whose conduct they are designed to influence. Although the emergence of interpersonal exchange was the result of a long evolution, no gradual transition is conceivable between autistic and interpersonal exchange. There were no intermediary modes of exchange between them. The step which leads from autistic to interpersonal exchange was no less a jump into something entirely new and essentially different than was the step from automatic reaction of the cells and nerves to conscious and purposeful behavior, to action.

2. Contractual Bonds and Hegemonic Bonds

There are two different kinds of social cooperation: cooperation by virtue of contract and coordination, and cooperation by virtue of command and subordination or hegemony.

Where and as far as cooperation is based on contract, the logical relation between the cooperating individuals is symmetrical. They are all parties to interpersonal exchange contracts. John has the same relation to Tom as Tom has to John. Where and as far as cooperation is based on command and subordination, there is the man who commands and there are those who obey his orders. The logical relation between these two classes of men is asymmetrical. There is a director and there are people under his care. The director alone chooses and directs; the others — the wards — are mere pawns in his actions.

The power that calls into life and animates any social body is always ideological might, and the fact that makes an individual a member of any social compound is always his own conduct. This is no less valid with regard to a hegemonic societal bond. It is true, people are as a rule born into the most important hegemonic bonds, into the family and into the state, and this was also the case with the hegemonic bonds of older days, slavery and serfdom, which disappeared in the realm of Western civilization. But no physical violence and compulsion can possibly force a man against his will to remain in the status of the ward of a hegemonic order. What violence or the threat of violence brings about is a state of affairs in which subjection as a rule is considered more desirable than rebellion. Faced with the choice between the consequences of obedience and of disobedience, the ward prefers the former and thus integrates himself into the hegemonic bond. Every new command places this choice before him again. In yielding again and again he himself contributes his share to the continuous existence of the hegemonic societal body. Even as a ward in such a system he is an acting human being, i.e., a being not simply yielding to blind impulses, but using his reason in choosing between alternatives.

What differentiates the hegemonic bond from the contractual bond is the scope in which the choices of the individuals determine the course of events. As soon as a man has decided in favor of his subjection to a hegemonic system, he becomes, within the margin of this system’s activities and for the time of his subjection, a pawn of the director’s actions. Within the hegemonic societal body and as far as it directs its subordinates’ conduct, only the director acts. The wards act only in choosing subordination; having once chosen subordination they no longer act for themselves, they are taken care of. In the frame of a contractual society the individual members exchange definite quantities of goods and services of a definite quality. In choosing subjection in a hegemonic body a man neither gives nor receives anything that is definite. He integrates himself into a system in which he has to render indefinite services and will receive what the director is willing to assign to him. He is at the mercy of the director. The director alone is free to choose. Whether the director is an individual or an organized group of individuals, a directorate, and whether the director is a selfish maniacal tyrant or a benevolent paternal despot is of no relevance for the structure of the whole system.

The distinction between these two kinds of social cooperation is common to all theories of society. Ferguson described it as the contrast between warlike nations and commercial nation; Saint Simon as the contrast between pugnacious nations and peaceful or industrial nations;[3]Cf. Adam Ferguson, An Essay on the History of Civil Society (new ed; Basel, 1789), p. 208. Herbert Spencer as the contrast between societies of individual freedom and those of a militant structure;[4]Cf. Herbert Spencer, The Principles of Sociology (New York, 1914), vol. 3, pp. 575–611. Sombart as the contrast between heroes and peddlers.[5]Cf. Werner Sombart, Haendler und Helden (Munich, 1915). The Marxians distinguish between the “gentile organization” of a fabulous state of primitive society and the eternal bliss of socialism on the one hand and the unspeakable degradation of capitalism on the other hand.[6]Cf. Frederick Engels, The Origin of the Family, Private Property and the State (New York, 1942), p. 144. The Nazi philosophers distinguish the counterfeit system of bourgeois security from the heroic system of authoritarian Führertum. The valuation of both systems is different with the various sociologists. But they fully agree in the establishment of the contrast and no less in recognizing that no third principle is thinkable and feasible.

Western civilization as well as the civilization of the more advanced Eastern peoples are achievements of men who have cooperated according to the pattern of contractual coordination. These civilizations, it is true, have adopted in some respects bonds of hegemonic structure. The state as an apparatus of compulsion and coercion is by necessity a hegemonic organization. So is the family and its household community. However, the characteristic feature of these civilizations is the contractual structure proper to the cooperation of the individual families. There once prevailed almost complete autarky and economic isolation of the individual household units. When interfamilial exchange of goods and services was substituted for each family’s economic self-sufficiency, it was, in all nations commonly considered civilized, a cooperation based on contract. Human civilization as it has been hitherto known to historical experience is preponderantly a product of contractual relations.

Any kind of human cooperation and social mutuality is essentially an order of peace and conciliatory settlement of disputes. In the domestic relations of any societal unit, be it a contractual or a hegemonic bond, there must be peace. Where there are violent conflicts and as far as there are such conflicts, there is neither cooperation nor societal bonds. Those political parties which in their eagerness to substitute the hegemonic system for the contractual system point at the rottenness of peace and of bourgeois security, extol the moral nobility of violence and bloodshed and praise war and revolution as the eminently natural methods of interhuman relations, contradict themselves. For their own utopias are designed as realms of peace. The Reich of the Nazis and the commonwealth of the Marxians are planned as societies of undisturbed peace. They are to be created by pacification, i.e., the violent subjection of all those not ready to yield without resistance. In a contractual world various states can quietly coexist. In a hegemonic world there can only be one Reich or commonwealth and only one dictator. Socialism must choose between a renunciation of the advantages of division of labor encompassing the whole earth and all peoples and the establishment of a world-embracing hegemonic order. It is this fact that made Russian Bolshevism, German Nazism, and Italian Fascism “dynamic,” i.e., aggressive. Under contractual conditions empires are dissolved into a loose league of autonomous member nations. The hegemonic system is bound to strive after the annexation of all independent states.

The contractual order of society is an order of right and law. It is a government under the rule of law (Rechtsstaat) as differentiated from the welfare state (Wohlfahrtsstaat) or paternal state. Right or law is the complex of rules determining the orbit in which individuals are free to act. No such orbit is left to wards of a hegemonic society. In the hegemonic state there is neither right nor law; there are only directives and regulations which the director may change daily and apply with what discrimination he pleases and which the wards must obey. The wards have one freedom only: to obey without asking questions.

1. The Nature of Society

The idea of human destiny dominates all the more ancient views of social existence. Society progresses towards a goal fore-ordained by the deity. Whoever thinks in this way is logically correct if, in speaking of progress and retrogression, of revolution and counterrevolution, of action and reaction he lays on these concepts the emphasis adopted by so many historians and politicians. History is judged according as it brings mankind nearer to the goal or carries it farther away.

Social science, however, begins at the point where one frees oneself from such habits, and indeed from all valuation. Social science is indeed teleological in the sense in which every causal study of the will must be. But its concept of purpose is wholly comprised in the causal explanation. For social science causality remains the fundamental principle of cognition, the maintenance of which must not be impaired even by teleology.[8][Hermann] Cohen, Logik der reinen Erkenntnis, 2nd ed. (Berlin, 1914), p. 359. Since it does not evaluate purposes, it cannot speak of evolution to a higher plane, in the sense let us say, of Hegel and Marx. For it is by no means proved that all evolution leads upwards, or that every later stage is a higher one. No more, of course, can it agree with the pessimistic philosophers of history, who see in the historical process a decline, a progressive approach to a bad end. To ask what are the driving forces of historical evolution is to ask what is the nature of society and the origin and causes of the changes in social conditions. What society is, how it originates, how it changes — these alone can be the problems which scientific sociology sets itself.

That the social life of men resembles the biological process is an observation of ancient date. It lies at the basis of the famous legend of Menenius Agrippa, handed down to us by Livy. Social science did itself little good when, inspired by the triumph of Biology in the nineteenth century, voluminous works developed this analogy to the point of absurdity. What is the use of calling the products of human activity “social intercellular substance”?[9]As is done by [Paul von] Lilienfeld, La pathologie sociale (Paris, 1896), p. 95. When a government takes a loan from the House of Rothschild organic sociology conceives the process as follows: “La maison Rothschild agit, dans cette occasion, parfaitement en analogie avec l’action d’un groupe de cellules qui, dans le corps humain, coopèrent à la production du sang nécessaire à l’alimentation du cerveau dans l’espoir d’en être indemnisées par une réaction des cellules de la substance grise dont ils ont besoin pour s’activer de nouveau et accumuler de nouvelles énergies.” (“The House of Rothschild’s operation, on such an occasion, is precisely similar to the action of a group of human body cells which cooperate in the production of the blood necessary for nourishing the brain, in the hope of being compensated by a reaction of the gray matter cells which they need to reactivate and to accumulate new energies.”) (Ibid., p. 104.) This is the method which claims that it stands on “firm ground” and explores “the Becoming of Phenomena step by step, proceeding from the simpler to the more complex.” See Lilienfeld, Zur Verteidigung der organischen Methode in der Soziologie (Berlin, 1898), p. 75.
([Hermann] Cohen, Logik der reinen Erkenntnis, 2nd ed. (Berlin, 1914), p. 359.)
Who was enlightened when scholars disputed which organ of the social body corresponded to the central nervous system? The best comment on this form of sociological study was the remark of an economist, to the effect that anyone who compared money with blood and the circulation of money with the circulation of blood would be making the same contribution to economics as would be made to biology by a man who compared blood with money and the blood-circulation with the circulation of money. Modern biology has borrowed from social science some of its most important concepts — that of evolution, of the division of labour, and of the struggle for existence. But it has not stopped short at metaphorical phrases and conclusions by analogy; rather has it proceeded to make profitable use of what it had gained. On the other hand biological-sociology did nothing but play a futile word-spinning game with the ideas it borrowed back. The romantic movement, with its “organic” theory of the state has done even less to clear up our knowledge of social interrelations. Because it deliberately cold-shouldered the most important achievement of social science up to that date — the system of classical Political Economy — it was unable to utilize the doctrine of the division of labour, that part of the classical system which must be the starting point of all sociology, as it is of modern biology.[10]It is characteristic that just the romantics stress excessively society’s organic character, whereas liberal social philosophy has never done so. Quite understandably. A social theory which was genuinely organic did not need to stress obtrusively this attribute of its system.

Comparison with the biological organism should have taught sociology one thing: that the organism can only be conceived as a system of organs. This, however, merely means that the essence of the organism is the division of labour. Only division of labour makes the parts become members; it is in the collaboration of the members that we recognize the unity of the system, the organism.[11]Cohen, Logik der reinen Erkenntnis, p. 349. This is true of the life of plants and animals as well as of society. As far as the principle of the division of labour is concerned, the social body may be compared with the biological. The division of labour is the tertium comparationis (basis for comparison) of the old simile.

The division of labour is a fundamental principle of all forms of life.[12][Oscar] Hertwig, Allgemeine Biologie, 4th ed. (Jena, 1912), pp. 500 ff; Hertwig, Zur Abwehr des ethischen, des sozialen und des politischen Darwinismus (Jena, 1918), pp. 69 ff. It was first detected in the sphere of social life when political economists emphasized the meaning of the division of labour in the social economy. Biology then adopted it, at the instigation in the first place of Milne Edwards in 1827. The fact that we can regard the division of labour as a general law must not, however, prevent us from recognizing the fundamental differences between division of labour in the animal and vegetable organism on the one hand and division of labour in the social life of human beings on the other. Whatever we imagine to be the origin, evolution, and meaning of the physiological division of labour, it clearly does not shed any light on the nature of the sociological division of labour. The process that differentiates and integrates homogeneous cells is completely different from that which led to the growth of human society out of self-sufficient individuals. In the second process, reason and will play their part in the coalescence, by which the previously independent units form a larger unit and become parts of a whole, whereas the intervention of such forces in the first process is inconceivable.

Even where creatures such as ants and bees come together in “animal communities,” all movements and changes take place instinctively and unconsciously. Instinct may very well have operated at the beginning and in the earliest stages of social formation also. Man is already a member of a social body when he appears as a thinking, willing creature, for the thinking man is inconceivable as a solitary individual. “Only amongst men does man become a man” (Fichte). The development of human reason and the development of human society are one and the same process. All further growth of social relations is entirely a matter of will. Society is the product of thought and will. It does not exist outside thought and will. Its being lies within man, not in the outer world. It is projected from within outwards.

Society is co-operation; it is community in action.

To say that Society is an organism, means that society is division of labour.[13][Jean] Izoulet, La cité moderne (Paris, 1894), pp. 35 ff. To do justice to this idea we must take into account all the aims which men set themselves and the means by which these are to be attained. It includes every inter-relation of thinking and willing man. Modern man is a social being, not only as one whose material needs could not be supplied in isolation, but also as one who has achieved a development of reason and of the perceptive faculty that would have been impossible except within society. Man is inconceivable as an isolated being, for humanity exists only as a social phenomenon and mankind transcended the stage of animality only in so far as co-operation evolved the social relationships between the individuals. Evolution from the human animal to the human being was made possible by and achieved by means of social cooperation and by that alone. And therein lies the interpretation of Aristotle’s dictum that man is the ζvονπsλιτιχον (the living body politic).

2. The Division of Labour as the Principle of Social Development

We are still far from understanding the ultimate and most profound secret of life, the principle of the origin of organisms. Who knows whether we shall ever discover it? All we know today is that when organisms are formed, something which did not exist before is created out of individuals. Vegetable and animal organisms are more than conglomerations of single cells, and society is more than the sum of the individuals of which it is composed. We have not yet grasped the whole significance of this fact. Our thoughts are still limited by the mechanical theory of the conservation of energy and of matter, which is never able to tell us how one can become two. Here again, if we are to extend our knowledge of the nature of life, understanding of the social organization will have to precede that of the biological.

Historically division of labour originates in two facts of nature: the inequality of human abilities and the variety of the external conditions of human life on the earth. These two facts are really one: the diversity of Nature, which does not repeat itself but creates the universe in infinite, inexhaustible variety. The special nature of our inquiry, however, which is directed towards sociological knowledge, justifies us in treating these two aspects separately.

It is obvious that as soon as human action becomes conscious and logical it must be influenced by these two conditions. They are indeed such as almost to force the division of labour on mankind.[14][Émile] Durkheim, De la division du travail social (Paris, 1893), pp. 294 ff. endeavours (following Comte and against Spencer) to prove that the division of labour prevails not because, as the economists think, it increases output but as a result of the struggle for existence. The denser the social mass the sharper the struggle for existence. This forces individuals to specialize in their work, as otherwise they would not be able to maintain themselves. But Durkheim overlooks the fact that the division of labour makes this possible only because it makes labour more productive. Durkheim comes to reject the theory of the importance of the greater productivity in the division of labour through a false conception of the fundamental idea of utilitarianism and of the law of the satiation of wants (ibid., 218 ff., 257 ff.). His view that civilization is called forth by changes in the volume and density of society is untenable. Population grows because labour becomes more productive and is able to nourish more people, not vice versa.
([Jean] Izoulet, La cité moderne (Paris, 1894), pp. 35 ff.)
Old and young, men and women co-operate by making appropriate use of their various abilities. Here also is the germ of the geographical division of labour; man goes to the hunt and woman to the spring to fetch water. Had the strength and abilities of all individuals and the external conditions of production been everywhere equal the idea of division of labour could never have arisen. Man would never of himself have hit upon the idea of making the struggle for existence easier by co-operation in the division of labour. No social life could have arisen among men of equal natural capacity in a world which was geographically uniform.[15]On the important part played by the local variety of productive conditions in the origin of the division of labour see [Karl] von den Steinen, Unter den Naturvölkern Zentralbrasiliens, 2nd ed. (Berlin, 1897), pp. 196 ff. Perhaps men would have joined together to cope with tasks which were beyond the strength of individuals, but such alliances do not make a society. The relations they create are transient, and endure only for the occasion that brings them about. Their only importance in the origin of social life is that they create a rapprochement between men which brings with it mutual recognition of the difference in the natural capacities of individuals and thus in turn gives rise to the division of labour.

Once labour has been divided, the division itself exercises a differentiating influence. The fact that labour is divided makes possible further cultivation of individual talent and thus co-operation becomes more and more productive. Through co-operation men are able to achieve what would have been beyond them as individuals, and even the work which individuals are capable of doing alone is made more productive. But all this can only be grasped fully when the conditions which govern increase of productivity under co-operation are set out with analytical precision.

The theory of the international division of labour is one of the most important contributions of Classical Political Economy. It shows that as long as — for any reasons — movements of capital and labour between countries are prevented, it is the comparative, not the absolute, costs of production which govern the geographical division of labour.[16][David] Ricardo, Principles of Political Economy and Taxation, in Works, ed. John Ramsay MacCulloch, 2nd. (London, 1852), pp. 76 ff.; [John Stuart] Mill, Principles of Political Economy (People’s ed.; London, 1867), pp. 348 ff.; [C.F.] Bastable, The Theory of International Trade, 3rd ed. (London, 1900), pp. 16 ff. When the same principle is applied to the personal division of labour it is found that the individual enjoys an advantage in co-operating not only with people superior to himself in this or that capacity but also with those who are inferior to himself in every relevant way. If, through his superiority to B, A needs three hours’ labour for the production of one unit of commodity p compared with B’s five, and for the production of commodity q two hours against B’s four, then A will gain if he confines his labour to producing q and leaves B to produce p. If each gives sixty hours to producing both p and q, the result of A’s labour is 20 p + 30 q, of B’s 12 p + 15 q, and for both together 32 p + 45 q. If however, A confines himself to producing q alone he produces sixty units in 120 hours, whilst B, if he confines himself to producing p, produces in the same time twenty-four units. The result of the activity is then 24 p + 60 q, which, as p has for A a substitution value of 3:2 q and for B one of 5:4 q, signifies a larger production than 32 p + 45 q. Therefore it is obvious that every expansion of the personal division of labour brings advantages to all who take part in it. He who collaborates with the less talented, less able, and less industrious individuals gains an advantage equally as the man who associated with the more talented, more able, and more industrious. The advantage of the division of labour is mutual; it is not limited to the case where work is done which the solitary individual could never have carried out.

The greater productivity of work under the division of labour is a unifying influence. It leads men to regard each other as comrades in a joint struggle for welfare, rather than as competitors in a struggle for existence. It makes friends out of enemies, peace out of war, society out of individuals.[17]“Trade makes the human race, which originally has only the unity of the species, into a really unitary society.” See Heymann Steinthal, Allgemeine Ethik (Berlin, 1885), p. 208. Trade, however, is nothing more than a technical aid of the division of labour. On the division of labour in the sociology of Thomas Aquinas see Edmund Schreiber, Die volkswirtschaftlichen Anschauungen der Scholastik seit Thomas von Aquin (Jena, 1913), pp. 19 ff.

3. Organism and Organization

Organism and organization are as different from each other as life is from a machine, as a flower which is natural from one which is artificial. In the natural plant each cell lives its own life for itself while functioning reciprocally with the others. What we call living is just this self-existence and self-maintenance. In the artificial plant the separate parts are members of the whole only as far as the will of him, who united them, has been effective. Only to the extent to which this will is effective are the parts within the organization inter-related. Each part occupies only the place given to it, and leaves that place, so to speak, only on instructions. Within this framework the parts can live, that is, exist for themselves, only in so far as the creator has put them alive into his creation. The horse which the driver has harnessed to the cart lives as a horse. In the organization, the “team,” the horse is just as foreign to the vehicle as is an engine to the car it drives. The parts may use their life in opposition to the organization, as, for instance, when the horse runs away with the carriage or the tissue out of which the artificial flower is made disintegrates under chemical action. Human organization is no different. Like society it is a result of will. But in this case the will no more produces a living social organism than the flower-maker produces a living rose. The organization holds together as long as the creating will is effective, no longer. The parts which compose the organization merge into the whole only so far as the will of the creator can impose itself upon them and their life can be fixed in the organization. In the battalion on parade there is one will, the will of the commander. Everything else so far as it functions within the organization is lifeless machinery. In this destruction of the will, or that portion of it which does not serve the purpose of the body of troops, lies the essence of military drill. The soldier in the phalangial order, fighting in line, in which the body of troops must be nothing more than an organization — is drilled. Within the mass there is no life. Whatever life the individual lives is by the side of, or outside the body of troops — against it perhaps, but never in it. Modern warfare, based on the skirmisher’s personal enterprise, has to make use of the individual soldier, of his thought and his will. So the army no longer simply drills the soldier. It seeks to educate him.

Organization is an association based on authority, organism is mutuality. The primitive thinker always sees things as having been organized from outside, never as having grown themselves, organically. He sees the arrow which he has carved, he knows how it came into existence and how it was set in motion. So he asks of everything he sees, who made it and who sets it in motion. He inquires after the creation of every form of life, the authors of every change in nature, and discovers an animistic explanation. Thus the Gods are born. Man sees the organized community with its contrast of rulers and ruled, and, accordingly, he tries to understand life as an organization, not as an organism. Hence the ancient conception of the head as the master of the body, and the use of the same term “head” for the chief of the organization.

In recognizing the nature of the organism and sweeping away the exclusiveness of the concept of organization, science made one of its great steps forward. With all deference to earlier thinkers one may say that in the domain of Social Science this was achieved mainly in the eighteenth century, and that Classical Political Economy and its immediate precursors played the chief part. Biology took up the good work, flinging off all animistic and vitalistic beliefs. For modern biology the head is no longer the crown, the ruler of the body. In the living body there is no longer leader and followers, a contrast of sovereign and subjects, of means and purpose. There are only members, organs.

To seek to organize society is just as crazy as it would be to tear a living plant to bits in order to make a new one out of the dead parts. An organization of mankind can only be conceived after the living social organism has been killed. The collectivist movements are therefore fore-doomed to failure. It may be possible to create an organization embracing all mankind. But this would always be merely an organization, side by side with which social life would continue. It could be altered and destroyed by the forces of social life, and it certainly would be destroyed from the moment it tried to rebel against these forces. To make Collectivism a fact one must first kill all social life, then build up the collectivist state. The Bolshevists are thus quite logical in wishing to dissolve all traditional social ties, to destroy the social edifice built up through countless centuries, in order to erect a new structure on the ruins. Only they overlook the fact that isolated individuals, between whom no kind of social relations exist, can no longer be organized.

Organizations are possible only as long as they are not directed against the organic or do it any injury. All attempts to coerce the living will of human beings into the service of something they do not want must fail. An organization cannot flourish unless it is founded on the will of those organized and serves their purposes.

4. The Individual and Society

Society is not mere reciprocity. There is reciprocity amongst animals, for example when the wolf eats the lamb or when the wolf and she-wolf mate. Yet we do not speak of animal societies or of a society of wolves. Wolf and lamb, wolf and she-wolf, are indeed members of an organism — the organism of Nature. But this organism lacks the specific characteristic of the social organism: it is beyond the reach of will and action. For the same reason, the relation between the sexes is not, as such, a social relation. When a man and a woman come together they follow the law which assigns to them their place in Nature. Thus far they are ruled by instinct. Society exists only where willing becomes a co-willing and action co-action. To strive jointly towards aims which alone individuals could not reach at all, or not with equal effectiveness — that is society.[18]Therefore, too, one must reject the idea of Guyau, which derives the social bond directly from bi-sexuality. See [Jean-Marie] Guyau, Sittlichkeit ohne Pflicht, trans. [Elisabeth] Schwarz (Leipzig, 1909), pp. 113 ff.

Therefore, Society is not an end but a means, the means by which each individual member seeks to attain his own ends. That society is possible at all is due to the fact that the will of one person and the will of another find themselves linked in a joint endeavour. Community of work springs from community of will. Because I can get what I want only if my fellow citizen gets what he wants, his will and action become the means by which I can attain my own end. Because my willing necessarily includes his willing, my intention cannot be to frustrate his will. On this fundamental fact all social life is built up.[19]Fouillée argues as follows against the utilitarian theory of society, which calls society a “moyen universal” (“universal means”) (Belot): “Tout moyen n’a qu’une valeur provisoire; le jour où un instrument dont je me servais me devient inutile ou nuisible, je le mets de côté. Si la société n’ est qu’un moyen, le jour où, exceptionellement, elle se trouvera contraire à mes fins, je me delivrerai des lois sociales et moyens. sociaux. … Aucune considération sociale ne pourra empêcher la révolte de l’individu tant qu’on ne lui aura pas montré que la société est établie pour des fins qui sont d’abord et avant tout ses vraies fins à lui-même et qui, de plus, ne sont pas simplement des fins de plaisir ou d’intérêt, l’intérêt n’étant que le plaisir différé et attendu pour l’avenir … L’idée d’intérét est précisément ce qui divise les hommes, malgré les rapprochements qu’elle peut produire lorsqu’il y a convergence d’intérêts sur certains points.” (“Every means has only a temporary value; the day when a means ceases to serve me or becomes harmful to me, I cast it aside. If society is only a means, the day when, by some special circumstances, it is found to act contrary to my ends, I will free myself from its social laws and social means. … No social consideration can prevent an individual from rebelling when it has not been demonstrated to him that society exists for ends which are primarily and above all his own true ends and, further, which are not simply for the ends of pleasure or self-interest, self-interest being only pleasure postponed and expected in the future. … The idea of self-interest is precisely what divides men, in spite of the cooperation it can produce when self-interests coincide in certain instances.”) [Alfred] Fouillée, Humanitaires et libertaires au point de vue Sociologique et moral (Paris, 1914), pp. 146 ff.; see also [Jean-Marie] Guyau, Die englische Ethik der Gegenwart, trans. Peusner (Leipzig, 1914), pp. 372 ff. Fouillée does not see that the provisional value which society gets as a means, lasts as long as the conditions of human life, given by nature, continue unchanged and as long as man continues to recognize the advantages of human co-operation. The “eternal,” not merely provisional, existence of society follows from the eternity of the conditions on which it is built up. Those in power may demand of social theory that it should serve them by preventing the individual from revolting against society, but this is by no means a scientific demand. Besides no social theory could, as easily as the utilitarian, induce the social individual to enrol himself voluntarily in the social union. But when an individual shows that he is an enemy of society there is nothing left for society to do but make him harmless.

The principle of the division of labour revealed the nature of the growth of society. Once the significance of the division of labour had been grasped, social knowledge developed at an extraordinary pace, as we see from a comparison between Kant and those who came after him. The doctrine of the division of labour as put forward by eighteenth-century economists, was far from fully developed when Kant wrote. It had yet to be made precise by the Ricardian Theory of International Trade. But the Doctrine of the Harmony of Interests had already anticipated its far-reaching application to social theory. Kant was untouched by these ideas. His only explanation of society, therefore, is that there is an impulse in human beings to form a society, and a second contrary impulse that seeks to split up society. The antagonism of these two tendencies is used by Nature to lead men towards the ultimate goal to which it wishes to lead them.[20][Immanuel] Kant, “Idee zu einer allgemeinen Geschichte in weltbürgerlicher Absicht” (Collected Works), vol. 1, pp. 227 ff. It is difficult to imagine a more threadbare idea than such an attempt to explain society by the interplay of two impulses, the impulse “to socialize oneself” and the impulse “to isolate oneself.” Obviously it goes no farther than the attempt to explain the effects of opium from the virtus dormitiva, cuius est natura sensus assupire (the sleep-inducing property whose nature is to dull the senses).

Once it has been perceived that the division of labour is the essence of society, nothing remains of the antithesis between individual and society. The contradiction between individual principle and social principle disappears.

5. The Development of the Division of Labour

In so far as the individual becomes a social being under the influence of blind instinct, before thought and will are fully conscious, the formation of society cannot be the subject of sociological inquiry. But this does not mean that Sociology must shift the task of explaining the origins of society on to another science, accepting the social web of mankind as a given fact. For if we decide — and this is the immediate consequence of equating society and division of labour — that the structure of society was incomplete at the appearance of the thinking and willing human being and that the constructive process is continuous throughout history, then we must seek a principle which makes this evolution intelligible to us. The economic theory of the division of labour gives us this principle. It has been said that the happy accident which made possible the birth of civilization was the fact that divided labour is more productive than labour without division. The division of labour extends by the spread of the realization that the more labour is divided the more productive it is. In this sense the extension of the division of labour is economic progress: it brings production nearer to its goal — the greatest possible satisfaction of wants, and this progress is sociological progress also, for it involves the intensification of the social relation.

It is only in this sense, and if all teleological or ethical valuation is excluded, that it is legitimate to use the expression “progress” sociologically in historical inquiry. We believe that we can observe a certain tendency in the changes of social conditions and we examine each single change separately, to see whether and how far this assumption is compatible with it. It may be that we make various assumptions of this kind, each of which corresponds in like measure to experience. The problem next arises of the relations between these assumptions, whether they are independent of each other or whether they are connected internally. We should then have to go further, and define the nature of the connection. But all that this amounts to is a study, free from valuation and based on a hypothesis, of the course of successive changes.

If we disregard those theories of evolution that are naively built up on value judgments, we shall find, in the majority of the theories claiming to interpret social evolution, two outstanding defects which render them unsatisfactory. The first is that their evolutionary principle is not connected with society as such. Neither Comte’s law of the three stages of the human mind nor Lamprecht’s five stages of social-psychical development gives any clue to the inner and necessary connection between evolution of the mind and evolution of society. We are shown how society behaves when it has entered a new stage, but we want to know more, namely by what law society originates and transforms itself. The changes which we see as social changes are treated by such theories as facts acting on society from outside; but we need to understand them as the workings of a constant law. The second defeat is that all these theories are “stage” theories (Stufentheorien). For the stage-theories there is really no such thing as evolution, that is, no continuous change in which we can recognize a definite trend. The statements of these theories do not go beyond establishing a definite sequence of events; they give no proof of the causal connection between the stages constituting the sequence. At best they succeed in establishing parallels between the sequence of events in different nations. But it is one thing to divide human life into childhood, youth, maturity, and old age, it is another to reveal the law which governs the growth and decay of the organism. A certain arbitrariness attaches to every theory of stages. The delimitation of the stages always fluctuates.

Modern German economic history has undoubtedly done right in making the division of labour the basis of its theory of evolution. But it has not been able to free itself from the old traditional scheme of development by stages. Its theory is still a stage-theory. Thus Bücher distinguishes the stage of the closed domestic economy (pure production for one’s own use, barterless economy), the stage of town economy (production for clients, the stage of direct exchange), and the stage of national economy (production for markets, the stage of the circulation of goods).[21][Karl] Bücher, Die Entstehung der Volkswirtschaft, First collection, 10th ed. (Tübingen, 1917), p. 91. Schmoller differentiates the periods of village economy, town economy, territorial economy, and state economy.[22][Gustav] Schmoller, Grundriss der allgemeinen Volkswirtschaftslehre (Munich, 1920), vol. 2, pp. 760 ff. Philippovich distinguishes closed domestic economy and trade economy, and within trade economy he finds the period of the locally limited trade, the period of trade controlled by the state and limited to the state area, and the period of free trade (developed national economy, Capitalism).[23][Eugen von] Philippovich, Grundriss der politischen Ökonomie, 11th ed. (Tübingen, 1916), vol. 1, pp. 11 ff. Against these attempts to force evolution into a general scheme many grave objections have been raised. We need not discuss what value such classification may have in revealing the characteristics of clearly defined historical epochs and how far they may be admitted as aids to description. At any rate they should be used with great discretion. The barren dispute over the economic life of the nations of antiquity shows how easily such classifying may lead to our mistaking the shadow of scholastic word-splitting for the substance of historical reality. For sociological study the stage theories are useless.[24]On the stages theory see also my Grundprobleme der Nationalökonomie (Jena, 1933), pp. 106 ff. They mislead us in regard to one of the most important problems of history — that of deciding how far historical evolution is continuous. The solution of this problem usually takes the form either of an assumption, that social evolution — which it should be remembered is the development of the division of labour — has moved in an uninterrupted line, or by the assumption that each nation has progressed step-by-step over the same ground. Both assumptions are beside the point. It is absurd to say that evolution is uninterrupted when we can clearly discern periods of decay in history, periods when the division of labour has retrogressed. On the other hand, the progress achieved by individual nations by reaching a higher stage of the division of labour is never completely lost. It spreads to other nations and hastens their evolution. The fall of the ancient world undoubtedly put back economic evolution for centuries. But more recent historical research has shown that the ties connecting the economic civilization of antiquity with that of the Middle Ages were much stronger than people used to assume. The Exchange Economy certainly suffered badly under the storm of the great migration of peoples, but it survived them. The towns on which it depended, were not entirely ruined, and a link was soon made between the remnants of town-life and the new development of traffic by barter.[25][Alphons] Dopsch, Wirtschaftliche und soziale Grundlagen der europäischen Kulturentwicklung (Vienna, 1918), vol. 1, pp. 91 ff. In the civilization of the towns a fragment of the social achievements of antiquity was preserved and carried over into the life of the Middle Ages.

Progress in the division of labour depends entirely on a realization of its advantages, that is, of its higher productivity. The truth of this first became fully evident through the free-trade doctrines of the physiocrats and the classical eighteenth-century political economy. But in rudiments it is found in all arguments favouring peace, wherever peace is praised, or war condemned. History is a struggle between two principles, the peaceful principle, which advances the development of trade, and the militarist-imperialist principle, which interprets human society not as a friendly division of labour but as the forcible repression of some of its members by others. The imperialistic principle continually regains the upper hand. The liberal principle cannot maintain itself against it until the inclination for peaceful labour inherent in the masses shall have struggled through to full recognition of its own importance as a principle of social evolution. Wherever the imperialistic principle is in force peace can only be local and temporary: it never lasts longer than the facts which created it. The mental atmosphere with which Imperialism surrounds itself is little suited to the promotion of the growth of the division of labour within state frontiers; it practically prohibits the extension of the division of labour beyond the political-military barriers which separate the states. The division of labour needs liberty and peace. Only when the modern liberal thought of the eighteenth century had supplied a philosophy of peace and social collaboration was the basis laid for the astonishing development of the economic civilization of that age — an age branded by the latest imperialistic and socialistic doctrines as the age of crass materialism, egotism and capitalism.

Nothing could be more perverted than the conclusions drawn in this connection by the materialistic conception of history, which represents the development of social ideology as dependent on the stage of technical evolution which has been attained. Nothing is more erroneous than Marx’s well-known saying: “The handmill produces a society with feudal lords, the steam-mill a society with industrial capitalists.”[26][Karl] Marx, Das Elend der Philosophie, p. 92. In the formulations which Marx later on gave to his conception of history he avoided the rigidity of this earliest version. Behind such indefinite expressions as “productive forces” and “conditions of production” are hidden the critical doubts which Marx may meanwhile have experienced. But obscurity, opening the way to multitudinous interpretations, does not make an untenable theory tenable. It is not even formally correct. To try and explain social evolution through the evolution of technique is merely to side-track the problem without in any way solving it. For on such a conception, how are we to explain technical evolution itself?

Ferguson showed that the development of technique depends on social conditions, and that each age gets as far in technique as is permitted by the stages it has reached in the social division of labour.[27][Adam] Ferguson, Abhandlung über die Geschichte der bürgerlichen Gesellschaft, trans. Dorn (Jena, 1904), pp. 237 ff.; also [Paul] Barth, Die Philosophie der Geschichte als Soziologie, 2nd ed. (Leipzig, 1915), Part 1, pp. 578 ff. Technical advances are possible only where the division of labour has prepared the way for their application. The mass manufacturing of shoes presupposes a society in which the production of shoes for hundreds of thousands or millions of human beings can be united in a few enterprises. In a society of self-sufficing peasants there is no possible use for the steam mill. Only the division of labour could inspire the idea of placing mechanical forces at the service of manufacture.[28]All that remains of the materialist conception of history, which appeared with the widest possible claims, is the discovery that all human and social action is decisively influenced by the scarcity of goods and the disutility of labour. But the Marxists can least admit just this, for all they say about the future socialist order of society disregards these two economic conditions.

To trace the origin of everything concerned with society in the development of the division of labour has nothing in common with the gross and naive materialism of the technological and other materialistic theories of history. Nor does it by any means signify, as disciples of the idealistic philosophy are apt to maintain, an inadmissible limitation of the concept of social relations. Neither does it restrict society to the specifically material. That part of social life which lies beyond the economic is indeed the ultimate aim, but the ways which lead to it are governed by the law of all rational action; wherever they come into question there is economic action.

6. Changes in the Individual in Society

The most important effect of the division of labour is that it turns the independent individual into a dependent social being. Under the division of labour social man changes, like the cell which adapts itself to be part of an organism. He adapts himself to new ways of life, permits some energies and organs to atrophy and develops others. He becomes one-sided. The whole tribe of romantics, the unbending laudatores temporis acti (praisers of time past), have deplored this fact. For them the man of the past who developed his powers “harmoniously” is the ideal: an ideal which alas no longer inspires our degenerate age. They recommend retrogression in the division of labour, hence their praise of agricultural labour, by which they always mean the almost self-sufficing peasant.[29]Adam Müller says about “the vicious tendency to divide labour in all branches of private industry and in government business too,” that man needs “an all round, I might say a sphere-round field of activity.” If the “division of labour in large cities or industrial or mining provinces cuts up man, the completely free man, into wheels, rollers, spokes, shafts, etc., forces on him an utterly one-sided scope in the already one-sided field of the provisioning of one single want, how can one then demand that this fragment should accord with the whole complete life and with its law, or with legality; how should the rhombuses, triangles, and figures of all kinds accord separately with the great sphere of political life and its law?” See Adam Müller, Ausgewählte Abhandlungen, ed. Baxa (Jena, 1921), p. 46.

Here, again the modern socialist outdoes the rest. Marx promises that in the higher phase of the communist society “the enslaving subjection of individuals under the division of labour, and with this also the contrast between mental and bodily labour, shall have disappeared.”[30][Karl] Marx, Zur Kritik des sozialdemokratischen Parteiprogramms von Gotha (New York, 1920), p. 17. Innumerable passages in his writings show how falsely Marx conceived the nature of labour in industry. Thus he thought also that “the division of labour in the mechanical factory” is characterized by “having lost every specialized character. … The automatic factory abolishes the specialist and the one-track mind.” And he blames Proudhon, “who did not understand even this one revolutionary side of the automatic factory.” Marx, Das Elend der Philosophie, p. 129. Account will be taken of the human “need for change.” “Alternation of mental and bodily labour” will “safeguard man’s harmonious development.”[31][August] Bebel, Die Frau und der Sozialismus, pp. 283 ff.

We have already dealt with this illusion. Were it possible to achieve all human aims with only that amount of labour which does not itself cause any discomfort but at the same time relieves the sensation of displeasure that arises from doing nothing, then labour would not be an economic object at all. To satisfy needs would not be work but play. This, however, is not possible. Even the self-sufficient worker, for the most part, must labour far beyond the point where the effort is agreeable. One may assume that work is less unpleasant to him than to the worker who is tied to a definite task, as he finds at the beginning of each job he tackles fresh sensations of pleasure in the activity itself. If, nevertheless, man has given himself up more and more to the division of labour, it is because he has recognized that the higher productivity of labour thus specialized more than repays him for the loss of pleasure. The extent of the division of labour cannot be curtailed without reducing the productivity of labour. This is true of all kinds of labour. It is an illusion to believe that one can maintain productivity and reduce the division of labour.

Abolition of the division of labour would be no remedy for the injuries inflicted on the individual, body and soul, by specialized labour, unless we are prepared to set back social development. It is for the individual himself to set about becoming a complete human being. The remedy lies in reforming consumption, not in “reforming” labour. Play and sport, the pleasure of art, reading are the obvious way of escape.

It is futile to look for the harmoniously developed man at the outset of economic evolution. The almost self-sufficient economic subject as we know him in the solitary peasant of remote valleys shows none of that noble, harmonious development of body, mind, and feeling which the romantics ascribe to him. Civilization is a product of leisure and the peace of mind that only the division of labour can make possible. Nothing is more false than to assume that man first appeared in history with an independent individuality and that only during the evolution which led to the Great Society did he lose, together with material freedom, his spiritual independence. All history, evidence and observation of the lives of primitive peoples is directly contrary to this view. Primitive man lacks all individuality in our sense. Two South Sea Islanders resemble each other far more closely than two twentieth-century Londoners. Personality was not bestowed upon man at the outset. It has been acquired in the course of evolution of society.[32]Durkheim, De la division du travail social, pp. 452 ff.

7. Social Regression

Social evolution — in the sense of evolution of the division of labour — is a will-phenomenon: it depends entirely on the human will. We do not consider whether one is justified in regarding every advance in the division of labour and hence in the intensification of the social bond, as a rise to a higher stage; we must ask whether such a development is a necessary phenomenon. Is an ever greater development of society the content of history? Is it possible for society to stand still or retrogress?

We must reject a priori any assumption that historical evolution is provided with a goal by any “intention,” or “hidden plan” of Nature, such as Kant imagined and Hegel and Marx had in mind; but we cannot avoid the inquiry whether a principle might not be found to demonstrate that continuous social growth is inevitable. The first principle that offers itself to our attention is the principle of natural selection. More highly developed societies attain greater material wealth than the less highly developed; therefore they have more prospect of preserving their members from misery and poverty. They are also better equipped to defend themselves from the enemy. One must not be misled by the observation that richer and more civilized nations were often crushed in war by nations less wealthy and civilized. Nations in an advanced stage of social evolution have always been able at least to resist a superior force of less developed nations. It is only decaying nations, civilizations inwardly disintegrated, which have fallen a prey to nations on the upgrade. Where a more highly organized society has succumbed to the attack of a less developed people, the victors have in the end been culturally submerged, accepting the economic and social order, and even the language and faith of the conquered race.

The superiority of the more highly developed societies lies not only in their material welfare but also quantitatively in the number of their members and qualitatively in the greater solidity of their internal structure. For this, precisely, is the key to higher social development: the widening of the social range, the inclusion in the division of labour of more human beings and its stronger grip on each individual. The more highly developed society differs from the less developed in the closer union of its members; this precludes the violent solution of internal conflict and forms externally a closed defensive front against any enemy. In less developed societies, where the social bond is still weak, and between the separate parts of which there exists a confederation for the purposes of war rather than true solidarity based on joint work and economic co-operation — disagreement breaks out more easily and more quickly than in highly developed societies. For the military confederation has no firm and lasting hold upon its members. By its very nature it is merely a temporary bond which is upheld by the prospect of momentary advantage, but dissolves as soon as the enemy has been defeated and the scramble for the booty sets in. In fighting against the less developed societies the more developed ones have always found that their greatest advantage lay in the lack of unity in the enemy’s ranks. Only temporarily do the nations in a lower state of organization manage to co-operate for great military enterprises. Internal disunity has always dispersed their armies quickly. Take for example the Mongol raids on the Central European civilization of the thirteenth century or the efforts of the Turks to penetrate into the West. The superiority of the industrial over the military type of society, to use Herbert Spencer’s expression, consists largely in the fact that associations which are merely military always fall to pieces through internal disunity.[33]The romantic-militarist notion of the military superiority of the nations which have made little progress in Capitalism, completely refuted afresh by the World War, arises from the view that what tells in a fight is man’s physical strength alone. This, however, is not completely true, even of the fights of the Homeric Age. Not physical but mental power decides a fight. On these mental powers depend the fighters’ tactics and the way he is armed. The A B C of the art of warfare is to have the superiority at the decisive moment, though otherwise one may be numerically weaker than the enemy. The A B C of the preparation for war is to set up armies as strong as possible and to provide them with all war materials in the best way. One has to stress this only because people are again endeavouring to obscure these connections, by trying to differentiate between the military and economic-political causes of victory and defeat in war. It always has been and always will be the fact, that victory or defeat is decided by the whole social position of the combatants before their armies meet in battle.

But there is another circumstance which advances further social development. It has been shown that it is to the interest of all members of society that the social range should be extended. For a highly developed social organism it is by no means a matter of indifference whether or not nations outside its range continue to lead a self-sufficient existence on a lower plane of social evolution. It is to the interest of the more advanced organism to draw the less advanced into the area of its economic and social community, even though its persistence in remaining on a lower plane makes it politically and militarily innocuous, and even though no immediate advantages are likely to accrue from the occupation of its territory, in which, presumably, the natural conditions of production are unfavourable. We have seen that it is always an advantage to widen the range of workers in a society that divides labour, so that even a more efficient people may have an interest in co-operating with a less efficient. This is what so often drives nations of a high social development to expand their field of economic activity by absorbing hitherto inaccessible territories. The opening up of the backward regions of the Near and Far East, of Africa and America, cleared the way for a world-wide economic community, so that shortly before the World War we were in sight of realizing the dream of an œcumenical society. Has the war merely interrupted this development for a brief period or has it utterly destroyed it? Is it conceivable that this development can cease, that society can even retrogress?

This problem cannot be approached except in connection with another: the problem of the death of nations. It is customary to talk of nations aging and dying, of young and old communities. The comparison is lame — as are all comparisons — and in discussing such things we are well advised to discard metaphorical phrases. What is the core of the problem that here presents itself?

It is clear that we must not confuse it with another not less difficult problem, the problem of the changes of the national quality. A thousand or fifteen hundred years ago the Germans spoke a different language from that of today, but we should not think of saying, on that account, that German medieval culture was “dead.” On the contrary we see in the German culture an uninterrupted evolutionary chain, stretching (without mentioning lost monuments of literature) from the “Heliand,” and Otfried’s Gospels to the present day. We do indeed say of the Pomeranians and Prussians, who in the course of centuries have been assimilated by the German colonists, that they have died out, yet we shall hardly maintain that as nations they grew “old.” To carry through the simile one would have to talk of nations that had died young. We are not concerned with national transformation; our problem is different. Neither does the decay of states come into the question, for this phenomenon sometimes appears as a sequence to the aging nations and sometimes independently of it. The fall of the ancient state of Poland had nothing to do with any decay of Polish civilization or of the Polish people. It did not stop the social development of Poland.

The facts which are present in practically all the examples brought forward of the aging of a culture are: a decline in population, a diminution of welfare, and the decay of the towns. The historical significance of all these phenomena becomes clear as soon as we conceive of the aging of nations as the retrogression of the social division of labour and of society. The decline of the ancient world for instance, was a social retrogression. The decline of the Roman Empire was only a result of the disintegration of ancient society which after reaching a high level of division of labour sank back into an almost moneyless economy. Thus towns were depopulated and thus, also, did the population of the countryside diminish and want and misery set in simply because an economic order working on a lower level in respect of the social division of labour is less productive. Technical skill was gradually lost, artistic talent decayed, scientific thought was slowly extinguished. The word which most aptly describes this process is disintegration. The Classical culture died because Classical society retrogressed.[34]On the decline of Ancient Greek Civilization see [Vilfredo] Pareto, Les Systèmes Socialistes (Paris, 1902), vol. 1, pp. 155 ff.

The death of nations is the retrogression of the social relation, the retrogression of the division of labour. Whatever may have been the cause in individual cases, it has always been the cessation of the disposition to social co-operation which actually effected the decline. This may once have seemed an incomprehensible riddle to us, but now that we watch with terror the process at work in our own experience we come nearer to understanding it, though we still fail to recognize the deepest, most ultimate causes of the change.

It is the social spirit, the spirit of social co-operation, which forms, develops, and upholds societies. Once it is lost, the society falls apart again. The death of a nation is social retrogression, the decline from the division of labour to self-sufficiency. The social organism disintegrates into the cells from which it began. Man remains, but society dies.[35]Izoulet, La Cité moderne, pp. 488 ff.

There is no evidence that social evolution must move steadily upwards in a straight line. Social standstill and social retrogression are historical facts which we cannot ignore. World history is the graveyard of dead civilizations, and in India and Eastern Asia we see large-scale examples of civilization at a standstill.

Our literary and artistic cliques whose exaggerated opinion of their own trifling productions contrast so vividly with the modesty and self-criticism of the really great artists, say that it does not matter much whether economic evolution continues so long as inner culture is intensified. But all inner culture requires external means for its realization, and these external means can be attained only by economic effort. When the productivity of labour decays through the retrogression of social co-operation the decay of inner culture follows.

All the older civilizations were born and grew up without being fully conscious of the basic laws of cultural evolution and the significance of division of labour and co-operation. In the course of their development they had often to combat tendencies and movements inimical to civilization. Often they triumphed over these, but sooner or later they fell. They succumbed to the spirit of disintegration. Through the social philosophy of Liberalism men became conscious of the laws of social evolution for the first time, and for the first time clearly recognized the basis of civilization and cultural progress. Those were days when hopes for the future ran high. Unimagined vistas seemed to be opening up. But it was not to be. Liberalism had to meet the opposition of militaristic-nationalist and, above all, of socialist-communist doctrines which tended to bring about social dissolution. The nationalist theory calls itself organic, the socialist theory calls itself social, but in reality both are disorganizing and anti-social in their effect.

Of all accusations against the system of Free Trade and Private Property, none is more foolish than the statement that it is anti-social and individualistic and that it atomizes the body social. Trade does not disintegrate, as romantic enthusiasts for the autarky of small portions of the earth’s surface assert; it unites. The division of labour is what first makes social ties: it is the social element pure and simple. Whoever advocates the economic self-sufficiency of nations and states, seeks to disintegrate the ecumenical society; whoever seeks to destroy the social division of labour within a nation by means of class war is anti-social.

A decline of the ecumenical society, which has been slowly forming itself during the last two hundred years under the influence of the gradual germination of the liberal idea, would be a world catastrophe absolutely without parallel in history as we know it. No nation would be spared. Who then would rebuild the shattered world?

8. Private Property and Social Evolution

The division of individuals into owners and non-owners is an outcome of the division of labour.

The second great sociological achievement of Classical Political Economy and the “individualistic” social theory of the eighteenth century was to recognize the social function of private property. From the older point of view property was always considered more or less a privilege of the Few, a raid upon the common stock, an institution regarded ethically as an evil, if sometimes as an inevitable one. Liberalism was the first to recognize that the social function of private ownership in the means of production is to put the goods into the hands of those who know best how to use them, into the hands, that is, of the most expert managers. Nothing therefore is more foreign to the essence of property than special privileges for special property and protection for special producers. Any kind of constraint such as exclusive rights and other privileges of producers, are apt to obstruct the working of the social function of property. Liberalism fights such institutions as vigorously as it opposes every attempt to limit the freedom of the worker.

The owner takes nothing away from anyone. No one can say that he goes short because of another’s abundance. It is flattering the envious instincts of the masses to give them a calculation of how much more the poor man would have to dispose of, if property were equally distributed. What is overlooked is the fact that the volume of production and of the social income are not fixed and unchangeable but depend essentially upon the distribution of property. If this is interfered with, there is danger that property may fall into the hands of those not so competent to maintain it, those whose foresight is less, whose disposal of their means is less productive; this would necessarily reduce the amount produced.[36]“The laws, in creating property, have created wealth, but with respect to poverty, it is not the work of the laws — it is the primitive condition of the human race. The man who lives only from day to day, is precisely the man in a state of nature. … The laws, in creating property, have been benefactors to those who remain in the original poverty. They participate more or less in the pleasures, advantages and resources of civilized society,” [Jeremy] Bentham, Principles of the Civil Code, ed. Bowring (Edinburgh, 1843), vol. 1, p. 309. The ideas of distributive Communism are atavistic, harking back to the times before social relations existed or reached their present stage of development, when the yield of production was correspondingly much lower. The landless man of an economic order based on production without exchange is quite logical in making the redistribution of fields the goal of his ambition. But the modern proletarian misunderstands the nature of social production when he hankers after a similar redistribution.

Liberalism combats the socialist ideal of transferring the means of production to the hands of organized society with the argument that socialist production would give a lower yield. Against this the Socialism of the Hegelian school seeks to prove that the evolution of history leads inevitably to the abolition of private ownership in the means of production.

It was the view of Lassalle that “the course of all legal history consists, generally speaking, in an ever greater limitation of the property of the individual, and in placing more and more objects outside private ownership.” The tendency to enlarge the freedom of property which is read into historical evolution is only apparent. However much the “idea of the increasingly rapid reduction of the sphere of private property as a principle working in the cultural and historical development of law could be held to be paradoxical,” yet, according to Lassalle it survived the most detailed examination. Unfortunately Lassalle produced no details of the examination of this idea. According to his own words he “honoured it (the idea) with a few very superficial glances instead.”[37][Ferdinand] Lassalle, Das System der erworbenen Rechte, 2nd ed. (Leipzig, 1880), Vol. 1, pp. 217 ff. Neither has anyone since Lassalle’s time undertaken to provide a proof. But even if the attempt had been made, this fact would by no means have demonstrated the necessity of the development in question. The conceptual constructions of speculative jurisprudence steeped in the Hegelian spirit serve at best to exhibit historical tendencies of evolution in the past. That the evolutionary tendency thus discovered must necessarily continue to develop is a thoroughly arbitrary assumption. Only if it could be shown that the force behind evolution was still active would the hypothetical proof which is needed be adduced. The Hegelian Lassalle did nothing of the kind. For him, the matter is disposed of when he realizes “that this progressive reduction of the sphere of private property is based on nothing else than the positive development of human liberty.”[38]Ibid., pp. 222 ff.
([Ferdinand] Lassalle, Das System der erworbenen Rechte, 2nd ed. (Leipzig, 1880), Vol. 1, pp. 217 ff.)
Having fitted his law of evolution into the great Hegelian scheme of historical evolution, he had done all that his school could ask.

Marx saw the faults in the Hegelian scheme of evolution. He too holds it to be an indisputable truth that the course of history leads from private property to common property. But unlike Hegel and Lassalle he does not deal with the idea of property and the juristic concept of property. Private property “in its political-economic tendencies” is drifting towards its dissolution, “but only by a development independent of it, of which it is unconscious, which is taking place against its will, and is conditioned by the nature of the question; only by creating the proletariat qua proletariat, the misery that is conscious of its spiritual and physical misery, the dehumanization that is conscious of its dehumanization.”[39][Karl] Marx, Die heilige Familie. Aus dem literarischen Nachlass yon Karl Marx, Friedrich Engels und Ferdinand Lassalle, ed. Mehring (Stuttgart, 1902), vol. 2, p. 132. Thus the doctrine of the class struggle is introduced as the driving element of historical evolution.

1. Human Cooperation

Society is concerted action, cooperation.

Society is the outcome of conscious and purposeful behavior. This does not mean that individuals have concluded contracts by virtue of which they have founded human society. The actions which have brought about social cooperation and daily bring it about anew do not aim at anything else than cooperation and coadjuvancy with others for the attainment of definite singular ends. The total complex of the mutual relations created by such concerted actions is called society. It substitutes collaboration for the — at least conceivable — isolated life of individuals. Society is division of labor and combination of labor. In his capacity as an acting animal man becomes a social animal.

Individual man is born into a socially organized environment. In this sense alone we may accept the saying that society is — logically or historically — antecedent to the individual. In every other sense this dictum is either empty or nonsensical. The individual lives and acts within society. But society is nothing but the combination of individuals for cooperative effort. It exists nowhere else than in the actions of individual men. It is a delusion to search for it outside the actions of individuals. To speak of a society’s autonomous and independent existence, of its life, its soul, and its actions is a metaphor which can easily lead to crass errors.

The questions whether society or the individual is to be considered as the ultimate end, and whether the interests of society should be subordinated to those of the individuals or the interests of the individuals to those of society are fruitless. Action is always action of individual men. The social or societal element is a certain orientation of the actions of individual men. The category end makes sense only when applied to action. Theology and the metaphysics of history may discuss the ends of society and the designs which God wants to realize with regard to society in the same way in which they discuss the purpose of all other parts of the created universe. For science, which is inseparable from reason, a tool manifestly unfit for the treatment of such problems, it would be hopeless to embark upon speculations concerning these matters.

Within the frame of social cooperation there can emerge between members of society feelings of sympathy and friendship and a sense of belonging together. These feelings are the source of man’s most delightful and most sublime experiences. They are the most precious adornment of life; they lift the animal species man to the heights of a really human existence. However, they are not, as some have asserted, the agents that have brought about social relationships. They are fruits of social cooperation, they thrive only within its frame; they did not precede the establishment of social relations and are not the seed from which they spring.

The fundamental facts that brought about cooperation, society, and civilization and transformed the animal man into a human being are the facts that work performed under the division of labor is more productive than isolated work and that man’s reason is capable of recognizing this truth. But for these facts men would have forever remained deadly foes of one another, irreconcilable rivals in their endeavors to secure a portion of the scarce supply of means of sustenance provided by nature. Each man would have been forced to view all other men as his enemies; his craving for the satisfaction of his own appetites would have brought him into an implacable conflict with all his neighbors. No sympathy could possibly develop under such a state of affairs.

Some sociologists have asserted that the original and elementary subjective fact in society is a “consciousness of kind.”[41]F.H. Giddings, The Principles of Sociology (New York, 1926), p. 17. Others maintain that there would be no social systems if there were no “sense of community or of belonging together.”[42]F.M. MacIver, Society (New York, 1937), pp. 6–7. One may agree, provided that these somewhat vague and ambiguous terms are correctly interpreted. We may call consciousness of kind, sense of community, or sense of belonging together the acknowledgment of the fact that all other human beings are potential collaborators in the struggle for survival because they are capable of recognizing the mutual benefits of cooperation, while the animals lack this faculty. However, we must not forget that the primary facts that bring about such consciousness or such a sense are the two mentioned above. In a hypothetical world in which the division of labor would not increase productivity, there would not be any society. There would not be any sentiments of benevolence and good will.

The principle of the division of labor is one of the great basic principles of cosmic becoming and evolutionary change. The biologists were right in borrowing the concept of the division of labor from social philosophy and in adapting it to their field of investigation. There is division of labor between the various parts of any living organism. There are, furthermore, organic entities composed of collaborating animal individuals; it is customary to call metaphorically such aggregations of the ants and bees “animal societies.” But one must never forget that the characteristic feature of human society is purposeful cooperation; society is an outcome of human action, i.e., of a conscious aiming at the attainment of ends. No such element is present, as far as we can ascertain, in the processes which have resulted in the emergence of the structure-function systems of plant and animal bodies and in the operation of the societies of ants, bees, and hornets. Human society is an intellectual and spiritual phenomenon. It is the outcome of a purposeful utilization of a universal law determining cosmic becoming, viz., the higher productivity of the division of labor. As with every instance of action, the recognition of the laws of nature is put into the service of man’s efforts to improve his conditions. …

3. The Division of Labor

The fundamental social phenomenon is the division of labor and its counterpart human cooperation.

Experience teaches man that cooperative action is more efficient and productive than isolated action of self-sufficient individuals. The natural conditions determining man’s life and effort are such that the division of labor increases output per unit of labor expended. These natural facts are:

First: the innate inequality of men with regard to their ability to perform various kinds of labor. Second: the unequal distribution of the nature-given, nonhuman opportunities of production on the surface of the earth. One may as well consider these two facts as one and the same fact, namely, the manifoldness of nature which makes the universe a complex of infinite varieties. If the earth’s surface were such that the physical conditions of production were the same at every point and if one man were as equal to all other men as is a circle to another with the same diameter in Euclidian geometry, division of labor would not offer any advantages for acting man.

There is still a third fact, viz., that there are undertakings whose accomplishment exceeds the forces of a single man and requires the joint effort of several. Some of them require an expenditure of labor which no single man can perform because his capacity to work is not great enough. Others again could be accomplished by individuals; but the time which they would have to devote to the work would be so long that the result would only be attained late and would not compensate for the labor expended. In both cases only joint effort makes it possible to attain the end sought.

If only this third condition were present, temporary cooperation between men would have certainly emerged. However, such transient alliances to cope with specific tasks which are beyond the strength of an individual would not have brought about lasting social cooperation. Undertakings which could be performed only in this way were not very numerous at the early stages of civilization. Moreover, all those concerned may not often agree that the performance in question is more useful and urgent than the accomplishment of other tasks which they could perform alone. The great human society enclosing all men in all of their activities did not originate from such occasional alliances. Society is much more than a passing alliance concluded for a definite purpose and ceasing as soon as its objective is realized, even if the partners are ready to renew it should an occasion present itself.

The increase in productivity brought about by the division of labor is obvious whenever the inequality of the participants is such that every individual or every piece of land is superior at least in one regard to the other individuals or pieces of land concerned. If A is fit to produce in 1 unit of time 6 p or 4 q and B only 2 p, but 8 q, they both, when working in isolation, will produce together 4 p + 6 q; when working under the division of labor, each of them producing only that commodity in whose production he is more efficient than his partner, they will produce 6 p + 8 q. But what will happen, if A is more efficient than B not only in the production of p but also in the production of q?

This is the problem which Ricardo raised and solved immediately.

4. The Ricardian Law of Association

Ricardo expounded the law of association in order to demonstrate what the consequences of the division of labor are when an individual or a group, more efficient in every regard, cooperates with an individual or a group less efficient in every regard. He investigated the effects of trade between two areas, unequally endowed by nature, under the assumption that the products, but not the workers and the accumulated factors of future production (capital goods), can freely move from each area into the other. The division of labor between two such areas will, as Ricardo’s law shows, increase the productivity of labor and is therefore advantageous to all concerned, even if the physical conditions of production for any commodity are more favorable in one of these two areas than in the other. It is advantageous for the better endowed area to concentrate its efforts upon the production of those commodities for which its superiority is greater, and to leave to the less endowed area the production of other goods in which its own superiority is less. The paradox that it is more advantageous to leave more favorable domestic conditions of production unused and to procure the commodities they could produce from areas in which conditions for their production are less favorable, is the outcome of the immobility of labor and capital, to which the more favorable places of production are inaccessible.

Ricardo was fully aware of the fact that his law of comparative cost, which he expounded mainly in order to deal with a special problem of international trade, is a particular instance of the more universal law of association.

If A is in such a way more efficient than B that he needs for the production of 1 unit of the commodity p 3 hours compared with B’s 5, and for the production of 1 unit of q 2 hours compared with B’s 4, then both will gain if Aconfines himself to producing q and leaves B to produce p. If each of them gives 60 hours to producing p and 60 hours to producing q, the result of A’s labor is 20 p + 30 q; of B’s, 12 p +15 q; and for both together, 32 p + 45 q. If, however, A confines himself to producing q alone, he produces 60 q in 120 hours, while B, if he confines himself to producing p, produces in the same time 24 p. The result of their activities is then 24 p + 60 q, which, as p has for A a substitution ratio of 3/2 q and for B one of 5/4 q, signifies a larger output than 32 p + 45 q. Therefore it is manifest that the division of labor brings advantages to all who take part in it. Collaboration of the more talented, more able, and more industrious with the less talented, less able, and less industrious results in benefit for both. The gains derived from the division of labor are always mutual.

The law of association makes us comprehend the tendencies which resulted in the progressive intensification of human cooperation. We conceive what incentive induced people not to consider themselves simply as rivals in a struggle for the appropriation of the limited supply of means of subsistence made available by nature. We realize what has impelled them and permanently impels them to consort with one another for the sake of cooperation. Every step forward on the way to a more developed mode of the division of labor serves the interests of all participants. In order to comprehend why man did not remain solitary, searching like the animals for food and shelter for himself only and at most also for his consort and his helpless infants, we do not need to have recourse to a miraculous interference of the Deity or to the empty hypostasis of an innate urge toward association. Neither are we forced to assume that the isolated individuals or primitive hordes one day pledged themselves by a contract to establish social bonds. The factor that brought about primitive society and daily works toward its progressive intensification is human action that is animated by the insight into the higher productivity of labor achieved under the division of labor.

Neither history nor ethnology nor any other branch of knowledge can provide a description of the evolution which has led from the packs and flocks of mankind’s nonhuman ancestors to the primitive, yet already highly differentiated, societal groups about which information is provided in excavations, in the most ancient documents of history, and in the reports of explorers and travelers who have met savage tribes. The task with which science is faced in respect of the origins of society can only consist in the demonstration of those factors which can and must result in association and its progressive intensification. Praxeology solves the problem. If and as far as labor under the division of labor is more productive than isolated labor, and if and as far as man is able to realize this fact, human action itself tends toward cooperation and association; man becomes a social being not in sacrificing his own concerns for the sake of a mythical Moloch, society, but in aiming at an improvement in his own welfare. Experience teaches that this condition — higher productivity achieved under the division of labor — is present because its cause — the inborn inequality of men and the inequality in the geographical distribution of the natural factors of production — is real. Thus we are in a position to comprehend the course of social evolution.

Current Errors Concerning the Law of Association

People cavil much about Ricardo’s law of association, better known under the name law of comparative cost. The reason is obvious. This law is an offense to all those eager to justify protection and national economic isolation from any point of view other than the selfish interests of some producers or the issues of war-preparedness.

Ricardo’s first aim in expounding this law was to refute an objection raised against freedom of international trade. The protectionist asks: What under free trade will be the fate of a country in which the conditions for any kind of production are less favorable than in all other countries? Now, in a world in which there is free mobility not only for products, but no less for capital goods and for labor, a country so little suited for production would cease to be used as the seat of any human industry. If people fare better without exploiting the — comparatively unsatisfactory — physical conditions of production offered by this country, they will not settle here and will leave it as uninhabited as the polar regions, the tundras and the deserts. But Ricardo deals with a world whose conditions are determined by settlement in earlier days, a world in which capital goods and labor are bound to the soil by definite institutions. In such a milieu free trade, i.e., the free mobility of commodities only, cannot bring about a state of affairs in which capital and labor are distributed on the surface of the earth according to the better or poorer physical opportunities afforded to the productivity of labor. Here the law of comparative cost comes into operation. Each country turns toward those branches of production for which its conditions offer comparatively, although not absolutely, the most favorable opportunities. For the inhabitants of a country it is more advantageous to abstain from the exploitation of some opportunities which — absolutely and technologically — are more propitious and to import commodities produced abroad under conditions which — absolutely and technologically — are less favorable than the unused domestic resources. The case is analogous to that of a surgeon who finds it convenient to employ for the cleaning of the operating-room and the instruments a man whom he excels in this performance also and to devote himself exclusively to surgery, in which his superiority is higher.

The theorem of comparative cost is in no way connected with the value theory of classical economics. It does not deal with value or with prices. It is an analytic judgment; the conclusion is implied in the two propositions that the technically movable factors of production differ with regard to their productivity in various places and are institutionally restricted in their mobility. The theorem, without prejudice to the correctness of its conclusions, can disregard problems of valuation because it is free to resort to a set of simple assumptions. These are: that only two products are to be produced; that these products are freely movable; that for the production of each of them two factors are required; that one of these factors (it may be either labor or capital goods) is identical in the production of both, while the other factor (a specific property of the soil) is different for each of the two processes; that the greater scarcity of the factor common to both processes determines the extent of the exploitation of the different factor. In the frame of these assumptions, which make it possible to establish substitution ratios between the expenditure of the common factor and the output, the theorem answers the question raised.

The law of comparative cost is as independent of the classical theory of value as is the law of returns, which its reasoning resembles. In both cases we can content ourselves with comparing only physical input and physical output. With the law of returns we compare the output of the same product. With the law of comparative costs we compare the output of two different products. Such a comparison is feasible because we assume that for the production of each of them, apart from one specific factor, only nonspecific factors of the same kind are required.

Some critics blame the law of comparative cost for this simplification of assumptions. They believe that the modern theory of value would require a reformulation of the law in conformity with the principles of subjective value. Only such a formulation could provide a satisfactory conclusive demonstration. However, they do not want to calculate in terms of money. They prefer to resort to those methods of utility analysis which they consider a means for making value calculations in terms of utility. It will be shown in the further progress of our investigation that these attempts to eliminate monetary terms from economic calculation are delusive. Their fundamental assumptions are untenable and contradictory and all formulas derived from them are vicious. No method of economic calculation is possible other than one based on money prices as determined by the market.

The meaning of the simple assumptions underlying the law of comparative cost is not precisely the same for the modern economists as it was for the classical economists. Some adherents of the classical school considered them as the starting point of a theory of value in international trade. We know now that they were mistaken in this belief. Besides, we realize that with regard to the determination of value and of prices there is no difference between domestic and foreign trade. What makes people distinguish between the home market and markets abroad is only a difference in the data, i.e., varying institutional conditions restricting the mobility of factors of production and of products.

If we do not want to deal with the law of comparative cost under the simplified assumptions applied by Ricardo, we must openly employ money calculation. We must not fall prey to the illusion that a comparison between the expenditure of factors of production of various kinds and of the output of products of various kinds can be achieved without the aid of money calculation. If we consider the case of the surgeon and his handyman we must say: If the surgeon can employ his limited working time for the performance of operations for which he is compensated at $50 per hour, it is to his interest to employ a handyman to keep his instruments in good order and to pay him $2 per hour, although this man needs 3 hours to accomplish what the surgeon could do in 1 hour. In comparing the conditions of two countries we must say: If conditions are such that in England the production of 1 unit of each of the two commodities a and b requires the expenditure of 1 working day of the same kind of labor, while in India with the same investment of capital for a 2 days and for b 3 days are required, and if capital goods and a and b are freely movable from England to India and vice versa, while there is no mobility of labor, wage rates in India in the production of a must tend to be 50 percent, and in the production of b 33 1/3 per cent, of the English rates. If the English rate is 6 shillings, the rates in India would be the equivalent of 3 shillings in the production of a and the equivalent of 2 shillings in the production of b. Such a discrepancy in the remuneration of labor of the same kind cannot last if there is mobility of labor on the domestic Indian labor market. Workers would shift from the production of b into the production of a; their migration would tend to lower the remuneration in the a industry and to raise it in the b industry. Finally Indian wage rates would be equal in both industries. The production of a would tend to expand and to supplant English competition. On the other hand the production of b would become unprofitable in India and would have to be discontinued, while it would expand in England. The same reasoning is valid if we assume that the difference in the conditions of production consists also or exclusively in the amount of capital investment needed.

It has been asserted that Ricardo’s law was valid only for his age and is of no avail for our time which offers other conditions. Ricardo saw the difference between domestic trade and foreign trade in differences in the mobility of capital and labor. If one assumes that capital, labor, and products are movable, then there exists a difference between regional and interregional trade only as far as the cost of transportation comes into play. Then it is superfluous to develop a theory of international trade as distinguished from national trade. Capital and labor are distributed on the earth’s surface according to the better or poorer conditions which the various regions offer to production. There are areas more densely populated and better equipped with capital, there are others less densely populated and poorer in capital supply. There prevails on the whole earth a tendency toward an equalization of wage rates for the same kind of labor.

Ricardo, however, starts from the assumption that there is mobility of capital and labor only within each country, and not between the various countries. He raises the question what the consequences of the free mobility of products must be under such conditions. (If there is no mobility of products either, then every country is economically isolated and autarkic, and there is no international trade at all.) The theory of comparative cost answers this question. Now, Ricardo’s assumptions by and large held good for his age. Later, in the course of the nineteenth century, conditions changed. The immobility of capital and labor gave way; international transfer of capital and labor became more and more common. Then came a reaction. Today capital and labor are again restricted in their mobility. Reality again corresponds to the Ricardian assumptions.

However, the teachings of the classical theory of interregional trade are above any change in institutional conditions. They enable us to study the problems involved under any imaginable assumptions.

5. The Effects of the Division of Labor

The division of labor is the outcome of man’s conscious reaction to the multiplicity of natural conditions. On the other hand it is itself a factor bringing about differentiation. It assigns to the various geographic areas specific functions in the complex of the processes of production. It makes some areas urban, others rural; it locates the various branches of manufacturing, mining, and agriculture in different places. Still more important, however, is the fact that it intensifies the innate inequality of men. Exercise and practice of specific tasks adjust individuals better to the requirements of their performance; men develop some of their inborn faculties and stunt the development of others. Vocational types emerge, people become specialists.

The division of labor splits the various processes of production into minute tasks, many of which can be performed by mechanical devices. It is this fact that made the use of machinery possible and brought about the amazing improvements in technical methods of production. Mechanization is the fruit of the division of labor, its most beneficial achievement, not its motive and fountain spring. Power-driven specialized machinery could be employed only in a social environment under the division of labor. Every step forward on the road toward the use of more specialized, more refined, and more productive machines requires a further specialization of tasks.

6. The Individual Within Society

If praxeology speaks of the solitary individual, acting on his own behalf only and independent of fellow men, it does so for the sake of a better comprehension of the problems of social cooperation. We do not assert that such isolated autarkic human beings have ever lived and that the social stage of man’s history was preceded by an age of independent individuals roaming like animals in search of feed. The biological humanization of man’s nonhuman ancestors and the emergence of the primitive social bonds were effected in the same process. Man appeared on the scene of earthly events as a social being. The isolated asocial man is a fictitious construction.

Seen from the point of view of the individual, society is the great means for the attainment of all his ends. The preservation of society is an essential condition of any plans an individual may want to realize by any action whatever. Even the refractory delinquent who fails to adjust his conduct to the requirements of life within the societal system of cooperation does not want to miss any of the advantages derived from the division of labor. He does not consciously aim at the destruction of society. He wants to lay his hands on a greater portion of the jointly produced wealth than the social order assigns to him. He would feel miserable if antisocial behavior were to become universal and its inevitable outcome, the return to primitive indigence, resulted.

It is illusory to maintain that individuals in renouncing the alleged blessings of a fabulous state of nature and entering into society have foregone some advantages and have a fair claim to be indemnified for what they have lost. The idea that anybody would have fared better under an asocial state of mankind and is wronged by the very existence of society is absurd. Thanks to the higher productivity of social cooperation the human species has multiplied far beyond the margin of subsistence offered by the conditions prevailing in ages with a rudimentary degree of the division of labor. Each man enjoys a standard of living much higher than that of his savage ancestors. The natural condition of man is extreme poverty and insecurity. It is romantic nonsense to lament the passing of the happy days of primitive barbarism. In a state of savagery the complainants would either not have reached the age of manhood, or if they had, they would have lacked the opportunities and amenities provided by civilization. Jean Jacques Rousseau and Frederick Engels, if they had lived in the primitive state which they describe with nostalgic yearning, would not have enjoyed the leisure required for their studies and for the writing of their books.

One of the privileges which society affords to the individual is the privilege of living in spite of sickness or physical disability. Sick animals are doomed. Their weakness handicaps them in their attempts to find food and to repel aggression on the part of other animals. Deaf, nearsighted, or crippled savages must perish. But such defects do not deprive a man of the opportunity to adjust himself to life in society. The majority of our contemporaries are afflicted with some bodily deficiencies which biology considers pathological. Our civilization is to a great extent the achievement of such men. The eliminative forces of natural selection are greatly reduced under social conditions. Hence some people say that civilization tends to deteriorate the hereditary qualities of the members of society.

Such judgments are reasonable if one looks at mankind with the eyes of a breeder intent upon raising a race of men equipped with certain qualities. But society is not a stud-farm operated for the production of a definite type of men. There is no “natural” standard to establish what is desirable and what is undesirable in the biological evolution of man. Any standard chosen is arbitrary, purely subjective, in short a judgment of value. The terms racial improvement and racial degeneration are meaningless when not based on definite plans for the future of mankind.

It is true, civilized man is adjusted to life in society and not to that of a hunter in virgin forests.

References • 2,100 Words

[1] [Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 10: “Exchange within Society,” pp. 195–98.]

[2] Gustav Cassel, The Theory of Social Economy, trans. S.L. Banon (new ed; London, 1932), p. 371.

[3] Cf. Adam Ferguson, An Essay on the History of Civil Society (new ed; Basel, 1789), p. 208.

[4] Cf. Herbert Spencer, The Principles of Sociology (New York, 1914), vol. 3, pp. 575–611.

[5] Cf. Werner Sombart, Haendler und Helden (Munich, 1915).

[6] Cf. Frederick Engels, The Origin of the Family, Private Property and the State (New York, 1942), p. 144.

[7] [Ludwig von Mises, Socialism (1922; Indianapolis, Ind.: Liberty Classics, 1981), chap. 18: “Society,” pp. 256–78.]

[8] [Hermann] Cohen, Logik der reinen Erkenntnis, 2nd ed. (Berlin, 1914), p. 359.

[9] As is done by [Paul von] Lilienfeld, La pathologie sociale (Paris, 1896), p. 95. When a government takes a loan from the House of Rothschild organic sociology conceives the process as follows: “La maison Rothschild agit, dans cette occasion, parfaitement en analogie avec l’action d’un groupe de cellules qui, dans le corps humain, coopèrent à la production du sang nécessaire à l’alimentation du cerveau dans l’espoir d’en être indemnisées par une réaction des cellules de la substance grise dont ils ont besoin pour s’activer de nouveau et accumuler de nouvelles énergies.” (“The House of Rothschild’s operation, on such an occasion, is precisely similar to the action of a group of human body cells which cooperate in the production of the blood necessary for nourishing the brain, in the hope of being compensated by a reaction of the gray matter cells which they need to reactivate and to accumulate new energies.”) (Ibid., p. 104.) This is the method which claims that it stands on “firm ground” and explores “the Becoming of Phenomena step by step, proceeding from the simpler to the more complex.” See Lilienfeld, Zur Verteidigung der organischen Methode in der Soziologie (Berlin, 1898), p. 75.

[10] It is characteristic that just the romantics stress excessively society’s organic character, whereas liberal social philosophy has never done so. Quite understandably. A social theory which was genuinely organic did not need to stress obtrusively this attribute of its system.

[11] Cohen, Logik der reinen Erkenntnis, p. 349.

[12] [Oscar] Hertwig, Allgemeine Biologie, 4th ed. (Jena, 1912), pp. 500 ff; Hertwig, Zur Abwehr des ethischen, des sozialen und des politischen Darwinismus (Jena, 1918), pp. 69 ff.

[13] [Jean] Izoulet, La cité moderne (Paris, 1894), pp. 35 ff.

[14] [Émile] Durkheim, De la division du travail social (Paris, 1893), pp. 294 ff. endeavours (following Comte and against Spencer) to prove that the division of labour prevails not because, as the economists think, it increases output but as a result of the struggle for existence. The denser the social mass the sharper the struggle for existence. This forces individuals to specialize in their work, as otherwise they would not be able to maintain themselves. But Durkheim overlooks the fact that the division of labour makes this possible only because it makes labour more productive. Durkheim comes to reject the theory of the importance of the greater productivity in the division of labour through a false conception of the fundamental idea of utilitarianism and of the law of the satiation of wants (ibid., 218 ff., 257 ff.). His view that civilization is called forth by changes in the volume and density of society is untenable. Population grows because labour becomes more productive and is able to nourish more people, not vice versa.

[15] On the important part played by the local variety of productive conditions in the origin of the division of labour see [Karl] von den Steinen, Unter den Naturvölkern Zentralbrasiliens, 2nd ed. (Berlin, 1897), pp. 196 ff.

[16] [David] Ricardo, Principles of Political Economy and Taxation, in Works, ed. John Ramsay MacCulloch, 2nd. (London, 1852), pp. 76 ff.; [John Stuart] Mill, Principles of Political Economy (People’s ed.; London, 1867), pp. 348 ff.; [C.F.] Bastable, The Theory of International Trade, 3rd ed. (London, 1900), pp. 16 ff.

[17] “Trade makes the human race, which originally has only the unity of the species, into a really unitary society.” See Heymann Steinthal, Allgemeine Ethik (Berlin, 1885), p. 208. Trade, however, is nothing more than a technical aid of the division of labour. On the division of labour in the sociology of Thomas Aquinas see Edmund Schreiber, Die volkswirtschaftlichen Anschauungen der Scholastik seit Thomas von Aquin (Jena, 1913), pp. 19 ff.

[18] Therefore, too, one must reject the idea of Guyau, which derives the social bond directly from bi-sexuality. See [Jean-Marie] Guyau, Sittlichkeit ohne Pflicht, trans. [Elisabeth] Schwarz (Leipzig, 1909), pp. 113 ff.

[19] Fouillée argues as follows against the utilitarian theory of society, which calls society a “moyen universal” (“universal means”) (Belot): “Tout moyen n’a qu’une valeur provisoire; le jour où un instrument dont je me servais me devient inutile ou nuisible, je le mets de côté. Si la société n’ est qu’un moyen, le jour où, exceptionellement, elle se trouvera contraire à mes fins, je me delivrerai des lois sociales et moyens. sociaux. … Aucune considération sociale ne pourra empêcher la révolte de l’individu tant qu’on ne lui aura pas montré que la société est établie pour des fins qui sont d’abord et avant tout ses vraies fins à lui-même et qui, de plus, ne sont pas simplement des fins de plaisir ou d’intérêt, l’intérêt n’étant que le plaisir différé et attendu pour l’avenir … L’idée d’intérét est précisément ce qui divise les hommes, malgré les rapprochements qu’elle peut produire lorsqu’il y a convergence d’intérêts sur certains points.” (“Every means has only a temporary value; the day when a means ceases to serve me or becomes harmful to me, I cast it aside. If society is only a means, the day when, by some special circumstances, it is found to act contrary to my ends, I will free myself from its social laws and social means. … No social consideration can prevent an individual from rebelling when it has not been demonstrated to him that society exists for ends which are primarily and above all his own true ends and, further, which are not simply for the ends of pleasure or self-interest, self-interest being only pleasure postponed and expected in the future. … The idea of self-interest is precisely what divides men, in spite of the cooperation it can produce when self-interests coincide in certain instances.”) [Alfred] Fouillée, Humanitaires et libertaires au point de vue Sociologique et moral (Paris, 1914), pp. 146 ff.; see also [Jean-Marie] Guyau, Die englische Ethik der Gegenwart, trans. Peusner (Leipzig, 1914), pp. 372 ff. Fouillée does not see that the provisional value which society gets as a means, lasts as long as the conditions of human life, given by nature, continue unchanged and as long as man continues to recognize the advantages of human co-operation. The “eternal,” not merely provisional, existence of society follows from the eternity of the conditions on which it is built up. Those in power may demand of social theory that it should serve them by preventing the individual from revolting against society, but this is by no means a scientific demand. Besides no social theory could, as easily as the utilitarian, induce the social individual to enrol himself voluntarily in the social union. But when an individual shows that he is an enemy of society there is nothing left for society to do but make him harmless.

[20] [Immanuel] Kant, “Idee zu einer allgemeinen Geschichte in weltbürgerlicher Absicht” (Collected Works), vol. 1, pp. 227 ff.

[21] [Karl] Bücher, Die Entstehung der Volkswirtschaft, First collection, 10th ed. (Tübingen, 1917), p. 91.

[22] [Gustav] Schmoller, Grundriss der allgemeinen Volkswirtschaftslehre (Munich, 1920), vol. 2, pp. 760 ff.

[23] [Eugen von] Philippovich, Grundriss der politischen Ökonomie, 11th ed. (Tübingen, 1916), vol. 1, pp. 11 ff.

[24] On the stages theory see also my Grundprobleme der Nationalökonomie (Jena, 1933), pp. 106 ff.

[25] [Alphons] Dopsch, Wirtschaftliche und soziale Grundlagen der europäischen Kulturentwicklung (Vienna, 1918), vol. 1, pp. 91 ff.

[26] [Karl] Marx, Das Elend der Philosophie, p. 92. In the formulations which Marx later on gave to his conception of history he avoided the rigidity of this earliest version. Behind such indefinite expressions as “productive forces” and “conditions of production” are hidden the critical doubts which Marx may meanwhile have experienced. But obscurity, opening the way to multitudinous interpretations, does not make an untenable theory tenable.

[27] [Adam] Ferguson, Abhandlung über die Geschichte der bürgerlichen Gesellschaft, trans. Dorn (Jena, 1904), pp. 237 ff.; also [Paul] Barth, Die Philosophie der Geschichte als Soziologie, 2nd ed. (Leipzig, 1915), Part 1, pp. 578 ff.

[28] All that remains of the materialist conception of history, which appeared with the widest possible claims, is the discovery that all human and social action is decisively influenced by the scarcity of goods and the disutility of labour. But the Marxists can least admit just this, for all they say about the future socialist order of society disregards these two economic conditions.

[29] Adam Müller says about “the vicious tendency to divide labour in all branches of private industry and in government business too,” that man needs “an all round, I might say a sphere-round field of activity.” If the “division of labour in large cities or industrial or mining provinces cuts up man, the completely free man, into wheels, rollers, spokes, shafts, etc., forces on him an utterly one-sided scope in the already one-sided field of the provisioning of one single want, how can one then demand that this fragment should accord with the whole complete life and with its law, or with legality; how should the rhombuses, triangles, and figures of all kinds accord separately with the great sphere of political life and its law?” See Adam Müller, Ausgewählte Abhandlungen, ed. Baxa (Jena, 1921), p. 46.

[30] [Karl] Marx, Zur Kritik des sozialdemokratischen Parteiprogramms von Gotha (New York, 1920), p. 17. Innumerable passages in his writings show how falsely Marx conceived the nature of labour in industry. Thus he thought also that “the division of labour in the mechanical factory” is characterized by “having lost every specialized character. … The automatic factory abolishes the specialist and the one-track mind.” And he blames Proudhon, “who did not understand even this one revolutionary side of the automatic factory.” Marx, Das Elend der Philosophie, p. 129.

[31] [August] Bebel, Die Frau und der Sozialismus, pp. 283 ff.

[32] Durkheim, De la division du travail social, pp. 452 ff.

[33] The romantic-militarist notion of the military superiority of the nations which have made little progress in Capitalism, completely refuted afresh by the World War, arises from the view that what tells in a fight is man’s physical strength alone. This, however, is not completely true, even of the fights of the Homeric Age. Not physical but mental power decides a fight. On these mental powers depend the fighters’ tactics and the way he is armed. The A B C of the art of warfare is to have the superiority at the decisive moment, though otherwise one may be numerically weaker than the enemy. The A B C of the preparation for war is to set up armies as strong as possible and to provide them with all war materials in the best way. One has to stress this only because people are again endeavouring to obscure these connections, by trying to differentiate between the military and economic-political causes of victory and defeat in war. It always has been and always will be the fact, that victory or defeat is decided by the whole social position of the combatants before their armies meet in battle.

[34] On the decline of Ancient Greek Civilization see [Vilfredo] Pareto, Les Systèmes Socialistes (Paris, 1902), vol. 1, pp. 155 ff.

[35] Izoulet, La Cité moderne, pp. 488 ff.

[36] “The laws, in creating property, have created wealth, but with respect to poverty, it is not the work of the laws — it is the primitive condition of the human race. The man who lives only from day to day, is precisely the man in a state of nature. … The laws, in creating property, have been benefactors to those who remain in the original poverty. They participate more or less in the pleasures, advantages and resources of civilized society,” [Jeremy] Bentham, Principles of the Civil Code, ed. Bowring (Edinburgh, 1843), vol. 1, p. 309.

[37] [Ferdinand] Lassalle, Das System der erworbenen Rechte, 2nd ed. (Leipzig, 1880), Vol. 1, pp. 217 ff.

[38] Ibid., pp. 222 ff.

[39] [Karl] Marx, Die heilige Familie. Aus dem literarischen Nachlass yon Karl Marx, Friedrich Engels und Ferdinand Lassalle, ed. Mehring (Stuttgart, 1902), vol. 2, p. 132.

[40] [Mises, Human Action, Part Two: Action Within the Framework of Society, chap. 8: “Human Society,” pp. 143–45, 157–65.]

[41] F.H. Giddings, The Principles of Sociology (New York, 1926), p. 17.

[42] F.M. MacIver, Society (New York, 1937), pp. 6–7.

Chapter 5 • Capitalism: The Market Economy • 6,000 Words

2. Capitalism or Market Economy

In the capitalistic economy the means of production are owned by individuals or associations of individuals, such as corporations. The owners use the means of production directly to produce, or they lend them, for a compensation, to others who want to use them in production. The individuals or associations of individuals who produce with their own or with borrowed money are called entrepreneurs.

Superficially, it seems that the entrepreneurs decide what should be produced, and how it should be produced. However, as they do not produce for their own needs but for those of all members of the community, they have to sell the products on the market to consumers, that is, those individuals who want to use and consume them. Only that entrepreneur is successful and realizes a profit who knows how to produce in the best and cheapest way, that is with a minimum expenditure of material and labor, the articles most urgently wanted by the consumers. Therefore, in actuality the consumers, not the entrepreneurs, determine the direction and scope of production. In the market economy the consumers are sovereign. They are the masters, and the entrepreneurs have to strive, in their own interest, to serve the wishes of the consumers to the best of their ability.

The market economy has been called a democracy of consumers, because it brings about a daily recurring ballot of consumer preferences. The casting of votes at an election and the spending of dollars in the market are both methods of expressing public opinion. The consumers decide, by buying or by refraining from buying, the success or failure of the entrepreneurs. They make poor entrepreneurs rich and rich entrepreneurs poor. They take away the means of production from those entrepreneurs who do not know how to use them best in the service of the consumers and transfer them to those who know how to make better use of them. It is true that only the entrepreneurs producing consumers’ goods have direct contact with the consumers; only they are immediately dependent on the consumers; only they receive directly the consumers’ orders. But they transmit those orders and their dependence to the entrepreneurs who bring producers’ goods to the market. The producers of consumers’ goods have to purchase where they can, at lowest cost, the producers’ goods which are required for the ultimate satisfaction of the wants of the consumers. Should they fail to use the cheapest supplies, should they fail to make the most efficient use of the producers’ goods in production, they would be unable to satisfy the wants of the consumers at lowest prices; more efficient entrepreneurs who know better how to buy and how to produce would crowd them out of the market. The consumer as buyer may follow his own liking and his own fancy. The entrepreneur must do the buying for his enterprise as the most efficient satisfaction of the wants of the consumers’ dictates. Deviations from this line prescribed by the consumers affect the entrepreneur’s returns, thus causing losses and endangering his position as entrepreneur.

Such is the oft-decried harshness of the entrepreneur who figures everything in dollars and cents. He is forced to take this attitude by order of the consumers, who are unwilling to reimburse the entrepreneurs for unnecessary expenditures. What in everyday language is called economy is simply law prescribed by the consumers for the actions of the entrepreneurs and their helpers. The consumers, by their behavior in the market, are the ones who indirectly determine prices and wages and, thus, the distribution of wealth among the members of society. Their choices in the market determine who shall be entrepreneur and owner of the means of production. By every dollar spent, the consumers influence the direction, size, and kind of production and marketing.

The entrepreneurs do not form a closed class or order. Any individual may become an entrepreneur if he has the ability to foresee the future development of the market better than his fellow-citizens, if he can inspire the confidence of capitalists, and if his attempts to act on his own risk and responsibility prove successful. One becomes an entrepreneur, literally, by pushing forward and exposing oneself to the impartial test to which the market puts everyone who wants to become or remain an entrepreneur. Everyone has the privilege of choosing whether he wants to submit himself to this rigorous examination or not. He doesn’t have to wait to be asked to do so — he must step forward on his own initiative, and he has to worry where and how he can secure the means for his entrepreneurial activity.

For decades it was repeatedly asserted that the rise of poor people into entrepreneurial positions was no longer possible in the stage of “late capitalism.” The proof for this assertion was never given. Since this thesis was first voiced, the composition of the entrepreneurial class has basically changed; a considerable part of the former entrepreneurs and their heirs have disappeared, and the most outstanding entrepreneurs of today are again what we usually call self-made men. This constant recomposition of the entrepreneurial elite is as old as the capitalist economy itself and forms an integral part of it.

What is true of the entrepreneurs holds true for the capitalists as well. Only the capitalist who knows how to use his capital properly (from the consumer’s point of view), that is, to invest it so that the means of production will be employed most efficiently in the service of consumers, is able to keep and augment his property. If he does not want to suffer losses the capitalist has to place his means at the disposal of successful enterprises. In the market economy the capitalist, just like the entrepreneurs and the workers, serves the consumers. It seems superfluous to point out specifically in this connection that the consumers are not merely consumers but that the totality of the consumers is identical with the totality of the workers, entrepreneurs, and capitalists.

In a world of unchanging economic conditions the exact amounts which the entrepreneurs would expend for the means of production as wages, interest, and rent, would later be received by them in the prices of their products. Production costs would thus equal the prices of the products and the entrepreneurs would neither make profits nor suffer losses. But the world of reality is constantly changing, and therefore all industrial activity is essentially uncertain and speculative in character. Goods are produced to meet a future demand, about which we have little positive knowledge in the present. It is from this uncertainty that profits and losses arise; the profits and losses of the entrepreneurs depend upon how successfully they can forecast the state of future demand. Only that entrepreneur realizes a profit who anticipates the future wants of the consumers better than his competitors.

It is irrelevant to the entrepreneur, as the servant of the consumers, whether the wishes and wants of the consumers are wise or unwise, moral or immoral. He produces what the consumers want. In this sense he is amoral. He manufactures whiskey and guns just as he produces food and clothing. It is not his task to teach reason to the sovereign consumers. Should one entrepreneur, for ethical reasons of his own, refuse to manufacture whiskey, other entrepreneurs would do so as long as whiskey is wanted and bought. It is not because we have distilleries that people drink whiskey; it is because people like to drink whiskey that we have distilleries. One may deplore this. But it is not up to the entrepreneurs to improve mankind morally. And they are not to be blamed if those whose duty this is have failed to do so.

Thus the market in the capitalist economy is the process regulating production and consumption. It is the nerve-center of the capitalist system. Through it the orders of the consumers are transmitted to the producers, and the smooth functioning of the economic system is secured thereby. The market prices establish themselves at the level which equates demand and supply. When, other things being equal, more goods are brought to the market, prices fall; when, other things being equal, demand increases, prices rise.

One thing more must be noted. If within a society based on private ownership of the means of production some of these means are publicly owned and operated, this still does not make for a mixed system which would combine socialism and private property. As long as only certain individual enterprises are publicly owned, the remaining being privately owned, the characteristics of the market economy which determine economic activity remain essentially unimpaired. The publicly owned enterprises, too, as buyers of raw materials, semi-finished goods, and labor, and as sellers of goods and services, must fit into the mechanism of the market economy; they are subject to the same laws of the market. In order to maintain their position they, too, have to strive after profits or at least to avoid losses. When it is attempted to mitigate or eliminate this dependence by covering the losses of such enterprises by subsidies out of public funds, the only accomplishment is a shifting of this dependence somewhere else. This is because the means for the subsidies have to be raised somewhere. They may be raised by collecting taxes; the burden of such taxes has its effects on the market, not on the government collecting the tax; it is the market and not the revenue department which decides upon whom the tax falls and how it affects production and consumption. In these facts the domination of the market and the inescapable force of its laws is evidenced.

“Capitalism”

Descriptive terms which people use are often quite misleading. In talking about modern captains of industry and leaders of big business, for instance, they call a man a “chocolate king” or a “cotton king” or an “automobile king.” Their use of such terminology implies that they see practically no difference between the modern heads of industry and those feudal kings, dukes or lords of earlier days. But the difference is in fact very great, for a chocolate king does not rule at all, he serves. He does not reign over conquered territory, independent of the market, independent of his customers. The chocolate king — or the steel king or the automobile king or any other king of modern industry — depends on the industry he operates and on the customers he serves. This “king” must stay in the good graces of his subjects, the consumers; he loses his “kingdom” as soon as he is no longer in a position to give his customers better service and provide it at lower cost than others with whom he must compete.

Two hundred years ago, before the advent of capitalism, a man’s social status was fixed from the beginning to the end of his life; he inherited it from his ancestors, and it never changed. If he was born poor, he always remained poor, and if he was born rich — a lord or a duke — he kept his dukedom and the property that went with it for the rest of his life.

As for manufacturing, the primitive processing industries of those days existed almost exclusively for the benefit of the wealthy. Most of the people (ninety percent or more of the European population) worked the land and did not come in contact with the city-oriented processing industries. This rigid system of feudal society prevailed in the most developed areas of Europe for many hundreds of years.

However, as the rural population expanded, there developed a surplus of people on the land. For this surplus of population without inherited land or estates, there was not enough to do, nor was it possible for them to work in the processing industries; the kings of the cities denied them access. The numbers of these “outcasts” continued to grow, and still no one knew what to do with them. They were, in the full sense of the word, “proletarians,” outcasts whom the government could only put into the workhouse or the poorhouse. In some sections of Europe, especially in the Netherlands and in England, they became so numerous that, by the eighteenth century, they were a real menace to the preservation of the prevailing social system.

Today, in discussing similar conditions in places like India or other developing countries, we must not forget that, in eighteenth-century England, conditions were much worse. At that time, England had a population of six or seven million people, but of those six or seven million people, more than one million, probably two million, were simply poor outcasts for whom the existing social system made no provision. What to do with these outcasts was one of the great problems of eighteenth-century England.

Another great problem was the lack of raw materials. The British, very seriously, had to ask themselves this question: what are we going to do in the future, when our forests will no longer give us the wood we need for our industries and for heating our houses? For the ruling classes it was a desperate situation. The statesmen did not know what to do, and the ruling gentry were absolutely without any ideas on how to improve conditions.

Out of this serious social situation emerged the beginnings of modern capitalism. There were some persons among those outcasts, among those poor people, who tried to organize others to set up small shops which could produce something. This was an innovation. These innovators did not produce expensive goods suitable only for the upper classes; they produced cheaper products for everyone’s needs. And this was the origin of capitalism as it operates today. It was the beginning of mass production, the fundamental principle of capitalistic industry. Whereas the old processing industries serving the rich people in the cities had existed almost exclusively for the demands of the upper classes, the new capitalist industries began to produce things that could be purchased by the general population. It was mass production to satisfy the needs of the masses.

This is the fundamental principle of capitalism as it exists today in all of those countries in which there is a highly developed system of mass production: Big business, the target of the most fanatic attacks by the so-called leftists, produces almost exclusively to satisfy the wants of the masses. Enterprises producing luxury goods solely for the well-to-do can never attain the magnitude of big businesses. And today, it is the people who work in large factories who are the main consumers of the products made in those factories. This is the fundamental difference between the capitalistic principles of production and the feudalistic principles of the preceding ages.

When people assume, or claim, that there is a difference between the producers and the consumers of the products of big businesses, they are badly mistaken. In American department stores you hear the slogan, “the customer is always right.” And this customer is the same man who produces in the factory those things which are sold in the department stores. The people who think that the power of big business is enormous are mistaken also, since big business depends entirely on the patronage of those who buy its products: the biggest enterprise loses its power and its influence when it loses its customers.

Fifty or sixty years ago it was said in almost all capitalist countries that the railroad companies were too big and too powerful; they had a monopoly; it was impossible to compete with them. It was alleged that, in the field of transportation, capitalism had already reached a stage at which it had destroyed itself, for it had eliminated competition. What people overlooked was the fact that the power of the railroads depended on their ability to serve people better than any other method of transportation. Of course it would have been ridiculous to compete with one of these big railroad companies by building another railroad parallel to the old line, since the old line was sufficient to serve existing needs. But very soon there came other competitors. Freedom of competition does not mean that you can succeed simply by imitating or copying precisely what someone else has done. Freedom of the press does not mean that you have the right to copy what another man has written and thus to acquire the success which this other man has duly merited on account of his achievements. It means that you have the right to write something different. Freedom of competition concerning railroads, for example, means that you are free to invent something, to do something, which will challenge the railroads and place them in a very precarious competitive situation.

In the United States the competition to the railroads — in the form of buses, automobiles, trucks, and airplanes — has caused the railroads to suffer and to be almost completely defeated, as far as passenger transportation is concerned.

The development of capitalism consists in everyone’s having the right to serve the customer better and/or more cheaply. And this method, this principle, has, within a comparatively short time, transformed the whole world. It has made possible an unprecedented increase in world population. In eighteenth-century England, the land could support only six million people at a very low standard of living. Today more than fifty million people enjoy a much higher standard of living than even the rich enjoyed during the eighteenth-century. And today’s standard of living in England would probably be still higher, had not a great deal of the energy of the British been wasted in what were, from various points of view, avoidable political and military “adventures.”

These are the facts about capitalism. Thus, if an Englishman — or, for that matter, any other man in any country of the world — says today to his friends that he is opposed to capitalism, there is a wonderful way to answer him: “You know that the population of this planet is now ten times greater than it was in the ages preceding capitalism; you know that all men today enjoy a higher standard of living than your ancestors did before the age of capitalism. But how do you know that you are the one out of ten who would have lived in the absence of capitalism? The mere fact that you are living today is proof that capitalism has succeeded, whether or not you consider your own life very valuable.”

In spite of all its benefits, capitalism has been furiously attacked and criticized. It is necessary that we understand the origin of this antipathy. It is a fact that the hatred of capitalism originated not with the masses, not among the workers themselves, but among the landed aristocracy — the gentry, the nobility, of England and the European continent. They blamed capitalism for something that was not very pleasant for them: at the beginning of the nineteenth century, the higher wages paid by industry to its workers forced the landed gentry to pay equally higher wages to their agricultural workers. The aristocracy attacked the industries by criticising the standard of living of the masses of the workers.

Of course — from our viewpoint, the workers’ standard of living was extremely low; conditions under early capitalism were absolutely shocking, but not because the newly developed capitalistic industries had harmed the workers. The people hired to work in factories had already been existing at a virtually subhuman level.

The famous old story, repeated hundreds of times, that the factories employed women and children and that these women and children, before they were working in factories, had lived under satisfactory conditions, is one of the greatest falsehoods of history. The mothers who worked in the factories had nothing to cook with; they did not leave their homes and their kitchens to go into the factories, they went into factories because they had no kitchens, and if they had a kitchen they had no food to cook in those kitchens. And the children did not come from comfortable nurseries. They were starving and dying. And all the talk about the so-called unspeakable horror of early capitalism can be refuted by a single statistic: precisely in these years in which British capitalism developed, precisely in the age called the Industrial Revolution in England, in the years from 1760 to 1830, precisely in those years the population of England doubled, which means that hundreds or thousands of children — who would have died in preceding times — survived and grew to become men and women.

There is no doubt that the conditions of the preceding times were very unsatisfactory. It was capitalist business that improved them. It was precisely those early factories that provided for the needs of their workers, either directly or indirectly by exporting products and importing food and raw materials from other countries. Again and again, the early historians of capitalism have — one can hardly use a milder word — falsified history.

One anecdote they used to tell, quite possibly invented, involved Benjamin Franklin. According to the story, Ben Franklin visited a cotton mill in England, and the owner of the mill told him, full of pride: “Look, here are cotton goods for Hungary.” Benjamin Franklin, looking around, seeing that the workers were shabbily dressed, said: “Why don’t you produce also for your own workers?”

But those exports of which the owner of the mill spoke really meant that he did produce for his own workers, because England had to import all its raw materials. There was no cotton either in England or in continental Europe. There was a shortage of food in England, and food had to be imported from Poland, from Russia, from Hungary. These exports were the payment for the imports of the food which made the survival of the British population possible. Many examples from the history of those ages will show the attitude of the gentry and aristocracy toward the workers. I want to cite only two examples. One is the famous British “Speenhamland” system. By this system, the British government paid all workers who did not get the minimum wage (determined by the government) the difference between the wages they received and this minimum wage. This saved the landed aristocracy the trouble of paying higher wages. The gentry would pay the traditionally low agricultural wage, and the government would supplement it, thus keeping workers from leaving rural occupations to seek urban factory employment.

Eighty years later, after capitalism’s expansion from England to continental Europe, the landed aristocracy again reacted against the new production system. In Germany the Prussian Junkers, having lost many workers to the higher-paying capitalistic industries, invented a special term for the problem: “flight from the countryside” — Landflucht. And in the German Parliament, they discussed what might be done against this evil, as it was seen from the point of view of the landed aristocracy.

Prince Bismarck, the famous chancellor of the German Reich, in a speech one day said, “I met a man in Berlin who once had worked on my estate, and I asked this man, ‘Why did you leave the estate; why did you go away from the country; why are you now living in Berlin?’ ” And according to Bismarck, this man answered, “You don’t have such a nice Biergarten in the village as we have here in Berlin, where you can sit, drink beer, and listen to music.” This is, of course, a story told from the point of view of Prince Bismarck, the employer. It was not the point of view of all his employees. They went into industry because industry paid them higher wages and raised their standard of living to an unprecedented degree.

Today, in the capitalist countries, there is relatively little difference between the basic life of the so-called higher and lower classes; both have food, clothing, and shelter. But in the eighteenth century and earlier, the difference between the man of the middle class and the man of the lower class was that the man of the middle class had shoes and the man of the lower class did not have shoes. In the United States today the difference between a rich man and a poor man means very often only the difference between a Cadillac and a Chevrolet. The Chevrolet may be bought secondhand, but basically it renders the same services to its owner: he, too, can drive from one point to another. More than fifty percent of the people in the United States are living in houses and apartments they own themselves.

The attacks against capitalism — especially with respect to the higher wage rates — start from the false assumption that wages are ultimately paid by people who are different from those who are employed in the factories. Now it is all right for economists and for students of economic theories to distinguish between the worker and the consumer and to make a distinction between them. But the fact is that every consumer must, in some way or the other, earn the money he spends, and the immense majority of the consumers are precisely the same people who work as employees in the enterprises that produce the things which they consume. Wage rates under capitalism are not set by a class of people different from the class of people who earn the wages; they are the same people. It is not the Hollywood film corporation that pays the wages of a movie star; it is the people who pay admission to the movies. And it is not the entrepreneur of a boxing match who pays the enormous demands of the prize fighters; it is the people who pay admission to the fight. Through the distinction between the employer and the employee, a distinction is drawn in economic theory, but it is not a distinction in real life; here, the employer and the employee ultimately are one and the same person.

There are people in many countries who consider it very unjust that a man who has to support a family with several children will receive the same salary as a man who has only himself to take care of. But the question is not whether the employer should bear greater responsibility for the size of a worker’s family.

The question we must ask in this case is: Are you, as an individual, prepared to pay more for something, let us say, a loaf of bread, if you are told that the man who produced this loaf of bread has six children? The honest man will certainly answer in the negative and say, “In principle I would, but in fact if it costs less I would rather buy the bread produced by a man without any children.” The fact is that, if the buyers do not pay the employer enough to enable him to pay his workers, it becomes impossible for the employer to remain in business.

The capitalist system was termed “capitalism” not by a friend of the system, but by an individual who considered it to be the worst of all historical systems, the greatest evil that had ever befallen mankind. That man was Karl Marx. Nevertheless, there is no reason to reject Marx’s term, because it describes clearly the source of the great social improvements brought about by capitalism. Those improvements are the result of capital accumulation; they are based on the fact that people, as a rule, do not consume everything they have produced, that they save — and invest — a part of it. There is a great deal of misunderstanding about this problem and — in the course of these lectures — I will have the opportunity to deal with the most fundamental misapprehensions which people have concerning the accumulation of capital, the use of capital, and the universal advantages to be gained from such use. I will deal with capitalism particularly in my lectures about foreign investment and about that most critical problem of present-day politics, inflation. You know, of course, that inflation exists not only in this country. It is a problem all over the world today.

An often unrealized fact about capitalism is this: savings mean benefits for all those who are anxious to produce or to earn wages. When a man has accrued a certain amount of money — let us say, one thousand dollars — and, instead of spending it, entrusts these dollars to a savings bank or an insurance company, the money goes into the hands of an entrepreneur, a businessman, enabling him to go out and embark on a project which could not have been embarked on yesterday, because the required capital was unavailable.

What will the businessman do now with the additional capital? The first thing he must do, the first use he will make of this additional capital, is to go out and hire workers and buy raw materials — in turn causing a furtherdemand for workers and raw materials to develop, as well as a tendency toward higher wages and higher prices for raw materials. Long before the saver or the entrepreneur obtains any profit from all of this, the unemployed worker, the producer of raw materials, the farmer, and the wage-earner are all sharing in the benefits of the additional savings.

When the entrepreneur will get something out of the project depends on the future state of the market and on his ability to anticipate correctly the future state of the market. But the workers as well as the producers of raw materials get the benefits immediately. Much was said, thirty or forty years ago, about the “wage policy,” as they called it, of Henry Ford. One of Mr. Ford’s great accomplishments was that he paid higher wages than did other industrialists or factories. His wage policy was described as an “invention,” yet it is not enough to say that this new “invented” policy was the result of the liberality of Mr. Ford. A new branch of business, or a new factory in an already existing branch of business, has to attract workers from other employments, from other parts of the country, even from other countries. And the only way to do this is to offer the workers higher wages for their work. This is what took place in the early days of capitalism, and it is still taking place today.

When the manufacturers in Great Britain first began to produce cotton goods, they paid their workers more than they had earned before. Of course, a great percentage of these new workers had earned nothing at all before that and were prepared to take anything they were offered. But after a short time — when more and more capital was accumulated and more and more new enterprises were developed — wage rates went up, and the result was the unprecedented increase in British population which I spoke of earlier.

The scornful depiction of capitalism by some people as a system designed to make the rich become richer and the poor become poorer is wrong from beginning to end. Marx’s thesis regarding the coming of socialism was based on the assumption that workers were getting poorer, that the masses were becoming more destitute, and that finally all the wealth of a country would be concentrated in a few hands or in the hands of one man only. And then the masses of impoverished workers would finally rebel and expropriate the riches of the wealthy proprietors. According to this doctrine of Karl Marx, there can be no opportunity, no possibility within the capitalistic system for any improvement of the conditions of the workers.

In 1864, speaking before the International Workingmen’s Association in England, Marx said the belief that labor unions could improve conditions for the working population was “absolutely in error.” The union policy of asking for higher wage rates and shorter work hours he called conservative — conservatism being, of course, the most condemnatory term which Karl Marx could use. He suggested that the unions set themselves a new, revolutionary goal: that they “do away with the wage system altogether,” that they substitute “socialism” — government ownership of the means of production — for the system of private ownership.

If we look upon the history of the world, and especially upon the history of England since 1865, we realize that Marx was wrong in every respect. There is no western, capitalistic country in which the conditions of the masses have not improved in an unprecedented way. All these improvements of the last eighty or ninety years were made in spite of the prognostications of Karl Marx. For the Marxian socialists believed that the conditions of the workers could never be ameliorated. They followed a false theory, the famous “iron law of wages” — the law which stated that a worker’s wages, under capitalism, would not exceed the amount he needed to sustain his life for service to the enterprise.

The Marxians formulated their theory in this way: if the workers’ wage rates go up, raising wages above the subsistence level, they will have more children; and these children, when they enter the labor force, will increase the number of workers to the point where the wage rates will drop, bringing the workers once more down to the subsistence level — to that minimal sustenance level which will just barely prevent the working population from dying out. But this idea of Marx, and of many other socialists, is a concept of the working man precisely like that which biologists use — and rightly so — in studying the life of animals. Of mice, for instance.

If you increase the quantity of food available for animal organisms or for microbes, then more of them will survive. And if you restrict their food, then you will restrict their numbers. But man is different. Even the worker — in spite of the fact that Marxists do not acknowledge it — has human wants other than food and reproduction of his species. An increase in real wages results not only in an increase in population, it results also, and first of all, in an improvement in the average standard of living. That is why today we have a higher standard of living in Western Europe and in the United States than in the developing nations of, say, Africa.

We must realize, however, that this higher standard of living depends on the supply of capital. This explains the difference between conditions in the United States and conditions in India; modern methods of fighting contagious diseases have been introduced in India — at least, to some extent — and the effect has been an unprecedented increase in population but, since this increase in population has not been accompanied by a corresponding increase in the amount of capital invested, the result has been an increase in poverty. A country becomes more prosperous in proportion to the rise in the invested capital per unit of its population.

I hope that in my other lectures I will have the opportunity to deal in greater detail with these problems and will be able to clarify them, because some terms — such as “the capital invested per capita” — require a rather detailed explanation.

But you have to remember that, in economic policies, there are no miracles. You have read in many newspapers and speeches, about the so-called German economic miracle — the recovery of Germany after its defeat and destruction in the Second World War. But this was no miracle. It was the application of the principles of the free market economy, of the methods of capitalism, even though they were not applied completely in all respects. Every country can experience the same “miracle” of economic recovery, although I must insist that economic recovery does not come from a miracle; it comes from the adoption of — and is the result of — sound economic policies.

References

[1] [Ludwig von Mises, Interventionism: An Economic Analysis, ed. Bettina Bien Greaves (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1998), Introduction, pp. 2–5.]

[2] [Ludwig von Mises, Economic Policy: Thoughts for Tomorrow and Today (1979; Washington, D.C.: Regnery Gateway, 2006), Lecture 1, pp. 1–15.]

Chapter 6 • Emergence of Indirect Exchange • 1,200 Words

The Epistemological Import of Carl Menger’s Theory of the Origin of Money

Carl Menger has not only provided an irrefutable praxeological theory of the origin of money. He has also recognized the import of his theory for the elucidation of fundamental principles of praxeology and its methods of research.[2]Cf. Carl Menger’s books Grundsätze der Volkswirtschaftslehre (Vienna, 1871), pp. 250 ff.; ibid. (2d ed. Vienna, 1923), pp. 241 ff.; Untersuchungen über die Methode der Sozialwissenschaften (Leipzig, 1883), pp. 171 ff.
([Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 1: “Acting Man,” chap. 17: “Indirect Exchange,” pp. 402–04.])

There were authors who tried to explain the origin of money by decree or covenant. The authority, the state, or a compact between citizens has purposively and consciously established indirect exchange and money. The main deficiency of this doctrine is not to be seen in the assumption that people of an age unfamiliar with indirect exchange and money could design a plan of a new economic order, entirely different from the real conditions of their own age, and could comprehend the importance of such a plan. Neither is it to be seen in the fact that history does not afford a clue for the support of such statements. There are more substantial reasons for rejecting it.

If it is assumed that the conditions of the parties concerned are improved by every step that leads from direct exchange to indirect exchange and subsequently to giving preference for use as a medium of exchange to certain goods distinguished by their especially high marketability, it is difficult to conceive why one should, in dealing with the origin of indirect exchange, resort in addition to authoritarian decree or an explicit compact between citizens. A man who finds it hard to obtain in direct barter what he wants to acquire renders better his chances to acquire what he is asking for in later acts of exchange by the procurement of a more marketable good. Under these circumstances there was no need of government interference or of a compact between the citizens. The happy idea of proceeding in this way could strike the shrewdest individuals, and the less resourceful could imitate the former’s method. It is certainly more plausible to take for granted that the immediate advantages conferred by indirect exchange were recognized by the acting parties than to assume that the whole image of a society trading by means of money was conceived by a genius and, if we adopt the covenant doctrine, made obvious to the rest of the people by persuasion.

If, however, we do not assume that individuals discovered the fact that they fare better through indirect exchange than through waiting for an opportunity for direct exchange, and, for the sake of argument, admit that the authorities or a compact introduced money, further questions are raised. We must ask what kind of measures were applied in order to induce people to adopt a procedure the utility of which they did not comprehend and which was technically more complicated than direct exchange. We may assume that compulsion was practiced. But then we must ask, further, at what time and by what occurrences indirect exchange and the use of money later ceased to be procedures troublesome or at least indifferent to the individuals concerned and became advantageous to them.

The praxeological method traces all phenomena back to the actions of individuals. If conditions of interpersonal exchange are such that indirect exchange facilitates the transactions, and if and as far as people realize these advantages, indirect exchange and money come into being. Historical experience shows that these conditions were and are present. How, in the absence of these conditions, people could have adopted indirect exchange and money and clung to these modes of exchanging is inconceivable.

The historical question concerning the origin of indirect exchange and money is after all of no concern to praxeology. The only relevant thing is that indirect exchange and money exist because the conditions for their existence were and are present. If this is so, praxeology does not need to resort to the hypothesis that authoritarian decree or a covenant invented these modes of exchanging. The étatists may if they like continue to ascribe the “invention” of money to the state, however unlikely this may be. What matters is that a man acquires a good not in order to consume it or to use it in production, but in order to give it away in a further act of exchange. Such conduct on the part of people makes a good a medium of exchange and, if such conduct becomes common with regard to a certain good, makes it money. All theorems of the catallactic theory of media of exchange and of money refer to the services which a good renders in its capacity as a medium of exchange. Even if it were true that the impulse for the introduction of indirect exchange and money was provided by the authorities or by an agreement between the members of society, the statement remains unshaken that only the conduct of exchanging people can create indirect exchange and money.

History may tell us where and when for the first time media of exchange came into use and how, subsequently, the range of goods employed for this purpose was more and more restricted. As the differentiation between the broader notion of a medium of exchange and the narrower notion of money is not sharp, but gradual, no agreement can be reached about the historical transition from simple media of exchange to money. This is a matter of historical understanding. But, as has been mentioned, the distinction between direct exchange and indirect exchange is sharp and everything that catallactics establishes with regard to media of exchange refers categorially to all goods which are demanded and acquired as such media.

As far as the statement that indirect exchange and money were established by decree or by covenant is meant to be an account of historical events, it is the task of historians to expose its falsity. As far as it is advanced merely as a historical statement, it can in no way affect the catallactic theory of money and its explanation of the evolution of indirect exchange. But if it is designed as a statement about human action and social events, it is useless because it states nothing about action. It is not a statement about human action to declare that one day rulers of citizens assembled in convention were suddenly struck by the inspiration that it would be a good idea to exchange indirectly and through the intermediary of a commonly used medium of exchange. It is merely pushing back the problem involved.

It is necessary to comprehend that one does not contribute anything to the scientific conception of human actions and social phenomena if one declares that the state or a charismatic leader or an inspiration which descended upon all the people have created them. Neither do such statements refute the teachings of a theory showing how such phenomena can be acknowledged as “the unintentional outcome, the resultant not deliberately designed and aimed at by specifically individual endeavors of the members of society.”

Footnotes

[1] [Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 1: “Acting Man,” chap. 17: “Indirect Exchange,” pp. 402–04.]

[2] Cf. Carl Menger’s books Grundsätze der Volkswirtschaftslehre (Vienna, 1871), pp. 250 ff.; ibid. (2d ed. Vienna, 1923), pp. 241 ff.; Untersuchungen über die Methode der Sozialwissenschaften (Leipzig, 1883), pp. 171 ff.

Chapter 7 • Economic Calculation • 5,400 Words

2. The Nature of Economic Calculation

Every man who, in the course of economic life, takes a choice between the satisfaction of one need as against another, eo ipso makes a judgment of value. Such judgments of value at once include only the very satisfaction of the need itself; and from this they reflect back upon the goods of a lower, and then further upon goods of a higher order. As a rule, the man who knows his own mind is in a position to value goods of a lower order. Under simple conditions it is also possible for him without much ado to form some judgment of the significance to him of goods of a higher order. But where the state of affairs is more involved and their interconnections not so easily discernible, subtler means must be employed to accomplish a correct[2]Using that term, of course, in the sense only of the valuating subject, and not in an objective and universally applicable sense. valuation of the means of production. It would not be difficult for a farmer in economic isolation to come by a distinction between the expansion of pasture-farming and the development of activity in the hunting field. In such a case the processes of production involved are relatively short and the expense and income entailed can be easily gauged. But it is quite a different matter when the choice lies between the utilization of a water-course for the manufacture of electricity or the extension of a coal mine or the drawing up of plans for the better employment of the energies latent in raw coal. Here the roundabout processes of production are many and each is very lengthy; here the conditions necessary for the success of the enterprises which are to be initiated are diverse, so that one cannot apply merely vague valuations, but requires rather more exact estimates and some judgment of the economic issues actually involved.

Valuation can only take place in terms of units, yet it is impossible that there should ever be a unit of subjective use value for goods. Marginal utility does not posit any unit of value, since it is obvious that the value of two units of a given stock is necessarily greater than, but less than double, the value of a single unit. Judgments of value do not measure; they merely establish grades and scales.[3]Franz Cuhel, Zur Lehre von den Bedürfnissen (Innsbruck: Wagner’sche Universität-Buchhandlung, 1907), pp. 198 f. Even Robinson Crusoe, when he has to make a decision where no ready judgment of value appears and where he has to construct one upon the basis of a more or less exact estimate, cannot operate solely with subjective use value, but must take into consideration the intersubstitutability of goods on the basis of which he can then form his estimates. In such circumstances it will be impossible for him to refer all things back to one unit. Rather will he, so far as he can, refer all the elements which have to be taken into account in forming his estimate to those economic goods which can be apprehended by an obvious judgment of value — that is to say, to goods of a lower order and to pain-cost. That this is only possible in very simple conditions is obvious. In the case of more complicated and more lengthy processes of production it will, plainly, not answer.

In an exchange economy the objective exchange value of commodities enters as the unit of economic calculation. This entails a threefold advantage. In the first place, it renders it possible to base the calculation upon the valuations of all participants in trade. The subjective use value of each is not immediately comparable as a purely individual phenomenon with the subjective use value of other men. It only becomes so in exchange value, which arises out of the interplay of the subjective valuations of all who take part in exchange. But in that case calculation by exchange value furnishes a control over the appropriate employment of goods. Anyone who wishes to make calculations in regard to a complicated process of production will immediately notice whether he has worked more economically than others or not; if he finds, from reference to the exchange relations obtaining in the market, that he will not be able to produce profitably, this shows that others understand how to make a better use of the goods of higher order in question. Lastly, calculation by exchange value makes it possible to refer values back to a unit. For this purpose, since goods are mutually substitutable in accordance with the exchange relations obtaining in the market, any possible good can be chosen. In a monetary economy it is money that is so chosen.

Monetary calculation has its limits. Money is no yardstick of value, nor yet of price. Value is not indeed measured in money, nor is price. They merely consist in money. Money as an economic good is not of stable value as has been naïvely, but wrongly, assumed in using it as a “standard of deferred payments.” The exchange-relationship which obtains between money and goods is subjected to constant, if (as a rule) not too violent, fluctuations originating not only from the side of other economic goods, but also from the side of money. However, these fluctuations disturb value calculations only in the slightest degree, since usually, in view of the ceaseless alternations in other economic data — these calculations will refer only to comparatively short periods of time — periods in which “good” money, at least normally, undergoes comparatively trivial fluctuations in regard to its exchange relations. The inadequacy of the monetary calculation of value does not have its mainspring in the fact that value is then calculated in terms of a universal medium of exchange, namely money, but rather in the fact that in this system it is exchange value and not subjective use value on which the calculation is based. It can never obtain as a measure for the calculation of those value determining elements which stand outside the domain of exchange transactions. If, for example, a man were to calculate the profitability of erecting a waterworks, he would not be able to include in his calculation the beauty of the waterfall which the scheme might impair, except that he may pay attention to the diminution of tourist traffic or similar changes, which may be valued in terms of money. Yet these considerations might well prove one of the factors in deciding whether or not the building is to go up at all.

It is customary to term such elements “extra-economic.” This perhaps is appropriate; we are not concerned with disputes over terminology; yet the considerations themselves can scarcely be termed irrational. In any place where men regard as significant the beauty of a neighborhood or of a building, the health, happiness and contentment of mankind, the honor of individuals or nations, they are just as much motive forces of rational conduct as are economic factors in the proper sense of the word, even where they are not substitutable against each other on the market and therefore do not enter into exchange relationships.

That monetary calculation cannot embrace these factors lies in its very nature; but for the purposes of our everyday economic life this does not detract from the significance of monetary calculation. For all those ideal goods are goods of a lower order, and can hence be embraced straightway within the ambit of our judgment of values. There is therefore no difficulty in taking them into account, even though they must remain outside the sphere of monetary value. That they do not admit of such computation renders their consideration in the affairs of life easier and not harder. Once we see clearly how highly we value beauty, health, honor and pride, surely nothing can prevent us from paying a corresponding regard to them. It may seem painful to any sensitive spirit to have to balance spiritual goods against material. But that is not the fault of monetary calculation; it lies in the very nature of things themselves. Even where judgments of value can be established directly without computation in value or in money, the necessity of choosing between material and spiritual satisfaction cannot be evaded. Robinson Crusoe and the socialist state have an equal obligation to make the choice.

Anyone with a genuine sense of moral values experiences no hardship in deciding between honor and livelihood. He knows his plain duty. If a man cannot make honor his bread, yet can he renounce his bread for honor’s sake. Only they who prefer to be relieved of the agony of this decision, because they cannot bring themselves to renounce material comfort for the sake of spiritual advantage, see in the choice a profanation of true values.

Monetary calculation only has meaning within the sphere of economic organization. It is a system whereby the rules of economics may be applied in the disposition of economic goods. Economic goods only have part in this system in proportion to the extent to which they may be exchanged for money. Any extension of the sphere of monetary calculation causes misunderstanding. It cannot be regarded as constituting a kind of yardstick for the valuation of goods, and cannot be so treated in historical investigations into the development of social relationships; it cannot be used as a criterion of national wealth and income, nor as a means of gauging the value of goods which stand outside the sphere of exchange, as who should seek to estimate the extent of human losses through emigrations or wars in terms of money?[4]Cf. Friedrich von Wieser, Über den Ursprung und die Hauptgesetze des wirtschaftlichen Eertes (Vienna: A. Hölder, 1884), pp. 185 f. This is mere sciolistic tomfoolery, however much it may be indulged in by otherwise perspicacious economists.

Nevertheless within these limits, which in economic life it never oversteps, monetary calculation fulfils all the requirements of economic calculation. It affords us a guide through the oppressive plenitude of economic potentialities. It enables us to extend to all goods of a higher order the judgment of value, which is bound up with and clearly evident in, the case of goods ready for consumption, or at best of production goods of the lowest order. It renders their value capable of computation and thereby gives us the primary basis for all economic operations with goods of a higher order. Without it, all production involving processes stretching well back in time and all the longer roundabout processes of capitalistic production would be gropings in the dark.

There are two conditions governing the possibility of calculating value in terms of money. Firstly, not only must goods of a lower, but also those of a higher order, come within the ambit of exchange, if they are to be included. If they do not do so, exchange relationships would not arise. True enough, the considerations which must obtain in the case of Robinson Crusoe prepared, within the range of his own hearth, to exchange, by production, labor and flour for bread, are indistinguishable from those which obtain when he is prepared to exchange bread for clothes in the open market, and, therefore, it is to some extent true to say that every economic action, including Robinson Crusoe’s own production, can be termed exchange.[5]Cf. [Ludwig von] Mises, Theorie des Geldes und der Umlaufsmittel (Munich and Leipzig: Duncker & Humblot, 1912), p. 16, with the references there given. [See the English translation by H.E. Batson, The Theory of Money and Credit (Indianapolis: Liberty Classics, 1980), p. 52.] Moreover, the mind of one man alone — be it ever so cunning, is too weak to grasp the importance of any single one among the countlessly many goods of a higher order. No single man can ever master all the possibilities of production, innumerable as they are, as to be in a position to make straightway evident judgments of value without the aid of some system of computation. The distribution among a number of individuals of administrative control over economic goods in a community of men who take part in the labor of producing them, and who are economically interested in them, entails a kind of intellectual division of labor, which would not be possible without some system of calculating production and without economy.

The second condition is that there exists in fact a universally employed medium of exchange — namely, money — which plays the same part as a medium in the exchange of production goods also. If this were not the case, it would not be possible to reduce all exchange-relationships to a common denominator.

Only under simple conditions can economics dispense with monetary calculation. Within the narrow confines of household economy, for instance, where the father can supervise the entire economic management, it is possible to determine the significance of changes in the processes of production, without such aids to the mind, and yet with more or less of accuracy. In such a case the process develops under a relatively limited use of capital. Few of the capitalistic roundabout processes of production are here introduced: what is manufactured is, as a rule, consumption goods or at least such goods of a higher order as stand very near to consumption-goods. The division of labor is in its rudimentary stages: one and the same laborer controls the labor of what is in effect, a complete process of production of goods ready for consumption, from beginning to end. All this is different, however, in developed communal production. The experiences of a remote and bygone period of simple production do not provide any sort of argument for establishing the possibility of an economic system without monetary calculation.

In the narrow confines of a closed household economy, it is possible throughout to review the process of production from beginning to end, and to judge all the time whether one or another mode of procedure yields more consumable goods. This, however, is no longer possible in the incomparably more involved circumstances of our own social economy. It will be evident, even in the socialist society, that 1,000 hectolitres of wine are better than 800, and it is not difficult to decide whether it desires 1,000 hectolitres of wine rather than 500 of oil. There is no need for any system of calculation to establish this fact: the deciding element is the will of the economic subjects involved. But once this decision has been taken, the real task of rational economic direction only commences, i.e., economically, to place the means at the service of the end. That can only be done with some kind of economic calculation. The human mind cannot orientate itself properly among the bewildering mass of intermediate products and potentialities of production without such aid. It would simply stand perplexed before the problems of management and location.[6]Friedrich von Gottl-Ottlilienfeld, Wirtschaft und technik (Grundriss der Sozialökonomik, Section 2; Tübingen: J.C.B. Mohr, 1914), p. 216.

It is an illusion to imagine that in a socialist state calculation in natura can take the place of monetary calculation. Calculation in natura, in an economy without exchange, can embrace consumption goods only; it completely fails when it comes to dealing with goods of a higher order. And as soon as one gives up the conception of a freely established monetary price for goods of a higher order, rational production becomes completely impossible. Every step that takes us away from private ownership of the means of production and from the use of money also takes us away from rational economics.

It is easy to overlook this fact, considering that the extent to which socialism is in evidence among us constitutes only a socialistic oasis in a society with monetary exchange, which is still a free society to a certain degree. In one sense we may agree with the socialists’ assertion which is otherwise entirely untenable and advanced only as a demagogic point, to the effect that the nationalization and municipalization of enterprise is not really socialism, since these concerns in their business organizations are so much dependent upon the environing economic system with its free commerce that they cannot be said to partake today of the really essential nature of a socialist economy. In state and municipal undertakings technical improvements are introduced because their effect in similar private enterprises, domestic or foreign, can be noticed, and because those private industries which produce the materials for these improvements give the impulse for their introduction. In these concerns the advantages of reorganization can be established, because they operate within the sphere of a society based upon private ownership of the means of production and upon the system of monetary exchange, being thus capable of computation and account. This state of affairs, however, could not obtain in the case of socialist concerns operating in a purely socialistic environment.

Without economic calculation there can be no economy. Hence, in a socialist state wherein the pursuit of economic calculation is impossible, there can be — in our sense of the term — no economy whatsoever. In trivial and secondary matters rational conduct might still be possible, but in general it would be impossible to speak of rational production any more. There would be no means of determining what was rational, and hence it is obvious that production could never be directed by economic considerations. What this means is clear enough, apart from its effects on the supply of commodities. Rational conduct would be divorced from the very ground which is its proper domain. Would there, in fact, be any such thing as rational conduct at all, or, indeed, such a thing as rationality and logic in thought itself? Historically, human rationality is a development of economic life. Could it then obtain when divorced therefrom?

For a time the remembrance of the experiences gained in a competitive economy, which has obtained for some thousands of years, may provide a check to the complete collapse of the art of economy. The older methods of procedure might be retained not because of their rationality but because they appear to be hallowed by tradition. Actually, they would meanwhile have become irrational, as no longer comporting with the new conditions. Eventually, through the general reconstruction of economic thought, they will experience alterations which will render them in fact uneconomic. The supply of goods will no longer proceed anarchically of its own accord; that is true. All transactions which serve the purpose of meeting requirements will be subject to the control of a supreme authority. Yet in place of the economy of the “anarchic” method of production, recourse will be had to the senseless output of an absurd apparatus. The wheels will turn, but will run to no effect.

One may anticipate the nature of the future socialist society. There will be hundreds and thousands of factories in operation. Very few of these will be producing wares ready for use; in the majority of cases what will be manufactured will be unfinished goods and production goods. All these concerns will be interrelated. Every good will go through a whole series of stages before it is ready for use. In the ceaseless toil and moil of this process, however, the administration will be without any means of testing their bearings. It will never be able to determine whether a given good has not been kept for a superfluous length of time in the necessary processes of production, or whether work and material have not been wasted in its completion. How will it be able to decide whether this or that method of production is the more profitable? At best it will only be able to compare the quality and quantity of the consumable end product produced, but will in the rarest cases be in a position to compare the expenses entailed in production. It will know, or think it knows, the ends to be achieved by economic organization, and will have to regulate its activities accordingly, i.e., it will have to attain those ends with the least expense. It will have to make its computations with a view to finding the cheapest way. This computation will naturally have to be a value computation. It is eminently clear, and requires no further proof, that it cannot be of a technical character, and that it cannot be based upon the objective use value of goods and services.

Now, in the economic system of private ownership of the means of production, the system of computation by value is necessarily employed by each independent member of society. Everybody participates in its emergence in a double way: on the one hand as a consumer and on the other as a producer. As a consumer he establishes a scale of valuation for goods ready for use in consumption. As a producer he puts goods of a higher order into such use as produces the greatest return. In this way all goods of a higher order receive a position in the scale of valuations in accordance with the immediate state of social conditions of production and of social needs. Through the interplay of these two processes of valuation, means will be afforded for governing both consumption and production by the economic principle throughout. Every graded system of pricing proceeds from the fact that men always and ever harmonized their own requirements with their estimation of economic facts.

All this is necessarily absent from a socialist state. The administration may know exactly what goods are most urgently needed. But in so doing, it has only found what is, in fact, but one of the two necessary prerequisites for economic calculation. In the nature of the case it must, however, dispense with the other — the valuation of the means of production. It may establish the value attained by the totality of the means of production; this is obviously identical with that of all the needs thereby satisfied. It may also be able to calculate the value of any means of production by calculating the consequence of its withdrawal in relation to the satisfaction of needs. Yet it cannot reduce this value to the uniform expression of a money price, as can a competitive economy, wherein all prices can be referred back to a common expression in terms of money. In a socialist commonwealth which, whilst it need not of necessity dispense with money altogether, yet finds it impossible to use money as an expression of the price of the factors of production (including labor), money can play no role in economic calculation.[7]This fact is also recognized by Otto Neurath (Durch die Kriegswirtschaft zur Naturalwirtschaft [Munich: G.D.W. Callwey, 1919], pp. 216 f.). He advances the view that every complete administrative economy is, in the final analysis, a natural economy. “Socialization,” he says, “is thus the pursuit of natural economy.” Neurath merely overlooks the insuperable difficulties that would have to develop with economic calculation in the socialist commonwealth.

Picture the building of a new railroad. Should it be built at all, and if so, which out of a number of conceivable roads should be built? In a competitive and monetary economy, this question would be answered by monetary calculation. The new road will render less expensive the transport of some goods, and it may be possible to calculate whether this reduction of expense transcends that involved in the building and upkeep of the next line. That can only be calculated in money. It is not possible to attain the desired end merely by counterbalancing the various physical expenses and physical savings. Where one cannot express hours of labor, iron, coal, all kinds of building material, machines and other things necessary for the construction and upkeep of the railroad in a common unit it is not possible to make calculations at all. The drawing up of bills on an economic basis is only possible where all the goods concerned can be referred back to money. Admittedly, monetary calculation has its inconveniences and serious defects, but we have certainly nothing better to put in its place, and for the practical purposes of life monetary calculation as it exists under a sound monetary system always suffices. Were we to dispense with it, any economic system of calculation would become absolutely impossible.

The socialist society would know how to look after itself. It would issue an edict and decide for or against the projected building. Yet this decision would depend at best upon vague estimates; it would never be based upon the foundation of an exact calculation of value.

The static state can dispense with economic calculation. For here the same events in economic life are ever recurring; and if we assume that the first disposition of the static socialist economy follows on the basis of the final state of the competitive economy, we might at all events conceive of a socialist production system which is rationally controlled from an economic point of view. But this is only conceptually possible. For the moment, we leave aside the fact that a static state is impossible in real life, as our economic data are forever changing, so that the static nature of economic activity is only a theoretical assumption corresponding to no real state of affairs, however necessary it may be for our thinking and for the perfection of our knowledge of economics. Even so, we must assume that the transition to socialism must, as a consequence of the levelling out of the differences in income and the resultant readjustments in consumption, and therefore production, change all economic data in such a way that a connecting link with the final state of affairs in the previously existing competitive economy becomes impossible. But then we have the spectacle of a socialist economic order floundering in the ocean of possible and conceivable economic combinations without the compass of economic calculation.

Thus in the socialist commonwealth every economic change becomes an undertaking whose success can be neither appraised in advance nor later retrospectively determined. There is only groping in the dark. Socialism is the abolition of rational economy.

1. Monetary Calculation as a Method of Thinking

Monetary calculation is the guiding star of action under the social system of division of labor. It is the compass of the man embarking upon production. He calculates in order to distinguish the remunerative lines of production from the unprofitable ones, those of which the sovereign consumers are likely to approve from those of which they are likely to disapprove. Every single step of entrepreneurial activities is subject to scrutiny by monetary calculation. The premeditation of planned action becomes commercial precalculation of expected costs and expected proceeds. The retrospective establishment of the outcome of past action becomes accounting of profit and loss.

The system of economic calculation in monetary terms is conditioned by certain social institutions. It can operate only in an institutional setting of the division of labor and private ownership of the means of production in which goods and services of all orders are bought and sold against a generally used medium of exchange, i.e., money.

Monetary calculation is the method of calculating employed by people acting within the frame of society based on private control of the means of production. It is a device of acting individuals; it is a mode of computation designed for ascertaining private wealth and income and private profits and losses of individuals acting on their own behalf within a free enterprise society.[9]In partnerships and corporations it is always individuals who act, although not only one individual. All its results refer to the actions of individuals only. When statisticians summarize these results, the outcome shows the sum of the autonomous actions of a plurality of self-directing individuals, but not the effect of the action of a collective body, of a whole, or of a totality. Monetary calculation is entirely inapplicable and useless for any consideration which does not look at things from the point of view of individuals. It involves calculating the individuals’ profits, not imaginary “social” values and “social” welfare.

Monetary calculation is the main vehicle of planning and acting in the social setting of a society of free enterprise directed and controlled by the market and its prices. It developed in this frame and was gradually perfected with the improvement of the market mechanism and with the expansion of the scope of things which are negotiated on markets against money. It was economic calculation that assigned to measurement, number, and reckoning the role they play in our quantitative and computing civilization. The measurements of physics and chemistry make sense for practical action only because there is economic calculation. It is monetary calculation that made arithmetic a tool in the struggle for a better life. It provides a mode of using the achievements of laboratory experiments for the most efficacious removal of uneasiness.

Monetary calculation reaches its full perfection in capital accounting. It establishes the money prices of the available means and confronts this total with the changes brought about by action and by the operation of other factors. This confrontation shows what changes occurred in the state of the acting men’s affairs, and the magnitude of those changes; it makes success and failure, profit and loss ascertainable. The system of free enterprise has been dubbed capitalism in order to deprecate and to smear it. However, this term can be considered very pertinent. It refers to the most characteristic feature of the system, its main eminence, viz. the role the notion of capital plays in its conduct.

There are people to whom monetary calculation is repulsive. They do not want to be roused from their daydreams by the voice of critical reason. Reality sickens them, they long for a realm of unlimited opportunity. They are disgusted by the meanness of a social order in which everything is nicely reckoned in dollars and pennies. They call their grumbling the noble deportment worthy of the friends of the spirit, of beauty, and virtue as opposed to the ignoble baseness and villainy of Babbittry. However, the cult of beauty and virtue, wisdom and the search for truth are not hindered by the rationality of the calculating and computing mind. It is only romantic reverie that cannot thrive in a milieu of sober criticism. The cool-headed reckoner is the stern chastiser of the ecstatic visionary.

Our civilization is inseparably linked with our methods of economic calculation. It would perish if we were to abandon this most precious intellectual tool of acting. Goethe was right in calling bookkeeping by double entry “one of the finest inventions of the human mind.”[10]Cf. [Johann Wolfgang von] Goethe, Wilhelm Meister’s Apprenticeship (1795), Bk. 1, chap. 10.

2. Economic Calculation and the Science of Human Action

The evolution of capitalist economic calculation was the necessary condition for the establishment of a systematic and logically coherent science of human action. Praxeology and economics have a definite place in the evolution of human history and in the process of scientific research. They could only emerge when acting man had succeeded in creating methods of thinking that made it possible to calculate his actions. The science of human action was at the beginning merely a discipline dealing with those actions which can be tested by monetary calculation. It dealt exclusively with what we may call the orbit of economics in the narrower sense, that is, with those actions which within a market society are transacted by the intermediary of money. The first steps on the way to its elaboration were odd investigations concerning currency, moneylending, and the prices of various goods. The knowledge conveyed by Gresham’s Law, the first crude formulations of the quantity theory of money — such as those of Bodin and Davanzati — and the Law of Gregory King mark the first dawn of the cognition that regularity of phenomena and inevitable necessity prevail in the field of action. The first comprehensive system of economic theory, that brilliant achievement of the classical economists, was essentially a theory of calculated action. It drew implicitly the borderline between what is to be considered economic and what extra-economic along the line which separates action calculated in monetary terms from other action. Starting from this basis the economists were bound to widen step by step the field of their studies until they finally developed a system dealing with all human choices, a general theory of action.

References • 200 Words

[1] [Ludwig von Mises, Economic Calculation in the Socialist Commonwealth (1920; Auburn, Ala.: Mises Institute, 1990), pp. 10–26.]

[2] Using that term, of course, in the sense only of the valuating subject, and not in an objective and universally applicable sense.

[3] Franz Cuhel, Zur Lehre von den Bedürfnissen (Innsbruck: Wagner’sche Universität-Buchhandlung, 1907), pp. 198 f.

[4] Cf. Friedrich von Wieser, Über den Ursprung und die Hauptgesetze des wirtschaftlichen Eertes (Vienna: A. Hölder, 1884), pp. 185 f.

[5] Cf. [Ludwig von] Mises, Theorie des Geldes und der Umlaufsmittel (Munich and Leipzig: Duncker & Humblot, 1912), p. 16, with the references there given. [See the English translation by H.E. Batson, The Theory of Money and Credit (Indianapolis: Liberty Classics, 1980), p. 52.]

[6] Friedrich von Gottl-Ottlilienfeld, Wirtschaft und technik (Grundriss der Sozialökonomik, Section 2; Tübingen: J.C.B. Mohr, 1914), p. 216.

[7] This fact is also recognized by Otto Neurath (Durch die Kriegswirtschaft zur Naturalwirtschaft [Munich: G.D.W. Callwey, 1919], pp. 216 f.). He advances the view that every complete administrative economy is, in the final analysis, a natural economy. “Socialization,” he says, “is thus the pursuit of natural economy.” Neurath merely overlooks the insuperable difficulties that would have to develop with economic calculation in the socialist commonwealth.

[8] [Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 13: “Monetary Calculation as a Tool of Action,” pp. 230–32.]

[9] In partnerships and corporations it is always individuals who act, although not only one individual.

[10] Cf. [Johann Wolfgang von] Goethe, Wilhelm Meister’s Apprenticeship (1795), Bk. 1, chap. 10.

Chapter 8 • Profit and Loss • 11,400 Words

“Profit and Loss”

1. The Emergence of Profit and Loss

In the capitalist system of society’s economic organization the entrepreneurs determine the course of production. In the performance of this function they are unconditionally and totally subject to the sovereignty of the buying public, the consumers. If they fail to produce in the cheapest and best possible way those commodities which the consumers are asking for most urgently, they suffer losses and are finally eliminated from their entrepreneurial position. Other men who know better how to serve the consumers replace them.

If all people were to anticipate correctly the future state of the market, the entrepreneurs would neither earn any profits nor suffer any losses. They would have to buy the complementary factors of production at prices which would, already at the instant of the purchase, fully reflect the future prices of the products. No room would be left either for profit or for loss. What makes profit emerge is the fact that the entrepreneur who judges the future prices of the products more correctly than other people do buys some or all of the factors of production at prices which, seen from the point of view of the future state of the market, are too low. Thus the total costs of production — including interest on the capital invested — lag behind the prices which the entrepreneur receives for the product. This difference is entrepreneurial profit.

On the other hand, the entrepreneur who misjudges the future prices of the products allows for the factors of production prices which, seen from the point of view of the future state of the market, are too high. His total costs of production exceed the prices at which he can sell the product. This difference is entrepreneurial loss.

Thus profit and loss are generated by success or failure in adjusting the course of production activities to the most urgent demand of the consumers. Once this adjustment is achieved, they disappear. The prices of the complementary factors of production reach a height at which total costs of production coincide with the price of the product. Profit and loss are ever-present features only on account of the fact that ceaseless change in the economic data makes again and again new discrepancies, and consequently the need for new adjustments originate.

2. The Distinction Between Profits and Other Proceeds

Many errors concerning the nature of profit and loss were caused by the practice of applying the term profit to the totality of the residual proceeds of an entrepreneur.

Interest on the capital employed is not a component part of profit. The dividends of a corporation are not profit. They are interest on the capital invested plus profit or minus loss.

The market equivalent of work performed by the entrepreneur in the conduct of the enterprise’s affairs is entrepreneurial quasi-wages but not profit.

If the enterprise owns a factor on which it can earn monopoly prices, it makes a monopoly gain. If this enterprise is a corporation, such gains increase the dividend. Yet they are not profit proper.

Still more serious are the errors due to the confusion of entrepreneurial activity and technological innovation and improvement.

The maladjustment, the removal of which is the essential function of entrepreneurship, may often consist in the fact that new technological methods have not yet been utilized to the full extent to which they should be in order to bring about the best possible satisfaction of consumers’ demand. But this is not necessarily always the case. Changes in the data, especially in consumers’ demand, may require adjustments which have no reference at all to technological innovations and improvements. The entrepreneur who simply increases the production of an article by adding to the existing production facilities a new outfit without any change in the technological method of production is no less an entrepreneur than the man who inaugurates a new way of producing. The business of the entrepreneur is not merely to experiment with new technological methods, but to select from the multitude of technologically feasible methods those which are best fit to supply the public in the cheapest way with the things they are asking for most urgently. Whether a new technological procedure is or is not fit for this purpose is to be provisionally decided by the entrepreneur and will be finally decided by the conduct of the buying public. The question is not whether a new method is to be considered as a more “elegant” solution of a technological problem. It is whether, under the given state of economic data, it is the best possible method of supplying the consumers in the cheapest way.

The activities of the entrepreneur consist in making decisions. He determines for what purpose the factors of production should be employed. Any other acts which an entrepreneur may perform are merely accidental to his entrepreneurial function. It is this that laymen often fail to realize. They confuse the entrepreneurial activities with the conduct of the technological and administrative affairs of a plant. In their eyes not the stockholders, the promoters and speculators, but hired employees are the real entrepreneurs. The former are merely idle parasites who pocket the dividends.

Now nobody ever contended that one could produce without working. But neither is it possible to produce without capital goods, the previously produced factors of further production. These capital goods are scarce, i.e., they do not suffice for the production of all things which one would like to have produced. Hence the economic problem arises: to employ them in such a way that only those goods should be produced which are fit to satisfy the most urgent demands of the consumers. No good should remain unproduced on account of the fact that the factors required for its production were used — wasted — for the production of another good for which the demand of the public is less intense. To achieve this is, under capitalism, the function of entrepreneurship that determines the allocation of capital to the various branches of production. Under socialism it would be a function of the state, the social apparatus of coercion and oppression. The problem whether a socialist directorate, lacking any method of economic calculation, could fulfill this function is not to be dealt with in this essay.

There is a simple rule of thumb to tell entrepreneurs from non-entrepreneurs. The entrepreneurs are those on whom the incidence of losses on the capital employed falls. Amateur-economists may confuse profits with other kinds of intakes. But it is impossible to fail to recognize losses on the capital employed.

3. Non-Profit Conduct of Affairs

What has been called the democracy of the market manifests itself in the fact that profit-seeking business is unconditionally subject to the supremacy of the buying public.

Non-profit organizations are sovereign unto themselves. They are, within the limits drawn by the amount of capital at their disposal, in a position to defy the wishes of the public.

A special case is that of the conduct of government affairs, the administration of the social apparatus of coercion and oppression, viz., the police power. The objectives of government, the protection of the inviolability of the individuals’ lives and health and of their efforts to improve the material conditions of their existence, are indispensable. They benefit all and are the necessary prerequisite of social cooperation and civilization. But they cannot be sold and bought in the way merchandise is sold and bought; they have therefore no price on the market. With regard to them there cannot be any economic calculation. The costs expended for their conduct cannot be confronted with a price received for the product. This state of affairs would make the officers entrusted with the administration of governmental activities irresponsible despots if they were not curbed by the budget system. Under this system the administrators are forced to comply with detailed instructions enjoined upon them by the sovereign, be it a self-appointed autocrat or the whole people acting through elected representatives. To the officers limited funds are assigned which they are bound to spend only for those purposes which the sovereign has ordered. Thus the management of public administration becomes bureaucratic, i.e., dependent on definite detailed rules and regulations.

Bureaucratic management is the only alternative available where there is no profit and loss management.

4. The Ballot of the Market

The consumers by their buying and abstention from buying elect the entrepreneurs in a daily repeated plebiscite as it were. They determine who should own and who not, and how much each owner should own.

As is the case with all acts of choosing a person — choosing holders of public office, employees, friends or a consort — the decision of the consumers is made on the ground of experience and thus necessarily always refers to the past. There is no experience of the future. The ballot of the market elevates those who in the immediate past have best served the consumers. However, the choice is not unalterable and can daily be corrected. The elected who disappoints the electorate is speedily reduced to the ranks.

Each ballot of the consumers adds only a little to the elected man’s sphere of action. To reach the upper levels of entrepreneurship he needs a great number of votes, repeated again and again over a long period of time, a protracted series of successful strokes. He must stand every day a new trial, must submit anew to reelection as it were.

It is the same with his heirs. They can retain their eminent position only by receiving again and again confirmation on the part of the public. Their office is revocable. If they retain it, it is not on account of the deserts of their predecessor, but on account of their own ability to employ the capital for the best possible satisfaction of the consumers.

The entrepreneurs are neither perfect nor good in any metaphysical sense. They owe their position exclusively to the fact that they are better fit for the performance of the functions incumbent upon them than other people are. They earn profit not because they are clever in performing their tasks, but because they are more clever or less clumsy than other people are. They are not infallible and often blunder. But they are less liable to error and blunder less than other people do. Nobody has the right to take offense at the errors made by the entrepreneurs in the conduct of affairs and to stress the point that people would have been better supplied if the entrepreneurs had been more skillful and prescient. If the grumbler knew better, why did he not himself fill the gap and seize the opportunity to earn profits? It is easy indeed to display foresight after the event. In retrospect all fools become wise.

A popular chain of reasoning runs this way: The entrepreneur earns profit not only on account of the fact that other people were less successful than he in anticipating correctly the future state of the market. He himself contributed to the emergence of profit by not producing more of the article concerned; but for intentional restriction of output on his part, the supply of this article would have been so ample that the price would have dropped to a point at which no surplus of proceeds over costs of production expended would have emerged. This reasoning is at the bottom of the spurious doctrines of imperfect and monopolistic competition. It was resorted to a short time ago by the American Administration when it blamed the enterprises of the steel industry for the fact that the steel production capacity of the United States was not greater than it really was.

Certainly those engaged in the production of steel are not responsible for the fact that other people did not likewise enter this field of production. The reproach on the part of the authorities would have been sensible if they had conferred on the existing steel corporations the monopoly of steel production. But in the absence of such a privilege, the reprimand given to the operating mills is not more justified than it would be to censure the nation’s poets and musicians for the fact that there are not more and better poets and musicians. If somebody is to blame for the fact that the number of people who joined the voluntary civilian defense organization is not larger, then it is not those who have already joined but only those who have not.

That the production of a commodity p is not larger than it really is, is due to the fact that the complementary factors of production required for an expansion were employed for the production of other commodities. To speak of an insufficiency of the supply of p is empty rhetoric if it does not indicate the various products mwhich were produced in too large quantities with the effect that their production appears now, i.e., after the event, as a waste of scarce factors of production. We may assume that the entrepreneurs who instead of producing additional quantities of p turned to the production of excessive amounts of m and consequently suffered losses did not intentionally make their mistake.

Neither did the producers of p intentionally restrict the production of p. Every entrepreneur’s capital is limited; he employs it for those projects which, he expects, will, by filling the most urgent demand of the public, yield the highest profit.

An entrepreneur at whose disposal are 100 units of capital employs, for instance, 50 units for the production of p and 50 units for the production of q. If both lines are profitable, it is odd to blame him for not having employed more, e.g., 75 units, for the production of p. He could increase the production of p only by curtailing correspondingly the production of q. But with regard to q the same fault could be found by the grumblers. If one blames the entrepreneur for not having produced more p, one must blame him also for not having produced more q. This means: one blames the entrepreneur for the facts that there is a scarcity of the factors of production and that the earth is not a land of Cockaigne.

Perhaps the grumbler will object on the ground that he considers p a vital commodity, much more important than q, and that therefore the production of p should be expanded and that of q restricted. If this is really the meaning of his criticism, he is at variance with the valuations of the consumers. He throws off his mask and shows his dictatorial aspirations. Production should not be directed by the wishes of the public but by his own despotic discretion.

But if our entrepreneur’s production of q involves a loss, it is obvious that his fault was poor foresight and not intentional.

Entrance into the ranks of the entrepreneurs in a market society, not sabotaged by the interference of government or other agencies resorting to violence, is open to everybody. Those who know how to take advantage of any business opportunity cropping up will always find the capital required. For the market is always full of capitalists anxious to find the most promising employment for their funds and in search of the ingenious newcomers, in partnership with whom they could execute the most remunerative projects.

People often failed to realize this inherent feature of capitalism because they did not grasp the meaning and the effects of capital scarcity. The task of the entrepreneur is to select from the multitude of technologically feasible projects those which will satisfy the most urgent of the not yet satisfied needs of the public. Those projects for the execution of which the capital supply does not suffice must not be carried out. The market is always crammed with visionaries who want to float such impracticable and unworkable schemes. It is these dreamers who always complain about the blindness of the capitalists who are too stupid to look after their own interests. Of course, the investors often err in the choice of their investments. But these faults consist precisely in the fact that they preferred an unsuitable project to another that would have satisfied more urgent needs of the buying public.

People often err very lamentably in estimating the work of the creative genius. Only a minority of men are appreciative enough to attach the right value to the achievement of poets, artists and thinkers. It may happen that the indifference of his contemporaries makes it impossible for a genius to accomplish what he would have accomplished if his fellow-men had displayed better judgment. The way in which the poet laureate and the philosopher à la mode are selected is certainly questionable.

But it is impermissible to question the free market’s choice of the entrepreneurs. The consumers’ preference for definite articles may be open to condemnation from the point of view of a philosopher’s judgment. But judgments of value are necessarily always personal and subjective. The consumer chooses what, as he thinks, satisfies him best. Nobody is called upon to determine what could make another man happier or less unhappy. The popularity of motor cars, television sets and nylon stockings may be criticized from a “higher” point of view. But these are the things that people are asking for. They cast their ballots for those entrepreneurs who offer them this merchandise of the best quality at the cheapest price.

In choosing between various political parties and programs for the commonwealth’s social and economic organization most people are uninformed and groping in the dark. The average voter lacks the insight to distinguish between policies suitable to attain the ends he is aiming at and those unsuitable. He is at a loss to examine the long chains of aprioristic reasoning which constitute the philosophy of a comprehensive social program. He may at best form some opinion about the short-run effects of the policies concerned. He is helpless in dealing with the long-run effects. The socialists and communists in principle often assert the infallibility of majority decisions. However, they belie their own words in criticizing parliamentary majorities rejecting their creed, and in denying to the people, under the one-party system, the opportunity to choose between different parties.

But in buying a commodity or abstaining from its purchase there is nothing else involved than the consumer’s longing for the best possible satisfaction of his instantaneous wishes. The consumer does not — like the voter in political voting — choose between different means whose effects appear only later. He chooses between things which immediately provide satisfaction. His decision is final.

An entrepreneur earns profit by serving the consumers, the people, as they are and not as they should be according to the fancies of some grumbler or potential dictator.

5. The Social Function of Profit and Loss

Profits are never normal. They appear only where there is a maladjustment, a divergence between actual production and production as it should be in order to utilize the available material and mental resources for the best possible satisfaction of the wishes of the public. They are the prize of those who remove this maladjustment; they disappear as soon as the maladjustment is entirely removed. In the imaginary construction of an evenly rotating economy there are no profits. There the sum of the prices of the complementary factors of production, due allowance being made for time preference, coincides with the price of the product.

The greater the preceding maladjustments, the greater the profit earned by their removal. Maladjustments may sometimes be called excessive. But it is inappropriate to apply the epithet “excessive” to profits.

People arrive at the idea of excessive profits by confronting the profit earned with the capital employed in the enterprise and measuring the profit as a percentage of the capital. This method is suggested by the customary procedure applied in partnerships and corporations for the assignment of quotas of the total profit to the individual partners and shareholders. These men have contributed to a different extent to the realization of the project and share in the profits and losses according to the extent of their contribution.

But it is not the capital employed that creates profits and losses. Capital does not “beget profit” as Marx thought. The capital goods as such are dead things that in themselves do not accomplish anything. If they are utilized according to a good idea, profit results. If they are utilized according to a mistaken idea, no profit or losses result. It is the entrepreneurial decision that creates either profit or loss. It is mental acts, the mind of the entrepreneur, from which profits ultimately originate. Profit is a product of the mind, of success in anticipating the future state of the market. It is a spiritual and intellectual phenomenon.

The absurdity of condemning any profits as excessive can easily be shown. An enterprise with a capital of the amount c produced a definite quantity of p which it sold at prices that brought a surplus of proceeds over costs of s and consequently a profit of n per cent. If the entrepreneur had been less capable, he would have needed a capital of 2 c for the production of the same quantity of p. For the sake of argument we may even neglect the fact that this would have necessarily increased costs of production as it would have doubled the interest on the capital employed, and we may assume that s would have remained unchanged. But at any rate s would have been confronted with 2 c instead of c and thus the profit would have been only n/2 per cent of the capital employed. The “excessive” profit would have been reduced to a “fair” level. Why? Because the entrepreneur was less efficient and because his lack of efficiency deprived his fellow-men of all the advantages they could have got if an amount c of capital goods had been left available for the production of other merchandise.

In branding profits as excessive and penalizing the efficient entrepreneurs by discriminatory taxation, people are injuring themselves. Taxing profits is tantamount to taxing success in best serving the public. The only goal of all production activities is to employ the factors of production in such a way that they render the highest possible output. The smaller the input required for the production of an article becomes, the more of the scarce factors of production is left for the production of other articles. But the better an entrepreneur succeeds in this regard, the more is he vilified and the more is he soaked by taxation. Increasing costs per unit of output, that is, waste, is praised as a virtue.

The most amazing manifestation of this complete failure to grasp the task of production and the nature and functions of profit and loss is shown in the popular superstition that profit is an addendum to the costs of production, the height of which depends uniquely on the discretion of the seller. It is this belief that guides governments in controlling prices. It is the same belief that has prompted many governments to make arrangements with their contractors according to which the price to be paid for an article delivered is to equal costs of production expended by the seller increased by a definite percentage. The effect was that the purveyor got a surplus the higher, the less he succeeded in avoiding superfluous costs. Contracts of this type enhanced considerably the sums the United States had to expend in the two world wars. But the bureaucrats, first of all the professors of economics who served in the various war agencies, boasted of their clever handling of the matter.

All people, entrepreneurs as well as non-entrepreneurs, look askance upon any profits earned by other people. Envy is a common weakness of men. People are loath to acknowledge the fact that they themselves could have earned profits if they had displayed the same foresight and judgment the successful businessman did. Their resentment is the more violent the more they are subconsciously aware of this fact.

There would not be any profits but for the eagerness of the public to acquire the merchandise offered for sale by the successful entrepreneur. But the same people who scramble for these articles vilify the businessman and call his profit ill got.

The semantic expression of this enviousness is the distinction between earned and unearned income. It permeates the textbooks, the language of the laws and administrative procedure. Thus, for instance, the official Form 201 for the New York state income tax return calls “earnings” only the compensation received by employees and, by implication, all other income, also that resulting from the exercise of a profession, unearned income. Such is the terminology of a state whose governor is a Republican and whose state assembly has a Republican majority.

Public opinion condones profits only as far as they do not exceed the salary paid to an employee. All surplus is rejected as unfair. The objective of taxation is, under the ability-to-pay principle, to confiscate this surplus.

Now one of the main functions of profits is to shift the control of capital to those who know how to employ it in the best possible way for the satisfaction of the public. The more profits a man earns, the greater his wealth consequently becomes, the more influential does he become in the conduct of business affairs. Profit and loss are the instruments by means of which the consumers pass the direction of production activities into the hands of those who are best fit to serve them. Whatever is undertaken to curtail or to confiscate profits impairs this function. The result of such measures is to loosen the grip the consumers hold over the course of production. The economic machine becomes, from the point of view of the people, less efficient and less responsive.

The jealousy of the common man looks upon the profits of the entrepreneurs as if they were totally used for consumption. A part of them is, of course, consumed. But only those entrepreneurs attain wealth and influence in the realm of business who consume merely a fraction of their proceeds and plough back the much greater part into their enterprises. What makes small business develop into big business is not spending, but saving and capital accumulation.

6. Profit and Loss in the Progressing and in the Retrogressing Economy

We call a stationary economy an economy in which the per head quota of the income and wealth of the individuals remains unchanged. In such an economy what the consumers spend more for the purchase of some articles must be equal to what they spend less for other articles. The total amount of the profits earned by one part of the entrepreneurs equals the total amount of losses suffered by other entrepreneurs.

A surplus of the sum of all profits earned in the whole economy above the sum of all losses suffered emerges only in a progressing economy, that is, in an economy in which the per head quota of capital increases. This increment is an effect of saving that adds new capital goods to the quantity already previously available. The increase of capital available creates maladjustments insofar as it brings about a discrepancy between the actual state of production and that state which the additional capital makes possible. Thanks to the emergence of additional capital, certain projects which hitherto could not be executed become feasible. In directing the new capital into those channels in which it satisfies the most urgent among the previously not satisfied wants of the consumers, the entrepreneurs earn profits which are not counterbalanced by the losses of other entrepreneurs.

The enrichment which the additional capital generates goes only in part to those who have created it by saving. The rest goes, by raising the marginal productivity of labor and thereby wage rates, to the earners of wages and salaries and, by raising the prices of definite raw materials and foodstuffs, to the owners of land, and, finally, to the entrepreneurs who integrate this new capital into the most economical production processes. But while the gain of the wage earners and of the landowners is permanent, the profits of the entrepreneurs disappear once this integration is accomplished. Profits of the entrepreneurs are, as has been mentioned already, a permanent phenomenon only on account of the fact that maladjustments appear daily anew by the elimination of which profits are earned.

Let us for the sake of argument resort to the concept of national income as employed in popular economics. Then it is obvious that in a stationary economy no part of the national income goes into profits. Only in a progressing economy is there a surplus of total profits over total losses. The popular belief that profits are a deduction from the income of workers and consumers is entirely fallacious. If we want to apply the term deduction to the issue, we have to say that this surplus of profits over losses as well as the increments of the wage earners and the landowners is deducted from the gains of those whose saving brought about the additional capital. It is their saving that is the vehicle of economic improvement, that makes the employment of technological innovations possible and raises productivity and the standard of living. It is the entrepreneurs whose activity takes care of the most economical employment of the additional capital. As far as they themselves do not save, neither the workers nor the landowners contribute anything to the emergence of the circumstances which generate what is called economic progress and improvement. They are benefited by other peoples’ saving that creates additional capital on the one hand and by the entrepreneurial action that directs this additional capital toward the satisfaction of the most urgent wants on the other hand.

A retrogressing economy is an economy in which the per head quota of capital invested is decreasing. In such an economy the total amount of losses incurred by entrepreneurs exceeds the total amount of profits earned by other entrepreneurs.

7. The Competition of Profit and Loss

The originary praxeological categories of profit and loss are psychic qualities and not reducible to any interpersonal description in quantitative terms. They are intensive magnitudes. The difference between the value of the end attained and that of the means applied for its attainment is profit if it is positive and loss if it is negative.

Where there are social division of efforts and cooperation as well as private ownership of the means of production, economic calculation in terms of monetary units becomes feasible and necessary. Profit and loss are computable as social phenomena. The psychic phenomena of profit and loss, from which they are ultimately derived, remain, of course, incalculable intensive magnitudes.

The fact that in the frame of the market economy entrepreneurial profit and loss are determined by arithmetical operations has misled many people. They fail to see that essential items that enter into this calculation are estimates emanating from the entrepreneur’s specific understanding of the future state of the market. They think that these computations are open to examination and verification or alteration on the part of a disinterested expert. They ignore the fact that such computations are as a rule an inherent part of the entrepreneur’s speculative anticipation of uncertain future conditions.

For the task of this essay it suffices to refer to one of the problems of cost accounting. One of the items of a bill of costs is the establishment of the difference between the price paid for the acquisition of what is commonly called durable production equipment and its present value. This present value is the money equivalent of the contribution this equipment will make to future earnings. There is no certainty about the future state of the market and about the height of these earnings. They can only be determined by a speculative anticipation on the part of the entrepreneur. It is preposterous to call in an expert and to substitute his arbitrary judgment for that of the entrepreneur. The expert is objective insofar as he is not affected by an error made. But the entrepreneur exposes his own material well-being.

Of course, the law determines magnitudes which it calls profit and loss. But these magnitudes are not identical with the economic concepts of profit and loss and must not be confused with them. If a tax law calls a magnitude profit, it in effect determines the height of taxes due. It calls this magnitude profit because it wants to justify its tax policy in the eyes of the public. It would be more correct for the legislator to omit the term profit and simply to speak of the basis for the computation of the tax due.

The tendency of the tax laws is to compute what they call profit as high as possible in order to increase immediate public revenue. But there are other laws which are committed to the tendency to restrict the magnitude they call profit. The commercial codes of many nations were and are guided by the endeavor to protect the rights of creditors. They aimed at restricting what they called profit in order to prevent the entrepreneur from withdrawing to the prejudice of creditors too much from the firm or corporation for his own benefit. It was these tendencies which were operative in the evolution of the commercial usages concerning the customary height of depreciation quotas.

There is no need today to dwell upon the problem of the falsification of economic calculation under inflationary conditions. All people begin to comprehend the phenomenon of illusory profits, the offshoot of the great inflations of our age.

Failure to grasp the effects of inflation upon the customary methods of computing profits originated the modern concept of profiteering. An entrepreneur is dubbed a profiteer if his profit and loss statement, calculated in terms of a currency subject to a rapidly progressing inflation, shows profits which other people deem “excessive.” It has happened very often in many countries that the profit and loss statement of such a profiteer, when calculated in terms of a non-inflated or less inflated currency, showed not only no profit at all but considerable losses.

Even if we neglect for the sake of argument any reference to the phenomenon of merely inflation-induced illusory profits, it is obvious that the epithet profiteer is the expression of an arbitrary judgment of value. There is no other standard available for the distinction between profiteering and earning fair profits than that provided by the censor’s personal envy and resentment. …

2. The Consequences of the Abolition of Profit[2][Ibid., section B: “The Condemnation of Profit,” pp. 132–43.]
([Ludwig von Mises, Planning for Freedom and Sixteen Other Essays and Addresses (1952; South Holland, Ill.: Libertarian Press, 1980), chap. 9: “Profit and Loss,” section A: “The Economic Nature of Profit and Loss,” pp. 108–28.])

The idea to abolish profit for the advantage of the consumers involves that the entrepreneur should be forced to sell the products at prices not exceeding the costs of production expended. As such prices are, for all articles the sale of which would have brought profit, below the potential market price, the available supply is not sufficient to make it possible for all those who want to buy at these prices to acquire the articles. The market is paralyzed by the maximum price decree. It can no longer allocate the products to the consumers. A system of rationing must be adopted.

The suggestion to abolish the entrepreneur’s profit for the benefit of the employees aims not at the abolition of profit. It aims at wresting it from the hands of the entrepreneur and handing it over to his employees.

Under such a scheme the incidence of losses incurred falls upon the entrepreneur, while profits go to the employees. It is probable that the effect of this arrangement would consist in making losses increase and profits dwindle. At any rate, a greater part of the profits would be consumed and less would be saved and ploughed back into the enterprise. No capital would be available for the establishment of new branches of production and for the transfer of capital from branches which — in compliance with the demand of the customers — should shrink into branches which should expand. For it would harm the interests of those employed in a definite enterprise or branch to restrict the capital employed in it and to transfer it into another enterprise or branch. If such a scheme had been adopted half a century ago, all the innovations accomplished in this period would have been rendered impossible. If, for the sake of argument, we were prepared to neglect any reference to the problem of capital accumulation, we would still have to realize that giving profit to the employees must result in rigidity of the once attained state of production and preclude any adjustment, improvement and progress.

In fact, the scheme would transfer ownership of the capital invested into the hands of the employees. It would be tantamount to the establishment of syndicalism and would generate all the effects of syndicalism, a system which no author or reformer ever had the courage to advocate openly.

A third solution of the problem would be to confiscate all the profits earned by the entrepreneurs for the benefit of the state. A one hundred per cent tax on profits would accomplish this task. It would transform the entrepreneurs into irresponsible administrators of all plants and workshops. They would no longer be subject to the supremacy of the buying public. They would just be people who have the power to deal with production as it pleases them.

The policies of all contemporary governments which have not adopted outright socialism apply all these three schemes jointly. They confiscate by various measures of price control a part of the potential profits for the alleged benefit of the consumers. They support the labor unions in their endeavors to wrest, under the ability-to-pay principle of wage determination, a part of the profits from the entrepreneurs. And, last but not least, they are intent upon confiscating, by progressive income taxes, special taxes on corporation income, and “excess profits” taxes, an ever-increasing part of profits for public revenue. It can easily be seen that these policies if continued will very soon succeed in abolishing entrepreneurial profit altogether.

The joint effect of the application of these policies is already today rising chaos. The final effect will be the full realization of socialism by smoking out the entrepreneurs. Capitalism cannot survive the abolition of profit. It is profit and loss that force the capitalists to employ their capital for the best possible service to the consumers. It is profit and loss that make those people supreme in the conduct of business who are best fit to satisfy the public. If profit is abolished, chaos results.

3. The Anti-Profit Arguments

All the reasons advanced in favor of an anti-profit policy are the outcome of an erroneous interpretation of the operation of the market economy.

The tycoons are too powerful, too rich and too big. They abuse their power for their own enrichment. They are irresponsible tyrants. Bigness of an enterprise is in itself an evil. There is no reason why some men should own millions while others are poor. The wealth of the few is the cause of the poverty of the masses.

Each word of these passionate denunciations is false. The businessmen are not irresponsible tyrants. It is precisely the necessity of making profits and avoiding losses that gives to the consumers a firm hold over the entrepreneurs and forces them to comply with the wishes of the people. What makes a firm big is its success in best filling the demands of the buyers. If the bigger enterprise did not better serve the people than a smaller one, it would long since have been reduced to smallness. There is no harm in a businessman’s endeavors to enrich himself by increasing his profits. The businessman has in his capacity as a businessman only one task: to strive after the highest possible profit. Huge profits are the proof of good service rendered in supplying the consumers. Losses are the proof of blunders committed, of failure to perform satisfactorily the tasks incumbent upon an entrepreneur. The riches of successful entrepreneurs are not the cause of anybody’s poverty; they are consequences of the fact that the consumers are better supplied than they would have been in the absence of the entrepreneur’s effort. The penury of millions in the backward countries is not caused by anybody’s opulence; it is the correlative of the fact that their country lacks entrepreneurs who have acquired riches. The standard of living of the common man is highest in those countries which have the greatest number of wealthy entrepreneurs. It is to the foremost material interest of everybody that control of the factors of production should be concentrated in the hands of those who know how to utilize them in the most efficient way.

It is the avowed objective of the policies of all present-day governments and political parties to prevent the emergence of new millionaires. If this policy had been adopted in the United States fifty years ago, the growth of the industries producing new articles would have been stunted. Motorcars, refrigerators, radio sets and a hundred other less spectacular but even more useful innovations would not have become standard equipment of most of the American family households.

The average wage earner thinks that nothing else is needed to keep the social apparatus of production running and to improve and to increase output than the comparatively simple routine work assigned to him. He does not realize that the mere toil and trouble of the routinist is not sufficient. Sedulousness and skill are spent in vain if they are not directed toward the most important goal by the entrepreneur’s foresight and are not aided by the capital accumulated by capitalists. The American worker is badly mistaken when he believes that his high standard of living is due to his own excellence. He is neither more industrious nor more skillful than the workers of Western Europe. He owes his superior income to the fact that his country clung to “rugged individualism” much longer than Europe. It was his luck that the United States turned to an anti-capitalistic policy as much as forty or fifty years later than Germany. His wages are higher than those of the workers of the rest of the world because the capital equipment per head of the employee is highest in America and because the American entrepreneur was not so much restricted by crippling regimentation as his colleagues in other areas. The comparatively greater prosperity of the United States is an outcome of the fact that the New Deal did not come in 1900 or 1910, but only in 1933.

If one wants to study the reasons for Europe’s backwardness, it would be necessary to examine the manifold laws and regulations that prevented in Europe the establishment of an equivalent of the American drugstore and crippled the evolution of chain stores, department stores, supermarkets and kindred outfits. It would be important to investigate the German Reich’s effort to protect the inefficient methods of traditional Handwerk(handicraft) against the competition of capitalist business. Still more revealing would be an examination of the Austrian Gewerbepolitik, a policy that from the early eighties on aimed at preserving the economic structure of the ages preceding the Industrial Revolution.

The worst menace to prosperity and civilization and to the material well-being of the wage earners is the inability of union bosses, of “union economists” and of the less intelligent strata of the workers themselves to appreciate the role entrepreneurs play in production. This lack of insight has found a classical expression in the writings of Lenin. As Lenin saw it all that production requires besides the manual work of the laborer and the designing of the engineers is “control of production and distribution,” a task that can easily be accomplished “by the armed workers.” For this accounting and control “have been simplified by capitalism to the utmost, till they have become the extraordinarily simple operations of watching, recording and issuing receipts, within the reach of everybody who can read and write and knows the first four rules of arithmetic.”[3]Lenin, State and Revolution (Edition by International Publishers, New York, 1917), pp. 83–84. The italics are Lenin’s (or the communist translator’s). No further comment is needed.

4. The Equality Argument

In the eyes of the parties who style themselves progressive and leftist the main vice of capitalism is the inequality of incomes and wealth. The ultimate end of their policies is to establish equality. The moderates want to attain this goal step by step; the radicals plan to attain it at one stroke, by a revolutionary overthrow of the capitalist mode of production.

However, in talking about equality and asking vehemently for its realization, nobody advocates a curtailment of his own present income. The term equality as employed in contemporary political language always means upward levelling of one’s income, never downward levelling. It means getting more, not sharing one’s own affluence with people who have less.

If the American automobile worker, railroadman or compositor says equality, he means expropriating the holders of shares and bonds for his own benefit. He does not consider sharing with the unskilled workers who earn less. At best, he thinks of equality of all American citizens. It never occurs to him that the peoples of Latin America, Asia and Africa may interpret the postulate of equality as world equality and not as national equality.

The political labor movement as well as the labor union movement flamboyantly advertise their internationalism. But this internationalism is a mere rhetorical gesture without any substantial meaning. In every country in which average wage rates are higher than in any other area, the unions advocate insurmountable immigration barriers in order to prevent foreign “comrades” and “brothers” from competing with their own members. Compared with the anti-immigration laws of the European nations, the immigration legislation of the American republics is mild indeed because it permits the immigration of a limited number of people. No such normal quotas are provided in most of the European laws.

All the arguments advanced in favor of income equalization within a country can with the same justification or lack of justification also be advanced in favor of world equalization. An American worker has no better title to claim the savings of the American capitalist than has any foreigner. That a man has earned profits by serving the consumers and has not entirely consumed his funds but ploughed back the greater part of them into industrial equipment does not give anybody a valid title to expropriate this capital for his own benefit. But if one maintains the opinion to the contrary, there is certainly no reason to ascribe to anybody a better right to expropriate than to anybody else. There is no reason to assert that only Americans have the right to expropriate other Americans. The big shots of American business are the scions of people who immigrated to the United States from England, Scotland, Ireland, France, Germany and other European countries. The people of their country of origin contend that they have the same title to seize the property acquired by these men as the American people have. The American radicals are badly mistaken in believing that their social program is identical or at least compatible with the objectives of the radicals of other countries. It is not. The foreign radicals will not acquiesce in leaving to the Americans, a minority of less than seven per cent of the world’s total population, what they think is a privileged position. A world government of the kind the American radicals are asking for would try to confiscate by a world income tax all the surplus an average American earns above the average income of a Chinese or Indian worker. Those who question the correctness of this statement would drop their doubts after a conversation with any of the intellectual leaders of Asia.

There is hardly any Iranian who would qualify the objections raised by the British Labor government against the confiscation of the oil wells as anything else but a manifestation of the most reactionary spirit of capitalist exploitation. Today governments abstain from virtually expropriating — by foreign exchange control, discriminatory taxation and similar devices — foreign investments only if they expect to get in the next years more foreign capital and thus to be able in the future to expropriate a greater amount.

The disintegration of the international capital market is one of the most important effects of the anti-profit mentality of our age. But no less disastrous is the fact that the greater part of the world’s population looks upon the United States — not only upon the American capitalists but also upon the American workers — with the same feelings of envy, hatred and hostility with which, stimulated by the socialist and communist doctrines, the masses everywhere look upon the capitalists of their own nation.

5. Communism and Poverty

A customary method of dealing with political programs and movements is to explain and to justify their popularity by referring to the conditions which people found unsatisfactory and to the goals they wanted to attain by the realization of these programs.

However, the only thing that matters is whether or not the program concerned is fit to attain the ends sought. A bad program and a bad policy can never be explained, still less justified by pointing to the unsatisfactory conditions of its originators and supporters. The sole question that counts is whether or not these policies can remove or alleviate the evils which they are designed to remedy.

Yet almost all our contemporaries declare again and again: If you want to succeed in fighting communism, socialism and interventionism, you must first of all improve peoples’ material conditions. The policy of laissez faire aims precisely at making people more prosperous. But it cannot succeed as long as want is worsened more and more by socialist and interventionist measures.

In the very short run the conditions of a part of the people can be improved by expropriating entrepreneurs and capitalists and by distributing the booty. But such predatory inroads, which even the Communist Manifestodescribed as “despotic” and as “economically insufficient and untenable,” sabotage the operation of the market economy, impair very soon the conditions of all the people, and frustrate the endeavors of entrepreneurs and capitalists to make the masses more prosperous. What is good for a quickly vanishing instant, (i.e., in the shortest run) may very soon (i.e., in the long run) result in most detrimental consequences.

Historians are mistaken in explaining the rise of Nazism by referring to real or imaginary adversities and hardships of the German people. What made the Germans support almost unanimously the twenty-five points of the “unalterable” Hitler program was not some conditions which they deemed unsatisfactory, but their expectation that the execution of this program would remove their complaints and render them happier. They turned to Nazism because they lacked common sense and intelligence. They were not judicious enough to recognize in time the disasters that Nazism was bound to bring upon them.

The immense majority of the world’s population is extremely poor when compared with the average standard of living of the capitalist nations. But this poverty does not explain their propensity to adopt the communist program. They are anti-capitalistic because they are blinded by envy, ignorant and too dull to appreciate correctly the causes of their distress. There is but one means to improve their material conditions, namely, to convince them that only capitalism can render them more prosperous.

The worst method to fight communism is that of the Marshall Plan. It gives to the recipients the impression that the United States alone is interested in the preservation of the profit system while their own concerns require a communist regime. The United States, they think, is aiding them because its people have a bad conscience. They themselves pocket this bribe but their sympathies go to the socialist system. The American subsidies make it possible for their governments to conceal partially the disastrous effects of the various socialist measures they have adopted.

Not poverty is the source of socialism, but spurious ideological pre-possessions. Most of our contemporaries reject beforehand, without having ever studied them, all the teachings of economics as aprioristic nonsense. Only experience, they maintain, is to be relied upon. But is there any experience that would speak in favor of socialism?

Retorts the socialist: But capitalism creates poverty; look at India and China. The objection is vain. Neither India nor China has ever established capitalism. Their poverty is the result of the absence of capitalism.

What happened in these and other underdeveloped countries was that they were benefited from abroad by some of the fruits of capitalism without having adopted the capitalist mode of production. European, and in more recent years also American, capitalists invested capital in their areas and thereby increased the marginal productivity of labor and wage rates. At the same time these peoples received from abroad the means to fight contagious diseases, medications developed in the capitalist countries. Consequently mortality rates, especially infant mortality, dropped considerably. In the capitalist countries this prolongation of the average length of life was partially compensated by a drop in the birth rate. As capital accumulation increased more quickly than population, the per head quota of capital invested grew continuously. The result was progressing prosperity. It was different in the countries which enjoyed some of the effects of capitalism without turning to capitalism. There the birth rate did not decline at all or not to the extent required to make the per head quota of capital invested rise. These nations prevent by their policies both the importation of foreign capital and the accumulation of domestic capital. The joint effect of the high birth rate and the absence of an increase in capital is, of course, increasing poverty.

There is but one means to improve the material well-being of men, viz., to accelerate the increase in capital accumulated as against population. No psychological lucubrations, however sophisticated, can alter this fact. There is no excuse whatever for the pursuit of policies which not only fail to attain the ends sought, but even seriously impair conditions.

8. Entrepreneurial Profit and Loss

Profit, in a broader sense, is the gain derived from action; it is the increase in satisfaction (decrease in uneasiness) brought about; it is the difference between the higher value attached to the result attained and the lower value attached to the sacrifices made for its attainment; it is, in other words, yield minus costs. To make profit is invariably the aim sought by any action. If an action fails to attain the ends sought, yield either does not exceed costs or lags behind costs. In the latter case the outcome means a loss, a decrease in satisfaction.

Profit and loss in this original sense are psychic phenomena and as such not open to measurement and a mode of expression which could convey to other people precise information concerning their intensity. A man can tell a fellow man that a suits him better than b; but he cannot communicate to another man, except in vague and indistinct terms, how much the satisfaction derived from a exceeds that derived from b.

In the market economy all those things that are bought and sold against money are marked with money prices. In the monetary calculus profit appears as a surplus of money received over money expended and loss as a surplus of money expended over money received. Profit and loss can be expressed in definite amounts of money. It is possible to ascertain in terms of money how much an individual has profited or lost. However, this is not a statement about this individual’s psychic profit or loss. It is a statement about a social phenomenon, about the individual’s contribution to the societal effort as it is appraised by the other members of society. It does not tell us anything about the individual’s increase or decrease in satisfaction or happiness. It merely reflects his fellow men’s evaluation of his contribution to social cooperation. This evaluation is ultimately determined by the efforts of every member of society to attain the highest possible psychic profit. It is the resultant of the composite effect of all these people’s subjective and personal value judgments as manifested in their conduct on the market. But it must not be confused with these value judgments as such.

We cannot even think of a state of affairs in which people act without the intention of attaining psychic profit and in which their actions result neither in psychic profit nor in psychic loss.[5]If an action neither improves nor impairs the state of satisfaction, it still involves a psychic loss because of the uselessness of the expended psychic effort. The individual concerned would have been better off if he had inertly enjoyed life. In the imaginary construction of an evenly rotating economy there are neither money profits nor money losses. But every individual derives a psychic profit from his actions, or else he would not act at all. The farmer feeds and milks his cows and sells the milk because he values the things he can buy against the money thus earned more highly than the costs expended. The absence of money profits or losses in such an evenly rotating system is due to the fact that, if we disregard the differences brought about by the higher valuation of present goods as compared with future goods, the sum of the prices of all complementary factors needed for production precisely equals the price of the product.

In the changing world of reality differences between the sum of the prices of the complementary factors of production and the prices of the products emerge again and again. It is these differences that bring about money profits and money losses. As far as such changes affect the sellers of labor and those of the original nature-given factors of production and of the capitalists as moneylenders, we will deal with them later. At this point we are dealing with entrepreneurial profit and loss. It is this problem that people have in mind when employing the terms profit and loss in mundane speech.

Like every acting man, the entrepreneur is always a speculator. He deals with the uncertain conditions of the future. His success or failure depends on the correctness of his anticipation of uncertain events. If he fails in his understanding of things to come, he is doomed. The only source from which an entrepreneur’s profits stem is his ability to anticipate better than other people the future demand of the consumers. If everybody is correct in anticipating the future state of the market of a certain commodity, its price and the prices of the complementary factors of production concerned would already today be adjusted to this future state. Neither profit nor loss can emerge for those embarking upon this line of business.

The specific entrepreneurial function consists in determining the employment of the factors of production. The entrepreneur is the man who dedicates them to special purposes. In doing so he is driven solely by the selfish interest in making profits and in acquiring wealth. But he cannot evade the law of the market. He can succeed only by best serving the consumers. His profit depends on the approval of his conduct by the consumers.

One must not confuse entrepreneurial profit and loss with other factors affecting the entrepreneur’s proceeds.

The entrepreneur’s technological ability does not affect the specific entrepreneurial profit or loss. As far as his own technological activities contribute to the returns earned and increase his net income, we are confronted with a compensation for work rendered. It is wages paid to the entrepreneur for his labor. Neither does the fact that not every process of production succeeds technologically in bringing about the product expected, influence the specific entrepreneurial profit or loss. Such failures are either avoidable or unavoidable. In the first case they are due to the technologically inefficient conduct of affairs. Then the losses resulting are to be debited to the entrepreneur’s personal insufficiency, i.e., either to his lack of technological ability or to his lack of the ability to hire adequate helpers. In the second case the failures are due to the fact that the present state of technological knowledge prevents us from fully controlling the conditions on which success depends. This deficiency may be caused either by incomplete knowledge concerning the conditions of success or by ignorance of methods for controlling fully some of the known conditions. The price of the factors of production takes into account this unsatisfactory state of our knowledge and technological power. The price of arable land, for instance, takes into full account the fact that there are bad harvests, as it is determined by the anticipated average yield. The fact that the bursting of bottles reduces the output of champagne does not affect entrepreneurial profit and loss. It is merely one of the factors determining the cost of production and the price of champagne.[6]Cf. [Hans von] Mangoldt, Die Lehre vom Unternehmergewinn (Leipzig, 1855), p. 82. The fact that out of 100 liters of plain wine one cannot produce 100 liters of champagne, but a smaller quantity, has the same significance as the fact that 100 kilograms of sugar beet do not yield 100 kilograms of sugar but a smaller quantity.

Accidents affecting the process of production, the means of production, or the products while they are still in the hands of the entrepreneur are an item in the bill of production costs. Experience, which conveys to the businessman all other technological knowledge, provides him also with information about the average reduction in the quantity of physical output which such accidents are likely to bring about. By opening contingency reserves, he converts their effects into regular costs of production. With regard to contingencies the expected incidence of which is too rare and too irregular to be dealt with in this way by individual firms of normal size, concerted action on the part of sufficiently large groups of firms takes care of the matter. The individual firms cooperate under the principle of insurance against damage caused by fire, flood, or other similar contingencies. Then an insurance premium is substituted for an appropriation to a contingency reserve. At any rate, the risks incurred by accidents do not introduce uncertainty into the conduct of the technological processes. If an entrepreneur neglects to deal with them duly, he gives proof of his technical insufficiency. The losses thus incurred are to be debited to bad techniques applied, not to his entrepreneurial function.

The elimination of those entrepreneurs who fail to give to their enterprises the adequate degree of technological efficiency or whose technological ignorance vitiates their cost calculation is effected on the market in the same way in which those deficient in the performance of the specific entrepreneurial functions are eliminated. It may happen that an entrepreneur is so successful in his specific entrepreneurial function that he can compensate losses caused by his technological failure. It may also happen that an entrepreneur can counterbalance losses due to failure in his entrepreneurial function by the advantages derived from his technological superiority or from the differential rent yielded by the higher productivity of the factors of production he employs. But one must not confuse the various functions which are combined in the conduct of a business unit. The technologically more efficient entrepreneur earns higher wage rates or quasi-wage rates than the less efficient in the same way in which the more efficient worker earns more than the less efficient. The more efficient machine and the more fertile soil produce higher physical returns per unit of costs expended; they yield a differential rent when compared with the less efficient machine and the less fertile soil. The higher wage rates and the higher rent are, ceteris paribus, the corollary of higher physical output. But the specific entrepreneurial profits and loses are not produced by the quantity of physical output. They depend on the adjustment of output to the most urgent wants of the consumers. What produces them is the extent to which the entrepreneur has succeeded or failed in anticipating the future — necessarily uncertain — state of the market.

The entrepreneur is also jeopardized by political dangers. Government policies, revolutions, and wars can damage or annihilate his enterprise. Such events do not affect him alone; they affect the market economy as such and all individuals, although not all of them to the same extent. For the individual entrepreneur they are data which he cannot alter. If he is efficient, he will anticipate them in time. But it is not always possible for him to adjust his operations in such a way as to avoid damage. If the dangers expected concern only a part of the territory which is accessible to his entrepreneurial activities, he can avoid operating in the menaced areas and can prefer countries in which the danger is less imminent. But if he cannot emigrate, he must stay where he is. If all entrepreneurs were fully convinced that the total victory of Bolshevism was impending, they would nevertheless not abandon their entrepreneurial activities. The expectation of imminent expropriation will impel the capitalists to consume their funds. The entrepreneurs will be forced to adjust their plans to the market situation created by such capital consumption and the threatened nationalization of their shops and plants. But they will not stop operating. If some entrepreneurs go out of business, others will take their place — newcomers or old entrepreneurs expanding the size of their enterprises. In the market economy there will always be entrepreneurs. Policies hostile to capitalism may deprive the consumers of the greater part of the benefits they would have reaped from unhampered entrepreneurial activities. But they cannot eliminate the entrepreneurs as such if they do not entirely destroy the market economy.

The ultimate source from which entrepreneurial profit and loss are derived is the uncertainty of the future constellation of demand and supply.

If all entrepreneurs were to anticipate correctly the future state of the market, there would be neither profits nor losses. The prices of all the factors of production would already today be fully adjusted to tomorrow’s prices of the products. In buying the factors of production the entrepreneur would have to expend (with due allowance for the difference between the prices of present goods and future goods) no less an amount than the buyers will pay him later for the product. An entrepreneur can make a profit only if he anticipates future conditions more correctly than other entrepreneurs. Then he buys the complementary factors of production at prices the sum of which, including allowance for the time difference, is smaller than the price at which he sells the product.

If we want to construct the image of changing economic conditions in which there are neither profits nor losses, we must resort to an unrealizable assumption: perfect foresight of all future events on the part of all individuals. If those primitive hunters and fishermen to whom it is customary to ascribe the first accumulation of produced factors of production had known in advance all the future vicissitudes of human affairs, and if they and all their descendants until the last day of judgment, equipped with the same omniscience, had appraised all factors of production accordingly, entrepreneurial profits and losses would never have emerged. Entrepreneurial profits and losses are created through the discrepancy between the expected prices and the prices later really fixed on the markets. It is possible to confiscate profits and to transfer them from the individuals to whom they have accrued to other people. But neither profits nor losses can ever disappear from a changing world not populated solely with omniscient people.

References • 200 Words

[1] [Ludwig von Mises, Planning for Freedom and Sixteen Other Essays and Addresses (1952; South Holland, Ill.: Libertarian Press, 1980), chap. 9: “Profit and Loss,” section A: “The Economic Nature of Profit and Loss,” pp. 108–28.]

[2] [Ibid., section B: “The Condemnation of Profit,” pp. 132–43.]

[3] Lenin, State and Revolution (Edition by International Publishers, New York, 1917), pp. 83–84. The italics are Lenin’s (or the communist translator’s).

[4] [Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 15: “The Market,” pp. 286–91.]

[5] If an action neither improves nor impairs the state of satisfaction, it still involves a psychic loss because of the uselessness of the expended psychic effort. The individual concerned would have been better off if he had inertly enjoyed life.

[6] Cf. [Hans von] Mangoldt, Die Lehre vom Unternehmergewinn (Leipzig, 1855), p. 82. The fact that out of 100 liters of plain wine one cannot produce 100 liters of champagne, but a smaller quantity, has the same significance as the fact that 100 kilograms of sugar beet do not yield 100 kilograms of sugar but a smaller quantity.

Chapter 9 • The Nature of Money • 9,000 Words

1. The General Economic Conditions for the Use of Money

Where the free exchange of goods and services is unknown, money is not wanted. In a state of society in which the division of labor was a purely domestic matter and production and consumption were consummated within the single household it would be just as useless as it would be for an isolated man. But even in an economic order based on division of labor, money would still be unnecessary if the means of production were socialized, the control of production and the distribution of the finished product were in the hands of a central body, and individuals were not allowed to exchange the consumption goods allotted to them for the consumption goods allotted to others.

The phenomenon of money presupposes an economic order in which production is based on division of labor and in which private property consists not only in goods of the first order (consumption goods), but also in goods of higher orders (production goods). In such a society, there is no systematic centralized control of production, for this is inconceivable without centralized disposal over the means of production. Production is “anarchistic.” What is to be produced, and how it is to be produced, is decided in the first place by the owners of the means of production, who produce, however, not only for their own needs, but also for the needs of others, and in their valuations take into account, not only the use-value that they themselves attach to their products, but also the use-value that these possess in the estimation of the other members of the community. The balancing of production and consumption takes place in the market, where the different producers meet to exchange goods and services by bargaining together. The function of money is to facilitate the business of the market by acting as a common medium of exchange.

2. The Origin of Money

Indirect exchange is distinguished from direct exchange according as a medium is involved or not.

Suppose that A and B exchange with each other a number of units of the commodities m and n. A acquires the commodity n because of the use-value that it has for him. He intends to consume it. The same is true of B, who acquires the commodity m for his immediate use. This is a case of direct exchange.

If there are more than two individuals and more than two kinds of commodity in the market, indirect exchange also is possible. A may then acquire a commodity p, not because he desires to consume it, but in order to exchange it for a second commodity q which he does desire to consume. Let us suppose that A brings to the market two units of the commodity m, B two units of the commodity n, and C two units of the commodity o, and that A wishes to acquire one unit of each of the commodities n and o, B one unit of each of the commodities o and m, and C one unit of each of the commodities m and n. Even in this case a direct exchange is possible if the subjective valuations of the three commodities permit the exchange of each unit of m, n, and ofor a unit of one of the others. But if this or a similar hypothesis does not hold good, and in by far the greater number of all exchange transactions it does not hold good, then indirect exchange becomes necessary, and the demand for goods for immediate wants is supplemented by a demand for goods to be exchanged for others.[2]See [Knut] Wicksell, Über Wert, Kapital und Rente (Jena, 1893; London, 1933), pp. 50 f.

Let us take, for example, the simple case in which the commodity p is desired only by the holders of the commodity q, while the commodity q is not desired by the holders of the commodity p but by those, say, of a third commodity r, which in its turn is desired only by the possessors of p. No direct exchange between these persons can possibly take place. If exchanges occur at all, they must be indirect; as, for instance, if the possessors of the commodity p exchange it for the commodity q and then exchange this for the commodity rwhich is the one they desire for their own consumption. The case is not essentially different when supply and demand do not coincide quantitatively; for example, when one indivisible good has to be exchanged for various goods in the possession of several persons.

Indirect exchange becomes more necessary as division of labor increases and wants become more refined. In the present stage of economic development, the occasions when direct exchange is both possible and actually effected have already become very exceptional. Nevertheless, even nowadays, they sometimes arise. Take, for instance, the payment of wages in kind, which is a case of direct exchange so long on the one hand as the employer uses the labor for the immediate satisfaction of his own needs and does not have to procure through exchange the goods in which the wages are paid, and so long on the other hand as the employee consumes the goods he receives and does not sell them. Such payment of wages in kind is still widely prevalent in agriculture, although even in this sphere its importance is being continually diminished by the extension of capitalistic methods of management and the development of division of labor.[3]The conclusion that indirect exchange is necessary in the majority of cases is extremely obvious. As we should expect, it is among the earliest discoveries of economics. We find it clearly expressed in the famous fragment of the Pandects of Paulus: “Quia non semper nec facile concurrebat, ut, cum tu haberas, quod ego desiderarem, invicem haberem, quod tu accipere velles” (Paulus, lib. 33 ad edictum 1.I pr. D. de contr. empt. 18, I). Schumpeter is surely mistaken in thinking that the necessity for money can be proved solely from the assumption of indirect exchange (see his Wesen und Hauptinhalt der theoretischen Nationalökonomie [Leipzig, 1908], pp. 273 ff.). On this point, cf. Weiss, Die moderne Tendenz in der Lehre vom Geldwert, Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung, vol. 19, pp. 518 ff.

Thus along with the demand in a market for goods for direct consumption there is a demand for goods that the purchaser does not wish to consume but to dispose of by further exchange. It is clear that not all goods are subject to this sort of demand. An individual obviously has no motive for an indirect exchange if he does not expect that it will bring him nearer to his ultimate objective, the acquisition of goods for his own use. The mere fact that there would be no exchanging unless it was indirect could not induce individuals to engage in indirect exchange if they secured no immediate personal advantage from it. Direct exchange being impossible, and indirect exchange being purposeless from the individual point of view, no exchange would take place at all. Individuals have recourse to indirect exchange only when they profit by it; that is, only when the goods they acquire are more marketable than those which they surrender.

Now all goods are not equally marketable. While there is only a limited and occasional demand for certain goods, that for others is more general and constant. Consequently, those who bring goods of the first kind to market in order to exchange them for goods that they need themselves have as a rule a smaller prospect of success than those who offer goods of the second kind. If, however, they exchange their relatively unmarketable goods for such as are more marketable, they will get a step nearer to their goal and may hope to reach it more surely and economically than if they had restricted themselves to direct exchange.

It was in this way that those goods that were originally the most marketable became common media of exchange; that is, goods into which all sellers of other goods first converted their wares and which it paid every would-be buyer of any other commodity to acquire first. And as soon as those commodities that were relatively most marketable had become common media of exchange, there was an increase in the difference between their marketability and that of all other commodities, and this in its turn further strengthened and broadened their position as media of exchange.[4]See [Carl] Menger, Untersuchungen über die Methode der Sozialwissenschaften und der politischen Okonomie insbesondere (Leipzig, 1883), pp. 172 ff.; Grundsätze der Volkswirtschaftslehre, 2d ed. (Vienna, 1923), pp. 247 ff.

Thus the requirements of the market have gradually led to the selection of certain commodities as common media of exchange. The group of commodities from which these were drawn was originally large, and differed from country to country; but it has more and more contracted. Whenever a direct exchange seemed out of the question, each of the parties to a transaction would naturally endeavor to exchange his superfluous commodities, not merely for more marketable commodities in general, but for the most marketable commodities; and among these again he would naturally prefer whichever particular commodity was the most marketable of all. The greater the marketability of the goods first acquired in indirect exchange, the greater would be the prospect of being able to reach the ultimate objective without further maneuvering. Thus there would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.

This stage of development in the use of media of exchange, the exclusive employment of a single economic good, is not yet completely attained. In quite early times, sooner in some places than in others, the extension of indirect exchange led to the employment of the two precious metals gold and silver as common media of exchange. But then there was a long interruption in the steady contraction of the group of goods employed for that purpose. For hundreds, even thousands, of years the choice of mankind has wavered undecided between gold and silver. The chief cause of this remarkable phenomenon is to be found in the natural qualities of the two metals. Being physically and chemically very similar, they are almost equally serviceable for the satisfaction of human wants. For the manufacture of ornaments and jewelry of all kinds the one has proved as good as the other. (It is only in recent times that technological discoveries have been made which have considerably extended the range of uses of the precious metals and may have differentiated their utility more sharply.) In isolated communities, the employment of one or the other metal as sole common medium of exchange has occasionally been achieved, but this short-lived unity has always been lost again as soon as the isolation of the community has succumbed to participation in international trade.

Economic history is the story of the gradual extension of the economic community beyond its original limits of the single household to embrace the nation and then the world. But every increase in its size has led to a fresh duality of the medium of exchange whenever the two amalgamating communities have not had the same sort of money. It would not be possible for the final verdict to be pronounced until all the chief parts of the inhabited earth formed a single commercial area, for not until then would it be impossible for other nations with different monetary systems to join in and modify the international organization.

Of course, if two or more economic goods had exactly the same marketability, so that none of them was superior to the others as a medium of exchange, this would limit the development toward a unified monetary system. We shall not attempt to decide whether this assumption holds good of the two precious metals gold and silver. The question, about which a bitter controversy has raged for decades, has no very important bearings upon the theory of the nature of money. For it is quite certain that even if a motive had not been provided by the unequal marketability of the goods used as media of exchange, unification would still have seemed a desirable aim for monetary policy. The simultaneous use of several kinds of money involves so many disadvantages and so complicates the technique of exchange that the endeavor to unify the monetary system would certainly have been made in any case.

The theory of money must take into consideration all that is implied in the functioning of several kinds of money side by side. Only where its conclusions are unlikely to be affected one way or the other, may it proceed from the assumption that a single good is employed as common medium of exchange. Elsewhere, it must take account of the simultaneous use of several media of exchange. To neglect this would be to shirk one of its most difficult tasks.

3. The “Secondary” Functions of Money

The simple statement, that money is a commodity whose economic function is to facilitate the interchange of goods and services, does not satisfy those writers who are interested rather in the accumulation of material than in the increase of knowledge. Many investigators imagine that insufficient attention is devoted to the remarkable part played by money in economic life if it is merely credited with the function of being a medium of exchange; they do not think that due regard has been paid to the significance of money until they have enumerated half a dozen further “functions” — as if, in an economic order founded on the exchange of goods, there could be a more important function than that of the common medium of exchange.

After Menger’s review of the question, further discussion of the connection between the secondary functions of money and its basic function should be unnecessary.[5]See Menger, Grundsätze, pp. 278 ff. Nevertheless, certain tendencies in recent literature on money make it appear advisable to examine briefly these secondary functions — some of them are coordinated with the basic function by many writers — and to show once more that all of them can be deduced from the function of money as a common medium of exchange.

This applies in the first place to the function fulfilled by money in facilitating credit transactions. It is simplest to regard this as part of its function as medium of exchange. Credit transactions are in fact nothing but the exchange of present goods against future goods. Frequent reference is made in English and American writings to a function of money as a standard of deferred payments.[6]See [J. Shield] Nicholson, A Treatise on Money and Essays on Present Monetary Problems (Edinburgh, 1888), pp. 22 ff.; [Laurence] Laughlin, The Principles of Money (London, 1903), pp. 22 f. But the original purpose of this expression was not to contrast a particular function of money with its ordinary economic function, but merely to simplify discussions about the influence of changes in the value of money upon the real amount of money debts. It serves this purpose admirably. But it should be pointed out that its use has led many writers to deal with the problems connected with the general economic consequences of changes in the value of money merely from the point of view of modifications in existing debt relations and to overlook their significance in all other connections.

The functions of money as a transmitter of value through time and space may also be directly traced back to its function as medium of exchange. Menger has pointed out that the special suitability of goods for hoarding, and their consequent widespread employment for this purpose, has been one of the most important causes of their increased marketability and therefore of their qualification as media of exchange.[7]Cf. Menger, Grundsätze, pp. 284 ff. As soon as the practice of employing a certain economic good as a medium of exchange becomes general, people begin to store up this good in preference to others. In fact, hoarding as a form of investment plays no great part in our present stage of economic development, its place having been taken by the purchase of interest-bearing property.[8]That is, apart from the exceptional propensity to hoard gold, silver, and foreign bills, encouraged by inflation and the laws enacted to further it. On the other hand, money still functions today as a means for transporting value through space.[9][Karl] Knies in particular (Geld und Kredit, 2d ed. [Berlin, 1885], vol. 1, pp. 233 ff.) has laid stress upon the function of money as interlocal transmitter of value.

This function again is nothing but a matter of facilitating the exchange of goods. The European farmer who emigrates to America and wishes to exchange his property in Europe for a property in America, sells the former, goes to America with the money (or a bill payable in money), and there purchases his new homestead. Here we have an absolute textbook example of an exchange facilitated by money.

Particular attention has been devoted, especially in recent times, to the function of money as a general medium of payment. Indirect exchange divides a single transaction into two separate parts which are connected merely by the ultimate intention of the exchangers to acquire consumption goods. Sale and purchase thus apparently become independent of each other Furthermore, if the two parties to a sale-and-purchase transaction perform their respective parts of the bargain at different times, that of the seller preceding that of the buyer (purchase on credit), then the settlement of the bargain, or the fulfillment of the seller’s part of it (which need not be the same thing), has no obvious connection with the fulfillment of the buyer’s part. The same is true of all other credit transactions, especially of the most important sort of credit transaction — lending. The apparent lack of a connection between the two parts of the single transaction has been taken as a reason for regarding them as independent proceedings, for speaking of the payment as an independent legal act, and consequently for attributing to money the function of being a common medium of payment. This is obviously incorrect. “If the function of money as an object which facilitates dealings in commodities and capital is kept in mind, a function that includes the payment of money prices and repayment of loans … there remains neither necessity nor justification for further discussion of a special employment, or even function of money, as a medium of payment.”

The root of this error (as of many other errors in economics) must be sought in the uncritical acceptance of juristical conceptions and habits of thought. From the point of view of the law, outstanding debt is a subject which can and must be considered in isolation and entirely (or at least to some extent) without reference to the origin of the obligation to pay. Of course, in law as well as in economics, money is only the common medium of exchange. But the principal, although not exclusive, motive of the law for concerning itself with money is the problem of payment. When it seeks to answer the question, What is money? it is in order to determine how monetary liabilities can be discharged. For the jurist, money is a medium of payment. The economist to whom the problem of money presents a different aspect, may not adopt this point of view if he does not wish at the very outset to prejudice his prospects of contributing to the advancement of economic theory.

“Senior’s Lectures on Monetary Problems”

When people today generally assert that things have so radically changed since the time in which the classical theory of money and foreign exchanges was expounded, that one cannot apply their results to modern conditions, they unfortunately do not give any proof. It is totally wrong to pretend that raising the rate of discount would not have any effect today on the flow of gold and on the exchange rate, or an insufficient effect. There is no proof that discount policy of the old type is inapplicable to the present situation. The fact is that the ruling parties prefer the consequences of a depreciation of the national currency to the consequences resulting from non-interference in the market’s money rate.

Let us consider separately the different recent cases of departure from the old gold parity. There was the case of England in 1931. Britain had to choose between a policy of defending the gold standard by raising the rate of discount, as has been done over and over again, and a policy of depreciation. She decided for the second because it made it possible to maintain unchanged the British level of prices and wages in the midst of a world of falling gold prices. Opinions differ on the soundness of this policy, and there is no doubt that it was very unsound from the point of view of [Nassau William] Senior’s ideas. But there was nothing in the situation which could not be explained from the point of view of Senior’s theoretical teaching. It is true that his decision would have been very different from that of Great Britain’s rulers in 1931. He would have believed that nominal wages had to fall pari passu with prices, and that there was nothing alarming in a situation where the prices of raw materials which England buys fall more rapidly than the prices of the manufactures which England exports. But Senior in discussing these problems with Mr. Norman and Mr. Keynes would at the end of the conversation have said: “I see, gentlemen, that you follow other aims.” But he would have had no reason to say: “You have to cope with a situation which my theory does not cover.”

Yet in another respect a radical change in the financial situation has been accomplished. In the modern banking system the short-term debts play a dominating role. The banks of the lending countries have lent enormous sums to the banks of the borrowing countries. Literally they had the right to withdraw this money at short notice. But in fact such withdrawals could not be affected at once, as the borrowing banks had lent this money to business which could not pay it back at all or at least only after some delay. The international credit relations were based on a fallacious assumption of liquidity. The moment the lenders tried to exert their right of withdrawal there were only two alternatives: open declaration of bankruptcy by the debtor banks or intervention of the government which suspended payments to foreign countries. The introduction of foreign exchange control in some continental countries in the summer of 1931 was a makeshift for a formal moratorium.

Banking today is not sounder when considered from the point of view of the home situation. Deposits subject to cheques and saving deposits are two entirely different things. The saver wishes to entrust his money for a longer period; he wishes to get interest. The bank which receives his money has to lend it to business. A withdrawal of the money entrusted to it by the saver can only take place in the same measure as the bank is able to get back the money it has lent. As the total amount of the saving deposits is working in the country’s business, a total withdrawal is not possible. The individual saver can get back his money from the bank, but not all savers at the same time. That does not mean that banking is unsound. It does not become unsound until the banks explicitly or tacitly promise what they cannot perform: to pay back the savings at call or at short notice.

The deposits subject to cheques have a different purpose. They are the business man’s cash like coins and bank notes. The depositor intends to dispose of them day by day. He does not demand interest, or at least he would entrust the money to the bank even without interest. The bank, to be sure, could not earn anything if it were to hold the whole amount of these deposits available. It has to lend the money at short notice to business. If all depositors simultaneously were to ask their deposits back, it could not meet the demand. This fact that a bank which issues notes or receives deposits subject to cheque cannot hold the total amount corresponding to the notes in circulation and to the deposits in its vaults, and therefore can never redeem at once the total amount of its liabilities of this kind, is the knotty problem of banking policy. It is the consideration of this difficulty which has to govern the credit policy of the banks which issue notes or receive deposits subject to cheque. It is this consideration that led to the legislation which limits the issue of bank notes and imposes on the central banks the retention of a reserve fund of a certain magnitude.

But the case of the saving deposits is different. Since the saver does not need the deposited sum at call or short notice it is not necessary that the saving banks and the other banks which take over such deposits should promise repayment at call or at short notice. Nevertheless, this is what they did. And so they became exposed to the dangers of a panic. They would not have run this danger, if they had accepted the saving deposits only on condition that withdrawal must be notified some months ahead.

Public opinion assumes that the real danger to maintenance of monetary stability lies in the flight of capital. This assumption is not correct. Capital invested in real estate or in industrial plants or in shares of companies holding property of this nature cannot fly. You can sell such property and leave the country with the proceeds. But — unless there is no expansion of credit — the buyer simply replaces you. If he is a foreigner, then the capital flight of the native is compensated by the immigration of capital from abroad. If the buyer is another native, then he can provide the means — when additional credit is not granted by credit expansion — merely by selling his property, and so the case with him is the same. One person or another can withdraw his capital from a country, but this can never be a mass movement. There is only one apparent exception, i.e., the saving deposit which can be withdrawn from the bank at once or at short notice. When the saving deposits are subject to instant withdrawal and the bank of issue renders the immediate withdrawal possible by advancing credits for these savings to be withdrawn, then credit expansion and inflation cause the exchange ratio to rise. It is obvious that not the flight of capital but the credit expansion in favor of the saving banks is the root of the evil.

The pith of the problem lies in the deposit policy. Banks which promise no more than they can fulfill without extraordinary assistance from the central bank, never jeopardize the stability of the country’s currency. And even the other banks who have been imprudent enough to assume liabilities which they cannot meet are only a danger when the central bank tries to assist them. If the Central Bank were to leave them to their fate, their peculiar embarrassment would not have any effect on foreign exchanges. That the additional issue of great amounts of bank notes for the sake of the repayment of the total amount or of a great portion of the country’s saving deposits makes the foreign exchange go up is easy to understand. It is not simply the wish of the capitalists to fly with their capital, but the expansion of the circulation, that imperils monetary stability.

Had the central banks not believed that it was their duty to cover up the consequences of the deposit banks’ wrong policy they would have not only maintained without artificial and, at the same time, ineffective measures of the stability of the exchange ratio, but would have forced the deposit banks to make agreements with their clients concerning the payments due. By such agreements they would have adjusted the payments due to the payments receivable. The Standstill Agreements would have been made definitively and for all debts, foreign, and domestic.

To sum up, we are not entitled to say that Senior in his writings on money and monetary subjects had to deal with problems other than those which we have today. The task of monetary and banking theory is in principle not different today from Senior’s time. Different, of course, are the conditions of our banking organization, the institutions, and the considerations which politicians keep in mind. Different are the data, but not the mechanism of exchange and social cooperation. All the questions of principles which Senior had to face are identical with those which our theory has to answer. We may differ from Senior in regard to the treatment of the fundamental items of value and exchange, but we have still the same problems to solve. And notwithstanding all changes in economic thought and reasoning, in social conditions and political aspects, in banking organization and in business life generally, no one can read these old pamphlets without profit.

“The Position of Money among Economic Goods”[12][Mises, Money, Method, and the Market Process (1932), chap. 4, pp. 55–64.]

Karl Knies has recommended to replace the traditional division of economic goods into consumer goods and producer goods with a threefold classification: producer goods, consumer goods, and means of exchange.[13]Karl Knies, Geld und Kredit, 2d. (Berlin: Weidmann, 1885), pp. 20 ff.Terminological questions of this kind, however, should be decided solely on the basis of their usefulness for furthering scientific work; definitions, concepts, and the taxonomy of phenomena have to prove their usefulness in the results of the research which makes use of them. When these criteria are applied to the classification and terminology suggested by Knies, it becomes apparent that they are extremely appropriate. Indeed, there is no theory of catallactics which does not make use of them. The theory of the value of money is always reserved for special treatment and separated for the explanation of the price formation of producer goods as well as consumer goods, although it is obviously part of a uniform theory of value and price. Even if we do not use the Kniesian terminology and classification consciously, in all significant discussions we act as if we had adopted them completely.

But it is also necessary to note that the special role of money among economic goods has, if anything, been over-emphasized. The problems of the determination of the purchasing power of money have mostly been treated as if they had nothing or very little in common with the problems of non-monetary exchange. This led to a special status of monetary theory and has been detrimental to the development of economic understanding. Even today, we continually encounter attempts to defend certain unjustified peculiarities of monetary theory.

Roscher’s often quoted remark, “[that] the wrong definitions of money can be divided into two main groups: Those which think of it as more and those which think of it as less than the most saleable good,”[14]Wilhelm Roscher, Gundlagen der Nationalökonomie, 25th ed. (Stuttgart and Berlin: J.G. Cotta’sche Buchhandlung Nachtfolger, 1918), p. 340. applies not only to the question of the definition of money. Even a number of those who consider the theory of money a part of catallactics go too far in emphasizing its special position. This branch of our science offers plenty of difficulties and it is not necessary to construct artificial problems; the existing ones provide enough challenge.

1. Monetary Services and the Value of Money

It is clear that the naive conception of the layman that things have value in themselves, i.e., intrinsic value, necessarily leads to a position which draws the dividing line between money and money substitutes differently from the position according to which the value of a thing is derived from its usefulness. Those who conceive of value as the result of properties inherent in things must necessarily make a distinction between physically valuable money and means of exchange which provide monetary services but are without material value. This approach inescapably leads to a contrasting of normal money with bad and abnormal money, which, in reality, is not money at all.

Today there is no need to deal with this theory. For the modern subjective theory of value, the question has long been decided. No one would still openly defend a concept according to which the whole or a portion of value and price theory was based upon intrinsic exchange value, i.e., independent of the valuations of acting men. Once this is admitted, one has already adopted the fundamental principle of subjective value theory, i.e., the theory of marginal utility.

For prescientific economists — the predecessors of the Physiocrats and the Classical Economists — it was a significant problem to integrate the theory of the value of money with that of the value of other goods. Holding a crudely materialistic bias, they saw the source of value in the “objective” usefulness of goods. From this point of view, it is obvious why bread, which can still hunger, and cloth, which can protect from the cold, will have value. But from where does money, which can neither nourish people nor keep them warm, derive its value? Some responded that it arose “from convention” and others maintained that the value of money was “imaginary.”

The error in this view was discovered early. John Law had put it most succinctly. If all value is derived from usefulness, then it must be true that the adoption of the precious metals as means of exchange must generate a value for it. If one wishes to call the value of the metal used as money, insofar as it is derived from its monetary services, imaginary, one has to regard all value as imaginary,

Car aucune chose n’a de valeur que par l’usage auquel on l’applique, et a raison des demandes qu’on en fait, proportionellement a sa quantite.[15]John Law, Considerations sur le Numeraire et le Commerce (Paris: Buisson, 1851), pp. 447 ff. The passage translates as: The value of a thing is only in the use we make of it and the expectations we put into it, proportional to its quantity.

With these words, Law anticipated the subjective theory of value; he should not be denied the place he deserves in the history of our science. The importance of his accomplishment is not reduced by his inability to develop all the implications from his fundamental idea or that he got lost in the impenetrable thicket of error or, perhaps, even of guilt.

Researchers who came after him were also unable to make full use of the content of the clearly developed fundamental idea advanced by Law. In three respects we still encounter misconceptions.

First, some writers categorically deny that the service provided by money can generate value. Unfortunately, they do not provide a justification why monetary services should be different from the services provided by food and clothing. The difficulty posed by “paper money” is circumvented by viewing “paper money” as a claim on genuine, i.e., “materially” valuable, metallic money. Fluctuations in the rate of exchange of “paper money” are explained by changes in the probability of payment in species. In view of the development of monetary theory during the last decades, I consider it superfluous to challenge this theory. I have attempted an empirical refutation and have not encountered adequate opposition.[16]See [Ludwig von] Mises, The Theory of Money and Credit, pp. 146–53.

In a way, the second error is connected with the first: the denial of the possibility of there being a money whose “substance” only produces monetary services and nothing else. It is usually granted that monetary services can generate value, just as every other service, in general. Without reservation, we have to agree with Knies when he argues, “[that] gold and silver would have been as unsuitable for the purpose of performing the functions of money as any other commodity, if they had not previously — before their adoption for monetary services — served as economic goods for the satisfaction of human wants, a ‘general’ economic need, a need that was widely felt and persistent.”[17]Knies, Geld und Kredit, p. 322. But Knies is in error when he continues, “it is not sufficient that this primary use of the precious metals has preceded their use for monetary services; it is necessary that this use continues, lest the pieces of precious metal lose their usefulness as money. … If people ceased to use gold and silver to satisfy their desire for jewelry or ornamentation, etc., then the other use of the precious metals, their use as a means of exchange, would be eliminated, also.”[18]Ibid., pp. 322 ff.
(Knies, Geld und Kredit, p. 322.)
Knies did not succeed in proving the validity of this assertion. It is by no means evident why an economic good, which performs the services of a commonly used means of exchange, should lose its ability to serve as money simply because its use for other purposes are gradually discontinued.

That the adoption of a good as a medium of exchange requires the goods’ previous use or consumption for other purposes results from the fact that the specific demand for its services as a means of exchange presupposes an already existing objective exchange value. This objective exchange value, which subsequently will be modified by the demand for the good as a medium of exchange in addition to the demand for it in its “other” use, will be based exclusively upon its “other” use when it begins to be used as a means of exchange. But once an economic good has become money, then the specific demand for money can tie into an already existing exchange relationship between money and goods in the market, even if the demand for the money-good, as motivated by the other use, disappears.

Only very slowly and with difficulty has the human spirit freed itself from the crude materialistic mode of thought that has resulted in a prolonged resistance to the idea that the use of a good as a medium of exchange, like any other possible use for the good, generates a demand that establishes a price and is capable of changing that price. If the ability of a thing to satisfy a human need, as well as the recognition of this ability, are made the prerequisites for establishing the goods-quality of a thing,[19]This is even done by [Carl] Menger; see, his Principles of Economics (1871) (New York: New York University Press, 1981), pp. 52–53. then one comes close to distinguishing between “real” and “unreal” goods among the objects of economic action. As soon as the economist steps upon this ground, he loses his footing and slides unintentionally out of the domain of scientific objectivity; he enters the realm of ethical valuations, morality, and policy. There, he will compare the “objectively useful” things to those which are merely “thought to be useful.” He will examine whether and to what extent the things which are thought to be useful (and therefore are treated accordingly) are indeed so in an “objective” sense. As soon as one has come this far, it is only logical to ask whether the usefulness provided by a good satisfies a genuine need or merely a fictitious one. This way of thinking may subsequently lead to the view that the value of precious metals (which serve “only” the desire for jewelry and do not satisfy a physiological need as, e.g., food and clothing undeniably do from a crude materialistic point-of-view) is entirely imaginary, a result of inappropriate social institutions and human vanity. On the other hand, the result can be that the value of precious metals is admitted as legitimate since even the desire for jewelry is “genuine” and “justified.” The objective utility of the precious metals is not denied; rather, the general validity of the requirement for the services of money is questioned since society had once existed without money and, in any case, such a society is imaginable. It is an untenable assumption that the “goods-quality” requires a “natural” utility not limited to the particular requirements of any presupposed social order.

But an even cruder materialism was the view which wanted to deny monetary services their value-creating power because money in its performance of this service did not lose its ability to serve other purposes; in other words, because its “substance” was not used up in its services as money.

All of those who denied the ability of the services of money to determine its exchange value failed to recognize that the only decisive element is demand. The fact that there exists a demand for money — the most marketable (most saleable) good, for which the owners of other goods are prepared to exchange — means that the monetary function is capable of creating value.

2. Money Supply and Money Demand: The “Velocity of Circulation” of Money

The most disastrous of the unjustified deviations of monetary theory from the theory of direct exchange was the failure to base the analysis of the fundamental problem of the theory of the value of money on the relation between the stock of money and the demand for it by the individual economic units, or between the demand for money and the supply of money on the market. Rather, the analysis began with the objective usefulness of the monetary unit for the aggregate economy, which was expressed as the velocity of money relative to the money stock and which was then compared to the sum of transactions.

The old tendency, taken over from the Cameralists, to base the analysis of economic problems of the “national economy,” on the “totality” and not on the acting human subjects, seems hard to eradicate. In spite of all the warnings of the subjective economists, we continue to observe relapses. It is one of the lesser evils that ethical judgments regarding phenomena are presented under the guise of scientific objectivity. For example, productive activity (i.e., activity carried out in an imagined socialist community led by the critic) is contrasted with profit-seeking activity (i.e., the activity of individuals in a society based on private property in the means of production). The former will be viewed as the “just” and the latter as the “unjust” mode of production. Much more important is the fact that if one thinks in terms of the totality of a society’s economy, one can never understand the operation of a society based on private property in the means of production. It is erroneous to maintain that the necessity for the collectivist method can be proved by showing that actions of the individuals can only be understood within the framework of that individual’s environment. This is so because economic analysis does not depend on the psychological understanding of the motives of action, but only an understanding of action itself. It is unimportant for catallactics why bread, clothes, books, cannons or religious items are desired on the market; it is only important that a certain demand does exist. The mechanism of the market and, therefore, the laws of the capitalistic economy can only be grasped if one begins with the forces operating on the market. But on the market there are only individuals acting as buyers and sellers, never the “totality.” In economic theory, the totality can be taken only in the sense of an economic collective where the means of production are entirely outside the orbit of exchange and, therefore, cannot be sold for money. Here there is neither room for price theory nor a theory of money. But if we wish to grasp the value problems of a collective economy, we can — ironically — only use that method of analysis which has come to be known as the “individualistic method.”

The attempts to solve the problem of the value of money with reference to the aggregate economy, rather than through market factors, culminated in a tautological equation without any epistemological value. Only a theory which shows how subjective value judgments of buyers and sellers are influenced by changes in the different elements of the equation of exchange can legitimately be called a theory of the value of money.

Buyers and sellers on the market never concern themselves with the elements in the equation of exchange, of which two — velocity of circulation and the price level — do not even exist before market parties act and the other two — the quantity of money (in the whole economy) and the sum of transactions — could not possibly be known to the parties in the market. Only the importance which the various actors in the market attach, on the one hand, to the maintenance of a cash balance of a certain magnitude and, on the other hand, to the ownership of the various goods in question determines the formation of the exchange relationship between money and goods.

Connected with the concept of the velocity of circulation of money is the mental image that money generates its usefulness only at the instant of transaction, but is “idle” and useless at other times. A distinction between active and idle money is also made when one speaks of money hoarding and proceeds to a comparison between the “hoarded” quantity of money and the quantity of money that would be necessary to perform the monetary services; what distinguishes this from the previous case is the way in which the boundary between active and idle money is drawn. Both distinctions must be rejected.

The service of money is not confined to transactions. It fulfills its task not only at the moment it passes from one hand to the next. It also performs services when it rests in the till, as the most marketable good, in anticipation of its future use in trade as a generally used means of exchange. The demand for money of individuals, as well as the entire economy, is determined by the desire to maintain a cash balance and not by the aggregate of transactions to be carried out during a certain time period.[20]Also see, Edwin Cannan, Money, 4th ed. (Westminster: P.S. King and Son, 1932), pp. 72 ff.

It is an arbitrary procedure to divide the money stock into two parts: that which is designated to perform money services proper and that which serves as a money hoard. Of course, no damage will be done if, on the one hand, the demand for money is separated into a demand for hoarding and a demand to perform the monetary service proper. But a formula which portrays and solves only an arbitrarily delineated part of the problem must be rejected if we are able to show another one which will deal with and solve the whole problem in a uniform fashion.

3. Fluctuations in the Value of Money

One of the most peculiar phenomena in the history of monetary theory is the stubborn resistance encountered by the quantity theory. The imperfect formulation given to it by many of its advocates inevitably ran into opposition, with many — as, for example, Benjamin Anderson[21]Benjamin Anderson, The Value of Money (New York: Macmillan, 1917). — ascribing to the concept a meaning quite different from that commonly accepted. As a result, what they call the quantity theory, and oppose as such, is not the theory itself but only a variation of it. This is not particularly astonishing. But what is quite surprising is that an attempt was made and sometimes is still made today to deny that changes in the relation between money supply and money demand will modify the purchasing power of the monetary unit. It is not sufficient to base an explanation on the special interests of inflationists, statists and socialists, of civil servants and politicians who would be harmed by a spreading of knowledge concerning monetary policy. We will never arrive at an answer by following the path of the Historical-Realistic School, which (following the Marxian example) explains all ideas by ideologies. It had never been a problem to explain why a particular ideology is developed and advocated by certain classes who believe they can benefit from it directly (even if this direct advantage is more than outweighed by indirect disadvantages). What has to be explained, however, is rather how incorrect theories come about and find followers. How does it come about that many people, without justification, come to assume that a certain policy benefits either the entire society or many groups in that society?

However, the theory of money as such is not interested in these psychological aspects which explain the reasons for the unpopularity of the quantity theory and the tendency to adopt other explanations for the value of money. Rather, it is interested in the question: which elements of the doctrines opposing the quantity theory could be useful? Since it was equally inadmissible to deny the importance of changes in supply for the formation of exchange relations in the area of indirect exchange as it was in the area of direct exchange, one could oppose the quantity theory only by admitting its correctness in principle, but arguing that notwithstanding its general validity another principle would regularly eliminate its effectiveness. This attempt was made by the Banking School with its famous theory of hoarding, and its offshoot, the theory of the automatic adjustment of the circulation of money substitutes to the demand for money in the broader sense. Today, both theories are overthrown.

As is the case with so many theories, the advocates of the quantity theory have harmed it more than its enemies. We have already mentioned the inadequacy of those theories based on the concept of the velocity of circulation of money. It was not any less erroneous to interpret the quantity theory as saying that the changes in the quantity of money resulted in proportional changes in the prices of goods. It was overlooked that every change in the relationship between the supply of money and the demand for money would necessarily bring about a shift in the distribution of wealth and income and that, therefore, the prices of the different goods and services could not be effected proportionally and simultaneously.

Nowhere has the practice of working with formulas modeled after mechanics, instead of paying attention to the problem of the influence of market factors, taken a greater toll than in this case. Economists wanted to operate with the equation of exchange without noticing that the changes in the volume of money and the demand for money can come about in only one way: at first, the evaluations and with them the actions of only a few economic subjects will be influenced, with the resulting changes in the purchasing power of the monetary unit only spreading through the economy in a step-by-step pattern. In other words, the problem of changes in the value of money have been treated with the method of “statics,” although there should never have been any doubt concerning the dynamic character of the problem.

4. Money Substitutes

The most difficult and most important special problem of monetary theory is that of money substitutes. The fact that money services can also be rendered by secure money claims redeemable on demand, presents considerable difficulties to the monetary theorists’ attempt to define the supply of money and the demand for money. This difficulty could not be overcome as long as money substitutes were not clearly defined and separated into money certificates and fiduciary media, in order to treat the granting of credit through the issue of fiduciary media separately from all other types of credit.

Loans which do not involve the issuing of fiduciary media (i.e., bank notes or deposits which are not backed by money) is of no consequence for the volume of money. The demand for money can be influenced by lending as much as by any other institution of the economic order. Without knowledge of the data of the specific case, we cannot say in which direction this influence will operate. The widely-held opinion that an expansion of credit will always lead to a reduction in the demand for money is not correct. If many of the loan contracts provide for large repayments on certain days (for example, at the end of the month or quarter), the result will be an increase and not a reduction in the demand for money. The consequences of this increase in the demand for money will be expressed in prices, if it were not for clearing arrangements, on the one hand, and the practice of banks to increase the volume of fiduciary media on critical days, on the other hand.

Everything depends on the clear separation of money from money substitutes and within the category of money substitutes a distinction between money certificates (a money substitute fully backed by money) and the fiduciary medium (the money substitute not backed by money). But this is above all a question of terminological appropriateness. However, this question gains in importance in view of the difficulty and complexity of the problems. It is not — as so often is still maintained — the “granting of credit” but the issuing of fiduciary media which causes those effects on prices, wages, and interest rates, which banking theory has to deal with. It is, therefore, not inappropriate to refer to banking theory as the theory of fiduciary media.

References • 400 Words

[1] [Ludwig von Mises, The Theory of Money and Credit (1934; Indianapolis, Ind.: LibertyClassics, 1980), chap. 1: “The Function of Money,” pp. 29–37.]

[2] See [Knut] Wicksell, Über Wert, Kapital und Rente (Jena, 1893; London, 1933), pp. 50 f.

[3] The conclusion that indirect exchange is necessary in the majority of cases is extremely obvious. As we should expect, it is among the earliest discoveries of economics. We find it clearly expressed in the famous fragment of the Pandects of Paulus: “Quia non semper nec facile concurrebat, ut, cum tu haberas, quod ego desiderarem, invicem haberem, quod tu accipere velles” (Paulus, lib. 33 ad edictum 1.I pr. D. de contr. empt. 18, I). Schumpeter is surely mistaken in thinking that the necessity for money can be proved solely from the assumption of indirect exchange (see his Wesen und Hauptinhalt der theoretischen Nationalökonomie [Leipzig, 1908], pp. 273 ff.). On this point, cf. Weiss, Die moderne Tendenz in der Lehre vom Geldwert, Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung, vol. 19, pp. 518 ff.

[4] See [Carl] Menger, Untersuchungen über die Methode der Sozialwissenschaften und der politischen Okonomie insbesondere (Leipzig, 1883), pp. 172 ff.; Grundsätze der Volkswirtschaftslehre, 2d ed. (Vienna, 1923), pp. 247 ff.

[5] See Menger, Grundsätze, pp. 278 ff.

[6] See [J. Shield] Nicholson, A Treatise on Money and Essays on Present Monetary Problems (Edinburgh, 1888), pp. 22 ff.; [Laurence] Laughlin, The Principles of Money (London, 1903), pp. 22 f.

[7] Cf. Menger, Grundsätze, pp. 284 ff.

[8] That is, apart from the exceptional propensity to hoard gold, silver, and foreign bills, encouraged by inflation and the laws enacted to further it.

[9] [Karl] Knies in particular (Geld und Kredit, 2d ed. [Berlin, 1885], vol. 1, pp. 233 ff.) has laid stress upon the function of money as interlocal transmitter of value.

[11] [Ludwig von Mises, Money, Method, and the Market Process: Essays by Ludwig von Mises, ed. Richard M. Ebeling (1933; Norwell, Mass. and Auburn, Ala.: Kluwer Academic Publishers and Mises Institute, 1990), chap. 8, pp. 106–09.]

[12] [Mises, Money, Method, and the Market Process (1932), chap. 4, pp. 55–64.]

[13] Karl Knies, Geld und Kredit, 2d. (Berlin: Weidmann, 1885), pp. 20 ff.

[14] Wilhelm Roscher, Gundlagen der Nationalökonomie, 25th ed. (Stuttgart and Berlin: J.G. Cotta’sche Buchhandlung Nachtfolger, 1918), p. 340.

[15] John Law, Considerations sur le Numeraire et le Commerce (Paris: Buisson, 1851), pp. 447 ff. The passage translates as: The value of a thing is only in the use we make of it and the expectations we put into it, proportional to its quantity.

[16] See [Ludwig von] Mises, The Theory of Money and Credit, pp. 146–53.

[17] Knies, Geld und Kredit, p. 322.

[18] Ibid., pp. 322 ff.

[19] This is even done by [Carl] Menger; see, his Principles of Economics (1871) (New York: New York University Press, 1981), pp. 52–53.

[20] Also see, Edwin Cannan, Money, 4th ed. (Westminster: P.S. King and Son, 1932), pp. 72 ff.

[21] Benjamin Anderson, The Value of Money (New York: Macmillan, 1917).

Chapter 10 • Monetary Theory and Policy • 22,100 Words

“The Main Issues in Present-Day Monetary Controversies”

Introductory Remarks

This is not a systematic presentation of the problems of money and credit. Neither is it a complete exposition of the theories and doctrines dealt with. The aim of this paper is merely to enumerate certain topics that should not be neglected in a discussion of money and credit.

I. The Purchasing Power Controversy

A. Is Money “Neutral”?

The older economists believed that — other things being equal — changes in the supply or demand of money make all commodity prices and wage rates simultaneously rise or fall in exact proportion to these changes. The price “level” changes, but the relations among the prices of individual commodities and services remain the same. Those mathematical economists whose theorizing culminates in the formulation of an equation of exchange still maintain this thesis.

Modern economic analysis rejects this assumption. The changes in the supply or demand of money do not affect all individuals at the same time and to the same extent. In the case of inflation, for instance, the additional quantity of money does not find its way at first into the pockets of all individuals, nor does every individual of those benefited first with the increase in the quantity of money get the same amount; and not every individual reacts to the same additional quantity in the same way. Consequently, the prices of various commodities and services rise neither at the same time nor to the same extent. The nonsimultaneous appearance and unevenness of the price changes brought about by increases in the quantity of money results in a shift of income and wealth from some groups of the population to other groups. Monetary fluctuations are not neutral, even apart from their repercussions on all contracts stipulating some form of deferred payments. Monetary changes are a source of economic and social change.

B. Are Changes in the Purchasing Power of Money Measurable?

Even if we were prepared to leave out consideration of the nonsimultaneous appearance and unevenness of the price changes brought about by changes in the supply of or demand for money, we must realize that the index-number method does not provide a faithful criterion for the measurement of changes in the purchasing power of the monetary unit. Economic conditions are not rigid; they are — also apart from any changes occurring in monetary matters — continuously changing. New commodities appear, old commodities disappear. The quality of the various commodities is subject to change. Tastes, wants, and desires are changing and with them the valuation of the various goods offered on the market. A motorcar of 1920 and a motorcar of 1940 are entirely different things. Twenty-five years ago, where were vitamins, refrigerators, and talking pictures? How different is the role played today in the average American household by canned food, rayon, and radio sets? How much do clothes and shoes change from one year to the next? Even standard foods like milk, butter, meat, and vegetables have in the last decades improved in quality to such an extent that it is impermissible to take them as equivalent with those marketed in the past. A method which tacitly assumes that nothing else had changed in the economic system than the available quantity of money is utterly illusory. The chairman of our committee has provided us with the results of an investigation undertaken in his corporation. According to this information, only a fraction of the products manufactured today are of the same kind as the goods manufactured a few years ago. This is a typical case, more or less representative for all American processing industries.

Besides, mathematics provides us with various methods for the computation of averages from a given set of figures. Each of these methods has, with regard to the problem in question, some merits and some defects. Each of them yields different results. As it is impossible to declare one of these methods as the only adequate one and to discard all the others as manifestly unsuitable, it is obvious that the index-number approach does not provide an indisputable and uncontested solution that could command general acceptance.

C. Is It Possible to Adjust Monetary Manipulation to a Nonarbitrary Standard?

The advocates of a manipulated currency pretend to aim at the stability of the monetary unit’s purchasing power. They fail, however, to realize that in a changing economic world, the concept of a stable purchasing power is devoid of any real meaning.

There are three main objections to be raised against the proposals for a manipulated currency.

1. The various methods suggested for a measurement of changes in the monetary unit’s purchasing power are arbitrary. Their results are contested by all those whose material interests would be hurt if they were to be used as a basis of monetary manipulation. In advocating the application of a certain index-number system, the results of which happen at the moment to provide a quasi-scientific justification of their particular interests, every pressure group and political party will always be in a position to cite the doctrine of some economists and statisticians. On the other hand, their adversaries will quote dissenting opinions of no less renowned experts. There is no means to free a tabular standard from the faults of purely arbitrary and party-ridden bias.

2. It is impossible to know beforehand to what extent and at what date a definite amount of inflation or deflation (an increase or a reduction in the quantity of money and credit) will increase or reduce the prices of various commodities and services.

3. Apart from other deficiencies, the proposals for stabilization are faulty because they are based on the idea of money’s neutrality. They all suggest methods to undo changes in the purchasing power of money that have already had their effects. If there has been an inflation, they wish to deflate to the same extent and vice versa. They do not realize that by this procedure, they do not undo the social consequences of monetary changes (that is, the shift of income and wealth from some groups to others), but simply add to them the social consequences of a new change. If a man has been hurt by being run over by an automobile, it is no remedy to let the car go back over him in the opposite direction. D. The Case Against Flexible Foreign Exchange Parities

If the purchasing power of an individual country’s domestic currency changes, while the other countries’ currencies do not change at all or not to the same extent, foreign trade is affected. As a rule, foreign exchange rates are adjusted at an early stage of the inflationary or deflationary process to the new state of the domestic money supply, even while the prices of some commodities and services still lag behind and are not fully adjusted for a time. As long as the inflationary or deflationary changes have not exhausted all their effects on the structure of prices, the comparatively low or high state of some prices results — in the case of inflation — in encouraging exports and discouraging imports. From the viewpoint of mercantilist fallacies, a fall of the domestic monetary unit’s purchasing power is, therefore, considered as a very fortunate occurrence.

What really happens is this: The country exports more than it did before, and it gets, as compensation for these increased exports, a smaller amount of foreign products. Exports are, as it were, subsidized and imports penalized to the burden of the natives. The inflation is, by and large, tantamount to a tax imposed upon the domestic consumers in order to cheapen the consumption of domestic products by foreigners.

Nowadays, currency devaluation is mostly advocated as a remedy against the rigidity of wage rates. People are afraid of fighting openly the inappropriate policies of labor unions. They resort to an indirect attack. They hope that currency devaluation will, notwithstanding the rise of domestic commodity prices, not raise money wage rates and thus reduce real wage rates. Lord Keynes believes that “a gradual and automatic lowering or real wages as a result of rising prices” would not be “strongly resisted” by labor. He does not see that wage rates are rigid only on the downside, not on the upside, too.

E. The Case for the Gold Standard

The gold standard is not perfect. No human institution is.

The main argument in favor of the gold standard is that it renders the formation of the monetary unit’s purchasing power independent of arbitrary action on the part of governments, political parties, and pressure groups. It places a check upon inflationary policies, and is the only standard which can possibly become an international, a world standard.

II. The Credit Controversy

A. The Banking Principle

Some economists of the “Banking School” ventured to deny flatly that changes in the quantity of money available can affect prices and interest rates. They introduced into their reasoning the idea of monetary “hoards” as a deus ex machina. The amount of money kept in these mythical hoards changes in such a way as to neutralize automatically changes in the quantity of money. A surplus of money is swallowed by these hoards; a deficiency of money is made good by a restriction of the amount hoarded. This fable has long since been abandoned.

The bulk of the older Banking School economists and all contemporary representatives of this school do not deny that an increase in the quantity of money (metallic money, government paper money, irredeemable bank notes, and deposit currency) must — other things being equal — result in a general rise of prices. The core of their teachings is: Short-term credits granted by commercial banks in the form of bank notes or deposits created for this purpose do not affect prices and interest rates, provided they do not exceed “the needs of trade.” Such loans provide the debtor with the funds required for the production and the marketing of goods. They are self-liquidating. If the purchased raw materials are made up and sold, or if the buyer of products settles his balance, the loan is paid off, and the bank notes or deposits disappear again. An actual need has brought them into existence. With the cessation of this need, they go off the stage. The amount of credit of this type which the market can absorb is determined by the volume of production and business activity. It is beyond the power of the banks to alter this volume. No credit expansion is to be feared if the banks strictly abide by the rule to limit their lending to satisfy the demand of producers or merchants for short-term credit.

The reasoning of the Banking School misses the essential problem. It is obvious that no credit expansion takes place if the banks keep the total amount of their lending at the same level. But if a new bank enters the field or if an existing bank embarks upon the granting of additional credit above the amount of its previous credits, credit expansion results.

It is not true that the volume of credit that the banks are in a position to grant, if strictly abiding by the aforementioned rules, is independent of the bank’s policy. The market is always in a position to absorb a surplus of credit supply. An increase in the supply of credit brings about a tendency toward a lowering of the rate of interest. With the lower rate of interest, many projects appear attractive that did not appear so with a higher rate. The lowering of the rate of interest encourages the expansion of precisely those business activities that — according to the banking doctrine — are viewed as proper instances for the granting of bank credit. Thus the credit expansion automatically increases the “needs of trade.” It stimulates business activities because it cheapens the exchange of future purchasing power for present purchasing power. While the supply of capital goods remained unaltered, there is now a greater demand for them on the part of business. Prices must, consequently, rise. A boom starts.

B. The Currency Principle

The “Currency School” intended to provide an explanation of the recurrence of economic crises. Its proponents first observed that the root cause of the depression is the preceding boom and substituted for the study of crises the study of the trade cycle.

Their reasoning ran this way: If the British banks expanded credit while conditions in the other countries remained unchanged, British prices would begin to rise, and these on the world market would lag behind them. Consequently, there would be an excess of British imports over exports. As the surplus of imported goods could not be paid for by shipping bank notes, the importers would have to export gold. Hence, gold would be withdrawn from the banks; their reserves would dwindle. This “external drain” would force upon the banks a restriction of their lending activities. The artificial boom would come to an end and give way to a depression.

The main fault of the Currency School was that it dealt with bank notes only and did not realize that deposits subject to check are only technically different from bank notes, while their economic significance is equal to that of bank notes. This failure vitiated the British Bank Act of 1844. But it is easy to rectify this error by a simple extension of the theory.

C. Austrian Theory of the Trade Cycle

Currency theory did not consider the problem of the consequences of credit expansion within an isolated country or of a synchronous credit expansion in all countries. It did not enter into a discussion of the way in which the market and the whole apparatus of production and distribution react to credit expansion. This task was accomplished by Austrian theory.

The rate of interest established on a market not hampered by credit expansion, says Austrian theory, separates those business projects that can be carried out under the existing state of the supply of capital goods and consumers’ preferences from those that cannot. With the lowering of the rate of interest brought about by credit expansion, the entrepreneurs embark upon projects for the realization of which the available amount of factors of production does not suffice.[2]It is necessary to keep in mind that interest rates, in the course of a credit expansion, are — with the exception of the very beginning of the process — not always low when compared with the level which business used to consider as normal. But they are always low when measured by the standard that they would have to reach in a period of progressive inflation and its corollary, a general rise of prices, since they would have to include at such a time a compensation for the depreciation of the money unit going on in the period of the loan. They are deceived by the appearance of a nonexistent richness in the supply of material factors of production. They behave like a master builder who has overestimated the amount of building material available, has used up too much for the foundations and cannot complete his plan on account of a lack of material. Some of the new projects will never be finished; others, when finished, will be useless for lack of the plants producing the required complementary producers’ goods; others will not yield an adequate return on the capital invested.

It is true, the banks (or the governments) are in a position to prolong the boom for some time by injecting progressively increasing quantities of bank notes and deposits into the market. But the artificially created prosperity cannot last forever. Sooner or later it must come to an end. There are only two alternatives:

1. The banks do not stop and go on expanding credit at a progressively accelerated pace. But the spell of inflation breaks once the public has the conviction that the banks and the authorities are resolved not to stop. If no limit of the inflation and, consequently, of the general rise of prices can be foreseen, a general Flucht in die Sachwerte starts. Everybody becomes aware of the fact that to hold cash and deposit balances with the banks involves loss, and that he does better to buy and store goods. Everybody is anxious to get rid of money and to exchange it for some other commodities, no matter how much he must pay for them. Prices are running away, and the purchasing power of the monetary unit drops to zero. The national currency system cracks up.

2. As a rule, the banks do not let things go so far. They stop sooner by restricting credit. Then the day of reckoning dawns. The illusions disappear, people begin again to see reality as it is. The blunders committed in the boom become visible. In every case, the slump is unavoidable. There is no means to make permanent a boom created by credit expansion and inflation.

The slump does not destroy values, but merely illusions. It does not make people poorer, it merely makes them aware of the impoverishment brought about by the malinvestment of the boom. It is not the depression that is an evil, but the preceding boom. The depression is the process of adjustment of economic conditions to the real market state-of-affairs. The fall in prices and wage rates is the preliminary step toward recovery and future real prosperity. He who wants to prevent the recurrence of economic crises must prevent the resumption of credit expansion.

In short, credit expansion is doomed to failure at any rate. There is no means to substitute fictitious capital created by monetary and credit manipulation for nonexisting capital goods. The only method to increase a nation’s wealth and income is to save and to accumulate more real capital goods.

The rate of interest is a market phenomenon. In the long run, its height does not depend on the supply of money and credit. It is determined by the difference in the valuation of present goods and future goods. An increase in the supply of money and credit only temporarily lowers the rate of interest. In bringing about malinvestments, it finally results in a reduction in the amount of capital goods available. The economy has to pay heavily for the orgy of the artificial boom.

D. The Socialists’ Rejection of Austrian Theory

In the eyes of the socialists, there is no such thing as a scarcity of material factors of production. Mankind could enjoy a life in plenty. Scarcity is merely an outcome of the capitalist mode of production and distribution. Economic crises are an evil inherent in capitalism. They have nothing at all to do with the endeavors to expand credit and to lower the rate of interest by bank manipulation.

The consistent supporters of these tenets blithely assert that interest is a purely monetary phenomenon that could not exist in a barter economy. (Such were, for instance, the ideas of Silvio Gesell, the minister of finance of the short-lived communist Soviet regime in Munich; Lord Keynes is full of praise for Gesell and calls him an “unduly neglected prophet.”) Others are less outspoken and cling to a more cautious language. But a faulty doctrine does not gain anything from the fact that its advocates lack the courage to profess frankly all the conclusions which must be drawn logically from the principles they have espoused.

Whoever does not share the opinion that the rate of interest is only a monetary phenomenon is under the necessity to demonstrate the mechanism by which that level of the rate of interest, which corresponds to the whole structure of market conditions, reestablishes itself when temporarily disarranged by an easy money policy. The only solution of this problem provided up to now is that of the Austrian theory.

All those economists who want to explain the trade cycle as being caused by factors other than credit expansion must admit that no boom could arise if the amount of money and credit available were not increased. This implies that they cannot help admitting the fundamental thesis of Austrian theory.

E. Salvation Through Credit Manipulation

Consistent supporters of the doctrine that the rate of interest is a monetary phenomenon only and that there is no harm in the endeavors to abolish it by credit manipulation cannot help approving plans to establish the millennium by a reform of the monetary and banking system. The best known of the older projects of this type was that of the French socialist Proudhon, the man who coined the phrase “Property is theft.”

Such ideas are very popular with many successful businessmen. The Belgian Ernest Solvay advocated “social compatabilism,” a system hardly distinguished from that of Proudhon. More than twenty years ago, Thomas A. Edison and Henry Ford suggested that the construction of roads be financed by the issue of additional paper money in order to avoid the payment of interest to the banks or the public.

The present-day variety of this old superstition is embodied in the doctrine of unbalanced budgets and government spending. As far as the government procures the means required for spending by taxing the citizens and by borrowing from the public, its spending curtails individuals’ capacity to invest to the same extent that it increases that of the government. As far as the government borrows from the commercial banks or issues additional paper money, it embarks upon credit expansion and inflation. In the early stages of every instance of credit expansion and inflation, there is always optimism. People do not want to pay attention to the warning voices of economists. They stubbornly insist that their present situation has nothing in common with the boom periods of the past, and that the theorists are wrong in predicting the breakdown of the “prosperity.” But when the crisis comes, people become desperate; then they impeach not the faulty monetary and credit policies but the capitalist system as such.

III. The Foreign Exchange Controversy

A. Purchasing Power Parity Theory

The exchange ratio between two different kinds of money tends to correspond to the exchange ratio between each of them and commodities and services. It is usual to call this ratio the static or natural ratio. If this exchange ratio between two kinds of money is disturbed, people will start operations — buying and selling — in order to profit from existing discrepancies. These transactions tend to reestablish the natural ratio.

It does not make any difference whether the two kinds of money are used in the same country simultaneously (as was the case under the old parallel gold and silver standard) or whether each country uses one of them only. The natural rate of foreign exchange is determined by the purchasing power of each of the two kinds of money.

If a payment has to be effected in a distant place, the transaction is burdened with the cost of shipping the money. These costs are avoided if claims and debts of various people in the two places can be cleared. If complete settlement of all payments due can be achieved in this way, no actual shipping of money is required. If an unsettled surplus turns up, it must be settled by transfers from place to place. The balance of payments does not determine the exchange ratio. It only determines how much of the cost of shipping money can be saved. If the two places or countries in question use the same precious metal as the standard, the balance of payments determines the fluctuations of the rate-of-exchange within the rigid limits set by the cost of shipping money (gold points or shipping points).

B. Balance of Payment Theory

Balance of payment theory asserts that foreign exchange rates are determined by the balance of payments.

This doctrine fails to realize that the amount of foreign trade depends on the structure of prices. If Atlantis imports from Thule a commodity A, for the unit of which two ducats must be paid in Atlantis, the commodity must be sold in Thule at the equivalent of two ducats in its local currency, that is, ten florins. If, without any inflation in Thule, the price of the ducat goes up to three florins, the importation of A must drop or stop altogether because at the price of fifteen florins, the demand for A in Thule shrinks or disappears altogether. A rise of foreign exchange rates that does not correspond to a rise of domestic prices (a fall of the purchasing power of the domestic currency) thus has the tendency to render the country’s balance of payment “favorable.”

But, object the supporters of balance of payment theory, things are certainly different if A is a vital necessity for the citizens of Thule. Then, they must import A, no matter how much its price goes up. This, too, is a fallacy. If the individual citizens of Thule spend more florins for the purchase of A, they must, if there is no domestic inflation, restrict their buying of other commodities, either domestic or imported. In the first case, the prices of these domestic commodities drop, and they become available for export. In the second case, the amount of foreign exchange that would have been absorbed by the importation of other goods becomes available for the purchase of A.

If there is domestic inflation in Thule, then — and only then — a rise of the price of A (in florins) will not hinder the importation of A, as soon as the price of A (in Thule) is affected by the general rise of prices.

C. The Requirements of Foreign Exchange Stability

There is but one means to keep a nation’s domestic currency at par with gold and the sound currency of other countries: to abstain from credit expansion and inflation.

1. Subjective and Objective Factors in the Theory of the Value of Money

The central element in the economic problem of money is the objective exchange value of money, popularly called its purchasing power. This is the necessary starting point of all discussion; for it is only in connection with its objective exchange value that those peculiar properties of money that have differentiated it from commodities are conspicuous.

This must not be understood to imply that subjective value is of less importance in the theory of money than elsewhere. The subjective estimates of individuals are the basis of the economic valuation of money just as of that of other goods. And these subjective estimates are ultimately derived, in the case of money as in the case of other economic goods, from the significance attaching to a good or complex of goods as the recognized necessary condition for the existence of a utility, given certain ultimate aims on the part of some individual.[4]See [Eugen von] Böhm-Bawerk, Kapital und Kapitalzins, 3d ed. (Innsbruck, 1909–12], pp. 211 ff.Nevertheless, while the utility of other goods depends on certain external facts (the objective use-value of the commodity) and certain internal facts (the hierarchy of human needs), that is, on conditions that do not belong to the category of the economic at all but are partly of a technological and partly of a psychological nature, the subjective value of money is conditioned by its objective exchange value, that is, by a characteristic that falls within the scope of economics.

In the case of money, subjective use-value and subjective exchange value coincide.[5]See [Correa Moylan] Walsh, The Fundamental Problem in Monetary Science (New York, 1903), p. 11; and in like manner, [Arthur] Spiethoff, “Die Quantitätstheorie insbesondere in ihrer Verwertbarkeit als Haussetheorie,” Festgaben für Adolf Wagner (Leipzig, 1905), p. 256. Both are derived from objective exchange value, for money has no utility other than that arising from the possibility of obtaining other economic goods in exchange for it. It is impossible to conceive of any function of money, qua money, that can be separated from the fact of its objective exchange value. As far as the use-value of a commodity is concerned, it is immaterial whether the commodity also has exchange value or not; but for money to have use-value, the existence of exchange value is essential.

This peculiarity of the value of money can also be expressed by saying that, as far as the individual is concerned, money has no use-value at all, but only subjective exchange value. This, for example, is the practice of Rau[6]See [Karl Heinrich]Rau, Grundsätze der Volkswirtschaftslehre, 6th ed. (Leipzig, 1855), p. 80. and Böhm-Bawerk.[7]See Böhm-Bawerk, Kapital und Kapitalzins, Part II, p. 275. And similarly in [Friedrich von] Wieser, Der natürliche Wert, p. 45; “Der Geldwert und seine Veränderungen,” Schriften des Vereins für Sozialpolitik 132: 507. Whether the one or the other phraseology is employed, scientific investigation of the characteristic will lead to the same conclusions. There is no reason to enter upon a discussion of this point, especially since the distinction between value in use and value in exchange no longer holds the important place in the theory of value that it used to have.[8]See Böhm-Bawerk, Kapital und Kapitalzins, Part II, pp. 273 ff.; [Joseph] Schumpeter, Wesen und Hauptinhalt der theoretischen Nationalökonomie (Leipzig, 1908), p. 108. All that we are concerned with is to show that the task of economics in dealing with the value of money is a bigger one than its task in dealing with the value of commodities. When explaining the value of commodities, the economist can and must be content to take subjective use-value for granted and leave investigation of its origins to the psychologist; but the real problem of the value of money only begins where it leaves off in the case of commodity values, viz., at the point of tracing the objective determinants of its subjective value, for there is no subjective value of money without objective exchange value. It is not the task of the economist, but of the natural scientist, to explain why corn is useful to man and valued by him; but it is the task of the economist alone to explain the utility of money. Consideration of the subjective value of money without discussion of its objective exchange value is impossible. In contrast to commodities, money would never be used unless it had an objective exchange value or purchasing power. The subjective value of money always depends on the subjective value of the other economic goods that can be obtained in exchange for it. Its subjective value is in fact a derived concept. If we wish to estimate the significance that a given sum of money has, in view of the known dependence upon it of a certain satisfaction, we can do this only on the assumption that the money possesses a given objective exchange value. “The exchange value of money is the anticipated use-value of the things that can be obtained with it.”[9]Wieser, Der natürliche Wert, p. 46. Whenever money is valued by anybody it is because he supposes it to have a certain purchasing power.

It might possibly be objected that the mere possession by money of an undefined amount of objective exchange value is not alone sufficient to guarantee the possibility of using it as a medium of exchange; that it is also necessary that this purchasing power should be present in a certain degree, neither too great nor too small, but such that the proportion between the value of the units of money and that of the units of commodity is a convenient one for carrying through the ordinary exchange transactions of daily life; that even if it were true that half of the money in a country could perform the same service as the whole stock if the value of the monetary unit were doubled, yet it is doubtful if a similar proposition could be asserted of the case in which its value was increased a millionfold, or diminished to one-millionth, in inverse correspondence with changes in the quantity of it, since such a currency would hardly be capable of fulfilling the functions of a common medium of exchange so well as the currencies in actual use; that we should try to imagine a commodity money of which a whole ton, or one of which only a thousandth of a milligram was equivalent to a dollar, and think of the inconveniences, the insuperable obstacles in fact, which the employment of such a medium would inevitably place in the way of commerce.

However true this may be, the question of the actual dimensions of the exchange ratio between money and commodities and of the size of the monetary unit is not an economic problem. It is a question that belongs to discussion of the technical conditions that make any particular good suitable for use as money. The relative scarcity of the precious metals, great enough to give them a high objective exchange value but not so great as that of the precious stones or radium and therefore not great enough to make their exchange value too high, must indeed be reckoned, along with such of their other characteristics as their practically unlimited divisibility, their malleability, and their powers of resistance to destructive external influences, as among the factors that were once decisive in causing them to be recognized as the most marketable goods and consequently to be employed as money. But nowadays, as monetary systems have developed, the particular level of value of the precious metals no longer has any important bearing on their use as money. The modern organization of the clearing system and the institution of fiduciary media have made commerce independent of the volume and weight of the monetary material.

2. The Objective Exchange Value of Money

It follows from what has been said that there can be no discussion of the problem of the value of money without consideration of its objective exchange value. Under modern conditions, objective exchange value, which Wieser also calls Verkehrswert (or value in business transactions), is the most important kind of value, because it governs the social and not merely the individual aspect of economic life. Except in its explanation of the fundamentals of value theory, economics deals almost exclusively with objective exchange value.[10]Ibid., p. 52.
(Wieser, Der natürliche Wert, p. 46.)
And while this is true to some extent of all goods, including those which are useful apart from any exchange value which they possess, it is still truer of money.

“The objective exchange value of goods is their objective significance in exchange, or, in other words, their capacity in given circumstances to procure a specific quantity of other goods as an equivalent in exchange.”[11]Böhm-Bawerk, Kapital und Kapitalzins, Part II, pp. 214 f. It should be observed that even objective exchange value is not really a property of the goods themselves, bestowed on them by nature, for in the last resort it also is derived from the human process of valuing individual goods. But the exchange ratios that are established between different goods in commercial transactions, and are determined by the collective influence of the subjective valuations of all the persons doing business in the market, present themselves to separate individuals, who usually have an infinitesimal influence on the determination of the ratios, as accomplished facts, which in most cases have to be accepted unconditionally. It has thus been easy for false abstraction from this state of affairs to give rise to the opinion that each good comes to the market endowed with a definite quantity of value independent of the valuations of individuals.[12]See [Karl] Helfferich, Das Geld, 6th ed. (Leipzig, 1923), pp. 301 f. From this point of view, goods are not exchanged for one another, by human beings; they simply exchange.

Objective exchange value, as it appears in the subjective theory of value, has nothing except its name in common with the old idea developed by the Classical School of a value in exchange inherent in things themselves. In the value theory of Smith and Ricardo, and in that of their successors, value in exchange plays the leading part. These theories attempt to explain all the phenomena of value by starting from value in exchange, which they interpret as labor value or cost-of-production value. For modern value theory their terminology can claim only a historical importance, and a confusion of the two concepts of exchange value need no longer be feared. This removes the objections that have recently been made to the continued use of the expression “objective exchange value.”[13]Thus Schumpeter, Wesen und Hauptinhalt der theoretischen Nationalökonomie, p. 109.

If the objective exchange value of a good is its power to command a certain quantity of other goods in exchange, its price is this actual quantity of other goods. It follows that the concepts of price and objective exchange value are by no means identical. “But it is, nevertheless, true that both obey the same laws. For when the law of price declares that a good actually commands a particular price, and explains why it does so, it of course implies that the good is able to command this price, and explains why it is able to do so. The law of price comprehends the law of exchange value.”[14]See Böhm-Bawerk, Kapital und Kapitalzins, Part II, p. 217. By “the objective exchange value of money” we are accordingly to understand the possibility of obtaining a certain quantity of other economic goods in exchange for a given quantity of money; and by “the price of money” this actual quantity of other goods. It is possible to express the exchange value of a unit of money in units of any other commodity and speak of the commodity price of money; but in actual life this phraseology and the concept it expresses are unknown. For nowadays money is the sole indicator of prices. …

1. The Dependence of the Subjective Valuation of Money on the Existence of Objective Exchange Value[15][Mises, The Theory of Money and Credit, chap. 8: “The Determinants of the Objective Exchange Value, or Purchasing Power of Money,” pp. 129–44.]

According to modern value theory, price is the resultant of the interaction in the market of subjective valuations of commodities and price-goods. From beginning to end, it is the product of subjective valuations. Goods are valued by the individuals exchanging them, according to their subjective use-values, and their exchange ratios are determined within that range where both supply and demand are in exact quantitative equilibrium. The law of price stated by Menger and Böhm-Bawerk provides a complete and numerically precise explanation of these exchange ratios; it accounts exhaustively for all the phenomena of direct exchange. Under bilateral competition, market price is determined within a range whose upper limit is set by the valuations of the lowest bidder among the actual buyers and the highest offerer among the excluded would-be sellers, and whose lower limit is set by the valuations of the lowest offerer among the actual sellers and the highest bidder among the excluded would-be buyers.

This law of price is just as valid for indirect as for direct exchange. The price of money, like other prices, is determined in the last resort by the subjective valuations of buyers and sellers. But, as has been said already, the subjective use-value of money, which coincides with its subjective exchange value, is nothing but the anticipated use-value of the things that are to be bought with it. The subjective value of money must be measured by the marginal utility of the goods for which the money can be exchanged.[16]See pp. 99. Also Böhm-Bawerk, Kapital und Kapitalzins, Part II, p. 274; Wieser, Der natürliche Wert, p. 46. (Eng. trans. The Theory of Natural Value.)

It follows that a valuation of money is possible only on the assumption that the money has a certain objective exchange value. Such a point d’appui is necessary before the gap between satisfaction and “useless” money can be bridged. Since there is no direct connection between money as such and any human want, individuals can obtain an idea of its utility and consequently of its value only by assuming a definite purchasing power. But it is easy to see that this supposition cannot be anything but an expression of the exchange ratio ruling at the time in the market between the money and commodities.[17]See Wieser, “Der Geldwert und seine Veränderungen,” Schriften des Vereins für Sozialpolitik 132:513 ff.

Once an exchange ratio between money and commodities has been established in the market, it continues to exercise an influence beyond the period during which it is maintained; it provides the basis for the further valuation of money. Thus the past objective exchange value of money has a certain significance for its present and future valuation. The money prices of today are linked with those of yesterday and before, and with those of tomorrow and after.

But this alone will not suffice to explain the problem of the element of continuity in the value of money; it only postpones the explanation. To trace back the value that money has today to that which it had yesterday, the value that it had yesterday to that which it had the day before, and so on, is to raise the question of what determined the value of money in the first place. Consideration of the origin of the use of money and of the particular components of its value that depend on its monetary function suggests an obvious answer to this question. The first value of money was clearly the value which the goods used as money possessed (thanks to their suitability for satisfying human wants in other ways) at the moment when they were first used as common media of exchange. When individuals began to acquire objects, not for consumption, but to be used as media of exchange, they valued them according to the objective exchange value with which the market already credited them by reason of their “industrial” usefulness, and only as an additional consideration on account of the possibility of using them as media of exchange. The earliest value of money links up with the commodity value of the monetary material. But the value of money since then has been influenced not merely by the factors dependent on its “industrial” uses, which determine the value of the material of which the commodity money is made, but also by those which result from its use as money. Not only its supply and demand for industrial purposes, but also its supply and demand for use as a medium of exchange, have influenced the value of gold from that point of time onward when it was first used as money.[18]See [Karl] Knies, Geld und Kredit (Berlin, 1885), vol. 1, p. 324.

2. The Necessity for a Value Independent of the Monetary Function Before an Object Can Serve as Money

If the objective exchange value of money must always be linked with a preexisting market exchange ratio between money and other economic goods (since otherwise individuals would not be in a position to estimate the value of the money), it follows that an object cannot be used as money unless, at the moment when its use as money begins, it already possesses an objective exchange value based on some other use. This provides both a refutation of those theories which derive the origin of money from a general agreement to impute fictitious value to things intrinsically valueless[19]Thus [John] Locke, Some Considerations of the Consequences of the Lowering of Interest and Raising the Value of Money, 2d ed. (London, 1696), p. 31. and a confirmation of Menger’s hypothesis concerning the origin of the use of money.

This link with a preexisting exchange value is necessary not only for commodity money, but equally for credit money and fiat money.[20]See [Guillermo] Subercaseaux, Essai sur la nature du papier monnaie (Paris, 1909), pp. 17 f. No fiat money could ever come into existence if it did not satisfy this condition. Let us suppose that, among those ancient and modern kinds of money about which it may be doubtful whether they should be reckoned as credit money or fiat money, there have actually been representatives of pure fiat money. Such money must have come into existence in one of two ways. It may have come into existence because money substitutes already in circulation, that is, claims payable in money on demand, were deprived of their character as claims, and yet still used in commerce as media of exchange. In this case, the starting point for their valuation lay in the objective exchange value that they had at the moment when they were deprived of their character as claims. The other possible case is that in which coins that once circulated as commodity money are transformed into fiat money by cessation of free coinage (either because there was no further minting at all or because minting was continued only on behalf of the Treasury), no obligation of conversion being de jure or de facto assumed by anybody, and nobody having any grounds for hoping that such an obligation ever would be assumed by anybody. Here the starting point for the valuation lies in the objective exchange value of the coins at the time of the cessation of free coinage.

Before an economic good begins to function as money it must already possess exchange value based on some other cause than its monetary function. But money that already functions as such may remain valuable even when the original source of its exchange value has ceased to exist. Its value then is based entirely on its function as common medium of exchange.[21]See [Georg] Simmel, Philosophie des Geldes, 2d ed. (Leipzig, 1907), pp. 115 f.; but, above all, Wieser, “Der Geldwert und seine Veränderungen,” p. 513.

3. The Significance of Preexisting Prices in the Determination of Market Exchange Ratios

From what has just been said, the important conclusion follows that a historically continuous component is contained in the objective exchange value of money.

The past value of money is taken over by the present and transformed by it; the present value of money passes on into the future and is transformed in its turn. In this there is a contrast between the determination of the exchange value of money and that of the exchange value of other economic goods. All preexisting exchange ratios are quite irrelevant so far as the actual levels of the reciprocal exchange ratios of other economic goods are concerned. It is true that if we look beneath the concealing monetary veil to the real exchange ratios between goods we observe a certain continuity. Alterations in real prices occur slowly as a rule. But this stability of prices has its cause in the stability of the price determinants, not in the law of price determination itself. Prices change slowly because the subjective valuations of human beings change slowly. Human needs, and human opinions as to the suitability of goods for satisfying those needs, are no more liable to frequent and sudden changes than are the stocks of goods available for consumption, or the manner of their social distribution. The fact that today’s market price is seldom very different from yesterday’s is to be explained by the fact that the circumstances that determined yesterday’s price have not greatly changed overnight, so that today’s price is a resultant of nearly identical factors. If rapid and erratic variations in prices were usually encountered in the market, the conception of objective exchange value would not have attained the significance that it is actually accorded both by consumer and producer.

In this sense, reference to an inertia of prices is unobjectionable, although the errors of earlier economists should warn us of the real danger that the use of terms borrowed from mechanics may lead to a “mechanical” system, that is, to one that abstracts erroneously from the subjective valuations of individuals. But any suggestion of a causal relationship between past and present prices must be decisively rejected.

It is not disputed that there are institutional forces in operation which oppose changes in prices that would be necessitated by changes in valuations, and which are responsible when changes in prices that would have been caused by changes in supply and demand are postponed and when small or transitory changes in the relations between supply and demand lead to no corresponding change in prices at all. It is quite permissible to speak of an inertia of prices in this sense. Even the statement that the closing price forms the starting point for the transactions of the next market[22]See [Gustav von] Schmoller, Grundriss der allgemeinen Volkswirtschaftslehre (Leipzig, 1902), vol. 2, p. 110. may be accepted if it is understood in the sense suggested above. If the general conditions that determined yesterday’s price have altered but little during the night, today’s price should be but little different from that of yesterday, and in practice it does not seem incorrect to make yesterday’s the starting point. Nevertheless, there is no causal connection between past and present prices as far as the relative exchange ratios of economic goods (not including money) are concerned. The fact that the price of beer was high yesterday cannot be of the smallest significance as far as today’s price is concerned — we need only think of the effect upon the prices of alcoholic drinks that would follow a general triumph of the Prohibition movement. Anybody who devotes attention to market activities is daily aware of alterations in the exchange ratios of goods, and it is quite impossible for anybody who is well acquainted with economic phenomena to accept a theory which seeks to explain price changes by a supposed constancy of prices.

It may incidentally be remarked that to trace the determination of prices back to their supposed inertia, as even Zwiedineck in his pleadings for this assumption is obliged to admit, is to resign at the outset any hope of explaining the ultimate causes of prices and to be content with explanations from secondary causes.[23]See [Otto von] Zwiedineck, “Kritisches und Positives zur Preislehre,” Zeitschrift für die gesamte Staatswissenschaft, Vol. 65, pp. 200 ff. It must unreservedly be admitted that an explanation of the earliest forms of exchange transaction that can be shown to have existed — a task to the solution of which the economic historian has so far contributed but little would show that the forces that counteract sudden changes in prices were once stronger than they are now. But it must positively be denied that there is any sort of connection between those early prices and those of the present day; that is, if there really is anybody who believes it possible to maintain the assertion that the exchange ratios of economic goods (not the money prices) that prevail today on the German stock exchanges are in any sort of causal connection with those that were valid in the days of Hermann or Barbarossa. If all the exchange ratios of the past were erased from human memory, the process of market-price determination might certainly become more difficult, because everybody would have to construct a new scale of valuations for himself; but it would not become impossible. In fact, people the whole world over are engaged daily and hourly in the operation from which all prices result: the decision as to the relative significance enjoyed by specific quantities of goods as conditions for the satisfaction of wants.

It is so far as the money prices of goods are determined by monetary factors, that a historically continuous component is included in them, without which their actual level could not be explained. This component, too, is derived from exchange ratios which can be entirely explained by reference to the subjective valuations of the individuals taking part in the market, even though these valuations were not originally grounded upon the specifically monetary utility alone of these goods. The valuation of money by the market can only start from a value possessed by the money in the past, and this relationship influences the new level of the objective exchange value of money. The historically transmitted value is transformed by the market without regard to what has become its historical content.[24]See Wieser, “Der Geldwert und seine Veränderungen,” p. 513. But it is not merely the starting point for today’s objective exchange value of money; it is an indispensable element in its determination. The individual must take into account the objective exchange value of money, as determined in the market yesterday, before he can form an estimate of the quantity of money that he needs today. The demand for money and the supply of it are thus influenced by the value of money in the past; but they in their turn modify this value until they are brought into equilibrium.

4. The Applicability of the Marginal-Utility Theory to Money

Demonstration of the fact that search for the determinants of the objective exchange value of money always leads us back to a point where the value of money is not determined in any way by its use as a medium of exchange, but solely by its other functions, prepares the way for developing a complete theory of the value of money on the basis of the subjective theory of value and its peculiar doctrine of marginal utility.

Until now the subjective school has not succeeded in doing this. In fact, among the few of its members who have paid any attention at all to the problem there have been some who have actually attempted to demonstrate its insolubility. The subjective theory of value has been helpless in face of the task here confronting it.

There are two theories of money which, whatever else we may think of them, must be acknowledged as having attempted to deal with the whole problem of the value of money.

The objective theories of value succeeded in introducing a formally unexceptionable theory of money into their systems, which deduces the value of money from its cost of production.[25]See [Nassau William] Senior, Three Lectures on the Value of Money (London, 1840; 1931), pp. 1 ff.; Three Lectures on the Cost of Obtaining Money (London, 1830; 1931), pp. 1 ff. It is true that the abandonment of this monetary theory is not merely to be ascribed to those shortcomings of the objective theory of value in general which led to its supersession by the theory of the modern school. Apart from this fundamental weakness, the cost-of-production theory of the value of money exhibited one feature that was an easy target for criticism. While it certainly provided a theory of commodity money (even if only a formally correct one), it was unable to deal with the problem of credit money and fiat money. Nevertheless, it was a complete theory of money insofar as it did at least attempt to give a full explanation of the value of commodity money.

The other similarly complete theory of the value of money is that version of the quantity theory associated with the name of Davanzati.[26]See [Bernardo] Davanzati, Lezioni delle monete, 1588 (in Scrittori classici italiani di economia politica, Parte Antica (Milan, 1804), vol. 2, p. 32. Locke and, above all, Montesquieu (De l’Ësprit des lois, edition Touquet [Paris, 1821], vol. 2, pp. 458 f.) share this view. See [H. Parker] Willis, “The History and Present Application of the Quantity Theory,” Journal of Political Economy 4 (1896): 419 ff. According to this theory, all the things that are able to satisfy human wants are conventionally equated with all the monetary metal. From this, since what is true of the whole is also true of its parts, the exchange ratios between commodity units and units of money can be deduced. Here we are confronted with a hypothesis that is not in any way supported by facts. To demonstrate its untenability once more would nowadays be a waste of time. Nevertheless, it must not be overlooked that Davanzati was the first who attempted to present the problem as a whole and to provide a theory that would explain not merely the variations in an existing exchange ratio between money and other economic goods, but also the origin of this ratio.

The same cannot be said of other versions of the quantity theory. These all tacitly assume a certain value of money as given, and absolutely refuse to investigate further into the matter. They overlook the fact that what is required is an explanation of what determines the exchange ratio between money and commodities, and not merely of what causes changes in this ratio. In this respect, the quantity theory resembles various general theories of value (many versions of the doctrine of supply and demand, for example), which have not attempted to explain price as such but have been content to establish a law of price variations.[27]See [Emil] Zuckerkandl, Zur Theorie des Preises (Leipzig, 1889), p. 124. These forms of the quantity theory are in fact nothing but the application of the law of supply and demand to the problem of the value of money. They introduce into monetary theory all the strong points of this doctrine; and of course all its weak points as well.[28]See Wieser, “Der Geldwert und seine Veränderungen,” p. 514.

The revolution in economics since 1870 has not yet been any more successful in leading to an entirely satisfactory solution of this problem. Of course, this does not mean that the progress of the science has left no trace on monetary theory in general and on the theory of the value of money in particular. It is one of the many services of the subjective theory of value to have prepared the way for a deeper understanding of the nature and value of money. The investigations of Menger have placed the theory on a new basis. But till now one thing has been neglected. Neither Menger nor any of the many investigators who have tried to follow him have even so much as attempted to solve the fundamental problem of the value of money. Broadly speaking, they have occupied themselves with checking and developing the traditional views and here and there expounding them more correctly and precisely, but they have not provided an answer to the question: What are the determinants of the objective exchange value of money? Menger and Jevons have not touched upon the problem at all. Carver[29]See [T. N.] Carver, “The Value of the Money Unit,” Quarterly Journal of Economics 11 (1897): 429 f. and Kinley[30]See [David] Kinley, Money (New York, 1909), pp. 123 ff. have contributed nothing of real importance to its solution. Walras[31]See [Léon] Walras, Théorie de la Monnaie (Lausanne, 1886), pp. 25 ff. and Kemmerer[32]See [Edwin] Kemmerer, Money and Credit Instruments in Their Relation to General Prices (New York, 1907), pp. 11ff.assume a given value of money and develop what is merely a theory of variations in the value of money. Kemmerer, it is true, approaches very close to a solution of the problem but passes it by.

Wieser expressly refers to the incomplete nature of the previous treatment. In his criticism of the quantity theory he argues that the law of supply and demand in its older form, the application of which to the problem of money constitutes the quantity theory, has a very inadequate content, since it gives no explanation at all of the way in which value is really determined or of its level at any given time, but confines itself without any further explanation merely to stating the direction in which value will move in consequence of variations in supply or demand; that is, in an opposite direction to changes in the former and in the same direction as changes in the latter. He further argues that it is no longer possible to rest content with a theory of the economic value of money which deals so inadequately with the problem; that since the supersession of the old law of supply and demand as applied to commodities, the case for which it was originally constructed, a more searching law must also be sought to apply to the case of money.[33]See Wieser, “Der Geldwert und seine Veränderungen,” pp. 514 ff. But Wieser does not deal with the problem whose solution he himself states to be the object of his investigation, for in the further course of his argument he declares that the concepts of supply of money and demand for money as a medium of exchange are useless for his purpose and puts forward a theory which attempts to explain variations in the objective exchange value of money (objektive innere Tauschwert des Geldes)[34][See p. 124 n. H.E.B.] by reference to the relationship that exists in an economic community between money income and real income. For while it is true that reference to the ratio between money income and real income may well serve to explain variations in the objective exchange value of money, Wieser nowhere makes the attempt to evolve a complete theory of money — an attempt which, admittedly, the factors of supply and demand being excluded from consideration, would be certain to fail. The very objection that he raises against the old quantity theory, that it affirms nothing concerning the actual determination of value or the level at which it must be established at any time, must also be raised against his own doctrine; and this is all the more striking inasmuch as it was Wieser who, by revealing the historical element in the purchasing power of money, laid the foundation for the further development of the subjective theory of the value of money.

The unsatisfactory results offered by the subjective theory of value might seem to justify the opinion that this doctrine and especially its proposition concerning the significance of marginal utility must necessarily fall short as a means of dealing with the problem of money. Characteristically enough, it was a representative of the new school, Wicksell, who first expressed this opinion. Wicksell considers that the principle which lies at the basis of all modern investigation into the theory of value, namely, the concept of marginal utility, may well be suited to explaining the determination of exchange ratios between one commodity and another, but that it has practically no significance at all, or at most an entirely secondary significance, in explaining the exchange ratios between money and other economic goods. Wicksell, however, does not appear to detect any sort of objection to the marginal-utility theory in this assertion. According to his argument, the objective exchange value of money is not determined at all by the processes of the market in which money and the other economic goods are exchanged. If the money price of a single commodity or group of commodities is wrongly assessed in the market, then the resulting maladjustments of the supply and demand and the production and consumption of this commodity or group of commodities will sooner or later bring about the necessary correction. If, on the other hand, all commodity prices, or the average price level, should for any reason be raised or lowered, there is no factor in the circumstances of the commodity market that could bring about a reaction. Consequently, if there is to be any reaction at all against a price assessment that is either too high or too low it must in some way or other originate outside the commodity market. In the further course of his argument, Wicksell arrives at the conclusion that the regulator of money prices is to be sought in the relations of the commodity market to the money market, in the broadest sense of the term. The cause which influences the demand for raw materials, labor, the use of land, and other means of production, and thus indirectly determines the upward or downward movement of commodity prices, is the ratio between the money rate of interest (Darlehnszins) and the “natural” or equilibrium rate of interest (natürliche Kapitalzins), by which we are to understand that rate of interest which would be determined by supply and demand if real capital was itself lent directly without the intermediation of money.[35]See [Knut] Wicksell, Geldzins und Güterpreise (Jena, 1898), pp. iv ff, 16 ff.

Wicksell imagines that this argument of his provides a theory of the determination of the objective exchange value of money. In fact, however, all that he attempts to prove is that forces operate from the loan market on the commodity market which prevent the objective exchange value of money from rising too high or falling too low. He never asserts that the rate of interest on loans determines the actual level of this value in any way; in fact, to assert this would be absurd. But if we are to speak of a level of money prices that is “too high” or “too low,” we must first state how the ideal level with which the actual level is compared has been established. It is in no way sufficient to show that the position of equilibrium is returned to after any disturbance, if the existence of this position of equilibrium is not first explained. Indubitably, this is the primary problem, and its solution leads directly to that of the other; without it, further inquiry must remain unfruitful, for the state of equilibrium can only be maintained by those forces which first established it and continue to reestablish it. If the circumstances of the loan market can provide no explanation of the genesis of the exchange ratio subsisting between money and other economic goods, then neither can they help to explain why this ratio does not alter. The objective exchange value of money is determined in the market where money is exchanged for commodities and commodities for money. To explain its determination is the task of the theory of the value of money. But Wicksell is of the opinion that “the laws of the exchange of commodities contain in themselves nothing that could determine the absolute level of money prices.”[36]Ibid., p. 35.
(See [Knut] Wicksell, Geldzins und Güterpreise (Jena, 1898), pp. iv ff, 16 ff.)
This amounts to a denial of all possibility of scientific investigation in this sphere.

Helfferich also is of the opinion that there is an insurmountable obstacle in the way of applying the marginal-utility theory to the problem of money; for while the marginal-utility theory attempts to base the exchange value of goods on the degree of their utility to the individual, the degree of utility of money to the individual quite obviously depends on its exchange value, since money can have utility only if it has exchange value, and the degree of the utility is determined by the level of the exchange value. Money is valued subjectively according to the amount of consumable goods that can be obtained in exchange for it, or according to what other goods have to be given in order to obtain the money needed for making payments. The marginal utility of money to any individual, that is, the marginal utility derivable from the goods that can be obtained with the given quantity of money or that must be surrendered for the required money, presupposes a certain exchange value of the money; so the latter cannot be derived from the former.[37]See [Karl] Helfferich, Das Geld, 6th ed. (Leipzig, 1923), p. 577.

Those who have realized the significance of historically transmitted values in the determination of the objective exchange value of money will not find great difficulty in escaping from this apparently circular argument. It is true that valuation of the monetary unit by the individual is possible only on the assumption that an exchange ratio already exists in the market between the money and other economic goods. Nevertheless, it is erroneous to deduce from this that a complete and satisfactory explanation of the determination of the objective exchange value of money cannot be provided by the marginal-utility theory. The fact that this theory is unable to explain the objective exchange value of money entirely by reference to its monetary utility; that to complete its explanation, as we were able to show, it is obliged to go back to that original exchange value which was based not on a monetary function at all but on other uses of the object that was to be used as money — this must not in any way be reckoned to the discredit of the theory, for it corresponds exactly to the nature and origin of the particular objective exchange value under discussion. To demand of a theory of the value of money that it should explain the exchange ratio between money and commodities solely with reference to the monetary function, and without the assistance of the element of historical continuity in the value of money, is to make demands of it that run quite contrary to its nature and its proper task.

The theory of the value of money as such can trace back the objective exchange value of money only to that point where it ceases to be the value of money and becomes merely the value of a commodity. At this point the theory must hand over all further investigation to the general theory of value, which will then find no further difficulty in the solution of the problem. It is true that the subjective valuation of money presupposes an existing objective exchange value; but the value that has to be presupposed is not the same as the value that has to be explained; what has to be presupposed is yesterday’s exchange value, and it is quite legitimate to use it in an explanation of that of today. The objective exchange value of money which rules in the market today is derived from day’s under the influence of the subjective valuations of the individuals frequenting the market, just as yesterday’s in its turn was derived under the influence of subjective valuations from the objective exchange value possessed by the money the day before yesterday.

If in this way we continually go farther and farther back we must eventually arrive at a point where we no longer find any component in the objective exchange value of money that arises from valuations based on the function of money as a common medium of exchange; where the value of money is nothing other than the value of an object that is useful in some other way than as money. But this point is not merely an instrumental concept of theory; it is an actual phenomenon of economic history, making its appearance at the moment when indirect exchange begins.

Before it was usual to acquire goods in the market, not for personal consumption, but simply in order to exchange them again for the goods that were really wanted, each individual commodity was only accredited with that value given by the subjective valuations based on its direct utility. It was not until it became customary to acquire certain goods merely in order to use them as media of exchange that people began to esteem them more highly than before, on account of this possibility of using them in indirect exchange. The individual valued them in the first place because they were useful in the ordinary sense, and then additionally because they could be used as media of exchange. Both sorts of valuation are subject to the law of marginal utility. Just as the original starting point of the value of money was nothing but the result of subjective valuations, so also is the present-day value of money.

But Helfferich manages to bring forward yet another argument for the inapplicability of the marginal-utility theory to money. Looking at the economic system as a whole, it is clear that the notion of marginal utility rests on the fact that, given a certain quantity of goods, only certain wants can be satisfied and only a certain set of utilities provided. With given wants and a given set of means, the marginal degree of utility is determined also. According to the marginal-utility theory, this fixes the value of the goods in relation to the other goods that are offered as an equivalent in exchange, and fixes it in such a manner that that part of the demand that cannot be satisfied with the given supply is excluded by the fact that it is not able to offer an equivalent corresponding to the marginal utility of the good demanded. Now Helfferich objects that while the existence of a limited supply of any goods except money is in itself sufficient to imply the limitation of their utility also, this is not true of money. The utility of a given quantity of money depends directly upon the exchange value of the money, not only from the point of view of the individual, but also for society as a whole. The higher the value of the unit in relation to other goods, the greater will be the quantity of these other goods that can be paid for by means of the same sum of money. The value of goods in general results from the limitation of the possible utilities that can be obtained from a given supply of them, and while it is usually higher according to the degree of utility which is excluded by the limitation of supply, the total utility of the supply itself cannot be increased by an increase in its value; but in the case of money, the utility of a given supply can be increased at will by an increase in the value of the unit.[38]Ibid., p. 578.
(See [Karl] Helfferich, Das Geld, 6th ed. (Leipzig, 1923), p. 577.)

The error in this argument is to be found in its regarding the utility of money from the point of view of the community instead of from that of the individual. Every valuation must emanate from somebody who is in a position to dispose in exchange of the object valued. Only those who have a choice between two economic goods are able to form a judgment as to value, and they do this by preferring the one to the other. If we start with valuations from the point of view of society as a whole, we tacitly assume the existence of a socialized economic organization in which there is no exchange and in which the only valuations are those of the responsible official body. Opportunities for valuation in such a society would arise in the control of production and consumption, as, for example, in deciding how certain production goods were to be used when there were alternative ways of using them. But in such a society there would be no room at all for money. Under such conditions, a common medium of exchange would have no utility and consequently no value either. It is therefore illegitimate to adopt the point of view of the community as a whole when dealing with the value of money. All consideration of the value of money must obviously presuppose a state of society in which exchange takes place and must take as its starting point individuals acting as independent economic agents within such a society,[39]Dr. B. M. Anderson, pp. 100–10 of his excellent work The Value of Money (New York, 1917), has objected to the theory set forth above that instead of a logical analysis it provides merely a temporal regressus. Nevertheless, all the acute objections that he manages to bring forward are directed only against the argument that finds a historical component in the exchange ratios subsisting between commodities, an argument with which I also [see pp. 133ff. above] am in definite disagreement. But Dr. Anderson recognizes the logical foundation of my theory when he declares, “I shall maintain that value from some source other than the monetary employment is an essential precondition of the monetary employment” (p. 126). that is to say, individuals engaged in valuing things.

“The Non-Neutrality of Money”

The monetary economists of the sixteenth and seventeenth centuries succeeded in dissipating the popular fallacies concerning an alleged stability of money. The old error disappeared, but a new one originated, the illusion of money’s neutrality.

Of course, classical economics did its best to dispose of these mistakes. David Hume, the founder of British Political Economy, and John Stuart Mill, the last in the line of classical economists, both dealt with the problem in a masterful way. And then we should not forget Cairnes, who in his essay on the course of depreciation paved the way for a realistic view of the issue involved.

Notwithstanding these first steps towards a more correct grasp, modern economists incorporated the fallacy of money neutrality into their system of thought.

The reasoning of modern marginal utility economics begins from the assumption of a state of pure barter. The mechanism of exchanging commodities and of market transactions is considered on the supposition that direct exchange alone prevails. The economists depict a purely hypothetical entity, a market without indirect exchange, without a medium of exchange, without money. There is no doubt that this method is the only possible one, that the elimination of money is necessary and that we cannot do without this concept of a market with direct exchange only. But we have to realize that it is a hypothetical concept which has no counterpart in reality. The actual market is necessarily a market of indirect exchange and money transactions.

From this assumption of a market without money, the fallacious idea of neutral money is derived. The economists were so fond of the tool which this hypothetical concept provided that they overestimated the extent of its applicability. They began to believe that all problems of catallactics could be analyzed by means of this fictitious concept. In accordance with this view, they considered that the main work of economic analysis was the study of direct exchange. After that all that was left was to introduce the monetary terms into the formulas obtained. But this was, in their eyes, a work of only secondary importance, because, as they were convinced, the introduction of monetary terms did not affect the substantial operation of the mechanism they had described. The functioning of the market mechanism as demonstrated by the concept of pure barter was not affected by monetary factors.

Of course, the economists knew that the exchange ratio between money and commodities was subject to change. But they believed — and this is exactly the essence of the fallacy of money’s neutrality — that these changes in purchasing power were brought about simultaneously in the whole market and that they affected all commodities to the same extent. The most striking expression of this point of view is to be found in the current metaphorical use of the term “level” in reference to prices. Changes in the supply or demand of money — other things remaining equal — make all prices and wages simultaneously rise or fall. The purchasing power of the monetary unit changes, but the relations among the prices of individual commodities remain the same.

Of course, economists have developed for more than a hundred years the method of index numbers in order to measure changes in purchasing power in a world where the ratios between the prices of individual commodities are in continuous transition. But in doing so, they did not give up the assumption that the consequences of a change in the supply or demand of money were a proportional and simultaneous modification of prices. The method of index numbers was designed to provide them with a means of distinguishing between the consequences of those changes in prices which take their origins from the side of the demand for or supply of individual commodities and those which start from the side of demand for or supply of money.

The erroneous assumption of money neutrality is at the root of all endeavors to establish the formula of a so-called equation of exchange. In dealing with such an equation the mathematical economist assumes that something— one of the elements of the equation — changes and that corresponding changes in the other values must needs follow. These elements of the equation are not items in the individual’s economy, but items of the whole economic system, and consequently the changes occur not with individuals but with the whole economic system, with the Volkswirtschaft as a whole. Proceeding thus, the economists apply unawares for the treatment of monetary problems a method radically different from the modern catallactic method. They revert to the old manner of reasoning which doomed to failure the work of older economists. In those early days philosophers dealt in their speculations with universal concepts, such as mankind and other generic notions. They asked: What is the value of gold or of iron, that is: value in general, for all times and for all people, and again gold or iron in general, all the gold or iron available or even not yet mined. They could not succeed in this way; they discovered only alleged autinomies which were insoluble for them.

All the successful achievements of modern economic theory have to be ascribed to the fact that we have learned to proceed in a different way. We realize that individuals acting in the market are never presented with the choice between all the gold existing and all the iron existing. They do not have to decide whether gold or iron is more useful for mankind as a whole, but they have to choose between two limited quantities both of which they cannot have together. They decide which of these two alternatives is more favorable for them under the conditions and at the moment when they make their decision. These acts of choice performed by individuals faced with alternatives are the ultimate causes of the exchange ratios established in the market. We have to direct our attention to these acts of choice and are not at all interested in the metaphysical and purely academic, nay, vain question of which commodity in general appears more useful in the eyes of a superhuman intelligence surveying earthly conditions from a transcendental point of view.

Monetary problems are economic problems and have to be dealt with in the same way as all other economic problems. The monetary economist does not have to deal with universal entities like volume of trade meaning total volume of trade or quantity of money meaning all the money current in the whole economic system. Still less can he make use of the nebulous metaphor “velocity of circulation.” He has to realize that the demand for money arises from the preferences of individuals within a market society. Because everybody wishes to have a certain amount of cash, sometimes more, sometimes less, there is a demand for money. Money is never simply in the economic system, in the Volkswirtschaft, money is never simply circulating. All the money available is always in the cash holdings of somebody. Every piece of money may one day — sometimes oftener, sometimes more seldom — pass from one man’s cash holding to another man’s. But at every moment it is owned by somebody and is a part of his cash holdings. The decisions of individuals regarding the magnitude of their cash holdings constitute the ultimate factor in the formation of purchasing power.

Changes in the quantity of money and in the demand for money for cash holding do not occur in the economic system as a whole if they do not occur in the households of individuals. These changes in the households of individuals never occur for all individuals at the same time and to the same degree and they therefore never affect their judgments of value to the same extent and at the same time. It is exactly the merit of Hume and Mill that they tried to construct a hypothetical case where the changes in the supply of money could affect all individuals in such a way that the prices of all commodities would rise or fall at the same time and in the same proportion. The failure of their attempts provided a negative proof, and modern economics has added to this the positive proof that the prices of different commodities are not influenced at the same time and to the same extent. The oversimple formula both of the old quantity theory and of contemporary mathematical economists according to which prices, that is all prices, rise or fall in the proportion of the increase or decrease in the quantity of money, is disproved.

To simplify and to shorten our analysis let us look at the case of inflation only. The additional quantity of money does not find its way at first into the pockets of all individuals; not every individual of those benefited first gets the same amount and not every individual reacts to the same additional quantity in the same way. Those first benefited — in the case of gold, the owners of the mines, in the case of government paper money, the treasury — now have greater cash holdings and they are now in a position to offer more money on the market for goods and services they wish to buy. The additional amount of money offered by them on the market makes prices and wages go up. But not all the prices and wages rise, and those which do rise do not rise to the same degree. If the additional money is spent for military purposes, the prices of some commodities only and the wages of only some kinds of labor rise, others remain unchanged or may even temporarily fall. They may fall because there are now on the market some groups of men whose incomes have not risen but who nevertheless are obliged to pay more for some commodities, namely for those asked by the men first benefited by the inflation. Thus, price changes which are the result of the inflation start with some commodities and services only, and are diffused more or less slowly from one group to the others. It takes time till the additional quantity of money has exhausted all its price changing possibilities. But even in the end the different commodities are not affected to the same extent. The process of progressive depreciation has changed the income and the wealth of the different social groups. As long as this depreciation is still going on, as long as the additional quantity of money has not yet exhausted all its possibilities of influencing prices, as long as there are still prices left unchanged at all or not yet changed to the extent that they will be, there are in the community some groups favored and some at a disadvantage. Those selling the commodities or services whose prices rise first are in a position to sell at the new higher prices and to buy what they want to buy at the old still unchanged prices. On the other hand, those who sell commodities or services whose prices remain for some time unchanged are selling at the old prices whereas they already have to buy at the new higher prices. The former are making a specific gain, they are profiteers, the latter are losing, they are the losers, out of whose pockets the extra-gains of the profiteers must come. As long as the inflation is in progress, there is a perpetual shift in income and wealth from some social group, to other social groups. When all price consequences of the inflation are consummated, a transfer of wealth between social groups has taken place. The result is that there is in the economic system a new dispersion of wealth and income and in this new social order the wants of individuals are satisfied to different relative degrees, than formerly. Prices in this new order cannot simply be a multiple of the previous prices.

The social consequences of a change in the purchasing power of money are twofold: first, as money is the standard of deferred payments, the relations between creditors and debtors is changed. Second, as the changes in purchasing power do not affect all prices and wages at the same moment and to the same extent, there is a shift of wealth and income between different social groups. It was one of the errors of all proposals to stabilize purchasing power that they did not take into account this second consequence. We may say that economic theory in general did not pay enough attention to this matter. As far as it did, it principally considered it only in reference to the reaction of a change in a country’s currency on its foreign trade. But this is only a special application of a problem which has a much wider scope.

What is fundamental for economic theory is that there is no constant relation between changes in the quantity of money and in prices. Changes in the supply of money affect individual prices and wages in different ways. The metaphorical use of the term price level is misleading.

The erroneous opinion to the contrary was based on a consideration which may be represented thus: let us think of two absolutely independent systems of static equilibrium A and B. Both are in every respect alike except that to the total quantity of money (M) in A and to every individual cash holding (m) in A there correspond in B a total quantity of Mn and individual cash holdings mn. On these assumptions of course all the prices and wages in B are n times those in A. But they are exactly thus because these are our hypothetical assumptions. But nobody can devise a way by which the system A can be transformed into the system B. Of course it is unpermissible to operate with static equilibrium if we wish to approach a dynamic problem.

Setting aside all qualms about the use of the terms dynamic and static, I wish to say: money is necessarily a dynamic agent and it was a mistake to deal with monetary problems in a static way.

Of course there is no room left for money in a concept of static equilibrium. In forming the concept of a static society we assume that no changes are taking place. Everything is going on in the same old manner. Today is like yesterday and tomorrow will be like today. But under these conditions nobody needs a cash holding. Cash holding is necessary only when the individual does not know what situation he will have to face in an uncertain future. If everybody knows when and what he will have to buy, he does not need a private cash holding and can entrust all his money to the central bank as time deposits due on the dates and in the amounts necessary for his future payments. As everybody would proceed in the same way, the central bank does not need any reserves to meet its obligations. Of course, the total amount which it has to pay out to the buyers every day exactly balances the amount which it receives as deposits from the sellers. If we assume that in this world of static equilibrium once, before the equilibrium was attained, there was metallic currency only, let us say gold, we have to assume that with the gradual approach towards conditions of equilibrium the citizens deposited more and more of their gold and that the bank, which had no need for it, sold the gold to jewelers and others for industrial consumption. With the advent of equilibrium there is no more metallic money, there is in fact no more money at all, but an unsubstantial and immaterial clearing system, which cannot be considered as money in the ordinary sense. It is rather an unrealizable and even unthinkable system of accounting, a numeraire as some economists believed ideal money ought to be. This, if it could be called money, would be neutral money. But we should never forget, that the state of equilibrium is purely hypothetical, that this concept is nothing but a tool for our mental work. Not being able to make experiments, the social sciences have to forge such tools. But we must be very careful in their use. We have to be aware that the state of static equilibrium can never be attained in real life. Still more important is the fact, that in this hypothetical state the individual does not make choices, does not act and does not have to decide between incompatible alternatives. Life in this hypothetical state is therefore robbed of its essential element. In constructing this hypothetical state we want merely to understand the incentives of action, which always implies change, by conceiving conditions, in which no action takes place. But a changeless world would be a dead world. We do not just have to deal with death, but with life, action, and change. In a living world there is no room for neutrality of money.

Money, of course, is a dynamic factor and as such cannot be discussed in terms of static equilibrium.

Let me now briefly point out some of the major conclusions derived from an insight into the non-neutrality of money.

First we have to realize that the abandonment of the fallacious concept of neutral money destroys the last stronghold of the advocates of quantitative economics. For a very long time eminent economists have believed that it will be possible one day to replace qualitative economics by quantitative economics. What renders these hopes vain, is the fact, that in economic quantities we never have any constant ratios among magnitudes. What the economist discovers when he studies relations between demand and prices is not comparable with the work of the natural scientist who determines by experiments in his laboratory constant relations, e.g., the specific gravity of different substances. What the economist determines is of historical value only; he is in his statistical work a historian, but not an experimenter. The work of the late lamented Henry Schultz was economic history; what we learn from his research is what happened with some commodities in a limited period of the past in the United States and Canada. It tells us nothing about what happened with the same commodities elsewhere or in another period or what will happen in the future.

But there still has remained the belief that it is different with money. I may cite, for example, Professor Fisher’s book on the Purchasing Power of Money, which is founded on the assumption that the purchasing power of the monetary unit changes in inverse proportion to the quantity of money. I think that this assumption is arbitrary and fallacious.

The second conclusion which we have to draw is the futility of all endeavors to make money stable in purchasing power. It is beyond the scope of my short address to explain the advantages of a sound money policy and the disadvantages of both inflation and deflation. But we should not confuse the political concept of sound money with the theoretical concept of stable money. I do not wish to discuss the inner contradictions of this stability concept. From the point of view of the present subject it is more important to emphasize that all proposals for stabilization, apart from other deficiencies, are based on the idea of money’s neutrality. They all suggest methods to undo changes in purchasing power already effected if there has been an inflation they wish to deflate to the same extent and vice versa. They do not realize that by this procedure they do not undo the social consequences of the first change, but simply add to it the social consequences of a new change. If a man has been hurt by being run over by an automobile, it is no remedy to let the car go back over him in the opposition direction.

The popularity of all schemes for stabilization invites us to a philosophical consideration. It is a general weakness of the human mind to regard the state of rest and absence of change as more perfect than the state of motion. The absolute, that old phantom of misguided philosophical speculation, is still with us; its modern name is stability. But stability, e.g., absence of change, is, we have to repeat, absence of life.

The third conclusion which we may draw is the futility of the distinction between statics and dynamics and between short-run and long-run economics. The way in which we have to study monetary changes provides us with the best evidence that every correct economic consideration has to be dynamic and that static concepts are only instrumental. And at the same time we have to realize that all correct economic theorizing is a gradual progress from short-run to long-run effects.

But the most important value of the theory of money’s dynamism is its use for the development of the monetary theory of the trade cycle. The old British Currency-Theory was already in a restricted sense a monetary explanation of the cycle. It studied the consequences of credit expansion on the assumption only that there is credit expansion in one country whereas in the rest of the world things are left unchanged. This seemed to be enough for the explanation of the business cycle in Great Britain in the first half of the nineteenth century. But the explanation of an external drain does not provide an answer to the question what may happen in a completely isolated country or in the case of a simultaneous credit expansion all over the world. But only the answer to this second question could be considered satisfactory under the conditions prevailing in the twentieth century. Only the answer to this second question is important, if we have to consider the proposals for eliminating the cyclical changes either by loosening the international ties of the national economy or by making credit expansion international in the way the Bretton Woods Agreements provide. It is the boast of the monetary theory of the trade cycle that it provides us with a satisfactory answer to these and to some other serious problems.

I do not wish to infringe more upon your time and so I wish only to add some remarks on the treatment of the problem by certain younger economists. I myself am not responsible for the term “neutral money.” I have developed a theory of the changes in purchasing power and its social consequences. I have demonstrated that money acts as a dynamic agent and that the assumption that the changes in purchasing power are inversely proportional to the changes in the relation of demand for to the supply of money is fallacious. The term “neutral money” was coined by later authors. I do not wish to consider the question of whether it was a happy choice. But in any case I must protest against the belief that it has to be a goal of monetary policy to make money neutral and that it is the duty of the economists to determine a method of doing so. I wish to emphasize that in a living and changing world, in a world of action, there is no room left for a neutral money. Money is non-neutral or it does not exist.

Economic Policy: Thoughts for Tomorrow and Today[41][Ludwig von Mises, Economic Policy: Thoughts for Tomorrow and Today (1979; Washington, D.C.: Regnery Gateway, 2006), Lecture 4, pp. 55–73.]

“Inflation”

If the supply of caviar were as plentiful as the supply of potatoes, the price of caviar — that is, the exchange ratio between caviar and money or caviar and other commodities — would change considerably. In that case, one could obtain caviar at a much smaller sacrifice than is required today. Likewise, if the quantity of money is increased, the purchasing power of the monetary unit decreases, and the quantity of goods that can be obtained for one unit of this money decreases also.

When, in the sixteenth century, American resources of gold and silver were discovered and exploited, enormous quantities of the precious metals were transported to Europe. The result of this increase in the quantity of money was a general tendency toward an upward movement of prices in Europe. In the same way, today, when a government increases the quantity of paper money, the result is that the purchasing power of the monetary unit begins to drop, and so prices rise. This is called inflation.

Unfortunately, in the United States, as well as in other countries, some people prefer to attribute the cause of inflation not to an increase in the quantity of money but, rather, to the rise in prices.

However, there has never been any serious argument against the economic interpretation of the relationship between prices and the quantity of money, or the exchange ratio between money and other goods, commodities, and services. Under present day technological conditions there is nothing easier than to manufacture pieces of paper upon which certain monetary amounts are printed. In the United States, where all the notes are of the same size, it does not cost the government more to print a bill of a thousand dollars than it does to print a bill of one dollar. It is purely a printing procedure that requires the same quantity of paper and ink.

In the eighteenth century, when the first attempts were made to issue bank notes and to give these bank notes the quality of legal tender — that is, the right to be honored in exchange transactions in the same way that gold and silver pieces were honored — the governments and nations believed that bankers had some secret knowledge enabling them to produce wealth out of nothing. When the governments of the eighteenth century were in financial difficulties, they thought all they needed was a clever banker at the head of their financial management in order to get rid of all their difficulties.

Some years before the French Revolution, when the royalty of France was in financial trouble, the king of France sought out such a clever banker, and appointed him to a high position. This man was, in every regard, the opposite of the people who, up to that time, had ruled France. First of all he was not a Frenchman, he was a foreigner — a Swiss from Geneva, Jacques Necker. Secondly, he was not a member of the aristocracy, he was a simple commoner. And what counted even more in eighteenth century France, he was not a Catholic, but a Protestant. And so Monsieur Necker, the father of the famous Madame de Staël, became the minister of finance, and everyone expected him to solve the financial problems of France. But in spite of the high degree of confidence Monsieur Necker enjoyed, the royal cashbox remained empty — Necker’s greatest mistake having been his attempt to finance aid to the American colonists in their war of independence against England without raising taxes. That was certainly the wrong way to go about solving France’s financial troubles.

There can be no secret way to the solution of the financial problems of a government; if it needs money, it has to obtain the money by taxing its citizens (or, under special conditions, by borrowing it from people who have the money). But many governments, we can even say most governments, think there is another method for getting the needed money; simply to print it.

If the government wants to do something beneficial — if, for example, it wants to build a hospital — the way to find the needed money for this project is to tax the citizens and build the hospital out of tax revenues. Then no special “price revolution” will occur, because when the government collects money for the construction of the hospital, the citizens — having paid the taxes — are forced to reduce their spending. The individual taxpayer is forced to restrict either his consumption, his investments or his savings. The government, appearing on the market as a buyer, replaces the individual citizen: the citizen buys less, but the government buys more. The government, of course, does not always buy the same goods which the citizens would have bought; but on the average there occurs no rise in prices due to the government’s construction of a hospital.

I choose this example of a hospital precisely because people sometimes say: “It makes a difference whether the government uses its money for good or for bad purposes.” I want to assume that the government always uses the money which it has printed for the best possible purposes-purposes with which we all agree. For it is not the way in which the money is spent, it is the way in which the government obtains this money that brings about those consequences we call inflation and which most people in the world today do not consider as beneficial.

For example, without inflating, the government could use the tax-collected money for hiring new employees or for raising the salaries of those who are already in government service. Then these people, whose salaries have been increased, are in a position to buy more. When the government taxes the citizens and uses this money to increase the salaries of government employees, the taxpayers have less to spend, but the government employees have more. Prices in general will not increase.

But if the government does not use tax money for this purpose, if it uses freshly printed money instead, it means that there will be people who now have more money while all other people still have as much as they had before. So those who received the newly-printed money will be competing with those people who were buyers before. And since there are no more commodities than there were previously, but there is more money on the market — and since there are now people who can buy more today than they could have bought yesterday — there will be an additional demand for that same quantity of goods. Therefore prices will tend to go up. This cannot be avoided, no matter what the use of this newly-issued money will be.

And more importantly, this tendency for prices to go up will develop step by step; it is not a general upward movement of what has been called the “price level.” The metaphorical expression “price level” must never be used.

When people talk of a “price level,” they have in mind the image of a level of a liquid which goes up or down according to the increase or decrease in its quantity, but which, like a liquid in a tank, always rises evenly. But with prices, there is no such thing as a “level.” Prices do not change to the same extent at the same time. There are always prices that are changing more rapidly, rising or falling more rapidly than other prices. There is a reason for this.

Consider the case of the government employee who received the new money added to the money supply. People do not buy today precisely the same commodities and in the same quantities as they did yesterday. The additional money which the government has printed and introduced into the market is not used for the purchase of all commodities and services. It is used for the purchase of certain commodities, the prices of which will rise, while other commodities will still remain at the prices that prevailed before the new money was put on the market. Therefore, when inflation starts, different groups within the population are affected by this inflation in different ways. Those groups who get the new money first gain a temporary benefit.

When the government inflates in order to wage a war, it has to buy munitions, and the first to get the additional money are the munitions industries and the workers within these industries. These groups are now in a very favorable position. They have higher profits and higher wages; their business is moving. Why? Because they were the first to receive the additional money. And having now more money at their disposal, they are buying. And they are buying from other people who are manufacturing and selling the commodities that these munitions makers want.

These other people form a second group. And this second group considers inflation to be very good for business. Why not? Isn’t it wonderful to sell more? For example, the owner of a restaurant in the neighborhood of a munitions factory says: “It is really marvelous! The munitions workers have more money; there are many more of them now than before; they are all patronizing my restaurant; I am very happy about it.” He does not see any reason to feel otherwise.

The situation is this: those people to whom the money comes first now have a higher income, and they can still buy many commodities and services at prices which correspond to the previous state of the market, to the condition that existed on the eve of inflation. Therefore, they are in a very favorable position. And thus inflation continues step by step, from one group of the population to another. And all those to whom the additional money comes at the early state of inflation are benefited because they are buying some things at prices still corresponding to the previous stage of the exchange ratio between money and commodities.

But there are other groups in the population to whom this additional money comes much, much later. These people are in an unfavorable position. Before the additional money comes to them they are forced to pay higher prices than they paid before for some — or for practically all — of the commodities they wanted to purchase, while their income has remained the same, or has not increased proportionately with prices.

Consider for instance a country like the United States during the Second World War; on the one hand, inflation at that time favored the munitions workers, the munitions industries, the manufacturers of guns, while on the other hand it worked against other groups of the population. And the ones who suffered the greatest disadvantages from inflation were the teachers and the ministers.

As you know, a minister is a very modest person who serves God and must not talk too much about money. Teachers, likewise, are dedicated persons who are supposed to think more about educating the young than about their salaries. Consequently, the teachers and ministers were among those who were most penalized by inflation, for the various schools and churches were the last to realize that they must raise salaries. When the church elders and the school corporations finally discovered that after all, one should also raise the salaries of those dedicated people, the earlier losses they had suffered still remained.

For a long time, they had to buy less than they did before, to cut down their consumption of better and more expensive foods, and to restrict their purchase of clothing — because prices had already adjusted upward, while their incomes, their salaries, had not yet been raised. (This situation has changed considerably today, at least for teachers.)

There are therefore always different groups in the population being affected differently by inflation. For some of them, inflation is not so bad; they even ask for a continuation of it because they are the first to profit from it. We will see, in the next lecture, how this unevenness in the consequences of inflation vitally affects the politics that lead toward inflation.

Under these changes brought about by inflation, we have groups who are favored and groups who are directly profiteering. I do not use the term “profiteering” as a reproach to these people, for if there is someone to blame, it is the government that established the inflation. And there are always people who favor inflation, because they realize what is going on sooner than other people do. Their special profits are due to the fact that there will necessarily be unevenness in the process of inflation.

The government may think that inflation — as a method of raising funds — is better than taxation, which is always unpopular and difficult. In many rich and great nations, legislators have often discussed, for months and months, the various forms of new taxes that were necessary because the parliament had decided to increase expenditures. Having discussed various methods of getting the money by taxation, they finally decided that perhaps it was better to do it by inflation.

But of course, the word “inflation” was not used. The politician in power who proceeds toward inflation does not announce: “I am proceeding toward inflation.” The technical methods employed to achieve the inflation are so complicated that the average citizen does not realize inflation has begun.

One of the biggest inflations in history was in the German Reich after the First World War. The inflation was not so momentous during the war; it was the inflation after the war that brought about the catastrophe. The government did not say: “We are proceeding toward inflation.” The government simply borrowed money very indirectly from the central bank. The government did not have to ask how the central bank would find and deliver the money. The central bank simply printed it.

Today the techniques for inflation are complicated by the fact that there is checkbook money. It involves another technique, but the result is the same. With the stroke of a pen, the government creates fiat money, thus increasing the quantity of money and credit. The government simply issues the order, and the fiat money is there.

The government does not care, at first, that some people will be losers, it does not care that prices will go up. The legislators say: “This is a wonderful system!” But this wonderful system has one fundamental weakness: it cannot last. If inflation could go on forever, there would be no point in telling governments they should not inflate. But the certain fact about inflation is that, sooner or later, it must come to an end. It is a policy that cannot last.

In the long run, inflation comes to an end with the breakdown of the currency; it comes to a catastrophe, to a situation like the one in Germany in 1923. On August 1, 1914, the value of the dollar was four marks and twenty pfennigs. Nine years and three months later, in November 1923, the dollar was pegged at 4.2 trillion marks. In other words, the mark was worth nothing. It no longer had any value.

Some years ago, a famous author, John Maynard Keynes, wrote: “In the long run we are all dead.” This is certainly true, I am sorry to say. But the question is, how short or long will the short run be? In the eighteenth century there was a famous lady, Madame de Pompadour, who is credited with the dictum: “Après nous le déluge” (“After us will come the flood”). Madame de Pompadour was happy enough to die in the short run. But her successor in office, Madame du Barry, outlived the short run and was beheaded in the long run. For many people the “long run” quickly becomes the “short run” — and the longer inflation goes on the sooner the “short run.”

How long can the short run last? How long can a central bank continue an inflation? Probably as long as people are convinced that the government, sooner or later, but certainly not too late, will stop printing money and thereby stop decreasing the value of each unit of money.

When people no longer believe this, when they realize that the government will go on and on without any intention of stopping, then they begin to understand that prices tomorrow will be higher than they are today. Then they begin buying at any price, causing prices to go up to such heights that the monetary system breaks down.

I refer to the case of Germany, which the whole world was watching. Many books have described the events of that time. (Although I am not a German, but an Austrian, I saw everything from the inside: in Austria, conditions were not very different from those in Germany; nor were they much different in many other European countries.) For several years, the German people believed that their inflation was just a temporary affair, that it would soon come to an end. They believed it for almost nine years, until the summer of 1923. Then, finally, they began to doubt. As the inflation continued, people thought it wiser to buy anything available, instead of keeping money in their pockets. Furthermore, they reasoned that one should not give loans of money, but on the contrary, that it was a very good idea to be a debtor. Thus inflation continued feeding on itself.

And it went on in Germany until exactly November 20, 1923. The masses had believed inflation money to be real money, but then they found out that conditions had changed. At the end of the German inflation, in the fall of 1923, the German factories paid their workers every morning in advance for the day. And the workingman who came to the factory with his wife, handed his wages — all the millions he got — over to her immediately. And the lady immediately went to a shop to buy something, no matter what. She realized what most people knew at that time-that overnight, from one day to another, the mark lost 50% of its purchasing power. Money, like chocolate in a hot oven, was melting in the pockets of the people. This last phase of German inflation did not last long; after a few days, the whole nightmare was over: the mark was valueless and a new currency had to be established.

Lord Keynes, the same man who said that in the long run we are all dead, was one of a long line of inflationist authors of the twentieth century. They all wrote against the gold standard. When Keynes attacked the gold standard, he called it a “barbarous relic.” And most people today consider it ridiculous to speak of a return to the gold standard. In the United States, for instance, you are considered to be more or less a dreamer if you say: “Sooner or later, the United States will have to return to the gold standard.”

Yet the gold standard has one tremendous virtue: the quantity of money under the gold standard is independent of the policies of governments and political parties. This is its advantage. It is a form of protection against spendthrift governments. If, under the gold standard, a government is asked to spend money for something new, the minister of finance can say: “And where do I get the money? Tell me, first, how I will find the money for this additional expenditure.”

Under an inflationary system, nothing is simpler for the politicians to do than to order the government printing office to provide as much money as they need for their projects. Under a gold standard, sound government has a much better chance; its leaders can say to the people and to the politicians: “We can’t do it unless we increase taxes.”

But under inflationary conditions, people acquire the habit of looking upon the government as an institution with limitless means at its disposal: the state, the government, can do anything. If, for instance, the nation wants a new highway system, the government is expected to build it. But where will the government get the money?

One could say that in the United States today — and even in the past, under McKinley — the Republican party was more or less in favor of sound money and of the gold standard, and the Democratic party was in favor of inflation, of course not a paper inflation, but a silver inflation.

It was, however, a Democratic president of the United States, President Cleveland, who at the end of the 1880s vetoed a decision of Congress, to give a small sum — about $10,000 — to help a community that had suffered some disaster. And President Cleveland justified his veto by writing: “While it is the duty of the citizens to support the government, it is not the duty of the government to support the citizens.” This is something which every statesman should write on the wall of his office to show to people who come asking for money.

I am rather embarrassed by the necessity to simplify these problems. There are so many complex problems in the monetary system, and I would not have written volumes about them if they were as simple as I am describing them here. But the fundamentals are precisely these: if you increase the quantity of money, you bring about the lowering of the purchasing power of the monetary unit. This is what people whose private affairs are unfavorably affected do not like. People who do not benefit from inflation are the ones who complain.

If inflation is bad and if people realize it, why has it become almost a way of life in all countries? Even some of the richest countries suffer from this disease. The United States today is certainly the richest country in the world, with the highest standard of living. But when you travel in the United States, you will discover that there is constant talk about inflation and about the necessity to stop it. But they only talk; they do not act.

To give you some facts: after the First World War, Great Britain returned to the prewar gold parity of the pound. That is, it revalued the pound upward. This increased the purchasing power of every worker’s wages. In an unhampered market the nominal money wage would have fallen to compensate for this and the workers’ realwage would not have suffered. We do not have time here to discuss the reasons for this. But the unions in Great Britain were unwilling to accept an adjustment of money wage rates downward as the purchasing power of the monetary unit rose. Therefore real wages were raised considerably by this monetary measure. This was a serious catastrophe for England, because Great Britain is a predominantly industrial country that has to import its raw materials, half-finished goods, and food stuffs in order to live, and has to export manufactured goods to pay for these imports. With the rise in the international value of the pound, the price of British goods rose on foreign markets and sales and exports declined. Great Britain had, in effect, priced itself out of the world market.

The unions could not be defeated. You know the power of a union today. It has the right, practically the privilege, to resort to violence. And a union order is, therefore, let us say, not less important than a government decree. The government decree is an order for the enforcement of which the enforcement apparatus of the government — the police — is ready. You must obey the government decree, otherwise you will have difficulties with the police.

Unfortunately, we have now, in almost all countries all over the world, a second power that is in a position to exercise force: the labor unions. The labor unions determine wages and then strike to enforce them in the same way in which the government might decree a minimum wage rate. I will not discuss the union question now; I shall deal with it later. I only want to establish that it is the union policy to raise wage rates above the level they would have on an unhampered market. As a result a considerable part of the potential labor force can be employed only by people or industries that are prepared to suffer losses. And, since businesses are not able to keep on suffering losses, they close their doors and people become unemployed. The setting of wage rates above the level they would have on the unhampered market always results in the unemployment of a considerable part of the potential labor force.

In Great Britain, the result of high wage rates enforced by the labor unions was lasting unemployment, prolonged year after year. Millions of workers were unemployed, production figures dropped. Even experts were perplexed. In this situation the British government made a move which it considered an indispensable, emergency measure: it devalued its currency.

The result was that the purchasing power of the money wages, upon which the unions had insisted, was no longer the same. The real wages, the commodity wages, were reduced. Now the worker could not buy as much as he had been able to buy before, even though the nominal wage rates remained the same. In this way, it was thought, real wage rates would return to free market levels and unemployment would disappear.

This measure — devaluation — was adopted by various other countries, by France, the Netherlands, and Belgium. One country even resorted twice to this measure within a period of one year and a half. That country was Czechoslovakia. It was a surreptitious method, let us say, to thwart the power of the unions. You could not call it a real success, however.

After a few years, the people, the workers, even the unions, began to understand what was going on. They came to realize that currency devaluation had reduced their real wages. The unions had the power to oppose this. In many countries they inserted a clause into wage contracts providing that money wages must go up automatically with an increase in prices. This is called indexing. The unions became index conscious. So, this method of reducing unemployment that the government of Great Britain started in 1931 — which was later adopted by almost all important governments — this method of “solving unemployment” no longer works today.

In 1936, in his General Theory of Employment, Interest and Money, Lord Keynes unfortunately elevated this method — the emergency measures of the period between 1929 and 1933 — to a principle, to a fundamental system of policy. And he justified it by saying, in effect: “Unemployment is bad. If you want unemployment to disappear you must inflate the currency.”

He realized very well that wage rates can be too high for the market, that is, too high to make it profitable for an employer to increase his work force, thus too high from the point of view of the total working population, for with wage rates imposed by unions above the market only a part of those anxious to earn wages can obtain jobs.

And Keynes said, in effect: “Certainly mass unemployment prolonged year after year, is a very unsatisfactory condition.” But instead of suggesting that wage rates could and should be adjusted to market conditions, he said, in effect: “If one devalues the currency and the workers are not clever enough to realize it, they will not offer resistance against a drop in real wage rates, as long as nominal wage rates remain the same.” In other words, Lord Keynes was saying that if a man gets the same amount of sterling today as he got before the currency was devalued, he will not realize that he is, in fact, now getting less.

In old fashioned language, Keynes proposed cheating the workers. Instead of declaring openly that wage rates must be adjusted to the conditions of the market — because, if they are not, a part of the labor force will inevitably remain unemployed — he said, in effect: “Full employment can be reached only if you have inflation. Cheat the workers.” The most interesting fact, however, is that when his General Theory was published, it was no longer possible to cheat, because people had already become index conscious. But the goal of full employment remained.

What does “full employment” mean? It has to do with the unhampered labor market, which is not manipulated by the unions or by the government. On this market, wage rates for every type of labor tend to reach a point at which everybody who wants a job can get one and every employer can hire as many workers as he needs. If there is an increase in the demand for labor, the wage rate will tend to be greater, and if fewer workers are needed, the wage rate will tend to fall.

The only method by which a “full employment” situation can be brought about is by the maintenance of an unhampered labor market. This is valid for every kind of labor and for every kind of commodity.

What does a businessman do who wants to sell a commodity for five dollars a unit? When he cannot sell it at that price, the technical business expression in the United States is, “the inventory does not move.” But it mustmove. He cannot retain things because he must buy something new; fashions are changing. So he sells at a lower price. If he cannot sell the merchandise at five dollars, he must sell it at four. If he cannot sell it at four, he must sell it at three. There is no other choice as long as he stays in business. He may suffer losses, but these losses are due to the fact that his anticipation of the market for his product was wrong.

It is the same with the thousands and thousands of young people who come every day from the agricultural districts into the city trying to earn money. It happens so in every industrial nation. In the United States they come to town with the idea that they should get, say, a hundred dollars a week. This may be impossible. So if a man cannot get a job for a hundred dollars a week, he must try to get a job for ninety or eighty dollars, and perhaps even less. But if he were to say — as the unions do — “one hundred dollars a week or nothing,” then he might have to remain unemployed. (Many do not mind being unemployed, because the government pays unemployment benefits — out of special taxes levied on the employers — which are sometimes nearly as high as the wages the man would receive if he were employed.)

Because a certain group of people believes that full employment can be attained only by inflation, inflation is accepted in the United States. But people are discussing the question: Should we have a sound currency with unemployment, or inflation with full employment? This is in fact a very vicious analysis.

To deal with this problem we must raise the question: How can one improve the condition of the workers and of all other groups of the population? The answer is: by maintaining an unhampered labor market and thus achieving full employment. Our dilemma is, shall the market determine wage rates or shall they be determined by union pressure and compulsion? The dilemma is not “shall we have inflation or unemployment?”

This mistaken analysis of the problem is argued in England, in European industrial countries and even in the United States. And some people say: “Now look, even the United States is inflating. Why should we not do it also.”

To these people one should answer first of all: “One of the privileges of a rich man is that he can afford to be foolish much longer than a poor man.” And this is the situation of the United States. The financial policy of the United States is very bad and is getting worse. Perhaps the United States can afford to be foolish a bit longer than some other countries.

The most important thing to remember is that inflation is not an act of God; inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy — a deliberate policy of people who resort to inflation because they consider it to be a lesser evil than unemployment. But the fact is that, in the not very long run, inflation does not cure unemployment.

Inflation is a policy. And a policy can be changed. Therefore, there is no reason to give in to inflation. If one regards inflation as an evil, then one has to stop inflating. One has to balance the budget of the government. Of course, public opinion must support this; the intellectuals must help the people to understand. Given the support of public opinion, it is certainly possible for the people’s elected representatives to abandon the policy of inflation.

We must remember that, in the long run, we may all be dead and certainly will be dead. But we should arrange our earthly affairs, for the short run in which we have to live, in the best possible way. And one of the measures necessary for this purpose is to abandon inflationary policies.

References • 800 Words

[1] [In Selected Writings of Ludwig von Mises, vol. 3: The Political Economy of International Reform and Reconstruction, ed. Richard M. Ebeling (1946; Indianapolis, Ind.: Liberty Fund, 2000), pp. 119–32.]

[2] It is necessary to keep in mind that interest rates, in the course of a credit expansion, are — with the exception of the very beginning of the process — not always low when compared with the level which business used to consider as normal. But they are always low when measured by the standard that they would have to reach in a period of progressive inflation and its corollary, a general rise of prices, since they would have to include at such a time a compensation for the depreciation of the money unit going on in the period of the loan.

[3] [Ludwig von Mises, The Theory of Money and Credit (1952; Indianapolis, Ind.: LibertyClassics, 1980), chap. 7: “The Concept of the Value of Money,” pp. 117–22.]

[4] See [Eugen von] Böhm-Bawerk, Kapital und Kapitalzins, 3d ed. (Innsbruck, 1909–12], pp. 211 ff.

[5] See [Correa Moylan] Walsh, The Fundamental Problem in Monetary Science (New York, 1903), p. 11; and in like manner, [Arthur] Spiethoff, “Die Quantitätstheorie insbesondere in ihrer Verwertbarkeit als Haussetheorie,” Festgaben für Adolf Wagner (Leipzig, 1905), p. 256.

[6] See [Karl Heinrich]Rau, Grundsätze der Volkswirtschaftslehre, 6th ed. (Leipzig, 1855), p. 80.

[7] See Böhm-Bawerk, Kapital und Kapitalzins, Part II, p. 275. And similarly in [Friedrich von] Wieser, Der natürliche Wert, p. 45; “Der Geldwert und seine Veränderungen,” Schriften des Vereins für Sozialpolitik 132: 507.

[8] See Böhm-Bawerk, Kapital und Kapitalzins, Part II, pp. 273 ff.; [Joseph] Schumpeter, Wesen und Hauptinhalt der theoretischen Nationalökonomie (Leipzig, 1908), p. 108.

[9] Wieser, Der natürliche Wert, p. 46.

[10] Ibid., p. 52.

[11] Böhm-Bawerk, Kapital und Kapitalzins, Part II, pp. 214 f.

[12] See [Karl] Helfferich, Das Geld, 6th ed. (Leipzig, 1923), pp. 301 f.

[13] Thus Schumpeter, Wesen und Hauptinhalt der theoretischen Nationalökonomie, p. 109.

[14] See Böhm-Bawerk, Kapital und Kapitalzins, Part II, p. 217.

[15] [Mises, The Theory of Money and Credit, chap. 8: “The Determinants of the Objective Exchange Value, or Purchasing Power of Money,” pp. 129–44.]

[16] See pp. 99. Also Böhm-Bawerk, Kapital und Kapitalzins, Part II, p. 274; Wieser, Der natürliche Wert, p. 46. (Eng. trans. The Theory of Natural Value.)

[17] See Wieser, “Der Geldwert und seine Veränderungen,” Schriften des Vereins für Sozialpolitik 132:513 ff.

[18] See [Karl] Knies, Geld und Kredit (Berlin, 1885), vol. 1, p. 324.

[19] Thus [John] Locke, Some Considerations of the Consequences of the Lowering of Interest and Raising the Value of Money, 2d ed. (London, 1696), p. 31.

[20] See [Guillermo] Subercaseaux, Essai sur la nature du papier monnaie (Paris, 1909), pp. 17 f.

[21] See [Georg] Simmel, Philosophie des Geldes, 2d ed. (Leipzig, 1907), pp. 115 f.; but, above all, Wieser, “Der Geldwert und seine Veränderungen,” p. 513.

[22] See [Gustav von] Schmoller, Grundriss der allgemeinen Volkswirtschaftslehre (Leipzig, 1902), vol. 2, p. 110.

[23] See [Otto von] Zwiedineck, “Kritisches und Positives zur Preislehre,” Zeitschrift für die gesamte Staatswissenschaft, Vol. 65, pp. 200 ff.

[24] See Wieser, “Der Geldwert und seine Veränderungen,” p. 513.

[25] See [Nassau William] Senior, Three Lectures on the Value of Money (London, 1840; 1931), pp. 1 ff.; Three Lectures on the Cost of Obtaining Money (London, 1830; 1931), pp. 1 ff.

[26] See [Bernardo] Davanzati, Lezioni delle monete, 1588 (in Scrittori classici italiani di economia politica, Parte Antica (Milan, 1804), vol. 2, p. 32. Locke and, above all, Montesquieu (De l’Ësprit des lois, edition Touquet [Paris, 1821], vol. 2, pp. 458 f.) share this view. See [H. Parker] Willis, “The History and Present Application of the Quantity Theory,” Journal of Political Economy 4 (1896): 419 ff.

[27] See [Emil] Zuckerkandl, Zur Theorie des Preises (Leipzig, 1889), p. 124.

[28] See Wieser, “Der Geldwert und seine Veränderungen,” p. 514.

[29] See [T. N.] Carver, “The Value of the Money Unit,” Quarterly Journal of Economics 11 (1897): 429 f.

[30] See [David] Kinley, Money (New York, 1909), pp. 123 ff.

[31] See [Léon] Walras, Théorie de la Monnaie (Lausanne, 1886), pp. 25 ff.

[32] See [Edwin] Kemmerer, Money and Credit Instruments in Their Relation to General Prices (New York, 1907), pp. 11ff.

[33] See Wieser, “Der Geldwert und seine Veränderungen,” pp. 514 ff.

[34] [See p. 124 n. H.E.B.]

[35] See [Knut] Wicksell, Geldzins und Güterpreise (Jena, 1898), pp. iv ff, 16 ff.

[36] Ibid., p. 35.

[37] See [Karl] Helfferich, Das Geld, 6th ed. (Leipzig, 1923), p. 577.

[38] Ibid., p. 578.

[39] Dr. B. M. Anderson, pp. 100–10 of his excellent work The Value of Money (New York, 1917), has objected to the theory set forth above that instead of a logical analysis it provides merely a temporal regressus. Nevertheless, all the acute objections that he manages to bring forward are directed only against the argument that finds a historical component in the exchange ratios subsisting between commodities, an argument with which I also [see pp. 133ff. above] am in definite disagreement. But Dr. Anderson recognizes the logical foundation of my theory when he declares, “I shall maintain that value from some source other than the monetary employment is an essential precondition of the monetary employment” (p. 126).

[40] [Ludwig von Mises, Money, Method, and the Market Process: Essays by Ludwig von Mises, ed. Richard M. Ebeling (1938; Boston: Kluwer, 1990), chap. 5, pp. 69–77.]

[41] [Ludwig von Mises, Economic Policy: Thoughts for Tomorrow and Today (1979; Washington, D.C.: Regnery Gateway, 2006), Lecture 4, pp. 55–73.]

Chapter 11 • Time and Time Preference • 5,800 Words

1. Perspective in the Valuation of Time Periods

Acting man distinguishes the time before satisfaction of a want is attained and the time for which the satisfaction continues.

Action always aims at the removal of future uneasiness, be it only the future of the impending instant. Between the setting in of action and the attainment of the end sought there always elapses a fraction of time, viz., the maturing time in which the seed sown by the action grows to maturity. The most obvious example is provided by agriculture. Between the tilling of the soil and the ripening of the fruit there passes a considerable period of time. Another example is the improvement of the quality of wine by aging. In some cases, however, the maturing time is so short that ordinary speech may assert that the success appears instantly.

As far as action requires the employment of labor, it is concerned with the working time. The performance of every kind of labor absorbs time. In some cases the working time is so short that people say the performance requires no time at all.

Only in rare cases does a simple, indivisible and nonrepeated act suffice to attain the end aimed at. As a rule what separates the actor from the goal of his endeavors is more than one step only. He must make many steps. And every further step to be added to those previously made raises anew the question whether or not he should continue marching toward the goal once chosen. Most goals are so far away that only determined persistence leads to them. Persevering action, unflinchingly directed to the end sought, is needed in order to succeed. The total expenditure of time required, i.e., working time plus maturing time, may be called the period of production. The period of production is long in some cases and short in other cases. It is sometimes so short that it can be entirely neglected in practice.

The increment in want-satisfaction which the attainment of the end brings about is temporally limited. The result produced extends services only over a period of time which we may call the duration of serviceableness. The duration of serviceableness is shorter with some products and longer with other goods which are commonly called durable goods. Hence acting man must always take into account the period of production and the duration of serviceableness of the product. In estimating the disutility of a project considered he is not only concerned with the expenditure of material factors and labor required, but also with the period of production. In estimating the utility of the expected product he is concerned with the duration of its serviceableness. Of course, the more durable a product is, the greater is the amount of services it renders. But if these services are not cumulatively available on the same date, but extended piecemeal over a certain period of time, the time element, as will be shown, plays a particular role in their evaluation. It makes a difference whether n units of service are rendered on the same date or whether they are stretched over a period of n days in such a way that only one unit is available daily.

It is important to realize that the period of production as well as the duration of serviceableness are categories of human action and not concepts constructed by philosophers, economists, and historians as mental tools for their interpretation of events. They are essential elements present in every act of reasoning that precedes and directs action. It is necessary to stress this point because Böhm-Bawerk, to whom economics owes the discovery of the role played by the period of production, failed to comprehend the difference.

Acting man does not look at his condition with the eyes of a historian. He is not concerned with how the present situation originated. His only concern is to make the best use of the means available today for the best possible removal of future uneasiness. The past does not count for him. He has at his disposal a definite quantity of material factors of production. He does not ask whether these factors are nature-given or the product of production processes accomplished in the past. It does not matter for him how great a quantity of nature-given, i.e., original material factors of production and labor, was expended in their production and how much time these processes of production have absorbed. He values the available means exclusively from the aspect of the services they can render him in his endeavors to make future conditions more satisfactory. The period of production and the duration of serviceableness are for him categories in planning future action, not concepts of academic retrospection and historical research. They play a role in so far as the actor has to choose between periods of production of different length and between the production of more durable and less durable goods.

Action is not concerned with the future in general, but always with a definite and limited fraction of the future. This fraction is limited, on the one side, by the instant in which the action must take place. Where its other end lies depends on the actor’s decision and choice. There are people who are concerned with only the impending instant. There are other people whose provident care stretches far beyond the prospective length of their own life. We may call the fraction of future time for which the actor in a definite action wants to provide in some way and to some extent, the period of provision. In the same way in which acting man chooses among various kinds of want-satisfaction within the same fraction of future time, he chooses also between want-satisfaction in the nearer and in the remoter future. Every choice implies also a choice of a period of provision. In making up his mind how to employ the various means available for the removal of uneasiness, man also determines implicitly the period of provision. In the market economy the demand of the consumers also determines the length of the period of provision.

There are various methods available for a lengthening of the period of provision:

1. The accumulation of larger stocks of consumers’ goods destined for later consumption. 2. The production of goods which are more durable. 3. The production of goods requiring a longer period of production. 4. The choice of methods of production consuming more time for the production of goods which could also be produced within a shorter period of production. The first two methods do not require any further comment. The third and the fourth methods must be scrutinized more closely.

It is one of the fundamental data of human life and action that the shortest processes of production, i.e., those with the shortest period of production, do not remove felt uneasiness entirely. If all those goods which these shortest processes can provide are produced, unsatisfied wants remain and incentive to further action is still present. As acting man prefers those processes which, other things being equal, produce the products in the shortest time,[2]Why man proceeds in this way, will be shown on the following pages. only such processes are left for further action which consume more time. People embark upon these more time-consuming processes because they value the increment in satisfaction expected more highly than the disadvantage of waiting longer for their fruits. Böhm-Bawerk speaks of the higher productivity of roundabout ways of production requiring more time. It is more appropriate to speak of the higher physical productivity of production processes requiring more time. The higher productivity of these processes does not always consist in the fact that they produce — with the same quantity of factors of production expended — a greater quantity of products. More often it consists in the fact that they produce products which could not be produced at all in shorter periods of production. These processes are not roundabout processes. They are the shortest and quickest way to the goal chosen. If one wants to catch more fish, there is no other method available than the substitution of fishing with the aid of nets and canoes for fishing without the aid of this equipment. There is no better, shorter, and cheaper method for the production of aspirin known than that adopted by the chemical plants. If one disregards error and ignorance, there cannot be any doubt about the highest productivity and expediency of the processes chosen. If people had not considered them the most direct processes, viz., those leading by the shortest way to the end sought, they would not have adopted them.

The lengthening of the period of provision through the mere accumulation of stocks of consumers’ goods is the outcome of the desire to provide in advance for a longer period of time. The same is valid for the production of goods the durability of which is greater in proportion to the greater expenditure of factors of production required.[3]If the lengthening of durability were not at least proportionate to the increment in expenditure needed, it would be more advantageous to increase the quantity of units of a shorter durability. But if temporally remoter goals are aimed at, lengthening of the period of production is a necessary corollary of the venture. The end sought cannot be attained in a shorter period of production.

The postponement of an act of consumption means that the individual prefers the satisfaction which later consumption will provide to the satisfaction which immediate consumption could provide. The choice of a longer period of production means that the actor values the product of the process bearing fruit only at a later date more highly than the products which a process consuming less time could provide. In such deliberations and the resulting choices the period of production appears as waiting time. It was the great contribution of Jevons and Böhm-Bawerk to have shown the role played by taking account of waiting time.

If acting men were not to pay heed to the length of the waiting time, they would never say that a goal is temporally so distant that one cannot consider aiming at it. Faced with the alternative of choosing between two processes of production which render different output with the same input, they would always prefer that process which renders the greater quantity of the same products or better products in the same quantity, even if this result could be attained only by lengthening the period of production. Increments in input which result in a more than proportionate increase in the products’ duration of serviceableness would unconditionally be deemed advantageous. The fact that men do not act in this way evidences that they value fractions of time of the same length in a different way according as they are nearer or remoter from the instant of the actor’s decision. Other things being equal, satisfaction in a nearer period of the future is preferred to satisfaction in a more distant period; disutility is seen in waiting.

This fact is already implied in the statement stressed in the opening of this chapter that man distinguishes the time before satisfaction is attained and the time for the duration of which there is satisfaction. If any role at all is played by the time element in human life, there cannot be any question of equal valuation of nearer and remoter periods of the same length. Such an equal valuation would mean that people do not care whether success is attained sooner or later. It would be tantamount to a complete elimination of the time element from the process of valuation.

The mere fact that goods with a longer duration of serviceableness are valued more highly than those with a shorter duration does not yet in itself imply a consideration of time. A roof that can protect a house against the weather during a period of ten years is more valuable than a roof which renders this service only for a period of five years. The quantity of service rendered is different in both cases. But the question which we have to deal with is whether or not an actor in making his choices attaches to a service to be available in a later period of the future the same value he attaches to a service available at an earlier period.

2. Time Preference as an Essential Requisite of Action

The answer to this question is that acting man does not appraise time periods merely with regard to their dimension. His choices regarding the removal of future uneasiness are directed by the categories sooner and later. Time for man is not a homogeneous substance of which only length counts. It is not a more or a less in dimension. It is an irreversible flux the fractions of which appear in different perspective according to whether they are nearer to or remoter from the instant of valuation and decision. Satisfaction of a want in the nearer future is, other things being equal, preferred to that in the farther distant future. Present goods are more valuable than future goods.

Time preference is a categorial requisite of human action. No mode of action can be thought of in which satisfaction within a nearer period of the future is not — other things being equal — preferred to that in a later period. The very act of gratifying a desire implies that gratification at the present instant is preferred to that at a later instant. He who consumes a nonperishable good instead of postponing consumption for an indefinite later moment thereby reveals a higher valuation of present satisfaction as compared with later satisfaction. If he were not to prefer satisfaction in a nearer period of the future to that in a remoter period, he would never consume and so satisfy wants. He would always accumulate, he would never consume and enjoy. He would not consume today, but he would not consume tomorrow either, as the morrow would confront him with the same alternative.

Not only the first step toward want-satisfaction, but also any further step is guided by time preference. Once the desire a to which the scale of values assigns the rank 1 is satisfied, one must choose between the desire b to which the rank 2 is assigned and c that desire of tomorrow to which — in the absence of time preference — the rank 1 would have been assigned. If b is preferred to c, the choice clearly involves time preference. Purposive striving after want-satisfaction must needs be guided by a preference for satisfaction in the nearer future over that in a remoter future.

The conditions under which modern man of the capitalist West must act are different from those under which his primitive ancestors lived and acted. As a result of the providential care of our forebears we have at our disposal an ample stock of intermediate products (capital goods or produced factors of production) and of consumers’ goods. Our activities are designed for a longer period of provision because we are the lucky heirs of a past which has lengthened, step by step, the period of provision and has bequeathed to us the means to expand the waiting period. In acting we are concerned with longer periods and are aiming at an even satisfaction in all parts of the period chosen as the period of provision. We are in a position to rely upon a continuing influx of consumers’ goods and have at our disposal not only stocks of goods ready for consumption but also stocks of producers’ goods out of which our continuous efforts again and again make new consumers’ goods mature. In our dealing with this increasing “stream of income,” says the superficial observer, there is no heed paid to any considerations related to a different valuation of present and of future goods. We synchronize, he asserts, and thus the time element loses any importance for the conduct of affairs. It is, therefore, pointless, he continues, in the interpretation of modern conditions to resort to time preference.

The fundamental error involved in this popular objection is caused, like so many other errors, by a lamentable misapprehension of the imaginary construction of the evenly rotating economy. In the frame of this imaginary construction no change occurs; there prevails an unvarying course of all affairs. In the evenly rotating economy consequently nothing is altered in the allocation of goods for the satisfaction of wants in nearer and in remoter periods of the future. No one plans any change because — according to our assumptions — the prevailing allocation best serves him and because he does not believe that any possible rearrangement could improve his condition. No one wants to increase his consumption in a nearer period of the future at the expense of his consumption in a more distant period or vice versa because the existing mode of allocation pleases him better than any other thinkable and feasible mode.

The praxeological distinction between capital and income is a category of thought based on a different valuation of want-satisfaction in various periods of the future. In the imaginary construction of the evenly rotating economy it is implied that the whole income but not more than the income is consumed and that therefore the capital remains unchanged. An equilibrium is reached in the allocation of goods for want-satisfaction in different periods of the future. It is permissible to describe this state of affairs by asserting that nobody wants to consume tomorrow’s income today. We have precisely designed the imaginary construction of the evenly rotating economy in such a way as to make it fit just this condition. But it is necessary to realize that we can assert with the same apodictic assurance that, in the evenly rotating economy, nobody wants to have more of any commodity than he really has. These statements are true with regard to the evenly rotating economy because they are implied in our definition of this imaginary construction. They are nonsensical when asserted with regard to a changing economy which alone is real. As soon as a change in the data occurs, the individuals are faced anew with the necessity of choosing both between various modes of want-satisfaction in the same period and between want-satisfaction in different periods. An increment can be either employed for immediate consumption or invested for further production. No matter how the actors employ it, their choice must needs be the result of a weighing of the advantages expected from want-satisfaction in different periods of the future. In the world of reality, in the living and changing universe, each individual in each of his actions is forced to choose between satisfaction in various periods of time. Some people consume all that they earn, others consume a part of their capital, others save a part of their income.

Those contesting the universal validity of time preference fail to explain why a man does not always invest a sum of 100 dollars available today, although these 100 dollars would increase to 104 dollars within a year’s time. It is obvious that this man in consuming this sum today is determined by a judgment of value which values 100 present dollars higher than 104 dollars available a year later. But even in case he chooses to invest these 100 dollars, the meaning is not that he prefers satisfaction in a later period to that of today. It means that he values 100 dollars today less than 104 dollars a year later. Every penny spent today is, precisely under the conditions of a capitalist economy in which institutions make it possible to invest even the smallest sums, a proof of the higher valuation of present satisfaction as compared with later satisfaction.

The theorem of time preference must be demonstrated in a double way. First for the case of plain saving in which people must choose between the immediate consumption of a quantity of goods and the later consumption of the same quantity. Second for the case of capitalist saving in which the choice is to be made between the immediate consumption of a quantity of goods and the later consumption either of a greater quantity or of goods which are fit to provide a satisfaction which — except for the difference in time — is valued more highly. The proof has been given for both cases. No other case is thinkable.

It is possible to search for a psychological understanding of the problem of time preference. Impatience and the pains caused by waiting are certainly psychological phenomena. One may approach their elucidation by referring to the temporal limitations of human life, to the individual’s coming into existence, his growth and maturing, and his inevitable decay and passing away. There is in the course of man’s life a right moment for everything as well as a too early and a too late. However, the praxeological problem is in no way related to psychological issues. We must conceive, not merely understand. We must conceive that a man who does not prefer satisfaction within a nearer period of the future to that in a remoter period would never achieve consumption and enjoyment at all.

Neither must the praxeological problem be confused with the physiological. He who wants to live to see the later day, must first of all care for the preservation of his life in the intermediate period. Survival and appeasement of vital needs are thus requirements for the satisfaction of any wants in the remoter future. This makes us understand why in all those situations in which bare life in the strict sense of the term is at stake satisfaction in the nearer future is preferred to that in later periods. But we are dealing with action as such, not with the motives directing its course. In the same way in which as economists we do not ask why albumin, carbohydrates, and fat are demanded by man, we do not inquire why the satisfaction of vital needs appears imperative and does not brook any delay. We must conceive that consumption and enjoyment of any kind presuppose a preference for present satisfaction to later satisfaction. The knowledge provided by this insight far exceeds the orbit for which the physiological facts concerned provide explanation. It refers to every kind of want-satisfaction, not only to the satisfaction of the vital necessities of mere survival.

It is important to stress this point because the term “supply of subsistence, available for advances of subsistence,” as used by Böhm-Bawerk, can easily be misinterpreted. It is certainly one of the tasks of this stock to provide the means for a satisfaction of the bare necessities of life and thus to secure survival. But besides it must be large enough to satisfy, beyond the requirements of necessary maintenance for the waiting time, all those wants and desires which — apart from mere survival — are considered more urgent than the harvesting of the physically more abundant fruits of production processes consuming more time.

Böhm-Bawerk declared that every lengthening of the period of production depends on the condition that “a sufficient quantity of present goods is available to make it possible to overbridge the lengthened average interval between the starting of preparatory work and the harvesting of its product.”[4]Cf. [Eugen von] Böhm-Bawerk, Kleinere Abhandlungen über Kapital und Zins, vol. 2 in Gesammelte Schriften, ed. F.X. Weiss (Vienna, 1926), p. 169. The expression “sufficient quantity” needs elucidation. It does not mean a quantity sufficient for necessary sustenance. The quantity in question must be large enough to secure the satisfaction of all those wants the satisfaction of which during the waiting time is considered more urgent than the advantages which a still greater lengthening of the period of production would provide. If the quantity in question were smaller, a shortening of the period of production would appear advantageous; the increase in the quantity of products or the improvement of their quality to be expected from the preservation of the longer period of production would no longer be considered a sufficient remuneration for the restriction of consumption enjoined during the waiting time. Whether or not the supply of subsistence is sufficient, does not depend on any physiological or other facts open to objective determination by the methods of technology and physiology. The metaphorical term “overbridge,” suggesting a body of water the breadth of which poses to the bridge builder an objectively determined task, is misleading. The quantity in question is valued by men, and their subjective judgments decide whether or not it is sufficient.

Even in a hypothetical world in which nature provides every man with the means for the preservation of biological survival (in the strict sense of the term), in which the most important foodstuffs are not scarce and action is not concerned with the provision for bare life, the phenomenon of time preference would be present and direct all actions.[5]Time preference is not specifically human. It is an inherent feature of the behavior of all living beings. The distinction of man consists in preference is not inexorable and the lengthening of the period of provision not merely instinctive as with certain animals that store food, but the result of a process of valuation.

Some Applications of the Time-Preference Theory

Every part of economics is open to intentional misrepresentation and misinterpretation on the part of people eager to excuse or to justify fallacious doctrines underlying their party programs. To prevent such misuse as far as possible it seems expedient to add some explanatory remarks to the exposition of the time-preference theory.

There are schools of thought which flatly deny that men differ with regard to innate characteristics inherited from their ancestors.[6]About the Marxian attack against genetics, cf. T.D. Lysenko, Heredity and Variability (New York, 1945). A critical appraisal of this controversy is provided by J.R. Baker, Science and the Planned State (New York, 1945), pp. 71–76. In the opinion of these authors the only difference between the white men of Western civilization and Eskimos is that the latter are in arrears in their progress toward modern industrial civilization. This merely temporal difference of a few thousand years is insignificant when compared with the many hundreds of thousands of years which were absorbed by man’s evolution from the simian state of his apelike forebears to the conditions of present-day homo sapiens. It does not support the assumption that racial differences prevail between the various specimens of mankind.

Praxeology and economics are foreign to the issues raised by this controversy. But they must take precautionary measures lest they become implicated by partisan spirit in this clash of antagonistic ideas. If those fanatically rejecting the teachings of modern genetics were not entirely ignorant of economics, they would certainly try to turn the time-preference theory to their advantage. They would refer to the circumstance that the superiority of the Western nations consists merely in their having started earlier in endeavors to save and to accumulate capital goods. They would explain this temporal difference by accidental factors, the better opportunity offered by environment.

Against such possible misinterpretations one must emphasize the fact that the temporal head start gained by the Western nations was conditioned by ideological factors which cannot be reduced simply to the operation of environment. What is called human civilization has up to now been a progress from cooperation by virtue of hegemonic bonds to cooperation by virtue of contractual bonds. But while many races and peoples were arrested at an early stage of this movement, others kept on advancing. The eminence of the Western nations consisted in the fact that they succeeded better in checking the spirit of predatory militarism than the rest of mankind and that they thus brought forth the social institutions required for saving and investment on a broader scale. Even Marx did not contest the fact that private initiative and private ownership of the means of production were indispensable stages in the progress from primitive man’s penury to the more satisfactory conditions of nineteenth-century Western Europe and North America. What the East Indies, China, Japan, and the Mohammedan countries lacked were institutions for safeguarding the individual’s rights. The arbitrary administration of pashas, kadis, rajahs, mandarins, and daimios was not conducive to large-scale accumulation of capital. The legal guarantees effectively protecting the individual against expropriation and confiscation were the foundations upon which the unprecedented economic progress of the West came into flower. These laws were not an outgrowth of chance, historical accidents, and geographical environment. They were the product of reason.

We do not know what course the history of Asia and Africa would have taken if these peoples had been left alone. What happened was that some of these peoples were subject to European rule and others — like China and Japan — were forced by the display of naval power to open their frontiers. The achievements of Western industrialism came to them from abroad. They were ready to take advantage of the foreign capital lent to them and invested in their territories. But they were rather slow in the reception of the ideologies from which modern industrialism had sprung. Their assimilation to Western ways of life is superficial.

We are in the midst of a revolutionary process which will very soon do away with all varieties of colonialism. This revolution is not limited to those countries which were subject to the rule of the British, the French and the Dutch. Even nations which without any infringement of their political sovereignty had profited from foreign capital are intent upon throwing off what they call the yoke of foreign capitalists. They are expropriating the foreigners by various devices — discriminatory taxation, repudiation of debts, undisguised confiscation, foreign exchange restrictions. We are on the eve of the complete disintegration of the international capital market. The economic consequences of this event are obvious; its political repercussions are unpredictable.

In order to appreciate the political consequences of the disintegration of the international capital market it is necessary to remember what effects were brought about by the internationalization of the capital market. Under the conditions of the later nineteenth century it did not matter whether or not a nation was prepared and equipped with the required capital in order to utilize adequately the natural resources of its territory. There was practically free access for everybody to every area’s natural wealth. In searching for the most advantageous opportunities for investment capitalists and promoters were not stopped by national borderlines. As far as investment for the best possible utilization of the known natural resources was concerned, the greater part of the earth’s surface could be considered as integrated into a uniform world-embracing market system. It is true that this result was attained in some areas, like the British and the Dutch East Indies and Malaya, only by colonial regimes and that autochthonous governments of these territories would probably not have created the institutional setting indispensable for the importation of capital. But Eastern and Southern Europe and the Western Hemisphere had of their own accord joined the community of the international capital market.

The Marxians were intent upon indicting foreign loans and investments for the lust for war, conquest, and colonial expansion. In fact the internationalization of the capital market, together with free trade and the freedom of migration, was instrumental in removing the economic incentives to war and conquest. It no longer mattered for a man where the political boundaries of his country were drawn. The entrepreneur and the investor were not checked by them. Precisely those nations which in the age preceding the first World War were paramount in foreign lending and investment were committed to the ideas of peace-loving “decadent” liberalism. Of the foremost aggressor nations Russia, Italy, and Japan were not capital exporters; they themselves needed foreign capital for the development of their own natural resources. Germany’s imperialist adventures were not supported by its big business and finance.[7]Cf. [Ludwig von] Mises, Omnipotent Government (New Haven, 1944), p. 99 and the books quoted there.

The disappearance of the international capital market alters conditions entirely. It abolishes the freedom of access to natural resources. If one of the socialist governments of the economically backward nations lacks the capital needed for the utilization of its natural resources, there will be no means to remedy this situation. If this system had been adopted a hundred years ago, it would have been impossible to exploit the oil fields of Mexico, Venezuela, and Iran, to establish the rubber plantations in Malaya or to develop the banana production of Central America. It is illusory to assume that the advanced nations will acquiesce forever in such a state of affairs. They will resort to the only method which gives them access to badly needed raw materials; they will resort to conquest. War is the alternative to freedom of foreign investment as realized by the international capital market.

The inflow of foreign capital did not harm the receiving nations. It was European capital that accelerated considerably the marvelous economic evolution of the United States and the British Dominions. Thanks to foreign capital the countries of Latin America and Asia are today equipped with facilities for production and transportation which they would have had to forego for a very long time if they had not received this aid. Real wage rates and farm yields are higher today in those areas than they would have been in the absence of foreign capital. The mere fact that almost all nations are vehemently asking today for “foreign aid” explodes the fables of the Marxians and the nationalists.

However, the mere lust for imported capital goods does not resuscitate the international capital market. Investment and lending abroad are only possible if the receiving nations are unconditionally and sincerely committed to the principle of private property and do not plan to expropriate the foreign capitalists at a later date. It was such expropriations that destroyed the international capital market.

Intergovernmental loans are no substitute for the functioning of an international capital market. If they are granted on business terms, they presuppose no less than private loans the full acknowledgment of property rights. If they are granted, as is usually the case, as virtual subsidies without any regard for payment of principal and interest, they impose restrictions upon the debtor nation’s sovereignty. In fact such “loans” are for the most part the price paid for military assistance in coming wars. Such military considerations already played an important role in the years in which the European powers prepared the great wars of our age. The outstanding example was provided by the huge sums which the French capitalists, pressed hard by the Government of the Third Republic, lent to Imperial Russia. The Tsars used the capital borrowed for armaments, not for an improvement of the Russian apparatus of production.

Footnotes

[1] [Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 18: “Action in the Passing of Time,” pp. 476–85, 496–99.]

[2] Why man proceeds in this way, will be shown on the following pages.

[3] If the lengthening of durability were not at least proportionate to the increment in expenditure needed, it would be more advantageous to increase the quantity of units of a shorter durability.

[4] Cf. [Eugen von] Böhm-Bawerk, Kleinere Abhandlungen über Kapital und Zins, vol. 2 in Gesammelte Schriften, ed. F.X. Weiss (Vienna, 1926), p. 169.

[5] Time preference is not specifically human. It is an inherent feature of the behavior of all living beings. The distinction of man consists in preference is not inexorable and the lengthening of the period of provision not merely instinctive as with certain animals that store food, but the result of a process of valuation.

[6] About the Marxian attack against genetics, cf. T.D. Lysenko, Heredity and Variability (New York, 1945). A critical appraisal of this controversy is provided by J.R. Baker, Science and the Planned State (New York, 1945), pp. 71–76.

[7] Cf. [Ludwig von] Mises, Omnipotent Government (New Haven, 1944), p. 99 and the books quoted there.

Chapter 12 • The Interest Rate • 3,800 Words

1. The Phenomenon of Interest

It has been shown that time preference is a category inherent in every human action. Time preference manifests itself in the phenomenon of originary interest, i.e., the discount of future goods as against present goods.

Interest is not merely interest on capital. Interest is not the specific income derived from the utilization of capital goods. The correspondence between three factors of production — labor, capital, and land — and three classes of income — wages, profit, and rent — as taught by the classical economists is untenable. Rent is not the specific revenue from land. Rent is a general catallactic phenomenon; it plays in the yield of labor and capital goods the same role it plays in the yield of land. Furthermore there is no homogeneous source of income that could be called profit in the sense in which the classical economists applied this term. Profit (in the sense of entrepreneurial profit) and interest are no more characteristic of capital than they are of land.

The prices of consumers’ goods are by the interplay of the forces operating on the market apportioned to the various complementary factors cooperating in their production. As the consumers’ goods are present goods, while the factors of production are means for the production of future goods, and as present goods are valued higher than future goods of the same kind and quantity, the sum thus apportioned, even in the imaginary construction of the evenly rotating economy, falls behind the present price of the consumers’ goods concerned. This difference is the originary interest. It is not specifically connected with any of the three classes of factors of production which the classical economists distinguished. Entrepreneurial profit and loss are produced by changes in the data and the resulting price changes which occur in the passing of the period of production.

Naïve reasoning does not see any problem in the current revenue derived from hunting, fishing, cattle breeding, forestry, and agriculture. Nature generates deer, fish, and cattle and makes them grow, causes the cows to give milk and the chickens to lay eggs, the trees to put on wood and to bear fruit, and the seeds to shoot into ears. He who has a title to appropriate for himself this recurring wealth enjoys a steady income. Like a stream which continually carries new water, the “stream of income” flows continually and conveys again and again new wealth. The whole process appears as a natural phenomenon. But for the economist a problem is presented in the determination of prices for land, cattle, and all the rest. If future goods were not bought and sold at a discount as against present goods, the buyer of land would have to pay a price which equals the sum of all future net revenues and which would leave nothing for a current reiterated income.

The yearly recurring proceeds of the owners of land and cattle are not marked by any characteristic which would catallactically distinguish them from the proceeds stemming from produced factors of production which are used up sooner or later in the processes of production. The power of disposal over a piece of land is the control of this field’s cooperation in the production of all the fruit which can ever be grown on it, and the power of disposal over a mine is the control of its cooperation in the extraction of all the minerals which can ever be brought to the surface from it. In the same way the ownership of a machine or a bale of cotton is the control of its cooperation in the manufacture of all goods which are produced with its cooperation. The fundamental fallacy implied in all the productivity and use approaches to the problem of interest was that they traced back the phenomenon of interest to these productive services rendered by the factors of production. However, the serviceableness of the factors of production determines the prices paid for them, not interest. These prices exhaust the whole difference between the productivity of a process aided by a definite factor’s cooperation and that of a process lacking this cooperation. The difference between the sum of the prices of the complementary factors of production and the products which emerges even in the absence of changes in the market data concerned, is an outcome of the higher valuation of present goods as compared with future goods. As production goes on, the factors of production are transformed or ripen into present goods of a higher value. This increment is the source of specific proceeds flowing into the hands of the owners of the factors of production, of originary interest.

The owners of the material factors of production — as distinct from the pure entrepreneurs of the imaginary construction of an integration of catallactic functions — harvest two catallactically different items: the prices paid for the productive cooperation of the factors they control on the one hand and interest on the other hand. These two things must not be confused. It is not permissible to refer, in the explanation of interest, to the services rendered by the factors of production in the turning out of products.

Interest is a homogeneous phenomenon. There are no different sources of interest. Interest on durable goods and interest on consumption-credit are like other kinds of interest an outgrowth of the higher valuation of present goods as against future goods.

2. Originary Interest

Originary interest is the ratio of the value assigned to want-satisfaction in the immediate future and the value assigned to want-satisfaction in remoter periods of the future. It manifests itself in the market economy in the discount of future goods as against present goods. It is a ratio of commodity prices, not a price in itself. There prevails a tendency toward the equalization of this ratio for all commodities. In the imaginary construction of the evenly rotating economy the rate of originary interest is the same for all commodities.

Originary interest is not “the price paid for the services of capital.”[2]This is the popular definition of interest as, for instance, given by [Richard T.] Ely, [Thomas] Adams, [Max]Lorenz, and [Allyn] Young, Outlines of Economics (3d ed. New York, 1920), p. 493. The higher productivity of more time-consuming roundabout methods of production which is referred to by Böhm-Bawerk and by some later economists in the explanation of interest, does not explain the phenomenon. It is, on the contrary, the phenomenon of originary interest that explains why less time-consuming methods of production are resorted to in spite of the fact that more time-consuming methods would render a higher output per unit of input. Moreover, the phenomenon of originary interest explains why pieces of usable land can be sold and bought at finite prices. If the future services which a piece of land can render were to be valued in the same way in which its present services are valued, no finite price would be high enough to impel its owner to sell it. Land could neither be bought nor sold against definite amounts of money, nor bartered against goods which can render only a finite number of services. Pieces of land would be bartered only against other pieces of land. A superstructure that can yield during a period of ten years an annual revenue of one hundred dollars would be priced (apart from the soil on which it is built) at the beginning of this period at one thousand dollars, at the beginning of the second year at nine hundred dollars, and so on.

Originary interest is not a price determined on the market by the interplay of the demand for and the supply of capital or capital goods. Its height does not depend on the extent of this demand and supply. It is rather the rate of originary interest that determines both the demand for and the supply of capital and capital goods. It determines how much of the available supply of goods is to be devoted to consumption in the immediate future and how much to provision for remoter periods of the future.

People do not save and accumulate capital because there is interest. Interest is neither the impetus to saving nor the reward or the compensation granted for abstaining from immediate consumption. It is the ratio in the mutual valuation of present goods as against future goods.

The loan market does not determine the rate of interest. It adjusts the rate of interest on loans to the rate of originary interest as manifested in the discount of future goods.

Originary interest is a category of human action. It is operative in any valuation of external things and can never disappear. If one day the state of affairs were to return which was actual at the close of the first millennium of the Christian era when people believed that the ultimate end of all earthly things was impending, men would stop providing for future secular wants. The factors of production would in their eyes become useless and worthless. The discount of future goods as against present goods would not vanish. It would, on the contrary, increase beyond all measure. On the other hand, the fading away of originary interest would mean that people do not care at all for want-satisfaction in nearer periods of the future. It would mean that they prefer to an apple available today, tomorrow, in one year or in ten years, two apples available in a thousand or ten thousand years.

We cannot even think of a world in which originary interest would not exist as an inexorable element in every kind of action. Whether there is or is not division of labor and social cooperation and whether society is organized on the basis of private or of public control of the means of production, originary interest is always present. In a socialist commonwealth its role would not differ from that in the market economy.

Böhm-Bawerk has once for all unmasked the fallacies of the naïve productivity explanations of interest, i.e., of the idea that interest is the expression of the physical productivity of factors of production. However, Böhm-Bawerk has himself based his own theory to some extent on the productivity approach. In referring in his explanation to the technological superiority of more time-consuming, roundabout processes of production, he avoids the crudity of the naïve productivity fallacies. But in fact he returns, although in a subtler form, to the productivity approach. Those later economists who, neglecting the time-preference idea, have stressed exclusively the productivity idea contained in Böhm-Bawerk’s theory cannot help concluding that originary interest must disappear if men were one day to reach a state of affairs in which no further lengthening of the period of production could bring about a further increase in productivity.[3]Cf. [Friedrich A.] Hayek, “The Mythology of Capital,” The Quarterly Journal of Economics 50 (1936): 223 ff. However Professor Hayek has since partly changed his point of view. (Cf. his article “Time-Preference and Productivity, a Reconsideration,” Economica 12 [1945]: 22–25.) But the idea criticized in the text is still widely held by economists. This is, however, utterly wrong. Originary interest cannot disappear as long as there is scarcity and therefore action.

As long as the world is not transformed into a land of Cockaigne, men are faced with scarcity and must act and economize; they are forced to choose between satisfaction in nearer and in remoter periods of the future because neither for the former nor for the latter can full contentment be attained. Then a change in the employment of factors of production which withdraws such factors from their employment for want-satisfaction in the nearer future and devotes them to want-satisfaction in the remoter future must necessarily impair the state of satisfaction in the nearer future and improve it in the remoter future. If we were to assume that this is not the case, we should become embroiled in insoluble contradictions. We may at best think of a state of affairs in which technological knowledge and skill have reached a point beyond which no further progress is possible for mortal men. No new processes increasing the output per unit of input can henceforth be invented. But if we suppose that some factors of production are scarce, we must not assume that all processes which — apart from the time they absorb — are the most productive ones are fully utilized, and that no process rendering a smaller output per unit of input is resorted to merely because of the fact that it produces its final result sooner than other, physically more productive processes. Scarcity of factors of production means that we are in a position to draft plans for the improvement of our well-being the realization of which is unfeasible because of the insufficient quantity of the means available. It is precisely the unfeasibility of such desirable improvements that constitutes the element of scarcity. The reasoning of the modern supporters of the productivity approach is misled by the connotations of Böhm-Bawerk’s term roundabout methods of production and the idea of technological improvement which it suggests. However, if there is scarcity, there must always be an unused technological opportunity to improve the state of well-being by a lengthening of the period of production in some branches of industry, regardless of whether or not the state of technological knowledge has changed. If the means are scarce, if the praxeological correlation of ends and means still exists, there are by logical necessity unsatisfied wants with regard both to nearer and to remoter periods of the future. There are always goods the procurement of which we must forego because the way that leads to their production is too long and would prevent us from satisfying more urgent needs. The fact that we do not provide more amply for the future is the outcome of a weighing of satisfaction in nearer periods of the future against satisfaction in remoter periods of the future. The ratio which is the outcome of this valuation is originary interest.

In such a world of perfect technological knowledge a promoter drafts a plan A according to which a hotel in picturesque, but not easily accessible, mountain districts and the roads leading to it should be built. In examining the practicability of this plan he discovers that the means available are not sufficient for its execution. Calculating the prospects of the profitability of the investment, he comes to the conclusion that the expected proceeds are not great enough to cover the costs of material and labor to be expended and interest on the capital to be invested. He renounces the execution of project A and embarks instead upon the realization of another plan, B. According to plan B the hotel is to be erected in a more easily accessible location which does not offer all the advantages of the picturesque landscape which plan A had selected, but in which it can be built either with lower costs of construction or finished in a shorter time. If no interest on the capital invested were to enter into the calculation, the illusion could arise that the state of the market data — supply of capital goods and the valuations of the public — allows for the execution of plan A. However, the realization of plan A would withdraw scarce factors of production from employments in which they could satisfy wants considered more urgent by the consumers. It would mean a manifest malinvestment, a squandering of the means available.

A lengthening of the period of production can increase the quantity of output per unit of input or produce goods which cannot be produced at all within a shorter period of production. But it is not true that the imputation of the value of this additional wealth to the capital goods required for the lengthening of the period of production generates interest. If one were to assume this, one would relapse into the crassest errors of the productivity approach, irrefutably exploded by Böhm-Bawerk. The contribution of the complementary factors of production to the result of the process is the reason for their being considered as valuable; it explains the prices paid for them and is fully taken into account in the determination of these prices. No residuum is left that is not accounted for and could explain interest.

It has been asserted that in the imaginary construction of the evenly rotating economy no interest would appear.[4]Cf. [Joseph] Schumpeter, The Theory of Economic Development, trans. by R. Opie (Cambridge, 1934), pp. 34–46, 54. However, it can be shown that this assertion is incompatible with the assumptions on which the construction of the evenly rotating economy is based.

We begin with the distinction between two classes of saving: plain saving and capitalist saving. Plain saving is merely the piling up of consumers’ goods for later consumption. Capitalist saving is the accumulation of goods which are designed for an improvement of production processes. The aim of plain saving is later consumption; it is merely postponement of consumption. Sooner or later the goods accumulated will be consumed and nothing will be left. The aim of capitalist saving is first an improvement in the productivity of effort. It accumulates capital goods which are employed for further production and are not merely reserves for later consumption. The boon derived from plain saving is later consumption of the stock not instantly consumed but accumulated for later use. The boon derived from capitalist saving is the increase of the quantity of goods produced or the production of goods which could not be produced at all without its aid. In constructing the image of an evenly rotating (static) economy, economists disregard the process of capital accumulation; the capital goods are given and remain, as, according to the underlying assumptions, no changes occur in the data. There is neither accumulation of new capital through saving, nor consumption of capital available through a surplus of consumption over income, i.e., current production minus the funds required for the maintenance of capital. It is now our task to demonstrate that these assumptions are incompatible with the idea that there is no interest.

There is no need to dwell, in this reasoning, upon plain saving. The objective of plain saving is to provide for a future in which the saver could possibly be less amply supplied than in the present. Yet, one of the fundamental assumptions characterizing the imaginary construction of the evenly rotating economy is that the future does not differ at all from the present, that the actors are fully aware of this fact and act accordingly. Hence, in the frame of this construction, no room is left for the phenomenon of plain saving.

It is different with the fruit of capitalist saving, the accumulated stock of capital goods. There is in the evenly rotating economy neither saving and accumulation of additional capital goods nor eating up of already existing capital goods. Both phenomena would amount to a change in the data and would thus disturb the even rotation of the imaginary system. Now, the magnitude of saving and capital accumulation in the past — i.e., in the period preceding the establishment of the evenly rotating economy — was adjusted to the height of the rate of interest. If — with the establishment of the conditions of the evenly rotating economy — the owners of the capital goods were no longer to receive any interest, the conditions which were operative in the allocation of the available stocks of goods to the satisfaction of wants in the various periods of the future would be upset. The altered state of affairs requires a new allocation. Also in the evenly rotating economy the difference in the valuation of want-satisfaction in various periods of the future cannot disappear. Also in the frame of this imaginary construction, people will assign a higher value to an apple available today as against an apple available in ten or a hundred years. If the capitalist no longer receives interest, the balance between satisfaction in nearer and remoter periods of the future is disarranged. The fact that a capitalist has maintained his capital at just 100,000 dollars was conditioned by the fact that 100,000 present dollars were equal to 105,000 dollars available twelve months later. These 5,000 dollars were in his eyes sufficient to outweigh the advantages to be expected from an instantaneous consumption of a part of this sum. If interest payments are eliminated, capital consumption ensues.

This is the essential deficiency of the static system as Schumpeter depicts it. It is not sufficient to assume that the capital equipment of such a system has been accumulated in the past, that it is now available to the extent of this previous accumulation and is henceforth unalterably maintained at this level. We must also assign in the frame of this imaginary system a role to the operation of forces which bring about such a maintenance. If one eliminates the capitalist’s role as receiver of interest, one replaces it by the capitalist’s role as consumer of capital. There is no longer any reason why the owner of capital goods should abstain from employing them for consumption. Under the assumptions implied in the imaginary construction of static conditions (the evenly rotating economy) there is no need to keep them in reserve for rainy days. But even if, inconsistently enough, we were to assume that a part of them is devoted to this purpose and therefore withheld from current consumption, at least that part of capital will be consumed which corresponds to the amount that capitalist saving exceeds plain saving.[5]Cf. [Lionel] Robbins, “On a Certain Ambiguity in the Conception of Stationary Equilibrium,” The Economic Journal 40 (1930): 211 ff.

If there were no originary interest, capital goods would not be devoted to immediate consumption and capital would not be consumed. On the contrary, under such an unthinkable and unimaginable state of affairs there would be no consumption at all, but only saving, accumulation of capital, and investment. Not the impossible disappearance of originary interest, but the abolition of payment of interest to the owners of capital, would result in capital consumption. The capitalists would consume their capital goods and their capital precisely because there is originary interest and present want-satisfaction is preferred to later satisfaction.

Therefore there cannot be any question of abolishing interest by any institutions, laws, and devices of bank manipulation. He who wants to “abolish” interest will have to induce people to value an apple available in a hundred years no less than a present apple. What can be abolished by laws and decrees is merely the right of the capitalists to receive interest. But such laws would bring about capital consumption and would very soon throw mankind back into the original state of natural poverty.

Footnotes

[1] [Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 19: “Interest,” pp. 521–29.]

[2] This is the popular definition of interest as, for instance, given by [Richard T.] Ely, [Thomas] Adams, [Max]Lorenz, and [Allyn] Young, Outlines of Economics (3d ed. New York, 1920), p. 493.

[3] Cf. [Friedrich A.] Hayek, “The Mythology of Capital,” The Quarterly Journal of Economics 50 (1936): 223 ff. However Professor Hayek has since partly changed his point of view. (Cf. his article “Time-Preference and Productivity, a Reconsideration,” Economica 12 [1945]: 22–25.) But the idea criticized in the text is still widely held by economists.

[4] Cf. [Joseph] Schumpeter, The Theory of Economic Development, trans. by R. Opie (Cambridge, 1934), pp. 34–46, 54.

[5] Cf. [Lionel] Robbins, “On a Certain Ambiguity in the Conception of Stationary Equilibrium,” The Economic Journal 40 (1930): 211 ff.

Chapter 13 • The Business Cycle • 6,800 Words

2. Credit Expansion

It is a fundamental fact of human behavior that people value present goods higher than future goods. An apple available for immediate consumption is valued higher than an apple which will be available next year. And an apple which will be available in a year is in turn valued higher than an apple which will become available in five years. This difference in valuation appears in the market economy in the form of the discount, to which future goods are subject as compared to present goods. In money transactions this discount is called interest.

Interest therefore cannot be abolished. In order to do away with interest we would have to prevent people from valuing a house, which today is habitable, more highly than a house which will not be ready for use for ten years. Interest is not peculiar to the capitalistic system only. In a socialist community too the fact will have to be considered that a loaf of bread which will not be ready for consumption for another year does not satisfy present hunger.

Interest does not have its origin in the meeting of supply and demand of money loans in the capital market. It is rather the function of the loan market, which in business terms is called the money market (for short-term credit) and the capital market (for long-term credit), to adjust the interest rates for loans transacted in money to the difference in the valuation of present and future goods. This difference in valuation is the real source of interest. An increase in the quantity of money, no matter how large, cannot in the long run influence the rate of interest.

No other economic law is less popular than this, that interest rates are, in the long run, independent of the quantity of money. Public opinion is reluctant to recognize interest as a market phenomenon. Interest is thought to be an evil, an obstacle to human welfare, and, therefore, it is demanded that it be eliminated or at least considerably reduced. And credit expansion is considered the proper means to bring about “easy money.”

There is no doubt that credit expansion leads to a reduction of the interest rate in the short run. At the beginning, the additional supply of credit forces the interest rate for money loans below the point which it would have in an unmanipulated market. But it is equally clear that even the greatest expansion of credit cannot change the difference in the valuation of future and present goods. The interest rate must ultimately return to the point at which it corresponds to this difference in the valuation of goods. The description of this process of adjustment is the task of that part of economics which is called the theory of the business cycle.

At every constellation of prices, wages, and interest rates, there are projects which will not be carried out because a calculation of their profitability shows that there is no chance for the success of such undertakings. The businessman does not have the courage to start the enterprise because his calculations convince him that he will not gain, but will lose by it.

This unattractiveness of the project is not a consequence of money or credit conditions; it is due to the scarcity of economic goods and labor and to the fact that they have to be devoted to more urgent and therefore more attractive uses.

When the interest rate is artificially lowered by credit expansion the false impression is created that enterprises which previously had been regarded as unprofitable now become profitable. Easy money induces the entrepreneurs to embark upon businesses which they would not have undertaken at a higher interest rate. With the money borrowed from the banks they enter the market with additional demand and cause a rise in wages and in the prices of the means of production. This boom of course would have to collapse immediately in the absence of further credit expansion, because these price increases would make the new enterprises appear unprofitable again. But if the banks continue with the credit expansion this brake fails to work. The boom continues.

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system.[2]As explained in this section on “Credit Expansion.” Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.

It is obvious that a mere banking process like credit expansion cannot create more goods and wealth. What the credit expansion actually accomplishes is to introduce a source of error in the calculations of the entrepreneurs and thus causes them to misjudge business and investment projects. The entrepreneurs act as if more producers’ goods were available than are actually at hand. They plan expansion of production on a scale for which the available quantities of producers’ goods are not sufficient. These plans are bound to fail because of the deficiency in the available amount of producers’ goods. The result is that there are plants which cannot be used because the complementary facilities are lacking; there are plants which cannot be completed; there are other plants again whose products cannot be sold because consumers desire other products more urgently which cannot be produced in sufficient quantities because the necessary productive facilities are not ready. The boom is not over-investment, it is misdirected investment.

It is frequently argued against this conclusion that it would hold true only if at the beginning of the credit expansion there were neither unused capacity nor unemployment. If there were unemployment and idle capacity, things would be different, they claim. But these assumptions do not affect the argument.

The fact that a part of the productive capacity which cannot be diverted to other uses is unused is the consequence of errors of the past. Investments were made in the past under assumptions which proved to be incorrect; the market now demands something else than what can be produced by these facilities.[3]In the absence of credit expansion there also may be plants which are not fully utilized. But they do not disturb the market any more than does the unused submarginal land. The accumulation of inventories is speculation. The owner does not want to sell the goods at the current market price because he hopes to realize a higher price at a future date. Unemployment of workers is also an aspect of speculation. The worker does not want to change his location or occupation, nor does he want to lower his wage demands because he hopes to find the work he prefers at the place he prefers and at higher wages. Both the owners of merchandise and the unemployed refuse to adjust themselves to market conditions because they hope for new data which would change market conditions to their advantage. Because they do not make the necessary adjustments the economic system cannot reach “equilibrium.”

In the opinion of the advocates of credit expansion, what is necessary fully to utilize the unused capacity, to sell the supply at prices acceptable to the owners, and to enable the unemployed to find work at wages satisfactory to them is merely additional credit which such expansion could provide. This is the view which underlies all plans for “pump priming.” It would be correct for the stocks of goods and for the unemployed under two conditions: (1) if the price rises caused by the additional quantity of money and credit would uniformly and simultaneously affect all other prices and wages, and (2) if the owners of the excessive supplies and the unemployed would not increase their prices and wage demands. This would cause the exchange ratios between these goods and services and other goods and services to change in the same way as they would have to be changed in the absence of credit expansion, by reducing the price and wage demands in order to find buyers and employers.

The course of the boom is not any different because, at its inception, there are unused productive capacity, unsold stocks of goods, and unemployed workers. We might assume, for instance, that we are dealing with copper mines, copper inventories, and copper miners. The price of copper is at a point at which a number of mines cannot profitably continue their production; their workers must remain idle if they do not want to change jobs; and the owners of the copper stocks can only sell part of it if they are unwilling to accept a lower price. What is needed to put the idle mines and miners back to work and to dispose of the copper supply without a price drop is an increase (p) in producers’ goods in general, which would permit an expansion of overall production, so that an increase in the price, sales, and production of copper would follow. If this increase (p) does not occur, but the entrepreneurs are induced by credit expansion to act as if it had occurred, the effects on the copper market will first be the same as if p actually had appeared. But everything that has been said before of the effects of credit expansion develops in this case as well. The sole difference is that misdirected capital investment, as far as copper is concerned, does not necessitate the withdrawal of capital and labor from other branches of production, which under existing conditions are considered more important by the consumers. But this is only due to the fact that, as far as copper is concerned, the credit expansion boom impinges upon previously misdirected capital and labor which have not yet been adjusted by the normal corrective processes of the price mechanism.

The true meaning of the argument of unused capacity, unsold — or, as it is said inaccurately, unsalable — inventories, and idle labor, now becomes apparent. The beginning of every credit expansion encounters such remnants of older, misdirected capital investments and apparently “corrects” them. In actuality, it does nothing but disturb the workings of the adjustment process. The existence of unused means of production does not invalidate the conclusions of the monetary theory of the business cycle. The advocates of credit expansion are mistaken when they believe that, in view of unused means of production, the suppression of all possibilities of credit expansion would perpetuate the depression. The measures they propose would not perpetuate real prosperity, but would constantly interfere with the process of readjustment and the return of normal conditions.

It is impossible to explain the cyclical changes of business on any basis other than the theory which commonly is referred to as the monetary theory of the business cycle. Even those economists who refuse to recognize in the monetary theory the proper explanation of the business cycle have never attempted to deny the validity of its conclusions about the effects of credit expansion. In order to defend their theories about the business cycle, which differ from the monetary theory, they still have to admit that the upswing cannot occur without simultaneous credit expansion, and that the end of the credit expansion also marks the turning point of the cycle. The opponents of the monetary theory actually confine themselves to the assertion that the upswing of the cycle is not caused by credit expansion, but by other factors, and that the credit expansion, without which the upswing would be impossible, is not the result of a policy intended to lower the interest rate and to invite the execution of additional business plans, but that it is released somehow by conditions leading to the upswing without intervention by the banks or by the authorities.

It has been asserted that the credit expansion is released by the rise in the rate of interest through the failure of the banks to raise their interest rates in accordance with the rise in the “natural” rate.[4][Fritz] Machlup, (The Stock Market, Credit and Capital Formation, London, 1940), p. 248, speaks of “passive inflationism.” This argument too misses the main point of the monetary theory of the cycle. Whether the credit expansion gets under way because the banks ease credit terms, or because they fail to stiffen the terms in accordance with changed market conditions, is of minor importance.[5]If a bank is unable to expand credit it cannot create an upswing even if it lowers its interest rate below the market rate. It would merely make a gift to its debtors. The conclusion to be drawn from the monetary theory of the cycle with regard to stabilizing measures is not the postulate that the banks should not lower the interest rate, but that they should not expand credit. This [Gottfried] Haberler (Prosperity and Depression, League of Nations, Geneva, 1939, pp. 65 ff.) misunderstood and therefore his criticisms are untenable. Decisive only is the fact that there is credit expansion because there exist institutions which consider it their task to influence interest rates by the granting of additional credit. Whoever believes that credit expansion is a necessary factor in the movement which forces the economy into the upswing, which must be followed by a crisis and depression, would have to admit that the surest means to achieve a cycle-proof economic system lies in preventing credit expansion. But despite the general agreement that measures should be taken to smooth the wave-like movements of the cycle, measures to prevent credit expansion do not receive consideration. Business cycle policy is given the task to perpetuate the upswing created by the credit expansion and yet to prevent the breakdown. Proposals to prevent credit expansion are refuted because supposedly they would perpetuate the depression. Nothing could be a more convincing proof of the theory which explains the business cycle as originating from interventions in favor of easy money than the obstinate refusal to abandon credit expansion.

One would have to ignore all facts of recent economic history were one to deny that measures to lower rates are considered desirable and that credit expansion is regarded as the most reliable means to achieve this aim. The fact that the smooth functioning and the development and steady progress of the economy is over and over again disturbed by artificial booms and ensuing depressions is not a necessary characteristic of the market economy. It is rather the inevitable consequence of repeated interventions which intend to create easy money by credit expansion.

“Monetary Stabilization and Cyclical Policy”

1. The Banking School Fallacy

If notes are issued by the banks, or if bank deposits subject to check or other claim are opened, in excess of the amount of money kept in the vaults as cover, the effect on prices is similar to that obtained by an increase in the quantity of money. Since these fiduciary media, as notes and bank deposits not backed by metal are called, render the service of money as safe and generally accepted, payable on demand monetary claims, they may be used as money in all transactions. On that account, they are genuine money substitutes. Since they are in excess of the given total quantity of money in the narrower sense, they represent an increase in the quantity of money in the broader sense.

The practical significance of these undisputed and indisputable conclusions in the formation of prices is denied by the Banking School with its contention that the issue of such fiduciary media is strictly limited by the demand for money in the economy. The Banking School doctrine maintains that if fiduciary media are issued by the banks only to discount short-term commodity bills, then no more would come into circulation than were “needed” to liquidate the transactions. According to this doctrine, bank management could exert no influence on the volume of the commodity transactions activated. Purchases and sales from which short-term commodity bills originate would, by this very transaction, already have brought into existence paper credit which can be used, through further negotiation, for the exchange of goods and services. If the bank discounts the bill and, let us say, issues notes against it, that is, according to the Banking School, a neutral transaction as far as the market is concerned. Nothing more is involved than replacing one instrument which is technically less suitable for circulation, the bill of exchange, with a more suitable one, the note. Thus, according to this School, the effect of the issue of notes need not be to increase the quantity of money in circulation. If the bill of exchange is retired at maturity, then notes would flow back to the bank and new notes could enter circulation again only when new commodity bills came into being once more as a result of new business.

The weak link in this well-known line of reasoning lies in the assertion that the volume of transactions completed, as sales and purchases from which commodity bills can derive, is independent of the behavior of the banks. If the banks discount at a lower, rather than at a higher, interest rate, then more loans are made. Enterprises which are unprofitable at 5 percent, and hence are not undertaken, may be profitable at 4 percent. Therefore, by lowering the interest rate they charge, banks can intensify the demand for credit. Then, by satisfying this demand, they can increase the quantity of fiduciary media in circulation. Once this is recognized, the Banking Theory’s only argument, that prices are not influenced by the issue of fiduciary media, collapses.

One must be careful not to speak simply of the effects of credit in general on prices, but to specify clearly the effects of “increased credit” or “credit expansion.” A sharp distinction must be made between (1) credit which a bank grants by lending its own funds or funds placed at its disposal by depositors, which we call “commodity credit,” and (2) that which is granted by the creation of fiduciary media, i.e., notes and deposits not covered by money, which we call “circulation credit.” It is only through the granting of circulation credit that the prices of all commodities and services are directly affected.

If the banks grant circulation credit by discounting a three month bill of exchange, they exchange a future good — a claim payable in three months — for a present good that they produce out of nothing. It is not correct, therefore, to maintain that it is immaterial whether the bill of exchange is discounted by a bank of issue or whether it remains in circulation, passing from hand to hand. Whoever takes the bill of exchange in trade can do so only if he has the resources. But the bank of issue discounts by creating the necessary funds and putting them into circulation. To be sure, the fiduciary media flow back again to the bank at expiration of the note. If the bank does not give the fiduciary media out again, precisely the same consequences appear as those which come from a decrease in the quantity of money in its broader sense.

2. Early Effects of Credit Expansion

The fact that in the regular course of banking operations the banks issue fiduciary media only as loans to producers and merchants means that they are not used directly for purposes of consumption. Rather, these fiduciary media are used first of all for production, that is to buy factors of production and pay wages. The first prices to rise, therefore, as a result of an increase of the quantity of money in the broader sense, caused by the issue of such fiduciary media, are those of raw materials, semimanufactured products, other goods of higher orders, and wage rates. Only later do the prices of goods of the first order [consumers’ goods] follow. Changes in the purchasing power of a monetary unit, brought about by the issue of fiduciary media, follow a different path and have different accompanying social side effects from those produced by a new discovery of precious metals or by the issue of paper money. Still in the last analysis, the effect on prices is similar in both instances.

Changes in the purchasing power of the monetary unit do not directly affect the height of the rate of interest. An indirect influence on the height of the interest rate can take place as a result of the fact that shifts in wealth and income relationships, appearing as a result of the change in the value of the monetary unit, influence savings and, thus, the accumulation of capital. If a depreciation of the monetary unit favors the wealthier members of society at the expense of the poorer, its effect will probably be an increase in capital accumulation since the well-to-do are the more important savers. The more they put aside, the more their incomes and fortunes will grow.

If monetary depreciation is brought about by an issue of fiduciary media, and if wage rates do not promptly follow the increase in commodity prices, then the decline in purchasing power will certainly make this effect much more severe. This is the “forced savings” which is quite properly stressed in recent literature.[7]Albert Hahn and Joseph Schumpeter have given me credit for the expression “forced savings” or “compulsory savings.” However, three things should not be forgotten. First, it always depends upon the data of the particular case whether shifts of wealth and income, which lead to increased saving, are actually set in motion. Second, under circumstances which need not be discussed further here, by falsifying economic calculation, based on monetary bookkeeping calculations, a very substantial devaluation can lead to capital consumption (such a situation did take place temporarily during the recent inflationary period). Third, as advocates of inflation through credit expansion should observe, any legislative measure which transfers resources to the “rich” at the expense of the “poor” will also foster capital formation.

Eventually, the issue of fiduciary media in such manner can also lead to increased capital accumulation within narrow limits and, hence, to a further reduction of the interest rate. In the beginning, however, an immediate and direct decrease in the loan rate appears with the issue of fiduciary media, but this immediate decrease in the loan rate is distinct in character and degree from the later reduction. The new funds offered on the money market by the banks must obviously bring pressure to bear on the rate of interest. The supply and demand for loan money were adjusted at the interest rate prevailing before the issue of any additional supply of fiduciary media. Additional loans can be placed only if the interest rate is lowered. Such loans are profitable for the banks because the increase in the supply of fiduciary media calls for no expenditure except for the mechanical costs of banking (i.e., printing the notes and bookkeeping). The banks can, therefore, undercut the interest rates which would otherwise appear on the loan market, in the absence of their intervention. Since competition from them compels other money lenders to lower their interest charges, the market interest rate must therefore decline. But can this reduction be maintained? That is the problem.

3. Inevitable Effects of Credit Expansion on Interest Rates

In conformity with Wicksell’s terminology, we shall use “natural interest rate” to describe that interest rate which would be established by supply and demand if real goods were loaned in natura [directly, as in barter] without the intermediary of money. “Money rate of interest” will be used for that interest rate asked on loans made in money or money substitutes. Through continued expansion of fiduciary media, it is possible for the banks to force the money rate down to the actual cost of the banking operations, practically speaking that is almost to zero. As a result, several authors have concluded that interest could be completely abolished in this way. Whole schools of reformers have wanted to use banking policy to make credit gratuitous and thus to solve the “social question.” No reasoning person today, however, believes that interest can ever be abolished, nor doubts but what, if the “money interest rate” is depressed by the expansion of fiduciary media, it must sooner or later revert once again to the “natural interest rate.” The question is only how this inevitable adjustment takes place. The answer to this will explain at the same time the fluctuations of the business cycle.

The Currency Theory limited the problem too much. It only considered the situation that was of practical significance for the England of its time — that is, when the issue of fiduciary media is increased in one country while remaining unchanged in others. Under these assumptions, the situation is quite clear: General price increases at home; hence an increase in imports, a drop in commodity exports; and with this, as notes can circulate only within the country, an outflow of metallic money. To obtain metallic money for export, holders of notes present them for redemption; the metallic reserves of the banks decline; and consideration for their own solvency then forces them to restrict the credit offered.

That is the instant at which the business upswing, brought about by the availability of easy credit, is demonstrated to be illusory prosperity. An abrupt reaction sets in. The “money rate of interest” shoots up; enterprises from which credit is withdrawn collapse and sweep along with them the banks which are their creditors. A long persisting period of business stagnation now follows. The banks, warned by this experience into observing restraint, not only no longer underbid the “natural interest rate” but exercise extreme caution in granting credit.

4. The Price Premium

In order to complete this interpretation, we must, first of all, consider the price premium. As the banks start to expand the circulation credit, the anticipated upward movement of prices results in the appearance of a positive price premium. Even if the banks do not lower the actual interest rate any more, the gap widens between the “money interest rate” and the “natural interest rate” which would prevail in the absence of their intervention. Since loan money is now cheaper to acquire than circumstances warrant, entrepreneurial ambitions expand.

New businesses are started in the expectation that the necessary capital can be secured by obtaining credit. To be sure, in the face of growing demand, the banks now raise the “money interest rate.” Still they do not discontinue granting further credit. They expand the supply of fiduciary media issued, with the result that the purchasing power of the monetary unit must decline still further. Certainly the actual “money interest rate” increases during the boom, but it continues to lag behind the rate which would conform to the market, i.e., the “natural interest rate” augmented by the positive price premium.

So long as this situation prevails, the upswing continues. Inventories of goods are readily sold. Prices and profits rise. Business enterprises are overwhelmed with orders because everyone anticipates further price increases and workers find employment at increasing wage rates. However, this situation cannot last forever!

5. Malinvestment of Available Capital Goods

The “natural interest rate” is established at that height which tends toward equilibrium on the market. The tendency is toward a condition where no capital goods are idle, no opportunities for starting profitable enterprises remain unexploited and the only projects not undertaken are those which no longer yield a profit at the prevailing “natural interest rate.” Assume, however, that the equilibrium, toward which the market is moving, is disturbed by the interference of the banks. Money may be obtained below the “natural interest rate.” As a result businesses may be started which weren’t profitable before, and which become profitable only through the lower than “natural interest rate” which appears with the expansion of circulation credit.

Here again, we see the difference which exists between a drop in purchasing power, caused by the expansion of circulation credit, and a loss of purchasing power, brought about by an increase in the quantity of money. In the latter case [i.e., with an increase in the quantity of money in the narrower sense] the prices first affected are either (1) those of consumers’ goods only or (2) the prices of both consumers’ and producers’ goods. Which it will be depends on whether those first receiving the new quantities of money use this new wealth for consumption or production. However, if the decrease in purchasing power is caused by an increase in bank created fiduciary media, then it is the prices of producers’ goods which are first affected. The prices of consumers’ goods follow only to the extent that wages and profits rise.

Since it always requires some time for the market to reach full “equilibrium,” the “static” or “natural”[8]In the language of Knut Wicksell and the classical economists. prices, wage rates and interest rates never actually appear. The process leading to their establishment is never completed before changes occur which once again indicate a new “equilibrium.” At times, even on the unhampered market, there are some unemployed workers, unsold consumers’ goods and quantities of unused factors of production, which would not exist under “static equilibrium.” With the revival of business and productive activity, these reserves are in demand right away. However, once they are gone, the increase in the supply of fiduciary media necessarily leads to disturbances of a special kind.

In a given economic situation, the opportunities for production, which may actually be carried out, are limited by the supply of capital goods available. Roundabout methods of production can be adopted only so far as the means for subsistence exist to maintain the workers during the entire period of the expanded process. All those projects, for the completion of which means are not available, must be left uncompleted, even though they may appear technically feasible — that is, if one disregards the supply of capital. However, such businesses, because of the lower loan rate offered by the banks, appear for the moment to be profitable and are, therefore, initiated. However, the existing resources are insufficient. Sooner or later this must become evident. Then it will become apparent that production has gone astray, that plans were drawn up in excess of the economic means available, that speculation, i.e., activity aimed at the provision of future goods, was misdirected.

6. “Forced Savings”

In recent years, considerable significance has been attributed to the fact that “forced savings,” which may appear as a result of the drop in purchasing power that follows an increase of fiduciary media, leads to an increase in the supply of capital. The subsistence fund is made to go farther, due to the fact that (1) the workers consume less because wage rates tend to lag behind the rise in the prices of commodities, and (2) those who reap the advantage of this reduction in the workers’ incomes save at least a part of their gain. Whether “forced savings” actually appear depends, as noted above, on the circumstances in each case. There is no need to go into this any further.

Nevertheless, establishing the existence of “forced savings” does not mean that bank expansion of circulation credit does not lead to the initiation of more roundabout production than available capabilities would warrant. To prove that, one must be able to show that the banks are only in a position to depress the “money interest rate” and expand the issue of fiduciary media to the extent that the “natural interest rate” declines as a result of “forced savings.” This assumption is simply absurd and there is no point in arguing it further. It is almost inconceivable that anyone should want to maintain it.

What concerns us is the problem brought about by the banks, in reducing the “money rate of interest” belowthe “natural rate.” For our problem, it is immaterial how much the “natural interest rate” may also decline under certain circumstances and within narrow limits, as a result of this action by the banks. No one doubts that “forced savings” can reduce the “natural interest rate” only fractionally, as compared with the reduction in the “money interest rate” which produces the “forced savings.”[9]I believe this should be pointed out here again, although I have exhausted everything to be said on the subject [see section 2. Early Effects of Credit Expansion] and in The Theory of Money and Credit. Anyone who has followed the discussions of recent years will realize how important it is to stress these things again and again.

The resources which are claimed for the newly initiated longer time consuming methods of production are unavailable for those processes where they would otherwise have been put to use. The reduction in the loan rate benefits all producers, so that all producers are now in a position to pay higher wage rates and higher prices for the material factors of production. Their competition drives up wage rates and the prices of the other factors of production. Still, except for the possibilities already discussed, this does not increase the size of the labor force or the supply of available goods of the higher order. The means of subsistence are not sufficient to provide for the workers during the extended period of production. It becomes apparent that the proposal for the new, longer, roundabout production was not adjusted with a view to the actual capital situation. For one thing, the enterprises realize that the resources available to them are not sufficient to continue their operations. They find that “money” is scarce.

That is precisely what has happened. The general increase in prices means that all businesses need more funds than had been anticipated at their “launching.” More resources are required to complete them. However, the increased quantity of fiduciary media loaned out by the banks is already exhausted. The banks can no longer make additional loans at the same interest rates. As a result, they must raise the loan rate once more for two reasons. In the first place, the appearance of the positive price premium forces them to pay higher interest for outside funds which they borrow. Then also, they must discriminate among the many applicants for credit. Not all enterprises can afford this increased interest rate. Those which cannot run into difficulties.

7. A Habit-Forming Policy

Now, in extending circulation credit, the banks do not proceed by pumping a limited dosage of new fiduciary media into circulation and then stop. They expand the fiduciary media continuously for some time, sending, so to speak, after the first offering, a second, third, fourth, and so on. They do not simply undercut the “natural interest rate” once, and then adjust promptly to the new situation. Instead they continue the practice of making loans below the “natural interest rate” for some time. To be sure, the increasing volume of demands on them for credit may cause them to raise the “money rate of interest.” Yet, even if the banks revert to the former “natural rate,” the rate which prevailed before their credit expansion affected the market, they still lag behind the rate which would now exist on the market if they were not continuing to expand credit. This is because a positive price premium must now be included in the new “natural rate.” With the help of this new quantity of fiduciary media, the banks now take care of the businessman’s intensified demand for credit. Thus, the crisis does not appear yet. The enterprises using more roundabout methods of production, which have been started, are continued. Because prices rise still further, the earlier calculations of the entrepreneurs are realized. They make profits. In short, the boom continues.

8. The Inevitable Crisis and Cycle

The crisis breaks out only when the banks alter their conduct to the extent that they discontinue issuing any more new fiduciary media and stop undercutting the “natural interest rate.” They may even take steps to restrict circulation credit. When they actually do this, and why, is still to be examined. First of all, however, we must ask ourselves whether it is possible for the banks to stay on the course upon which they have embarked, permitting new quantities of fiduciary media to flow into circulation continuously and proceeding always to make loans below the rate of interest which would prevail on the market in the absence of their interference with newly created fiduciary media.

If the banks could proceed in this manner, with businesses improving continually, could they then provide for lasting good times? Would they then be able to make the boom eternal?

They cannot do this. The reason they cannot is that inflationism carried on ad infinitum is not a workable policy. If the issue of fiduciary media is expanded continuously, prices rise ever higher and at the same time the positive price premium also rises. (We shall disregard the fact that consideration for (1) the continually declining monetary reserves relative to fiduciary media and (2) the banks’ operating costs must sooner or later compel them to discontinue the further expansion of circulation credit.) It is precisely because, and only because, no end to the prolonged “flood” of expanding fiduciary media is foreseen, that it leads to still sharper price increases and, finally, to a panic in which prices and the loan rate move erratically upward.

Suppose the banks still did not want to give up the race? Suppose, in order to depress the loan rate, they wanted to satisfy the continuously expanding desire for credit by issuing still more circulation credit? Then they would only hasten the end, the collapse of the entire system of fiduciary media. The inflation can continue only so long as the conviction persists that it will one day cease. Once people are persuaded that the inflation will not stop, they turn from the use of this money. They flee then to “real values,” foreign money, the precious metals, and barter.

Sooner or later, the crisis must inevitably break out as the result of a change in the conduct of the banks. The later the crack-up comes, the longer the period in which the calculation of the entrepreneurs is misguided by the issue of additional fiduciary media. The greater this additional quantity of fiduciary money, the more factors of production have been firmly committed in the form of investments which appeared profitable only because of the artificially reduced interest rate and which prove to be unprofitable now that the interest rate has again been raised. Great losses are sustained as a result of misdirected capital investments. Many new structures remain unfinished. Others, already completed, close down operations. Still others are carried on because, after writing off losses which represent a waste of capital, operation of the existing structure pays at least something.

The crisis, with its unique characteristics, is followed by stagnation. The misguided enterprises and businesses of the boom period are already liquidated. Bankruptcy and adjustment have cleared up the situation. The banks have become cautious. They fight shy of expanding circulation credit. They are not inclined to give an ear to credit applications from schemers and promoters. Not only is the artificial stimulus to business, through the expansion of circulation credit, lacking, but even businesses which would be feasible, considering the capital goods available, are not attempted because the general feeling of discouragement makes every innovation appear doubtful. Prevailing “money interest rates” fall below the “natural interest rates.”

When the crisis breaks out, loan rates bound sharply upward because threatened enterprises offer extremely high interest rates for the funds to acquire the resources, with the help of which they hope to save themselves. Later, as the panic subsides, a situation develops, as a result of the restriction of circulation credit and attempts to dispose of large inventories, causing prices [and the “money interest rate”] to fall steadily and leading to the appearance of a negative price premium. This reduced rate of loan interest is adhered to for some time, even after the decline in prices comes to a standstill, when a negative price premium no longer corresponds to conditions. Thus, it comes about that the “money interest rate” is lower than the “natural rate.” Yet, because the unfortunate experiences of the recent crisis have made everyone uneasy, the incentive to business activity is not as strong as circumstances would otherwise warrant. Quite a time passes before capital funds, increased once again by savings accumulated in the meantime, exert sufficient pressure on the loan interest rate for an expansion of entrepreneurial activity to resume. With this development, the low point is passed and the new boom begins.

References • 300 Words

[1] [Ludwig von Mises, Interventionism: An Economic Analysis (Irvington-on-Hudson, N.Y.: The Foundation for Economic Education, 1998), chap. 3, “Inflation and Credit Expansion,” pp. 39–44.]

[2] As explained in this section on “Credit Expansion.”

[3] In the absence of credit expansion there also may be plants which are not fully utilized. But they do not disturb the market any more than does the unused submarginal land.

[4] [Fritz] Machlup, (The Stock Market, Credit and Capital Formation, London, 1940), p. 248, speaks of “passive inflationism.”

[5] If a bank is unable to expand credit it cannot create an upswing even if it lowers its interest rate below the market rate. It would merely make a gift to its debtors. The conclusion to be drawn from the monetary theory of the cycle with regard to stabilizing measures is not the postulate that the banks should not lower the interest rate, but that they should not expand credit. This [Gottfried] Haberler (Prosperity and Depression, League of Nations, Geneva, 1939, pp. 65 ff.) misunderstood and therefore his criticisms are untenable.

[6] [Ludwig von Mises, “Monetary Stabilization and Cyclical Policy,” in The Causes of the Economic Crisis and Other Essays Before and After the Great Depression, ed. Percy L. Greaves, Jr. (1928; Auburn, Ala.: Mises Institute, 2006), chap. 2: “Circulation Credit Theory,” pp. 103–15.]

[7] Albert Hahn and Joseph Schumpeter have given me credit for the expression “forced savings” or “compulsory savings.”

[8] In the language of Knut Wicksell and the classical economists.

[9] I believe this should be pointed out here again, although I have exhausted everything to be said on the subject [see section 2. Early Effects of Credit Expansion] and in The Theory of Money and Credit. Anyone who has followed the discussions of recent years will realize how important it is to stress these things again and again.

Chapter 14 • Labor Productivity, Wages, and Unemployment • 6,900 Words

“Wages, Unemployment and Inflation”

Our economic system — the market economy or capitalism — is a system of consumers’ supremacy. The customer is sovereign; he is, says a popular slogan, “always right.” Businessmen are under the necessity of turning out what the consumers ask for and they must sell their wares at prices which the consumers can afford and are prepared to pay. A business operation is a manifest failure if the proceeds from the sales do not reimburse the businessman for all he has expended in producing the article. Thus the consumers in buying at a definite price determine also the height of the wages that are paid to all those engaged in the industries.

1. Wages Ultimately Paid By the Consumers

It follows that an employer cannot pay more to an employee than the equivalent of the value the latter’s work, according to the judgment of the buying public, adds to the merchandise. (This is the reason why the movie star gets much more than the charwoman.) If he were to pay more, he would not recover his outlays from the purchasers; he would suffer losses and would finally go bankrupt. In paying wages, the employer acts as a mandatory of the consumers, as it were. It is upon the consumers that the incidence of the wage payments falls. As the immense majority of the goods produced are bought and consumed by people who are themselves receiving wages and salaries, it is obvious that in spending their earnings the wage earners and employees themselves are foremost in determining the height of the compensation they and those like them will get.

2. What Makes Wages Rise

The buyers do not pay for the toil and trouble the worker took nor for the length of time he spent in working. They pay for the products. The better the tools are which the worker uses in his job, the more he can perform in an hour, the higher is, consequently, his remuneration. What makes wages rise and renders the material conditions of the wage earners more satisfactory is improvement in the technological equipment. American wages are higher than wages in other countries because the capital invested per head of the worker is greater and the plants are thereby in the position to use the most efficient tools and machines. What is called the American way of life is the result of the fact that the United States has put fewer obstacles in the way of saving and capital accumulation than other nations. The economic backwardness of such countries as India consists precisely in the fact that their policies hinder both the accumulation of domestic capital and the investment of foreign capital. As the capital required is lacking, the Indian enterprises are prevented from employing sufficient quantities of modern equipment, are therefore producing much less per man-hour, and can only afford to pay wage rates which, compared with American wage rates, appear as shockingly low.

There is only one way that leads to an improvement of the standard of living for the wage-earning masses, viz., the increase in the amount of capital invested. All other methods, however popular they may be, are not only futile, but are actually detrimental to the well-being of those they allegedly want to benefit.

3. What Causes Unemployment

The fundamental question is: is it possible to raise wage rates for all those eager to find jobs above the height they would have attained on an unhampered labor market?

Public opinion believes that the improvement in the conditions of the wage earners is an achievement of the unions and of various legislative measures. It gives to unionism and to legislation credit for the rise in wage rates, the shortening of hours of work, the disappearance of child labor, and many other changes. The prevalence of this belief made unionism popular and is responsible for the trend in labor legislation of the last two decades. As people think that they owe to unionism their high standard of living, they condone violence, coercion, and intimidation on the part of unionized labor and are indifferent to the curtailment of personal freedom inherent in the union-shop and closed-shop clauses. As long as these fallacies prevail upon the minds of the voters, it is vain to expect a resolute departure from the policies that are mistakenly called progressive.

Yet this popular doctrine misconstrues every aspect of economic reality. The height of wage rates at which all those eager to get jobs can be employed depends on the marginal productivity of labor. The more capital — other things being equal — is invested, the higher wages climb on the free labor market, i.e., on the labor market not manipulated by the government and the unions. At these market wage rates all those eager to employ workers can hire as many as they want. At these market wage rates all those who want to be employed can get a job. There prevails on a free labor market a tendency toward full employment. In fact, the policy of letting the free market determine the height of wage rates is the only reasonable and successful full-employment policy. If wage rates, either by union pressure and compulsion or by government decree, are raised above this height, lasting unemployment of a part of the potential labor force develops.

4. Credit Expansion No Substitute for Capital

These opinions are passionately rejected by the union bosses and their followers among politicians and the self-styled intellectuals. The panacea they recommend to fight unemployment is credit expansion and inflation, euphemistically called “an easy money policy.”

As has been pointed out above, an addition to the available stock of capital previously accumulated makes a further improvement of the industries’ technological equipment possible, thus raises the marginal productivity of labor and consequently also wage rates. But credit expansion, whether it is effected by issuing additional banknotes or by granting additional credits on bank accounts subject to check, does not add anything to the nation’s wealth of capital goods. It merely creates the illusion of an increase in the amount of funds available for an expansion of production. Because they can obtain cheaper credit, people erroneously believe that the country’s wealth has thereby been increased and that therefore certain projects that could not be executed before are now feasible. The inauguration of these projects enhances the demand for labor and for raw materials and makes wage rates and commodity prices rise. An artificial boom is kindled.

Under the conditions of this boom, nominal wage rates which before the credit expansion were too high for the state of the market and therefore created unemployment of a part of the potential labor force are no longer too high and the unemployed can get jobs again. However, this happens only because under the changed monetary and credit conditions prices are rising or, what is the same expressed in other words, the purchasing power of the monetary unit drops. Then the same amount of nominal wages, i.e., wage rates expressed in terms of money, means less in real wages, i.e., in terms of commodities that can be bought by the monetary unit. Inflation can cure unemployment only by curtailing the wage earner’s real wages. But then the unions ask for a new increase in wages in order to keep pace with the rising cost of living and we are back where we were before, i.e., in a situation in which large-scale unemployment can only be prevented by a further expansion of credit.

This is what happened in this country as well as in many other countries in the last years. The unions, supported by the government, forced the enterprises to agree to wage rates that went beyond the potential market rates, i.e., the rates which the public was prepared to refund to the employers in purchasing their products. This would have inevitably resulted in rising unemployment figures. But the government policies tried to prevent the emergence of serious unemployment by credit expansion, i.e., inflation. The outcome was rising prices, renewed demands for higher wages and reiterated credit expansion; in short, protracted inflation.

5. Inflation Cannot Go On Endlessly

But finally the authorities become frightened. They know that inflation cannot go on endlessly. If one does not stop in time the pernicious policy of increasing the quantity of money and fiduciary media, the nation’s currency system collapses entirely. The monetary unit’s purchasing power sinks to a point which for all practical purposes is not better than zero. This happened again and again, in this country with the Continental Currency in 1781, in France in 1796, in Germany in 1923. It is never too early for a nation to realize that inflation cannot be considered as a way of life and that it is imperative to return to sound monetary policies. In recognition of these facts the administration and the Federal Reserve authorities some time ago discontinued the policy of progressive credit expansion.

It is not the task of this short article to deal with all the consequences which the termination of inflationary measures brings about. We have only to establish the fact that the return to monetary stability does not generate a crisis. It only brings to light the malinvestments and other mistakes that were made under the hallucination of the illusory prosperity created by the easy money. People become aware of the faults committed and, no longer blinded by the phantom of cheap credit, begin to readjust their activities to the real state of the supply of material factors of production. It is this — certainly painful, but unavoidable — readjustment that constitutes the depression.

6. The Policy Of The Unions

One of the unpleasant features of this process of discarding chimeras and returning to a sober estimate of reality concerns the height of wage rates. Under the impact of the progressive inflationary policy the union bureaucracy acquired the habit of asking at regular intervals for wage raises, and business, after some sham resistance, yielded. As a result these rates were at the moment too high for the state of the market and would have brought about a conspicuous amount of unemployment. But the ceaselessly progressive inflation very soon caught up with them. Then the unions asked again for new raises and so on.

7. The Purchasing Power Argument

It does not matter what kind of justification the unions and their henchmen advance in favor of their claims. The unavoidable effects of forcing the employers to remunerate work done at higher rates than those the consumers are willing to restore to them in buying the products are always the same: rising unemployment figures.

At the present juncture the unions try to take up the old, a hundred times refuted purchasing power fable. They declare that putting more money into the hands of the wage earners — by raising wage rates, by increasing the benefits to the unemployed and by embarking upon new public works — would enable the workers to spend more and thereby stimulate business and lead the economy out of the recession into prosperity. This is the spurious pro-inflation argument to make all people happy through printing paper bills. Of course, if the quantity of the circulating media is increased, those into whose pockets the new fictitious wealth comes — whether they are workers or farmers or any other kind of people — will increase their spending. But it is precisely this increase in spending that inevitably brings about a general tendency of all prices to rise or, what is the same expressed in a different way, a drop in the monetary unit’s purchasing power. Thus the help that an inflationary action could give to the wage earners is only of a short duration. To perpetuate it, one would have to resort again and again to new inflationary measures. It is clear that this leads to disaster.

8. Wage Raises As Such Not Inflationary

There is a lot of nonsense said about these things. Some people assert that wage raises are “inflationary.” But they are not in themselves inflationary. Nothing is inflationary except inflation, i.e., an increase in the quantity of money in circulation and credit subject to check (check-book money). And under present conditions nobody but the government can bring an inflation into being. What the unions can generate by forcing the employers to accept wage rates higher than the potential market rates is not inflation and not higher commodity prices, but unemployment of a part of the people anxious to get a job. Inflation is a policy to which the government resorts in order to prevent the large-scale unemployment the unions’ wage raising would otherwise bring about.

9. The Dilemma of Present-Day Policies

The dilemma which this country — and no less many other countries — has to face is very serious. The extremely popular method of raising wage rates above the height the unhampered labor market would have established would produce catastrophic mass unemployment if inflationary credit expansion were not to rescue it. But inflation has not only very pernicious social effects. It cannot go on endlessly without resulting in the complete breakdown of the whole monetary system.

Public opinion, entirely under the sway of the fallacious labor union doctrines, sympathizes more or less with the union bosses’ demand for a considerable rise in wage rates. As conditions are today, the unions have the power to make the employers submit to their dictates. They can call strikes and, without being restrained by the authorities, resort with impunity to violence against those willing to work. They are aware of the fact that the enhancement of wage rates will increase the number of jobless. The only remedy they suggest is more ample funds for unemployment compensation and a more ample supply of credit, i.e., inflation. The government, meekly yielding to a misguided public opinion and worried about the outcome of the impending election campaign, has unfortunately already begun to reverse its attempts to return to a sound monetary policy. Thus we are again committed to the pernicious methods of meddling with the supply of money. We are going on with the inflation that with accelerated speed makes the purchasing power of the dollar shrink. Where will it end? This is the question which Mr. Reuther and all the rest never ask.

Only stupendous ignorance can call the policies adopted by the self-styled progressives “pro-labor” policies. The wage earner like every other citizen is firmly interested in the preservation of the dollar’s purchasing power. If, thanks to his union, his weekly earnings are raised above the market rate, he must very soon discover that the upward movement in prices not only deprives him of the advantages he expected, but besides makes the value of his savings, of his insurance policy and of his pension rights dwindle. And, still worse, he may lose his job and will not find another.

10. Insincerity In The Fight Against Inflation

All political parties and pressure groups protest that they are opposed to inflation. But what they really mean is that they do not like the unavoidable consequences of inflation, viz., the rise in living costs. Actually they favor all policies that necessarily bring about an increase in the quantity of the circulating media. They ask not only for an easy money policy to make the unions’ endless wage boosting possible but also for more government spending and — at the same time — for tax abatement through raising the exemptions.

Duped by the spurious Marxian concept of irreconcilable conflicts between the interests of the social classes, people assume that the interests of the propertied classes alone are opposed to the unions’ demand for higher wage rates. In fact, the wage earners are no less interested in a return to sound money than any other group or class. A lot has been said in the last months about the harm fraudulent officers have inflicted upon the union membership. But the havoc done to the workers by the unions’ excessive wage boosting is much more detrimental.

It would be an exaggeration to contend that the tactics of the unions are the sole threat to monetary stability and to a reasonable economic policy. Organized wage earners are not the only pressure group whose claims menace today the stability of our monetary system. But they are the most powerful and most influential of these groups and the primary responsibility rests with them.

11. The Importance of Sound Monetary Policies

Capitalism has improved the standard of living of the wage earners to an unprecedented extent. The average American family enjoys today amenities of which, only a hundred years ago, not even the richest nabobs dreamed. All this well-being is conditioned by the increase in savings and capital accumulated; without these funds that enable business to make practical use of scientific and technological progress the American worker would not produce more and better things per hour of work than the Asiatic coolies, would not earn more and would, like them, wretchedly live on the verge of starvation. All measures which — like our income and corporation tax system — aim at preventing further capital accumulation or even at capital decumulation are therefore virtually anti-labor and anti-social.

One further observation must still be made about this matter of saving and capital formation. The improvement of well-being brought about by capitalism made it possible for the common man to save and thus to become in a modest way himself a capitalist. A considerable part of the capital working in American business is the counterpart of the savings of the masses. Millions of wage earners own saving deposits, bonds and insurance policies. All these claims are payable in dollars and their worth depends on the soundness of the nation’s money. To preserve the dollar’s purchasing power is also from this point of view a vital interest of the masses. In order to attain this end, it is not enough to print upon the bank notes the noble maxim In God We Trust. One must adopt an appropriate policy.

3. Wages

Labor is a scarce factor of production. As such it is sold and bought on the market. The price paid for labor is included in the price allowed for the product or the services if the performer of the work is the seller of the product or the services. If bare labor is sold and bought as such, either by an entrepreneur engaged in production for sale or by a consumer eager to use the services rendered for his own consumption, the price paid is called wages.

For acting man his own labor is not merely a factor of production but also the source of disutility; he values it not only with regard to the mediate gratification expected but also with regard to the disutility it causes. But for him, as for everyone, other people’s labor as offered for sale on the market is nothing but a factor of production. Man deals with other people’s labor in the same way that he deals with all scarce material factors of production. He appraises it according to the principles he applies in the appraisal of all other goods. The height of wage rates is determined on the market in the same way in which the prices of all commodities are determined. In this sense we may say that labor is a commodity. The emotional associations which people, under the influence of Marxism, attach to this term do not matter. It suffices to observe incidentally that the employers deal with labor as they do with commodities because the conduct of the consumers forces them to proceed in this way.

It is not permissible to speak of labor and wages in general without resorting to certain restrictions. A uniform type of labor or a general rate of wages do not exist. Labor is very different in quality, and each kind of labor renders specific services. Each is appraised as a complementary factor for turning out definite consumers’ goods and services. Between the appraisal of the performance of a surgeon and that of a stevedore there is no direct connection. But indirectly each sector of the labor market is connected with all other sectors. An increase in the demand for surgical services, however great, will not make stevedores flock into the practice of surgery. Yet the lines between the various sectors of the labor market are not sharply drawn. There prevails a continuous tendency for workers to shift from their branch to other similar occupations in which conditions seem to offer better opportunities. Thus finally every change in demand or supply in one sector affects all other sectors indirectly. All groups indirectly compete with one another. If more people enter the medical profession, men are withdrawn from kindred occupations who again are replaced by an inflow of people from other branches and so on. In this sense there exists a connexity between all occupational groups however different the requirements in each of them may be. There again we are faced with the fact that the disparity in the quality of work needed for the satisfaction of wants is greater than the diversity in men’s inborn ability to perform work.

Connexity exists not only between different types of labor and the prices paid for them but no less between labor and the material factors of production. Within certain limits labor can be substituted for material factors of production and vice versa. The extent that such substitutions are resorted to depends on the height of wage rates and the prices of material factors.

The determination of wage rates — like that of the prices of material factors of production — can be achieved only on the market. There is no such thing as nonmarket wage rates, just as there are no nonmarket prices. As far as there are wages, labor is dealt with like any material factor of production and sold and bought on the market. It is usual to call the sector of the market of producers’ goods on which labor is hired the labor market. As with all other sectors of the market, the labor market is actuated by the entrepreneurs intent upon making profits. Each entrepreneur is eager to buy all the kinds of specific labor he needs for the realization of his plans at the cheapest price. But the wages he offers must be high enough to take the workers away from competing entrepreneurs. The upper limit of his bidding is determined by anticipation of the price he can obtain for the increment in salable goods he expects from the employment of the worker concerned. The lower limit is determined by the bids of competing entrepreneurs who themselves are guided by analogous considerations. It is this that economists have in mind in asserting that the height of wage rates for each kind of labor is determined by its marginal productivity. Another way to express the same truth is to say that wage rates are determined by the supply of labor and of material factors of production on the one hand and by the anticipated future prices of the consumers’ goods.

This catallactic explanation of the determination of wage rates has been the target of passionate but entirely erroneous attacks. It has been asserted that there is a monopoly of the demand for labor. Most of the supporters of this doctrine think that they have sufficiently proved their case by referring to some incidental remarks of Adam Smith concerning “a sort of tacit but constant and uniform combination” among employers to keep wages down.[3]Cf. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (Basle, 1791), vol. 1, Bk. I, chap. 8, p. 100. Adam Smith himself seems to have unconsciously given up the idea. Cf. W.H. Hutt, The Theory of Collective Bargaining (London, 1930), pp. 24–25. Others refer in vague terms to the existence of trade associations of various groups of businessmen. The emptiness of all this talk is evident. However, the fact that these garbled ideas are the main ideological foundation of labor unionism and the labor policy of all contemporary governments makes it necessary to analyze them with the utmost care.

The entrepreneurs are in the same position with regard to the sellers of labor as they are with regard to the sellers of the material factors of production. They are under the necessity of acquiring all factors of production at the cheapest price. But if in the pursuit of this endeavor some entrepreneurs, certain groups of entrepreneurs, or all entrepreneurs offer prices or wage rates which are too low, i.e., do not agree with the state of the unhampered market, they will succeed in acquiring what they want to acquire only if entrance into the ranks of entrepreneurship is blocked through institutional barriers. If the emergence of new entrepreneurs or the expansion of the activities of already operating entrepreneurs is not prevented, any drop in the prices of factors of production not consonant with the structure of the market must open new chances for the earning of profits. There will be people eager to take advantage of the margin between the prevailing wage rate and the marginal productivity of labor. Their demand for labor will bring wage rates back to the height conditioned by labor’s marginal productivity. The tacit combination among the employers to which Adam Smith referred, even if it existed, could not lower wages below the competitive market rate unless access to entrepreneurship required not only brains and capital (the latter always available to enterprises promising the highest returns), but in addition also an institutional title, a patent, or a license, reserved to a class of privileged people.

It has been asserted that a job-seeker must sell his labor at any price, however low, as he depends exclusively on his capacity to work and has no other source of income. He cannot wait and is forced to content himself with any reward the employers are kind enough to offer him. This inherent weakness makes it easy for the concerted action of the masters to lower wage rates. They can, if need be, wait longer, as their demand for labor is not so urgent as the worker’s demand for subsistence. The argument is defective. It takes it for granted that the employers pocket the difference between the marginal-productivity wage rate and the lower monopoly rate as an extra monopoly gain and do not pass it on to the consumers in the form of a reduction in prices. For if they were to reduce prices according to the drop in costs of production, they, in their capacity as entrepreneurs and sellers of the products, would derive no advantage from cutting wages. The whole gain would go to the consumers and thereby also to the wage-earners in their capacity as buyers; the entrepreneurs themselves would be benefited only as consumers. However, to retain the extra profit resulting from the “exploitation” of the workers’ alleged poor bargaining power would require concerted action on the part of employers in their capacity as sellers of the products. It would require a universal monopoly of all kinds of production activities which can be created only by an institutional restriction of access to entrepreneurship.

The essential point of the matter is that the alleged monopolistic combination of the employers about which Adam Smith and a great part of public opinion speak would be a monopoly of demand. But we have already seen that such alleged monopolies of demand are in fact monopolies of supply of a particular character. The employers would be in a position enabling them to lower wage rates by concerted action only if they were to monopolize a factor indispensable for every kind of production and to restrict the employment of this factor in a monopolistic way. As there is no single material factor indispensable for every kind of production, they would have to monopolize all material factors of production. This condition would be present only in a socialist community, in which there is neither a market nor prices and wage rates.

Neither would it be possible for the proprietors of the material factors of production, the capitalists and the landowners, to combine in a universal cartel against the interests of the workers. The characteristic mark of production activities in the past and in the foreseeable future is that the scarcity of labor exceeds the scarcity of most of the primary, nature-given material factors of production. The comparatively greater scarcity of labor determines the extent to which the comparatively abundant primary natural factors can be utilized. There is unused soil, there are unused mineral deposits and so on because there is not enough labor available for their utilization. If the owners of the soil that is tilled today were to form a cartel in order to reap monopoly gains, their plans would be frustrated by the competition of the owners of the submarginal land. The owners of the produced factors of production in their turn could not combine in a comprehensive cartel without the cooperation of the owners of the primary factors.

Various other objections have been advanced against the doctrine of the monopolistic exploitation of labor by a tacit or avowed combine of employers. It has been demonstrated that at no time and at no place in the unhampered market economy can the existence of such cartels be discovered. It has been shown that it is not true that the job-seekers cannot wait and are therefore under the necessity of accepting any wage rates, however low, offered to them by the employers. It is not true that every unemployed worker is faced with starvation; the workers too have reserves and can wait; the proof is that they really do wait. On the other hand waiting can be financially ruinous to the entrepreneurs and capitalists too. If they cannot employ their capital, they suffer losses. Thus all the disquisitions about an alleged “employers’ advantage” and “workers’ disadvantage” in bargaining are without substance.[4]All these and many other points are carefully analyzed by Hutt, Theory of Collective Bargaining, pp. 35–72.

But these are secondary and accidental considerations. The central fact is that a monopoly of the demand for labor cannot and does not exist in an unhampered market economy. It could originate only as an outgrowth of institutional restrictions of access to entrepreneurship.

Yet one more point must be stressed. The doctrine of the monopolistic manipulation of wage rates by the employers speaks of labor as if it were a homogeneous entity. It deals with such concepts as demand for “labor in general” and supply of “labor in general.” But such notions have, as has been pointed out already, no counterpart in reality. What is sold and bought on the labor market is not “labor in general,” but definite specific labor suitable to render definite services. Each entrepreneur is in search of workers who are fitted to accomplish those specific tasks which he needs for the execution of his plans. He must withdraw these specialists from the employments in which they happen to work at the moment. The only means he has to achieve this is to offer them higher pay. Every innovation which an entrepreneur plans — the production of a new article, the application of a new process of production, the choice of a new location for a specific branch or simply the expansion of production already in existence either in his own enterprise or in other enterprises — requires the employment of workers hitherto engaged somewhere else. The entrepreneurs are not merely faced with a shortage of “labor in general,” but with a shortage of those specific types of labor they need for their plants. The competition among the entrepreneurs in bidding for the most suitable hands is no less keen than their competition in bidding for the required raw materials, tools, and machines and in their bidding for capital on the capital and loan market. The expansion of the activities of the individual firms as well as of the whole society is not only limited by the amount of capital goods available and of the supply of “labor in general.” In each branch of production it is also limited by the available supply of specialists. This is, of course, only a temporary obstacle which vanishes in the long run when more workers, attracted by the higher pay of the specialists in comparatively undermanned branches, will have trained themselves for the special tasks concerned. But in the changing economy such a scarcity of specialists emerges anew daily and determines the conduct of employers in search for workers.

Every employer must aim at buying the factors of production needed, inclusive of labor, at the cheapest price. An employer who paid more than agrees with the market price of the services his employees render him, would be soon removed from his entrepreneurial position. On the other hand an employer who tried to reduce wage rates below the height consonant with the marginal productivity of labor would not recruit the type of men that the most efficient utilization of his equipment requires. There prevails a tendency for wage rates to reach the point at which they are equal to the price of the marginal product of the kind of labor in question. If wage rates drop below this point, the gain derived from the employment of every additional worker will increase the demand for labor and thus make wage rates rise again. If wage rates rise above this point, the loss incurred from the employment of every worker will force the employers to discharge workers. The competition of the unemployed for jobs will create a tendency for wage rates to drop.

4. Catallactic Unemployment

If a job-seeker cannot obtain the position he prefers, he must look for another kind of job. If he cannot find an employer ready to pay him as much as he would like to earn, he must abate his pretensions. If he refuses, he will not get any job. He remains unemployed.

What causes unemployment is the fact that — contrary to the above-mentioned doctrine of the worker’s inability to wait — those eager to earn wages can and do wait. A job-seeker who does not want to wait will always get a job in the unhampered market economy in which there is always unused capacity of natural resources and very often also unused capacity of produced factors of production. It is only necessary for him either to reduce the amount of pay he is asking for or to alter his occupation or his place of work.

There were and still are people who work only for some time and then live for another period from the savings they have accumulated by working. In countries in which the cultural state of the masses is low, it is often difficult to recruit workers who are ready to stay on the job. The average man there is so callous and inert that he knows of no other use for his earnings than to buy some leisure time. He works only in order to remain unemployed for some time.

It is different in the civilized countries. Here the worker looks upon unemployment as an evil. He would like to avoid it provided the sacrifice required is not too grievous. He chooses between employment and unemployment in the same way in which he proceeds in all other actions and choices: he weighs the pros and cons. If he chooses unemployment, this unemployment is a market phenomenon whose nature is not different from other market phenomena as they appear in a changing market economy. We may call this kind of unemployment market-generated or catallactic unemployment.

The various considerations which may induce a man to decide for unemployment can be classified in this way:

1. The individual believes that he will find at a later date a remunerative job in his dwelling place and in an occupation which he likes better and for which he has been trained. He seeks to avoid the expenditure and other disadvantages involved in shifting from one occupation to another and from one geographical point to another. There may be special conditions increasing these costs. A worker who owns a homestead is more firmly linked with the place of his residence than people living in rented apartments. A married woman is less mobile than an unmarried girl. Then there are occupations which impair the worker’s ability to resume his previous job at a later date. A watchmaker who works for some time as a lumberman may lose the dexterity required for his previous job. In all these cases the individual chooses temporary unemployment because he believes that this choice pays better in the long run.

2. There are occupations the demand for which is subject to considerable seasonal variations. In some months of the year the demand is very intense, in other months it dwindles or disappears altogether. The structure of wage rates discounts these seasonal fluctuations. The branches of industry subject to them can compete on the labor market only if the wages they pay in the good season are high enough to indemnify the wage earners for the disadvantages resulting from the seasonal irregularity in demand. Then many of the workers, having saved a part of their ample earnings in the good season, remain unemployed in the bad season.

3. The individual chooses temporary unemployment for considerations which in popular speech are called noneconomic or even irrational. He does not take jobs which are incompatible with his religious, moral, and political convictions. He shuns occupations the exercise of which would impair his social prestige. He lets himself be guided by traditional standards of what is proper for a gentleman and what is unworthy. He does not want to lose face or caste.

Unemployment in the unhampered market is always voluntary. In the eyes of the unemployed man, unemployment is the minor of two evils between which he has to choose. The structure of the market may sometimes cause wage rates to drop. But, on the unhampered market, there is always for each type of labor a rate at which all those eager to work can get a job. The final wage rate is that rate at which all job-seekers get jobs and all employers as many workers as they want to hire. Its height is determined by the marginal productivity of each type of work.

Wage rate fluctuations are the device by means of which the sovereignty of the consumers manifests itself on the labor market. They are the measure adopted for the allocation of labor to the various branches of production. They penalize disobedience by cutting wage rates in the comparatively overmanned branches and recompense obedience by raising wage rates in the comparatively undermanned branches. They thus submit the individual to a harsh social pressure. It is obvious that they indirectly limit the individual’s freedom to choose his occupation. But this coercion is not rigid. It leaves to the individual a margin in the limits of which he can choose between what suits him better and what less. Within this orbit he is free to act of his own accord. This amount of freedom is the maximum of freedom that an individual can enjoy in the framework of the social division of labor, and this amount of coercion is the minimum of coercion that is indispensable for the preservation of the system of social cooperation. There is only one alternative left to the catallactic pressure exercised by the wages system: the assignment of occupations and jobs to each individual by the peremptory decrees of an authority, a central board planning all production activities. This is tantamount to the suppression of all freedom.

It is true that under the wages system the individual is not free to choose permanent unemployment. But no other imaginable social system could grant him a right to unlimited leisure. That man cannot avoid submitting to the disutility of labor is not an outgrowth of any social institution. It is an inescapable natural condition of human life and conduct.

It is not expedient to call catallactic unemployment in a metaphor borrowed from mechanics “frictional” unemployment. In the imaginary construction of the evenly rotating economy there is no unemployment because we have based this construction on such an assumption. Unemployment is a phenomenon of a changing economy. The fact that a worker discharged on account of changes occurring in the arrangement of production processes does not instantly take advantage of every opportunity to get another job but waits for a more propitious opportunity is not a consequence of the tardiness of the adjustment to the change in conditions, but is one of the factors slowing down the pace of this adjustment. It is not an automatic reaction to the changes which have occurred, independent of the will and the choices of the job-seekers concerned, but the effect of their intentional actions. It is speculative, not frictional.

Catallactic unemployment must not be confused with institutional unemployment. Institutional unemployment is not the outcome of the decisions of the individual job-seekers. It is the effect of interference with the market phenomena intent upon enforcing by coercion and compulsion wage rates higher than those the unhampered market would have determined. The treatment of institutional unemployment belongs to the analysis of the problems of interventionism.

References • 100 Words

[1] [Ludwig von Mises, Planning for Freedom and Sixteen Other Essays and Addresses (1952; South Holland, Ill.: Libertarian Press, 1980), chap. 10, pp. 150–61.]

[2] [Ludwig von Mises, Human Action (1949; Auburn, Ala.: Mises Institute, 1998), chap. 21: “Work and Wages,” pp. 589–98.]

[3] Cf. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (Basle, 1791), vol. 1, Bk. I, chap. 8, p. 100. Adam Smith himself seems to have unconsciously given up the idea. Cf. W.H. Hutt, The Theory of Collective Bargaining (London, 1930), pp. 24–25.

[4] All these and many other points are carefully analyzed by Hutt, Theory of Collective Bargaining, pp. 35–72.

Chapter 15 • The Hampered Market Economy • 4,600 Words

“Middle-of-the-Road Policy Leads to Socialism”

The fundamental dogma of all brands of socialism and communism is that the market economy or capitalism is a system that hurts the vital interests of the immense majority of people for the sole benefit of a small minority of rugged individualists. It condemns the masses to progressing impoverishment. It brings about misery, slavery, oppression, degradation and exploitation of the working men, while it enriches a class of idle and useless parasites.

This doctrine was not the work of Karl Marx. It had been developed long before Marx entered the scene. Its most successful propagators were not the Marxian authors, but such men as Carlyle and Ruskin, the British Fabians, the German professors and the American Institutionalists. And it is a very significant fact that the correctness of this dogma was contested only by a few economists who were very soon silenced and barred from access to the universities, the press, the leadership of political parties and, first of all, public office. Public opinion by and large accepted the condemnation of capitalism without any reservation.

1. Socialism

But, of course, the practical political conclusions which people drew from this dogma were not uniform. One group declared that there is but one way to wipe out these evils, namely to abolish capitalism entirely. They advocate the substitution of public control of the means of production for private control. They aim at the establishment of what is called socialism, communism, planning, or state capitalism. All these terms signify the same thing. No longer should the consumers, by their buying and abstention from buying, determine what should be produced, in what quantity and of what quality. Henceforth a central authority alone should direct all production activities.

2. Interventionism, Allegedly a Middle-of-the-Road Policy

A second group seems to be less radical. They reject socialism no less than capitalism. They recommend a third system, which, as they say, is as far from capitalism as it is from socialism, which as a third system of society’s economic organization, stands midway between the two other systems, and while retaining the advantages of both, avoids the disadvantages inherent in each. This third system is known as the system of interventionism. In the terminology of American politics it is often referred to as the middle-of-the-road policy.

What makes this third system popular with many people is the particular way they choose to look upon the problems involved. As they see it, two classes, the capitalists and entrepreneurs on the one hand and the wage earners on the other hand, are arguing about the distribution of the yield of capital and entrepreneurial activities. Both parties are claiming the whole cake for themselves. Now, suggest these mediators, let us make peace by splitting the disputed value equally between the two classes. The State as an impartial arbiter should interfere, and should curb the greed of the capitalists and assign a part of the profits to the working classes. Thus it will be possible to dethrone the moloch capitalism without enthroning the moloch of totalitarian socialism.

Yet this mode of judging the issue is entirely fallacious. The antagonism between capitalism and socialism is not a dispute about the distribution of booty. It is a controversy about which two schemes for society’s economic organization, capitalism or socialism, is conducive to the better attainment of those ends which all people consider as the ultimate aim of activities commonly called economic, viz., the best possible supply of useful commodities and services. Capitalism wants to attain these ends by private enterprise and initiative, subject to the supremacy of the public’s buying and abstention from buying on the market. The socialists want to substitute the unique plan of a central authority for the plans of the various individuals. They want to put in place of what Marx called the “anarchy of production” the exclusive monopoly of the government. The antagonism does not refer to the mode of distributing a fixed amount of amenities. It refers to the mode of producing all those goods which people want to enjoy.

The conflict of the two principles is irreconcilable and does not allow for any compromise. Control is indivisible. Either the consumers’ demand as manifested on the market decides for what purposes and how the factors of production should be employed, or the government takes care of these matters. There is nothing that could mitigate the opposition between these two contradictory principles. They preclude each other. Interventionism is not a golden mean between capitalism and socialism. It is the design of a third system of society’s economic organization and must be appreciated as such.

3. How Interventionism Works

It is not the task of today’s discussion to raise any questions about the merits either of capitalism or of socialism. I am dealing today with interventionism alone. And I do not intend to enter into an arbitrary evaluation of interventionism from any preconceived point of view. My only concern is to show how interventionism works and whether or not it can be considered as a pattern of a permanent system for society’s economic organization.

The interventionists emphasize that they plan to retain private ownership of the means of production, entrepreneurship and market exchange. But, they go on to say, it is peremptory to prevent these capitalist institutions from spreading havoc and unfairly exploiting the majority of people. It is the duty of government to restrain, by orders and prohibitions, the greed of the propertied classes lest their acquisitiveness harm the poorer classes. Unhampered or laissez-faire capitalism is an evil. But in order to eliminate its evils, there is no need to abolish capitalism entirely. It is possible to improve the capitalist system by government interference with the actions of the capitalists and entrepreneurs. Such government regulation and regimentation of business is the only method to keep off totalitarian socialism and to salvage those features of capitalism which are worth preserving. On the ground of this philosophy, the interventionists advocate a galaxy of various measures. Let us pick out one of them, the very popular scheme of price control.

4. How Price Control Leads to Socialism

The government believes that the price of a definite commodity, e.g., milk, is too high. It wants to make it possible for the poor to give their children more milk. Thus it resorts to a price ceiling and fixes the price of milk at a lower rate than that prevailing on the free market. The result is that the marginal producers of milk, those producing at the highest cost, now incur losses. As no individual farmer or businessman can go on producing at a loss, these marginal producers stop producing and selling milk on the market. They will use their cows and their skill for other more profitable purposes. They will, for example, produce butter, cheese or meat. There will be less milk available for the consumers, not more. This, or course, is contrary to the intentions of the government. It wanted to make it easier for some people to buy more milk. But, as an outcome of its interference, the supply available drops. The measure proves abortive from the very point of view of the government and the groups it was eager to favor. It brings about a state of affairs, which — again from the point of view of the government — is even less desirable than the previous state of affairs which it was designed to improve.

Now, the government is faced with an alternative. It can abrogate its decree and refrain from any further endeavors to control the price of milk. But if it insists upon its intention to keep the price of milk below the rate the unhampered market would have determined and wants nonetheless to avoid a drop in the supply of milk, it must try to eliminate the causes that render the marginal producers’ business unremunerative. It must add to the first decree concerning only the price of milk a second decree fixing the prices of the factors of production necessary for the production of milk at such a low rate that the marginal producers of milk will no longer suffer losses and will therefore abstain from restricting output. But then the same story repeats itself on a remoter plane. The supply of the factors of production required for the production of milk drops, and again the government is back where it started. If it does not want to admit defeat and to abstain from any meddling with prices, it must push further and fix the prices of those factors of production which are needed for the production of the factors necessary for the production of milk. Thus the government is forced to go further and further, fixing step by step the prices of all consumers’ goods and of all factors of production — both human, i.e., labor, and material — and to order every entrepreneur and every worker to continue work at these prices and wages. No branch of industry can be omitted from this all-around fixing of prices and wages and from this obligation to produce those quantities which the government wants to see produced. If some branches were to be left free out of regard for the fact that they produce only goods qualified as non-vital or even as luxuries, capital and labor would tend to flow into them and the result would be a drop in the supply of those goods, the prices of which government has fixed precisely because it considers them as indispensable for the satisfaction of the needs of the masses.

But when this state of all-around control of business is attained, there can no longer be any question of a market economy. No longer do the citizens by their buying and abstention from buying determine what should be produced and how. The power to decide these matters has devolved upon the government. This is no longer capitalism; it is all-around planning by the government, it is socialism.

5. The Zwangswirtschaft Type of Socialism

It is, of course, true that this type of socialism preserves some of the labels and the outward appearance of capitalism. It maintains, seemingly and nominally, private ownership of the means of production, prices, wages, interest rates and profits. In fact, however, nothing counts but the government’s unrestricted autocracy. The government tells the entrepreneurs and capitalists what to produce and in what quantity and quality, at what prices to buy and from whom, at what prices to sell and to whom. It decrees at what wages and where the workers must work. Market exchange is but a sham. All the prices, wages, and interest rates are determined by the authority. They are prices, wages, and interest rates in appearance only; in fact they are merely quantity relations in the government’s orders. The government, not the consumers, directs production. The government determines each citizen’s income, it assigns to everybody the position in which he has to work. This is socialism in the outward guise of capitalism. It is the Zwangswirtschaft of Hitler’s German Reich and the planned economy of Great Britain.

6. German and British Experience

For the scheme of social transformation which I have depicted is not merely a theoretical construction. It is a realistic portrayal of the succession of events that brought about socialism in Germany, in Great Britain and in some other countries.

The Germans, in the first World War, began with price ceilings for a small group of consumers’ goods considered as vital necessities. It was the inevitable failure of these measures that impelled them to go further and further until, in the second period of the war, they designed the Hindenburg plan. In the context of the Hindenburg plan no room whatever was left for a free choice on the part of the consumers and for initiative action on the part of business. All economic activities were unconditionally subordinated to the exclusive jurisdiction of the authorities. The total defeat of the Kaiser swept the whole imperial apparatus of administration away and with it went also the grandiose plan. But when in 1931 Chancellor Brüning embarked anew on a policy of price control and his successors, first of all Hitler, obstinately clung to it, the same story repeated itself.

Great Britain and all the other countries which in the first World War adopted measures of price control, had to experience the same failure. They too were pushed further and further in their attempts to make the initial decrees work. But they were still at a rudimentary stage of this development when the victory and the opposition of the public brushed away all schemes for controlling prices.

It was different in the second World War. Then Great Britain again resorted to price ceilings for a few vital commodities and had to run the whole gamut proceeding further and further until it had substituted all-around planning of the country’s whole economy for economic freedom. When the war came to an end, Great Britain was a socialist commonwealth.

It is noteworthy to remember that British socialism was not an achievement of Mr. Attlee’s Labor Government, but of the war cabinet of Mr. Winston Churchill. What the Labor Party did was not the establishment of socialism in a free country, but retaining socialism as it had developed during the war and in the post-war period. The fact has been obscured by the great sensation made about the nationalization of the Bank of England, the coal mines and other branches of business. However, Great Britain is to be called a socialist country not because certain enterprises have been formally expropriated and nationalized, but because all the economic activities of all citizens are subject to full control of the government and its agencies. The authorities direct the allocation of capital and of manpower to the various branches of business. They determine what should be produced. Supremacy in all business activities is exclusively vested in the government. The people are reduced to the status of wards, unconditionally bound to obey orders. To the businessmen, the former entrepreneurs, merely ancillary functions are left. All that they are free to do is to carry into effect, within a nearly circumscribed narrow field, the decisions of the government departments.

What we have to realize is that price ceilings affecting only a few commodities fail to attain the ends sought. On the contrary. They produce effects which from the point of view of the government are even worse than the previous state of affairs which the government wanted to alter. If the government, in order to eliminate these inevitable but unwelcome consequences, pursues its course further and further, it finally transforms the system of capitalism and free enterprise into socialism of the Hindenburg pattern.

7. Crises and Unemployment

The same is true of all other types of meddling with the market phenomena. Minimum wage rates, whether decreed and enforced by the government or by labor union pressure and violence, result in mass unemployment prolonged year after year as soon as they try to raise wage rates above the height of the unhampered market. The attempts to lower interest rates by credit expansion generate, it is true, a period of booming business. But the prosperity thus created is only an artificial hot-house product and must inexorably lead to the slump and to the depression. People must pay heavily for the easy-money orgy of a few years of credit expansion and inflation.

The recurrence of periods of depression and mass unemployment has discredited capitalism in the opinion of injudicious people. Yet these events are not the outcome of the operation of the free market. They are on the contrary the result of well-intentioned but ill-advised government interference with the market. There are no means by which the height of wage rates and the general standard of living can be raised other than by accelerating the increase of capital as compared with population. The only means to raise wage rates permanently for all those seeking jobs and eager to earn wages is to raise the productivity of the industrial effort by increasing the per-head quota of capital invested. What makes American wage rates by far exceed the wage rates of Europe and Asia is the fact that the American worker’s toil and trouble is aided by more and better tools. All that good government can do to improve the material well-being of the people is to establish and to preserve an institutional order in which there are no obstacles to the progressing accumulation of new capital required for the improvement of technological methods of production. This is what capitalism did achieve in the past and will achieve in the future too if not sabotaged by a bad policy.

8. Two Roads to Socialism

Interventionism cannot be considered as an economic system destined to stay. It is a method for the transformation of capitalism into socialism by a series of successive steps. It is as such different from the endeavors of the communists to bring about socialism at one stroke. The difference does not refer to the ultimate end of the political movement; it refers mainly to the tactics to be resorted to for the attainment of an end that both groups are aiming at.

Karl Marx and Friedrich Engels recommended successively each of these two ways for the realization of socialism. In 1848, in the Communist Manifesto, they outlined a plan for the step-by-step transformation of capitalism into socialism. The proletariat should be raised to the position of the ruling class and use its political supremacy “to wrest, by degrees, all capital from the bourgeoisie.” This, they declare, “cannot be effected except by means of despotic inroads on the rights of property and on the conditions of bourgeois production; by means of measures, therefore, which appear economically insufficient and untenable, but which in the course of the movement outstrip themselves, necessitate further inroads upon the old social order, and are unavoidable as a means of entirely revolutionizing the mode of production.” In this vein they enumerate by way of example ten measures.

In later years Marx and Engels changed their minds. In his main treatise, Das Capital, first published in 1867, Marx saw things in a different way. Socialism is bound to come “with the inexorability of a law of nature.” But it cannot appear before capitalism has reached its full maturity. There is but one road to the collapse of capitalism, namely the progressive evolution of capitalism itself. Then only will the great final revolt of the working class give it the finishing stroke and inaugurate the everlasting age of abundance.

From the point of view of this later doctrine Marx and the school of orthodox Marxism reject all policies that pretend to restrain, to regulate and to improve capitalism. Such policies, they declare, are not only futile, but outright harmful. For they rather delay the coming of age of capitalism, its maturity, and thereby also its collapse. They are therefore not progressive, but reactionary. It was this idea that led the German Social Democratic party to vote against Bismarck’s social security legislation and to frustrate Bismarck’s plan to nationalize the German tobacco industry. From the point of view of the same doctrine, the communists branded the American New Deal as a reactionary plot extremely detrimental to the true interests of the working people.

What we must realize is that the antagonism between the interventionists and the communists is a manifestation of the conflict between the two doctrines of the early Marxism and of the late Marxism. It is the conflict between the Marx of 1848, the author of the Communist Manifesto, and the Marx of 1867, the author of Das Capital. And it is paradoxical indeed that the document in which Marx endorsed the policies of the present-day self-styled anti-communists is called the Communist Manifesto.

There are two methods available for the transformation of capitalism into socialism. One is to expropriate all farms, plants, and shops and to operate them by a bureaucratic apparatus as departments of the government. The whole of society, says Lenin, becomes “one office and one factory, with equal work and equal pay,” the whole economy will be organized “like the postal system.” The second method is the method of the Hindenburg plan, the originally German pattern of the welfare state and of planning. It forces every firm and every individual to comply strictly with the orders issued by the government’s central board of production management. Such was the intention of the National Industrial Recovery Act of 1933 which the resistance of business frustrated and the Supreme Court declared unconstitutional. Such is the idea implied in the endeavors to substitute planning for private enterprise.

9. Foreign Exchange Control

The foremost vehicle for the realization of this second type of socialism in industrial countries like Germany and Great Britain is foreign exchange control. These countries cannot feed and clothe their people out of domestic resources. They must import large quantities of food and raw materials. In order to pay for these badly needed imports, they must export manufactures, most of them produced out of imported raw material. In such countries almost every business transaction directly or indirectly is conditioned either by exporting or importing or by both exporting and importing. Hence the government’s monopoly of buying and selling foreign exchange makes every kind of business activity depend on the discretion of the agency entrusted with foreign exchange control. In this country matters are different. The volume of foreign trade is rather small when compared with the total volume of the nation’s trade. Foreign exchange control would only slightly affect the much greater part of American business. This is the reason why in the schemes of our planners there is hardly any question of foreign exchange control. Their pursuits are directed toward the control of prices, wages, and interest rates, toward the control of investment and the limitation of profits and incomes.

10. Progressive Taxation

Looking backward on the evolution of income tax rates from the beginning of the Federal income tax in 1913 until the present day, one can hardly expect that the tax will not one day absorb 100 percent of all surplus above the income of the average voter. It is this that Marx and Engels had in mind when in the Communist Manifesto they recommended “a heavy progressive or graduated income tax.”

Another of the suggestions of the Communist Manifesto was “abolition of all right of inheritance.” Now, neither in Great Britain nor in this country have the laws gone up to this point. But again, looking backward upon the past history of the estate taxes, we have to realize that they more and more have approached the goal set by Marx. Estate taxes of the height they have already attained for the upper brackets are no longer to be qualified as taxes. They are measures of expropriation.

The philosophy underlying the system of progressive taxation is that the income and the wealth of the well-to-do classes can be freely tapped. What the advocates of these tax rates fail to realize is that the greater part of the income taxed away would not have been consumed but saved and invested. In fact, this fiscal policy does not only prevent the further accumulation of new capital. It brings about capital decumulation. This is certainly today the state of affairs in Great Britain.

11. The Trend Toward Socialism

The course of events in the past thirty years shows a continuous, although sometimes interrupted progress toward the establishment in this country of socialism of the British and German pattern. The United States embarked later than these two other countries upon this decline and is today still farther away from its end. But if the trend of this policy will not change, the final result will only in accidental and negligible points differ from what happened in the England of Attlee and in the Germany of Hitler. The middle-of-the-road policy is not an economic system that can last. It is a method for the realization of socialism by installments.

12. Loopholes Capitalism

Many people object. They stress the fact that most of the laws which aim at planning or at expropriation by means of progressive taxation have left some loopholes which offer to private enterprise a margin within which it can go on. That such loopholes still exist and that thanks to them this country is still a free country is certainly true. But this “loopholes capitalism” is not a lasting system. It is a respite. Powerful forces are at work to close these loopholes. From day to day the field in which private enterprise is free to operate is narrowed down.

13. The Coming of Socialism is Not Inevitable

Of course, this outcome is not inevitable. The trend can be reversed as was the case with many other trends in history. The Marxian dogma according to which socialism is bound to come “with the inexorability of a law of nature” is just an arbitrary surmise devoid of any proof.

But the prestige which this vain prognostic enjoys not only with the Marxians, but with many self-styled non-Marxians, is the main instrument of the progress of socialism. It spreads defeatism among those who otherwise would gallantly fight the socialist menace. The most powerful ally of Soviet Russia is the doctrine that the “wave of the future” carries us toward socialism and that it is therefore “progressive” to sympathize with all measures that restrict more and more the operation of the market economy.

Even in this country which owes to a century of “rugged individualism” the highest standard of living ever attained by any nation, public opinion condemns laissez-faire. In the last fifty years, thousands of books have been published to indict capitalism and to advocate radical interventionism, the welfare state, and socialism. The few books which tried to explain adequately the working of the free-market economy were hardly noticed by the public. Their authors remained obscure, while such authors as Veblen, Commons, John Dewey, and Laski were exuberantly praised. It is a well-known fact that the legitimate stage as well as the Hollywood industry are no less radically critical of free enterprise than are many novels. There are in this country many periodicals which in every issue furiously attack economic freedom. There is hardly any magazine of opinion that would plead for the system that supplied the immense majority of the people with good food and shelter, with cars, refrigerators, radio sets, and other things which the subjects of other countries call luxuries.

The impact of this state of affairs is that practically very little is done to preserve the system of private enterprise. There are only middle-of-the-roaders who think they have been successful when they have delayed for some time an especially ruinous measure. They are always in retreat. They put up today with measures which only ten or twenty years ago they would have considered as undiscussable. They will in a few years acquiesce in other measures which they today consider as simply out of the question. What can prevent the coming of totalitarian socialism is only a thorough change in ideologies.

What we need is neither anti-socialism nor anti-communism but an open positive endorsement of that system to which we owe all the wealth that distinguishes our age from the comparatively straitened conditions of ages gone by.

Footnotes

[1] [Ludwig von Mises, Planning for Freedom and Sixteen Other Essays and Addresses (1952; South Holland, Ill.: Libertarian Press, 1980), chap. 2, pp. 18–35.]

Chapter 16 • Price Controls • 6,300 Words

“Inflation and Price Control”

1. The Futility of Price Control

Under socialism production is entirely directed by the orders of the central board of production management. The whole nation is an “industrial army” (a term used by Karl Marx in the Communist Manifesto) and each citizen is bound to obey his superior’s orders. Everybody has to contribute his share to the execution of the overall plan adopted by the Government.

In the free economy no production czar tells a man what he should do. Everybody plans and acts for himself. The coordination of the various individuals’ activities, and their integration into a harmonious system for supplying the consumers with the goods and services they demand, is brought about by the market process and the price structure it generates.

The market steers the capitalistic economy. It directs each individual’s activities into those channels in which he best serves the wants of his fellow-men. The market alone puts the whole social system of private ownership of the means of production and free enterprise in order and provides it with sense and meaning.

There is nothing automatic or mysterious in the operation of the market. The only forces determining the continually fluctuating state of the market are the value judgments of the various individuals and their actions as directed by these value judgments. The ultimate factor in the market is the striving of each man to satisfy his needs and wants in the best possible way. Supremacy of the market is tantamount to the supremacy of the consumers. By their buying, and by their abstention from buying, the consumers determine not only the price structure, but no less what should be produced and in what quantity and quality and by whom. They determine each entrepreneur’s profit or loss, and thereby who should own the capital and run the plants. They make poor men rich and rich men poor. The profit system is essentially production for use, as profits can be earned only by success in supplying consumers in the best and cheapest way with the commodities they want to use.

From this it becomes clear what government tampering with the price structure of the market means. It diverts production from those channels into which the consumers want to direct it into other lines. Under a market not manipulated by government interference there prevails a tendency to expand the production of each article to the point at which a further expansion would not pay because the price realized would not exceed costs. If the government fixes a maximum price for certain commodities below the level which the unhampered market would have determined for them and makes it illegal to sell at the potential market price, production involves a loss for the marginal producers. Those producing with the highest costs go out of the business and employ their production facilities for the production of other commodities, not affected by price ceilings. The government’s interference with the price of a commodity restricts the supply available for consumption. This outcome is contrary to the intentions which motivated the price ceiling. The government wanted to make it easier for people to obtain the article concerned. But its intervention results in shrinking of the supply produced and offered for sale.

If this unpleasant experience does not teach the authorities that price control is futile and that the best policy would be to refrain from any endeavors to control prices, it becomes necessary to add to the first measure, restricting merely the price of one or of several consumers’ goods, further measures. It becomes necessary to fix the prices of the factors of production required for the production of the consumers’ goods concerned. Then the same story repeats itself on a remoter plane. The supply of those factors of production whose prices have been limited shrinks. Then again the government must expand the sphere of its price ceilings. It must fix the prices of the secondary factors of production required for the production of those primary factors. Thus the government must go farther and farther. It must fix the prices of all consumers’ goods and of all factors of production, both material factors and labor, and it must force every entrepreneur and every worker to continue production at these prices and wage rates. No branch of production must be omitted from this all-round fixing of prices and wages and this general order to continue production. If some branches were to be left free, the result would be a shifting of capital and labor to them and a corresponding fall in the supply of the goods whose prices the government has fixed. However, it is precisely these goods which the government considers as especially important for the satisfaction of the needs of the masses.

But when such a state of all-round control of business is achieved, the market economy has been replaced by a system of centralized planning, by socialism. It is no longer the consumers but the government who decides what should be produced and in what quantity and quality. The entrepreneurs are no longer entrepreneurs. They have been reduced to the status of shop managers — or Betriebsführer, as the Nazis said — and are bound to obey the orders issued by the government’s central board of prod