“Capitalism – A Treatise on Economics” by George Reisman – A Review

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It is not often that the present author is moved to review any particular publication by a specific author, let alone one that was published nearly twenty years ago. However, Capitalism by George Reisman, at more than one thousand pages long, is the first major treatise that is at least related to the “Austrian” tradition since the publication of Murray N Rothbard’s Man, Economy and State in 1962.

Although Reisman is a contemporary of Rothbard and a fellow student of Ludwig von Mises, Reisman’s approach to economics is markedly different from either. Indeed, armed solely with knowledge of his pedigree one might be forgiven for wondering why more attention has not been directed towards to Reisman’s work from within “Austrian” circles. It is only after having read this treatise that one can see why. Although Reisman claims that Mises is his primary intellectual influence, there is very little of this treatise that could be regarded as distinctly Misesian. Rather, Reisman’s direct influences are the classical economists (especially Smith, Ricardo and J S Mill, upon whom he relies for support to an extent far beyond his reliance upon Mises) and Ayn Rand. Reisman specifically rejects the categorisation of economics as the science of human action, and prefers, instead, to regard it as “the science that studies the production of wealth under the division of labour”. He therefore willingly abandons any analysis of individual values, means, ends, and choices, and restores economic theory to the study of holistic aggregates; indeed we might say that his definition of economics, which views wealth as an entity possessing some kind of objectively determinable magnitude, demands such a restriction. Reisman positions the businessman, rather than the consumer, as the centre of the economic system, stating that consumers (as a whole) are largely dependent upon businessmen (as a whole) rather than vice versa. While, according to Reisman, consumers provide the direction of economic activity (i.e. the precise direction of resources to fulfilling specific industries), businessmen and capitalists are responsible for its extent, i.e. the limits of saving and capital investment. In other words, it is the decisions of capitalists that determine the extent of “economic progress” (a term Reisman prefers to “economic growth”) rather than those of consumers. A corollary of this is that production and producers are reinstated as the keystones of economic activity rather than consumption and consumers (there is at least an implication in parts of the treatise that production is good and proper whereas consumption is bad and wasteful, although this is much muted compared to the same in Reisman’s classical influences). Furthermore, it is clear that Reisman does not regard his approach to economics as a wertfrei science and, instead, believes his economic theory to be a rigorous promoter and defender of the capitalist system – an attitude that cannot be avoided by his definition of economics as the study of the accumulation of wealth under the division of labour, a division that he says is only possible under private ownership of the means of production. Thus, in Reisman’s world, a discussion of economics is a discussion of capitalism which, presumably, explains the book’s title.

What can we say about Reisman’s approach? Without beating about the bush we must state at the outset that Reisman, who is thoroughly acquainted with “Austrian” economics, has jettisoned a tremendous degree of sound theoretical understanding from the science. Although Reisman, who self-identifies as an “Austro-classical” economist, endeavours to restore to economics many of the (in his opinion) sound doctrines of the classical economists that were allegedly rejected following the discovery of the law of marginal utility and the backlash against Marxism, we must conclude that the result is something of a retrogression rather than a synthesis of two, hitherto quite disparate, schools of thought. In Reisman’s world, the achievement of all ends and their associated costs never advance deeper than the objective measurement of exchanges for money. He never advances any exposition of individual ends and subjective costs (indeed, he explicitly rejects the doctrine of opportunity cost). Hence the entire purpose of the economic system as serving the needs of individuals and the types of decisions that individuals must make in order to achieve these ends is missing, subsumed by the supposedly limitless need of man as a whole to accumulate “wealth” in perpetuity. In other words, Reisman’s restoration of the primacy of the production of “wealth” overlooks the fact that all production is ultimately aimed at providing for consumers and that it is the ends of consumers to which the economic system is geared. It is perfectly consistent to state, as does the wertfrei “Austrian” school, that the purpose of all economic endeavour is to provide for consumption while on the other hand remaining firm that the means of achieving this consumption can only be served by increased production. Therefore, while we can hold that the desire for consumption is the ultimate cause of economic progress, we can also state that production is the proximate cause. Thus, while Reisman’s categorisation of economic theories under the headings of either “productionism” or “consumptionism” – the former of which involves the promotion and encouragement of increased production as the means towards economic progress, the latter the promotion and encouragement of increased consumption – provides an instant and convincing cognitive aid, it obscures the clarity afforded by this insight of the “Austrian” school.

Furthermore, Reisman’s repositioning of the capitalist/businessman as the driver of economic progress relies upon capitalists providing the bulk of investment funds, i.e. that it is the consumption/saving decisions primarily of businessmen that determines the extent of economic progress. He argues that the wages of labourers do not provide a significant source of investment funds and are usually consumed either immediately or are saved in order to purchase durable consumer goods such as housing or automobiles. Any investment saving that labourers do happen to undertake is likely to be wholly disinvested at retirement, thus netting out the saving of younger generations. However, there is no reason for Reisman to think that this this must be the case. It is just as possible for investment funds to come from the savings of everyday individuals that are then lent to businessmen for them to deploy in their enterprises via a conduit such as bank savings accounts (and such a view would greatly undermine any opinion that capitalism keeps the masses in servitude as wage labour). The distinctive role of the businessman is that he provides entrepreneurial talent in order to generate economic progress by directing those saved funds to where they are most urgently desired by consumers. Yet Reisman’s treatise lacks any extensive theory of entrepreneurship and only passively recognises the need for superior decision-making in order to fulfil the ends of consumers. This lacuna in Reisman’s theory means that in order to position the businessman as the driver of economic progress he has to paint him as the primary provider of investment funds. This contrasts greatly with Reisman’s mentor, Mises, who makes entrepreneurship a hallmark of Human Action, thus giving us an insight into the economic significance of the businessman that extends far beyond the fact that he simply didn’t consume his wealth. (Some of Reisman’s views on what determines an individual’s consumption/investment preferences, which inform his theory here, are also incorrect and we will explore these below). In any case, however, Reisman seems to support his theory through a blurring of economic categories, such as labourers, consumers, capitalists, etc. (something which, irritatingly, is done all too frequently). In reality, all individual people in the economy participate in different categories at different times – a man is clearly a labourer when he goes to work, a consumer when he spends his wages in the shops, and a saver when he buys a corporate bond. However, when we are discussing, for the purposes of conceptual clarity, the roles of individuals in these economic categories, we isolate those specific roles from other categories and thus we always talk of labourers qua labourers and consumers qua consumers, etc. So even if it may happen be true that the particular people who are businessmen are responsible for the greater part of saving and investment, businessmen are consumers too and considering them as consumers qua consumers it is their decision to refuse to consume their wealth today in favour of accumulating greater wealth for consumption tomorrow that provides the source of investment funds. It is therefore true to state that it is the choices of consumers who determine both the direction and extent of economic progress. Moreover, as Mises also recognises, any consumer who is currently a wage earner can transform himself into a businessman, entrepreneur or capitalist by saving and investing his wages (while, equally and oppositely of course, any businessman who decides to consume his fortune may end up as a wage earner).

Finally, it is one thing to state that the preoccupation of the economic activity of any one (or even most) individuals may be with the accumulation and augmentation of their own wealth. But it does not follow from this that the science of economics itself concerns the accumulation of wealth. Animals preoccupy themselves with the need to attain food and shelter but this does not mean that the focus of zoology is with the achievement of these things.

Examining Reisman’s treatise on its own, non-wertfrei terms as a rigorous defence of the capitalist system, much of its earlier part is a detailed offence against the fallacies of socialism, collectivism, interventionism and environmentalism (and later, Keynesianism and inflationism). These devastating, if often heavy handed, critiques are likely to be viewed as by Austro-libertarians as Reisman’s greatest achievement in this work, even if some of it was previously published as The Government Against the Economy. A specific and lengthy chapter is possibly the most passionate assault against the ecology movement, a chapter that could easily be expanded and published as a separate treatise (Reisman’s stress of the anti-human zeal of environmentalism resonates with that of environmentalists, such as former Greenpeace Canada President Patrick Moore, who have become disillusioned with the movement). Reisman’s explanation of various forms of government intervention, such as price fixing, with reference to specific notable examples such as the oil recession of the 1970s, in which he traces out all of the effects (and effects of alternatives to) government meddling have rarely been matched. Yet much of the remainder of Reisman’s exposition does not in fact read as a promotion or a defence of the capitalist system; rather it is more akin to an aggregative, accountancy-laden explanation of what the capitalist system does, much like a description of some giant machine that swallows up inputs measured in numbers and churns out some kind of output, also measured in numbers. Reisman categorises an endeavour as productive according to its ability to earn money voluntarily through exchange. Hence all government functions, relying upon taxation, must necessarily be classified as consumption and not production. In other words, government can never produce and must always be a leech on the genuinely productive, capitalist system. Moreover, his excellent critique of socialism recognises that socialism must entail tyranny and a replacement of the ends sought by individuals with the ends sought by leaders. However, Reisman’s aggregative, accountancy approach never builds upon this insight. In the depths of the latter half of the treatise one almost forgets any connection between these accounting entries and how the capitalist economy serves the needs of individual people. One of Reisman’s stated aims in the treatise is to show how a proper understanding of the capitalist system should prevent one from feeling any kind of “alienation” from or subjugation by the capitalist system – something which Reisman comes closest to achieving through his analysis of the division of labour. Yet in the main it would appear that the Mises-Rothbard approach of detailing the economy as a network of bilateral, voluntary exchanges between individual people striving to meet their own needs through voluntary co-operation (and how these disparate and often conflicting goals and purposes nevertheless mesh into a harmonious, productive society) is much more conducive to achieving this than is Reisman’s aggregative, accountancy method. While it is true that the ability of capitalism to manifestly increase the standard of living and the degree of material wealth lends it a tremendous amount of moral weight, we can suggest here without too much elaboration that any rigorous defence of capitalism and, moreover, freedom can proceed only by focussing on the primacy of the needs of each individual person, not all of which can be measured or attained though objectively viewable exchanges for money. This omission in Reisman’s work also weakens the distinctly economic flavour of this treatise, as individual choices, desires, wants, decisions and actions do not seem to matter.

Turning now to some of Reisman’s theoretical contributions to the science of economics, there are two that stand out in particular. The first is his attempted demolition of the “conceptual framework” of the Marxist exploitation theory by asserting the primacy of profit rather than of wages. In Reisman’s view, critics of Marxism, including Böhm-Bawerk, have accepted the categorisation, originating with Adam Smith, of profits paid to capitalists as deductions from wages, and have sought explanations in order to justify this deduction. Reisman, however, asserts that wages, paid to labourers, are, in fact, a deduction from profits. If profits are calculated by subtracting business costs from business revenue, it is clear that if a person undertakes an enterprise to achieve, say, 100 units of revenue then every monetary outlay he expends in order to achieve that 100 units of revenue must count as a deduction from it. The fewer costs he has the more profit he is left with. Thus it is profits that represent the primary economic income, not wages. It is conceivable for the economic system to have profits but not wages in the event that every individual person operated as a sole trader and employed no other individuals. If, however, a businessman hires labourers to assist in his enterprise, the wages he must pay to these workers for their assistance are deducted from the ultimate sales revenues. Therefore, according to Reisman, wages only appear in the economic system on account of the help that other people provide to a businessman’s enterprise, and their help stakes a claim on his revenue. Thus it is wages that are deducted from profits, not vice-versa.

Whatever the merits of this view we must conclude that, to the dyed-in-the-wool Marxist, it is likely to be beside the point. The source of contention in the exploitation theory is that the businessman doesn’t do anything and simply leeches off the productivity of the worker; in other words by hiring labourers the businessman simply abdicates any participation in the act of production yet still gains an income. Reisman himself provides the answer to this by pointing out that labour is not the only source of productivity in a division-of-labour society and that it is, in fact, decision making, risk-taking, management and oversight that are also essential – in other words, entrepreneurship. And yet, as we noted, any extensive treatment of entrepreneurship is precisely what is missing from Reisman’s theory. Therefore, it must be submitted that an understanding of entrepreneurial profit and loss and the insulation of the labourer from business risk coupled with the time preference theory of interest provides a more effective demolition of Marxism than the primacy of profit theory which, if correct, provides only additional ammunition for it.

This brings us to Reisman’s next theoretical contribution which is his net-consumption/net-investment theory of aggregate profits, profits which he tries to explain in an environment of an unchanging supply and flow of money. The attempt to explain profit in terms of physical goods is relatively straightforward. Goods, of course, can increase or decrease and thus there can be absolutely more (profits) or fewer (losses) of them across society as a whole. We can also understand clearly, across the time structure of production, how the consumption of a smaller quantity of physical goods can be foregone today in order to produce a larger quantity of goods tomorrow. This is not so when it comes to accounting for profits and losses in terms of money which is assumed to be fixed in supply and flow. For every transfer of money that represents a credit to ones businessman’s income must show up as a corresponding debit to another businessman’s costs. Hence, while some individual businesses would earn profits and others would suffer losses, all profits and losses across the economy as a whole would net out and hence any question of aggregate profit would be impossible. The only method of solving this conundrum is to somehow, on the societal balance sheet, create a credit entry to income/equity without a corresponding debit entry to costs. It is the explanation of how this is possible that Reisman sets out to achieve.

The first element of aggregate profits – “net consumption” – derives from the fact that business revenues from consumption spending by labourers (and, as we noted, Reisman categorises all spending by labourers as consumption spending) shows up also as a business cost in the form of wage payments. Therefore, revenue and cost cancel each other out on the societal income statement. Similarly, business to business spending will be counted as both an equal and opposite revenue and cost and will net to zero. However, “the payment of dividends by corporations, the draw of funds by partners and proprietors from their firms, and the payment of interest by business firms” (which Reisman regards as “transfers”) to business owners, which provide the latter with a source of consumption spending, does not show up as a business cost yet does, once spent, show up as a business revenue. Thus the rate of profit is determined solely by the desire of the capitalists to consume. This element of profit has, Reisman claims, the ability of providing continued aggregate profits in an environment of unchanging money. For example, if the volume of spending is 1000 units of money each period, business costs could be 900 while business revenues could be 1000 and profits 100 in each and every period. (Reisman uses similar reasoning to explain how the rate of profit is increased by taxation as all taxation is consumption spending). The second element, “net investment”, derives from the fact that business spending on assets to produce business revenue are capitalised as assets and only later depreciated incrementally as a business cost. Thus, in an environment where the volume of spending is the same, business revenue exceeds business cost. For example, if 100 units of money are expended on capital assets, 800 units are spent on business costs, and there are 1000 units of business revenue, profits would be 200 as the 100 units spend on capital assets are not charged as a cost. Reisman believes that net investment provides a finite outlet for aggregate profit because, eventually, depreciation charges from assets previously capitalised will equal the value of new assets capitalised. For example, if 100 units of monetary spending on assets per year are capitalised and then depreciated at an uncompounded, annual rate of 10%, depreciation charges will be 10 units in year one, 20 units in year two, 30 units in year three, and so on until, in year 10, depreciation charges will exactly equal the 100 units of additional investment and so net-investment will provide no source of aggregate profit in that year. Thus, Reisman believes, only net consumption is capable of providing continuous, aggregate profits period after period. Net consumption and net investment are, however, joined at the hip. Reduced net consumption provides increasing funds for net investment to be capitalised on the balance sheet and charged as business costs only at increasingly remote points in the future.

What can we say about this theory? It should not be surprising to “Austrians” that Reisman’s theory is based upon net-consumption and net-investment as it those elements that are determined by the “Austrian” theory of time preference, which affects the rate of interest. (What Reisman refers to as “profit” is what most “Austrians” would refer to as “interest” – Reisman offers no explicit distinction between entrepreneurial profit and loss on the one hand and what “Austrians” would regard as interest on the other). Yet Reisman regards his theory as standing in opposition to the time preference theory and, moreover, the older productivity theory of interest. However, Reisman’s approach, characterised as simply a description of accountancy practices and the summation of money flows, does not challenge the time preference theory at all. The primary question of profit and interest that is answered by this latter theory is why do businessmen not impute the full value of the final product to the factors of production. In other words, why, even after businessmen are compensated for their managerial or oversight activities as a factor of production, is there always a further residual surplus that is not eliminated by competitive bidding amongst entrepreneurs? Why is there, to use Reisman’s terminology, a “going rate of profit” at all? The net-consumption/net-investment theory, while explaining that rises in net consumption will increase the rate of profit while reductions in them will lower it, only really explains how, from an accounting point of view, profits are possible. Reisman offers no extended treatment of the motivations of capitalists in paying (and of labourers in accepting) a sum lower than the total of business revenues and thus it is difficult to regard this as a distinctly economic theory. A more convincing explanation of his theory would detail how, with decreasing time preference, more funds are advanced to factors of production yielding revenue in the future, thus diminishing net consumption and the rate of profit, while these expenditures will be capitalised at increasingly higher amounts, depending on the time period when they come to fruition, relative to the ultimate business revenue that is earned. Thus Reisman’s accountancy-laden approach would, in this way, be fully reconciled with the “Austrian” approach to profit, or, rather, to what “Austrians” would call interest.

When Reisman does address the motivations that determine net-consumption and net-investment he does so erroneously. Reisman defines time preference as the determinant of “the proportions in which people devote their income and wealth to present consumption versus provision for the future.” It is Reisman’s link between this posited desire to provide for the future and net-investment that causes him to declare that net investment can provide only a limited contribution to net profit. To quote: “As capital and savings accumulate relative to income, the need and desire of people to increase their accumulated capital and savings still further relative to their income diminishes, while their desire to consume their income correspondingly increases”. In other words, the more saving and capital people possess the more they have provided for the future and thus productive expenditure will fall and consumption will rise, choking off net investment in the form of further additions to the asset side of the balance sheet. Thus depreciation charges begin to equalise new investments and aggregate profits from net-investment begin to fall. This view, however, is mistaken. Time preference has nothing to do with the desire of people to provide for the future. The need to provide for the future is always a present end just like any other and could be achieved by plain saving rather than investment. Time preference, rather, is the rate at which individuals prefer a larger quantity of goods available at some point in the future ahead of a smaller quantity of goods available today. It is perfectly possible for people to continue to invest sums of capital that will not produce consumer goods for well after they are deceased. Indeed, this is precisely why people have inheritances to bequeath. Many of the buildings, factories and infrastructure we have today were created not in our own lifetimes but were handed down to us from past generations. And it is further possible that capital accumulation and technological progress, which Reisman himself stresses enhances the ability to produce capital goods, will enable the production of capital goods that last further and further into the future. People would not even need to create capital goods that last so long with the purpose that they do so – in other words they could be perfectly limited in their own time horizons and yet still produce capital goods that yield a product well after the elapse of this time horizon. Let’s say, for example, that the current rate of time preference means that the produce from all assets appearing after thirty years hence is fully discounted to zero. In other words, only what the assets can produce in the next thirty years is valuable to present persons. If a capital good was created that could yield produce for sixty years, after the elapse of each year, another year’s discounted produce would be capitalised as this year is drawn into the thirty year time horizon. Therefore, such assets will provide a continued source of credits to business equity (and, thus, profits) without corresponding business costs. This is precisely the case with some of the most valuable patches of urban land which, for all intents and purposes, will go on producing well beyond the lifetimes and time horizons of any living person. Thus there is no reason for net-investment to be so limited in its contribution to aggregate profits in the environment of unchanging money. Moreover, we can see in this way how accumulating, aggregate profits that are capitalised for longer and longer periods is the hallmark of an economically progressing society – one where more and more capital is invested for longer – while the opposite, aggregate losses, represents retrogression through capital consumption.

Finally, as we noted above, there is no reason to discount saving by labourers a source of investment funds. This would divert spending from business revenue as the funds would be lent to businesses who would then spend it on “productive expenditure”. Without any corresponding business revenue the rate of profit would fall. (Thus we can see why increased funds that are made available for lending must be made at increasingly lower rates of interest).

There are one or two further disagreements we can cite here. First, “Austrian” business cycle theory, the jewel in the crown of “Austrianism”, is never explained at length and instead takes its place in a wider treatment of the effects of inflation. Second, his treatment of neoclassical price theory is too aggregative and does not explain how individual bidders and suppliers bring about a harmony between the quantity demanded and the quantity supplied. Third, as in his critique of the time preference theory of interest, Reisman often perceives differences or disagreements where there are none, such as that alleged between his productivity theory of wages and the marginal productivity theory of wages, the latter of which he describes incorrectly. And finally, in spite of having been the translator of Mises’ Epistemological Problems of Economics, Reisman has little to say concerning method – something which perhaps descends from his rejection of economics as the science of human action, which underpins Mises’ methodological dualism that divides economics from the natural sciences.

Overall, therefore, the question of whether Reisman’s approach to economics has successfully synthesised the “Austrian” and classical schools, and, moreover provided a progressive outlook for the science of economics must, regrettably, be answered in the negative. Rather, Reisman’s positive economic theory in this treatise comes across more as a restatement and re-polishing of classical economics (with some corrections to that school of thought), peppered with insights from neoclassicism and the “Austrian” school. Reisman’s rejection of the primacy of human action as the subject matter of economics has been at the expense of not only losing a great deal of theoretical understanding in the wertfrei science that this affords, but also weakening any positive promotion for capitalism and freedom.

Nevertheless, while this review has been mainly been critical of Reisman’s positive economic theory, we must end by celebrating the fact that our author has, in this treatise, many great things to say concerning socialism, environmentalism, interventionism, inflationism, Keynesianism and all other manner of false doctrines rejected by “Austrians” and libertarians alike. What Reisman has put to paper here are among the finest critical analyses of these areas ever written and, even if one cannot agree with Reisman’s specific, economic outlook, these contributions alone place Reisman in the top rank of economists whose work should be studied avidly.

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Prices and Cost of Production

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A major field of study in the science of economics is the pricing of consumer goods and their antecedent factors of production. The history of this area of thought provides an almost textbook example of the falsehood of the “Whig theory” of historiography – the idea that the knowledge of humanity progresses in an ever upward direction and that what we know now is better and more enlightened than what we knew before. For this area of study in particular is marked by progression, retrogression and progression once more, often with disastrous consequences.

The most serious case of retrogression in this regard was of, course the Marxian labour theory of value that stipulated that the exchange ratio of goods depended upon the quantity of labour time inherent in their production. This theory, together with its corollaries and associates such as the iron law of wages and the exploitation theory, was derived, so it was believed, directly from the largely pre-capitalist classical economics of Smith and Ricardo.

A basic “Austrian” response to this is to reject Marxism and its supposed classical parent by pointing out, of course, that costs are also prices. To explain prices in reference to prices, therefore, would appear to be a case of circular reasoning. Rather, the prices of the factors of production were derived from the value of the final good. Capitalists would bid up the factors of production according to the valuation of the final product. Thus the value of every factor was explained not according to the effort expended but, rather, according to its value in producing consumer goods.

Unfortunately, however, this basic understanding of the “Austrian” approach towards prices ignores the much richer theoretical tapestry inherent in the “Austrian” approach (especially that of Böhm-Bawerk) which, in fact, does not contradict many of the tenets of price theory in classical economics but, rather, armed with the law of marginal utility, provides a more powerful explanatory basis for them. Thus, one need not throw out the classical economics baby with the Marxist bath water and risk losing many of the important and true conclusions that were abused and distorted by Marx.

An immediate problem with the basic “Austrian” view is that the sequence of valuations from consumer good through the stages of production to the ultimate land and labour factors is the reverse of the temporal sequence of events. A product has to have been produced through all of its stages of production before a consumer can bid a price for it. Thus, the prices of the factors of production pre-date those of the consumer goods upon which the former are supposedly based. It is difficult to understand, therefore, how something can be derived from something else that does not yet exist. The more accurate view is, of course, that the prices of the factors of production are based upon the estimated selling prices of the future consumer goods. In a static equilibrium such as the evenly rotating economy the prices of the final goods are known in advance and hence the pricing of the factors of production will accurately reflect the value of the final consumer goods. But as helpful as this model may be in conceptualising the structure of production, it is woefully easy to draw from it the conclusion, so beloved of mainstream economists, that a boost in the value of consumption must necessarily result in a subsequent boost of the value of the factors of production. In other words that consumption feeds production. This, of course, is patently untrue. As John Stuart Mill said, “demand for commodities is not demand for labour”. Rather, to produce a commodity for purchase, labour (and all of the factors of production) must already have been demanded by capitalist-entrepreneurs. In other words, it is production that feeds consumption not vice-versa.

Second, if the prices of the factors of production of a good are based upon the valuations of consumers this does not explain the individual pricing of the factors. If, for example, a consumer will buy a loaf of bread for £1.00, why does the flour that went into it cost, say, 40p, the labour 50p and the hire of the oven to bake it 10p? Why doesn’t flour cost 50p, labour 30p and the oven 20p? Or any other possible combination of prices? One possible answer to this problem is that each factor earns its marginal revenue product – that is, the portion of the value of the increased product that it is attributable to an incremental increase of that particular factor. So for example, if I have a patch of land and a given number of seeds and apply increasing units of fertiliser then each additional unit of fertiliser will be priced according to the additional revenue earned by the additional physical product that results. The problem with this view is that it ignores the fact that no additional product is the result of a single factor alone and that the value of the additional product need not be imputed solely to the additional fertiliser. What if, for example, the purchase price of the land and the seeds already accounted for the fact that additional fertiliser could be applied to it to produce a larger physical product? Moreover, even if, say, the land and seeds were purchased at a price that reflected the fact that only a limited quantity of fertiliser was available and thus only a reduced physical product could be yielded from them, any unexpected increase in the available quantity of fertiliser and thus increased physical product and increased revenue would also cause an increase in the capitalised value of the land and the price of seeds. In other words, there is no reason to assume that the marginal revenue product should be imputed to only a single factor. We are therefore no closer to solving our problem – what is it that causes the particular array of prices between the factors? As we shall see, each factor does, in fact, earn its marginal revenue product, but not in a partial equilibrium where we examine only a particular end or use for a factor. Rather we have to consider the entire assortment of uses to which a good can be directed.

A further problem with the basic “Austrian” approach is revealed when we consider large consumer goods such as cars and computers. It is patently obvious that the value of a car is zero unless it has a steering wheel. Indeed, the demand for steering wheels is likely to be extremely inelastic, stretching all the way up to the height of the value of the entire car. However, in reality, the full value of the car does not result in the imputation of that full value to the steering wheel but rather to all of the other factors as well. Similarly, a computer is useless without the monitor; a television without a plug; glasses without lenses. In fact, it is clear that the utility of thousands of goods is dependent upon the unity of all of their individual components and if any one of them is missing the utility of a particular good drops to zero. Yet in many cases we never have to pay more than a few pounds for the “essential ingredient” to be produced.

How then do we arrive at the prices of all of the individual factors? The answer to this question lies in a deeper understanding of the law of marginal utility. As we know, this law states that the value of a unit of a good is equal to the value attached to the least valuable use to which that unit can be directed. So if, for example, I have five bottles of water, I might use the first for my most important end which is drinking, the second for the next most important end which is washing, the third for cleaning laundry, the fourth for watering plants, and the fifth to make into ice cubes. As each bottle is interchangeable, if one bottle was to be lost it would be the least valuable use – making ice cubes – that would be foregone. Thus, the value of any one unit will equate to the value of the least valuable end of making ice cubes, in spite of the fact that some of those units will be directed to ends with far greater value.

What we can see, however, is that if the value of any one unit of a good equates to the value of the least valuable use to which that unit can be directed then this value must also be imputed to the factors of production. If a portion of those factors was to be lost, the resulting reduced supply of goods would result in the loss of the least valuable ends. Thus, each unit of the factors of production that created the five bottles of water must themselves be valued at the lowest valuable use of a good that those factors will produce.

However, this law will also apply when the factors of production are not specific and can be used to produce any range of goods that satisfy a number of different ends. Let’s say, for example, that a given quantity of factors of production can be used to produce the following consumer goods in descending order of value:

  1. A bottle of water;
  2. A loaf of bread;
  3. A bar of soap;
  4. A pair of socks;
  5. A box of tissues.

If the same factors of production can be used to produce my most valuable good, a bottle of water, as my least valuable good, a box of tissues, then it follows that the factors of production will be valued according to the value attached to the box of tissues. The loss of any portion of those factors of production will result in the cessation of the production of tissues while all of my other goods are still produced. Here, then, is the key to understanding the different prices of the factors of production. The value of a factor is based not upon the utility attached to the specific good to which that factor is directed but, rather, upon the least valuable good to which a portion of its supply is directed. Only highly specific factors of production which can be devoted only to a single end will derive their value fully from that specific end.

In real life, of course, it is never the case that whole combinations of factors of production can be exchanged between different ends. Rather factors have to take their place in different combinations of specific and non-specific factors. It is these various arrays that produce, at any one time, the individual prices of the factors of production. Thus the breakdown of prices of factors used to produce a particular good is derived from the lowest valued uses to which portions of the supply of those individual factors are directed.

We are now, therefore, in a position to see what we mean when we say that a factor of production earns its marginal revenue product. If we gain an additional unit of a particular factor, that unit will be directed towards the next most valuable end that is currently unfulfilled in the economy as a whole. All of the most valuable uses for the factor will already be fulfilled. Yet all units of this particular factor will now be priced according to the value of the marginal unit which will be derived from the least valuable end.

However, the pricing of the factors of production according to their marginal uses is not the only effect of the application of the law of marginal utility. It also affects the value of the supra-marginal products whose direct marginal utility is above that of the marginal product. These products too will be priced according to the combination of prices involved in their factors of production as the loss of any given portion of a factor will not result in the loss of this product but in the loss of the marginal product. Thus, the prices of most goods in the economy are priced according to the least valuable goods that are produced out by the marginal units of their shared factors of production. As George Reisman explains:

Allow me to illustrate Böhm-Bawerk’s point here by means of a modification of his famous example of the pioneer farmer with five sacks of grain. As will be recalled, the five sacks serve wants in descending order of importance. One sack is necessary for the farmer to get through the winter without dying of starvation. The second enables him to survive in good health. The third enables him to eat to the point of feeling contented. The fourth enables him to make a supply of brandy. The fifth enables him to feed pet parrots.


Now let us slightly modify the example. Let us imagine that the first sack of grain has been used to make a supply of flour, which in turn has been used to make a supply of biscuits, and that it is this resulting supply of biscuits by means of which the first sack of grain performs its service of preserving the farmer’s life […] We can imagine a little tag attached, this time saying, “Biscuits Required for Survival.” As before, our farmer still has four remaining sacks of grain, any of which can be used to make a fresh supply of flour and then a fresh supply of biscuits. And now, just as before, we may imagine rats or other vermin destroying the supply of biscuits. Will the answer to the question concerning the magnitude of the farmer’s loss be materially different? Certainly, his life does not depend on the supply of biscuits any more than it did on the sack of grain. For he can replace that supply of biscuits at the expense of the marginal employment of the remaining sacks of grain, which, of course, is the feeding of the pet parrots. To be sure, additional labor will have to be applied as well, but the magnitude of value lost here is that of the marginal product of that labor, which might be  something such as the construction of a sun shade or an additional sun shade or even the feeding of the parrots. The point is that the value of the biscuits will not be determined by the importance of the wants directly served by the biscuits but by the importance of the marginal wants served by the means of production used to produce biscuits and from which a replacement supply of biscuits can be produced at will.1

Thus, we can conclude, that for the majority of products that are available for sale today, their selling prices are based not upon their direct marginal utilities but, rather, upon their costs of production which is derived from the marginal utilities of the least valuable products to which factors of production are directed. There are several noteworthy effects of this analysis.

The first is that this does not nullify the operation of supply and demand in determining the price of any supra-marginal good. Rather, it results in a shifting of the supply curve to the right so that it intersects the demand curve at a level where price equals the cost of production, plus the going rate of profit. Changes in the availability of the factors of production which either increase or decrease their marginal utility will cause similar shifts of the supply curve to the left or right which will have the corresponding effect of raising or lowering the price of the specific consumer good. This is possible without any change in the quantity that is bought and sold if, for example, the shift of the supply curve takes place on a highly inelastic stretch of the demand curve. The same quantity will be bought and sold simply at a higher or lower price.

The second observation, derived from the first, is that this obliterates the standard economic analysis behind monopoly pricing. The basis of this analysis is that suppliers can exploit inelastic demand curves to reduce supply, raise their prices and thus rein in an artificially expanded profit at the expense of the consumer. However, our theory here reveals that the opportunities for doing this are minimal. For the raising of prices and consequent swollen profit margins will cause competitors to shift factors of production away from the production of marginal goods towards an increase in production of the goods whose prices have been raised, thus restoring an increase in supply and the reduction of prices back to near their costs of production. Thus, for any businessman, the primary tool for estimating his selling price is not elasticity of demand of the particular good that he is selling; rather, it is the cost of production of any potential competitor. It is for this reason why very basic goods such as bread, milk, eggs, salt etc. which have an inelastic demand curve are priced very low; and it is for this reason why sole suppliers in particular industries will earn only the going rate of profit; any attempt to raise prices will simply attract competition.

The third important observation is the impact of this analysis on wages. For labour too is, of course, a factor of production and thus will only draw income in line with the marginal use to which it can be devoted. What results, therefore, is that labour is paid a rate of wages that is far below the direct marginal utilities of the goods that the very vast majority of labourers will be producing. Yet it is also clear that, because the value of marginal products is imputed, via their factors of production, to the supra-marginal products, it is clear that the resulting lower prices means that labour can buy all of this produce. Thus increases in the supply of labour, resulting in the direction of the latter to further marginal uses and thus a lowering of the nominal wage rate, will have no bearing upon the ability of labourers, in their capacity as consumers, to buy its produce and, indeed, will serve to increase the real wage rate. Thus the argument that increases in the supply of labour through, say, immigration are largely unfounded.

What we can see therefore is that the “Austrian” understanding of the prices of goods and their costs of production, although complex, provides a strong bulwark against false theories in many important areas such as stimulus spending, wages, and competition law. Every individual who wishes to offer powerful affronts to the falsehoods that abound in these areas should study it avidly.

View the video version of this post.

1George Reisman, Eugen von Böhm-Bawerk’s “Value, Cost and Marginal Utility”: Notes on the Translation, QJAE, Vol. 5, No.3: 25-35.

Utilitarian Arguments for Liberty

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Utilitarianism or some form of consequentialism has underpinned the ethical worldview of many libertarians past and present. Within the “Austrian” School we may cite Ludwig von Mises, F A Hayek and Henry Hazlitt as proponents of this approach, contrasting with the more rule-based or deontological approaches of, say, Murray N Rothbard and Hans Hermann Hoppe, and the objectivism of Ayn Rand.

This essay will seek to examine some utilitarian and consequentialist arguments in favour of liberty. In doing so we must bear in mind two aspects. First, not all utilitarian arguments are of the same ilk and vary from simple approaches of judging outputs resulting from a posited situation with interpersonal utility comparisons, all the way to more general and sophisticated treatments such as that of Mises and that of Rothbard in his noted article “Towards a Reconstruction of Utility and Welfare Economics”1. Here, therefore, we will compare these two utilitarian approaches towards liberty. Second, the adequacy of utilitarianism can be examined from the point of view of providing a moral bulwark for a world of liberty on the one hand and from the point of view of promoting such a world on the other; our treatment of it may be different in each circumstance because that which may be suitable to form the moral foundations of liberty may be not be the key aspect that we can emphasise when persuading the populace of the virtues of a libertarian society. Hence we must examine any utilitarian argument from both points of view.

We will begin, then, with the basic forms of consequentialism that look to measure the output of individual scenarios. Such an approach will often posit an emotive and hypothetical situation where one individual owns property and another individual will succumb to some kind of malady such as hunger, illness and ultimately death unless he gets his hands on that same property. A typical example is of a lost man wandering in the woods, cold, malnourished and in immediate need of food and shelter. He comes across a log cabin, of which someone else is clearly the first user/occupier. By peering through the window our lost man can see that it is full of food. Would it be ethical for him to break in to the cabin, use it as shelter, and/or eat some of the food without the permission of the first user?2

The rule-based approach to libertarianism would state that the lost man does not have a right to break into the cabin, use it as shelter and eat the food without the permission of the cabin’s first user (hereafter, the “owner”) as it is a clear breach of the non-aggression principle. However, a utilitarian or consequentialist may argue that while the cabin owner has a prima facie right to the ownership of the cabin and its contents the question should be answered by taking the approach that avoids the most harmful consequences – or, conversely, promotes the best consequences. In this particular situation, the loss of the food or shelter to the cabin’s owner would, apparently, not be a remarkable cost. Yet the denial of it to the lost man, starving and shivering in the open, would be tremendous, may be even as much as his life. We may warrant, therefore, that the starving man should be able to break into the cabin.

Is it possible for such a view to form a) the moral backbone for libertarianism and b) a persuasive argument in promoting a libertarian society? In answer to the first question, we must decide firmly in the negative. First, all of these scenarios, such as the starving man in the woods, are purely hypothetical situations to which we are expected to give hypothetical responses. However, ethical dilemmas do not arise in hypothetical situations; they arise in real situations where there are genuine conflicts over scarcity. Although such hypothetical situations could one day come about, the danger of entertaining them is that it can be worded in such a way as to provoke the answer most desirable to its proponent. Thus the die is already loaded in favour of the latter’s political philosophy. Walter Block comments on such an example provided by Harold Demsetz of the Law and Economics movement (which is basically a utilitarian approach to legal rights). Demsetz’s scenario is that of “Austrian Pure Snow Trees”, which are owned by a religious sect. An ingredient from these trees happens to be the only cure for cancer, but the religious sect will not allow them to be used for that purpose, reserving them instead for religious worship. Demsetz challenges whether it is really “evil and vicious” to override the private property rights of the religious sect so that cancer sufferers can benefit from the trees’ curative ingredient. Block responds at length:

Given [Demsetz’s] highly emotional example, it is indeed hard to resist the notion that it would be preferable if the trees were used as a cancer cure.

Emotionalism can be a double edged sword, however. As long as our intuitive imagination has been unleashed by Demsetz in this creative way, why not push the envelope a bit? Consider, then, the case where the views of this religious sect are absolutely correct! That is, if the trees are torn down for so idolatrous and unimportant a purpose as curing cancer, then we’ll all be consigned to Hell forever. Wouldn’t it then be “intuitively appealing” to allow the islanders to continue their ownership of these trees?

Demsetz, in taking the opposite position, is acting as if the cult is erroneous in its religious beliefs. But assume for the moment the “cultists” to be correct in their world view. It would then be justified – according to Demsetz – not only to protect them from the onslaught of the cancer victims, but to seize the assets of the latter if this would in any way help the former. Suppose, that is, that there was a cancer cure, owned, now, by the victims of this dread disease, but that for some reason the worshippers determined that this material would help them in their efforts to contact the Deity. Then, according to the logic established by Demsetz, it would be appropriate public policy to forcibly transfer the cure to the control of the religious ”fanatics.” Surely Demsetz knows nothing-for certain that would render such a conclusion invalid.


Let us extend the Demsetzian argument in yet another dimension. Suppose that it was not the islanders’ trees that could cure cancer, but rather their hearts. That is, the only way to save the sufferers from this disease would be to kill, not the Austrian Pure Snow Trees, but their owners, the members of this religious sect, and then to take their hearts, chop them up, and feed them to cancer victims. Would Demsetz (“emotionally”) support this “modest proposal” to do just that?


Ultimately, there are only two ways of settling such problems. All others are merely combinations and permutations of these two. On the one hand, there is a provisional or instrumental property rights system. Here, holdings are secure only as long as no one can come up with a plausible reason for taking them away by force. Under this system, either dictators or majorities (or dictatorial majorities) hold the key to property rights. The difficulty is that there are no moral principles which can be adduced to derive any decisions. Presumably, utility or wealth or income maximization is the goal; but due to the utter impossibility of interpersonal comparisons of utility, this criterion reduces to arbitrariness. On the other hand is a thoroughgoing and secure property rights system. Here, one owns one’s possessions “for keeps.” The only problem here is the temptation to overthrow the system in order to achieve some vast gain, such as the cure for cancer. Demsetz’s example is so forceful by virtue of the fact that he expects his readers will consider a cure for cancer to be more valuable than a pagan rite – he knows it is likely they will engage in interpersonal comparisons of utility. But these temptations are easily resisted as they are inevitably imaginary and artificially constructed. We have yet to be presented with a real world example where there is a clear cut case for massive property rights violations.


Hypothetical arguments have their undoubted philosophical use. [However], the point being made here[…]is that [deontological] libertarian rules are only inconsistent with broad based utilitarian concerns in the imagination, not in reality.

Note how far from reality Demsetz must remove himself in order to manufacture an example that is intuitively consonant with his support for what in any other context would be considered murder (hearts) or theft (trees) or slavery-kidnapping (draft).


In very sharp contrast indeed, resort need not be made of fanciful examples to defend the libertarian vision.3

Imaginary scenarios, then, are always worded so that the listener is encouraged to empathise emotionally with the economically deprived while completely ignoring the point of view of the property owner, or at least making the latter look frivolous and capricious. Such a rhetorical trick applies not only to specific scenarios but also to entire political treatises. How much, for example, do the imaginary, hypothetical situations of the original position and the veil of ignorance in John Rawls A Theory of Justice – which do not exist in the real world – demand the very answer that the author desires?

Second, the purpose of ethics is to resolve or otherwise avoid conflicts that arise from the result of physical scarcity. Rule-based approaches to liberty that provide physical demarcations to denote property rights permit this to a high degree of certainty in any given situation as the boundaries of permissible action are constructed objectively. Because all valuations through action result in physical changes to physical goods, objective evidence of these changes – i.e. homesteading, production, etc. – give an immediate cue to indicate to a latecomer that the property may not be touched4. Consequentialist approaches, however, cannot rely on objective, physical demarcations to denote property rights; rather, they rely upon the measurement of competing subjective values. This renders the resolution of conflicts and conflict avoidance much more difficult. The question the lost man faces is what am I permitted to do right now? If moral boundaries are based upon hypothetical and changing values and tastes then this question cannot be answered. He may assume that the cabin owner values the cabin and its stock of food less than he does, but he has neither evidence nor proof of this. Indeed the cabin owner isn’t even there to ask. And whether the cabin owner values it less may change from day to day. Yesterday, the cabin owner might not have valued these resources very highly at all; today, however, what if the cabin owner has himself suffered an accident and requires the shelter and food, which he believes to be in secure possession, and is now under threat from the wanton consumption by the lost man? What if the cabin owner’s life is threatened by the loss of food and shelter? Indeed, what if he had purchased the cabin as insurance against that very possibility? There is, therefore, no way of making a rational decision ex ante.

Third, if ethical determinations cannot be made ex ante then it follows that a decision must be made ex post. In other words, the lost man could take a chance by breaking into the shelter and then battle out the question of whether he was right to have done so later through litigation or a settlement process. It is for this reason that utilitarian forms of libertarianism tend to be minarchical rather than anarchical. Hence, this basic form of utilitarianism provokes the very monolithic state apparatus that libertarians should be opposing, and puts in its hands a tool – interpersonal utility comparisons – with which to make its decisions, a tool that is ridiculously uncertain and malleable5. To be sure, it might be possible for individuals to form an empathetic judgment based on interpersonal utility comparisons in an individual situation. But it does not follow from that possibility that a government or a court could make a rigorous determination when passing legislation or enunciating judgments that affect the lives of millions of people in multitudes of different situations6.

Fourth, at the heart of many consequentialist approaches is a fundamental misunderstanding as to what the concepts of “liberty” and “freedom” actually mean. If one views them as meaning freedom from want, from hunger, from the elements and so on then one is naturally led to a consequentialist approach. However, properly considered, liberty is a sociological concept that applies to the relationship between each individual human being. A person is free if he can live his life without the physical interference of his person and property by others. Whether he is hungry, cold, or naked, on the other hand, concerns his relationship not with other human beings but, rather, with nature. This can only resolved not by extending his “freedom” forcibly into the territory of others but by gaining power over nature – in short, by productivity. Any number of theoreticians can spill oceans of ink in trying to determine whether or how the wealth of the cabin owner should be distributed to the lost man in the woods. Yet wouldn’t it be so much better if society was so wealthy that the lost man possessed the wherewithal to prevent himself from being in such a wandering state in the first place? What if the man had an inexpensive GPS system; compacted supplies of food in pill/tablet form that could sustain him for weeks or months; emergency communication devices that would alert a private protection agency to his whereabouts? Yet it is precisely such productivity that is threatened by consequentialist determinations of property rights. Strong private property rights that remain certain following original appropriation or voluntary transfer promote economic growth by encouraging saving, long term planning and low time preference. Uncertain or vague private property rights do the exact opposite. If it is possible that your property will be snaffled in an instant by someone who allegedly “values” it more than you do then the attractiveness of using the good for saving and investment is lowered. You will be willing to take fewer risks and will work less hard with the good if you know that the fruit of your efforts might be confiscated in the blinking of an eye. At worst, such weak property rights encourage immediate consumption as soon as you get your hands on any good at all. That way, in most cases it will no longer exist for someone to take it away again at a later date.

Turning now to our next question, would such basic consequentialism serve in any way to persuade people of the virtues of a libertarian society? Again we have to answer firmly in the negative. We must remember that the primary preoccupation of libertarianism is with the evil and oppressive monolith known as the state. This is the entity that truly destroys freedom; it confiscates our income to fund its profligate spending; forces us to use its worthless paper money that it prints incessantly to fuel its endless foreign wars; destroys families and fuels poverty and dependency with the massive welfare state; regulates what we can do with our bodies, what we can say with our own mouths, where we can set up business, whom we may employ in that business and on what terms. Government is estimated to have killed approximately 262 million people outside of warfare during the twentieth century; private affronts to liberty – even such horrendous crimes such as murder and rape – pale in comparison to this. The US government’s so-called war on terror, at a cost of several trillion dollars, has killed an estimated 1.3m Iraqis, Afghanistanians and Pakistanis in its first ten years, even though more Americans are killed by falling televisions than by terrorist attacks. The greatest insult has to be that it is this miniscule private crime that supposedly constitutes the very justification for the state and its monopolisation of security and litigation. Although there is no shortage of nobility in striving to apply justice in every individual case, libertarians must fry the biggest fish and not spend their time debating whether a lost man breaking into a cabin is or is not an affront to liberty. When attempting to promote liberty, let us confront the very real ogre of the state rather than dwelling in imaginary scenarios that will make no practical difference to people’s everyday lives. Furthermore, as we mentioned above, if justice depends on interpersonal utility comparisons in individual cases, then it craves for the existence of a compulsory referee in the form of the state, the very thing that destroys liberty entirely. We must conclude then that this basic form of utilitarianism, which seeks to evaluate outputs from specific situations, must fail on all accounts as an argument in favour of liberty.

Let us now turn towards a second conception of utilitarianism, the more sophisticated approach adopted by such eminent theoreticians as Ludwig von Mises. The tenor of this approach is that voluntary exchange under the division of labour – i.e. the market – is essential for the survival and flourishing of every individual human being; every human is so interdependent upon every other that to plump for anything else would result in the rapid disintegration of the standard of living or, at worst, certain death. Hence this form of utilitarianism concentrates on the virtues of the market itself rather than looking to the justice of individual situations. Mises, and others who follow this approach, therefore avoid any complications arising by way of interpersonal utility comparisons.

It is important to realise that this argument is predicated upon a few other important Misesian insights. First is that when pondering the economic organisation of society only two extremes are possible – the free market or total socialism. As Mises so effectively argued, any “interventionist” point or “mixed economy” approach in between these two extremes will cause effects that must either lead to abandonment of the intervention on the one hand or to total control on the other. One must therefore choose between one or the other and cannot favour anything in between. By demonstrating the economic impossibility and the catastrophic consequences of full socialism Mises demonstrates the complete lack of basis for making a choice that favours full government control. The only rational option, therefore, is the unfettered free market. Second, and related to this theme, Mises was of the view that “society” is synonymous with social co-operation under the division of labour. As he says in Human Action:

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.7

Following this line of thinking, questions such as “how to organise society” strike one as absurd when society itself is already a form of organisation. We do not have the choice of “picking” from an array of options when it comes to forming a society. Either there is social co-operation under the division of labour and society exists; or there is an atomistic hand-to-mouth existence and society does not exist. Any person, therefore, who genuinely wishes to promote a theory of society cannot rationally opt for any kind of socialism and, a fortiori, any kind of interventionism8.

How useful is this approach for forming a moral backbone for libertarianism? At first, this approach seems remarkably more plausible than the basic form of consequentialism that we just discussed. By looking at the general consequences of the market we do not get caught up in traps such as interpersonal utility comparisons and we have a strong counter-argument against anyone who proposes a collectivist theory of social organisation. Moreover, the fact that the marketplace serves to improve the material wellbeing of every individual human being lends it a heavy degree of moral weight. If the free market was to spread misery and discontent through perpetuating a lower standard of living we would surely be willing to lend it less moral credence. Unfortunately, however, this utilitarian approach lacks the very thing to which the basic form of consequentialism was far too devoted – a rigorous passion for the justice rather than simply for the utility of private property rights.

First, although it provides a rhetorical defence against those who profess their collectivist aspirations to be for the benefit of society, it will never provide a defence against megalomaniacs who are content to milk everyone else for all they are worth. In other words, it will never provide an answer to those who believe society exists to serve them alone and that they are entitled to use other people in any way they see fit. The existence of such megalomania should not be dismissed lightly. Simply because we associate it more with caligulan monarchs and despots of times gone by does not mean to say that our democratic structures are impervious to it. Many libertarians are vocal opponents of what they see as “US exceptionalism” – the idea that the US government can pretty much do whatever it pleases in foreign affairs and standards that apply to a foreign government do not apply to the US. How can this be described as anything except megalomania?

Second, the logical effects of the socialisation of society – the total collapse of the division of labour and the complete decimation of the standard of living – can be gut wrenchingly long run effects. Society currently has plenty of capital that can be consumed and afford a comfortable, even luxurious living to any one individual. The Soviet Union took an agonising seventy years to die, a span of time that exceeds that of most individual’s adult lives. An advocate of socialism and socialisation is therefore not necessarily advocating his own certain death or relegation to poverty. He may be content to live like a king for the duration of his life and not care a whit if society became deeply impoverished long after he has dropped off of his mortal coil. Arguably this was the attitude inherent in Keynes’ oft-quoted quip “in the long run we are all dead”. As Murray Rothbard is supposed to have retorted, “Keynes died and we were left with the long run”. But such an attitude is provoked and enflamed by the fact that democratic government is a revolving door with officeholders required to endure repeated elections, endowing them a very short time in which to accomplish their goals. Every politician yearns for his day in the sun when he is lauded and praised as a great statesman, but he has to achieve this now, in the short run, before he loses an election. As long as he can reap the headlines and rewards during his tenure and, possibly, for the remainder of his life, who cares if his policies are ultimately destructive after he is long gone? It is for this reason that democratic governments are suffering from ever increasing and crippling debt as each generation of politicians seeks to shower its electorate with free goodies that only have to be paid for years after they have left office (or have died) and it is somebody else’s problem9. So too, could we suggest, that endless war has become the norm as each successive leader tries to demonstrate his Churchillian qualities and to elevate himself to the legendary, almost Godlike realms of the great warrior-statesman such as Lincoln and Roosevelt. Never mind that war ultimately is destructive; never mind that it destroys entire cities and societies; never mind that it kills, maims and otherwise ruins the lives of millions of innocent civilians. As long as the commander-in-chief can claim to have vanquished a cherry-picked foe in some distant country then his place as a saviour of civilisation is assured, at least in the meantime. So too do the manufacturers and profiteers of armaments display the same attitude. They know how evil and destructive war ultimately is; there is no shortage of literature espousing this fact. But they get to reap heavy profits now and to enhance their own lifestyles now. Why should they care about what happens in the long run?

Third, by resting its case on the general virtues of the market this kind of utilitarianism suggests that if some form of social organisation, other than the market, however unlikely, becomes feasible then private property rights could be legitimately overridden. In other words if some form of collectivism could sustain the division of labour and a standard of living equal to or exceeding that of the free market would the force behind government taxation, theft, murder then become legitimate? However, surely if such a world was to come about we would still argue that people have the right to self-ownership and the right to the ownership of goods in their possession as first user or through voluntary transfer? Of course, a person might choose to submit to the yoke of government planning if it affords him a higher standard of living than that of the free market, but this is a different kettle of fish as the submission is then purely voluntary. On its own, however, any ability of a system other than the free market to sustain a society is insufficient as a justification to override private property rights.

Fourth, this brand of utilitarianism may convey a sense of prospective justice – that which should happen concerning property rights in the future – but what does it have to say about retrospective justice? In short, how does utilitarianism know whether the existing structure of property rights is just? After all, the existing structure of ownership benefits a lot of thieves and plunderers that would need to be dealt with in the transition from a statist to a libertarian society. A libertarian steeped in natural law and Lockean homesteading theory would answer this question rather straightforwardly. Any current owner would have to demonstrate that his title derives either from original appropriation or through voluntary transfers in title. If it is not and someone who claims such a title comes forward then ownership must be yielded to the latter. A utilitarian, however, has a bit of a problem as his philosophy generally focuses on the benefit changes to the existing array of property titles to the current market participants. He could argue that, like the natural lawyer, all existing titles to property could be examined against competing claims and then either endorsed or rectified accordingly. However, because his theory is based on the efficacy of the market in developing the division of labour his case for requiring this is demonstrably weakened. Certainly theft and plunder disrupted the efficiency of the market in the past. However, wouldn’t a mass of re-appropriations to rectify ancient crimes undermine the efficacy of the market today, at least temporarily? Would it not be easier, from the point of view of efficiency, to just preserve all existing titles then let everyone go forward? Why compound a past disruption to the market with a new one? It is upon this basis that this brand of utilitarianism is criticised for preserving the status quo, for permitting, in the transmission to a libertarian world, the bureaucratic class to keep their hands on the loot, much like the oligarchy did in Eastern Europe after the collapse of the Soviet Union. To be sure, this argument against utilitarianism is not, in the view of the present author, as strong as some libertarians make it out to be. Nevertheless, utilitarianism does open itself up to the charge that there comes a point where stolen property should remain in the hands of the thieves (or their heirs) simply because the act of unwinding the theft would cause more disruption to the market than to not to do so, particularly if the property is heavily invested in an enterprise that provides substantial employment and is apparently productive. Moreover, while it is straightforward enough to justify voluntary trade in the marketplace as promoting the division of labour and the standard of living, we have to wonder whether the utilitarian can provide much of a justification for original appropriation – that is, for the first user of a good to retain it – with his utilitarian arguments alone. Original appropriation is of course the genesis of voluntary trade – we appropriate virgin goods with the intent to produce with them and trade them away for things we want in exchange, thus helping to overcome the fact that the world’s resources are not evenly distributed amongst different geographic regions. However, such a justification can only stand if one can also demonstrate that the originally appropriated property is previously ownerless and unvalued by other people, and is only recognised as scarce and valuable by the first user. The only possible such demonstration is that the first user was the one to “mix his labour with it”, whereas the actions of everyone else demonstrated no preference for that property. Hence all utilitarian arguments in favour of the free market, fundamentally, collapse into the Lockean homesteading theory anyway.

Having addressed the question of whether this form of utilitarianism can be a useful moral underpinning for libertarianism, let us turn now to whether it is useful as a persuasive tool for espousing the virtues of a free society. In this sphere, utilitarianism certainly fares much better. The heaviest gun in the arsenal of the utilitarian libertarian is the fact that living in an unfettered free society where government exists, at most, as a “night watchman”, limited to protecting private property rights of the individual, will produce manifold increases in the standard of living through a rise in real wage rates. It also has the virtue, in contrast to the basic form of consequentialism, of concentrating its focus on the very institution that is an anathema to freedom – the government – instead of getting bogged down in the minutiae of individual cases. Squarely, it is government that needs to withdraw itself from the marketplace and it is government that needs to stop meddling in economic affairs in order to bring about these wonderful consequences. Furthermore, every government minister promotes his programmes on the basis that they will serve to help at least some sector of society, if not everybody. The utilitarian, however, armed with a thorough understanding of economics, can easily demonstrate why the results must always be the very opposite of those intended and why the government interference will always, necessarily, create more harm than good when examined under the terms of its own justification. While, therefore, a given politician or promoter may have ulterior motives in proposing any programme – such as to benefit lobbyists, donors or other special interests – his public justification for the programme can be shown as shambolic. There may, of course, be some difficulty in disabusing people of the notion that the free market is a “sink-or-swim” society and there is also added problem of those who steadfastly refuse to try their hand in the marketplace for what might seem like a distant reward and prefer instead to yield to the siren song of government redistribution. To this, only a passionate plea for the justice of the market place can provide an answer.


George Reisman explains how an understanding of the consequences of free market economics has “powerful implications for ethics”:

It demonstrates exhaustively that in a division-of-labor, capitalist society, one man’s gain is not another man’s loss, that, indeed, it is actually other men’s gain — especially in the case of the building of great fortunes. In sum, economics demonstrates that the rational self-interests of all men are harmonious. In so doing, economics raises a leading voice against the traditional ethics of altruism and self-sacrifice. It presents society — a division-of-labor, capitalist society — not as an entity over and above the individual, to which he must sacrifice his interests, but as an indispensable means within which the individual can fulfill the ultimate ends of his own personal life and happiness.

A knowledge of economics is indispensable for anyone who seeks to understand his own place in the modern world and that of others. It is a powerful antidote to unfounded feelings of being the victim or perpetrator of “exploitation” and to all feelings of “alienation” based on the belief that the economic world is immoral, purposeless, or chaotic. Such unfounded feelings rest on an ignorance of economics.10

While, therefore, we must conclude that no form of utilitarianism provides an adequate, watertight moral backbone for libertarianism, which can only be furnished by demonstrating the justice inherent in private property rights and free exchange, we must also agree that we can never ignore the manifold benefits to every individual and the harmonious society that they create. Indeed, few people, publically, ever attempt to propose an ethical theory that does not create a society of peace and harmony. Thus a through understanding of the effects of the free market can provide a framework with which to refute competing theories on their own terms. Furthermore, few deontological libertarians omit to pepper their theories with demonstrations of the beneficial consequences of the marketplace. While, therefore, this essay has been generally critical of utilitarianism it is likely that it will always have a central place in libertarian theory.

1Reprinted in “Economic Controversies”, pp. 289-333. Rothbard is, however, keen to note that his reconstruction does not provide any plea for an ethical system, merely “conclusions to the framer of ethical judgments as part of the data for his ethical system”.

2Another example is the so-called runaway train that will hit five people if diverted onto one track or only one if diverted onto the second. Should the signalman switch the points to the second track to ensure that only the one person is killed?

3Walter Block, Ethics, Efficiency, Coasian Property Rights and Psychic Income: A Reply To Demsetz, The Review of Austrian Economics, Vol.8, No. 2 (1995) 61-125, at 76-84 (emphasis added, some footnotes omitted.

4Libertarian jurisprudence does, of course, have to determine precisely which physical acts result in which property rights. However, any difficulty is likely to remain only in borderline cases or cases where evidence of prior ownership is fleeting or difficult to apprehend and, in general, all persons should be able to determine in the majority of situations whether property is subject to a prior right and a third party referee would not be required to determine this.

5As a result it is also the case that consequentialists vary in their particular views concerning the justice of taxation, eminent domain, intellectual property, etc. on to a greater degree than rule-based libertarians.

6Ironically, the same argument based on interpersonal utility comparisons – that the wealthy value what they have less than the poor and that the latter “need” this wealth more than the rich do – is used by proponents of government welfare and redistribution. It is difficult to understand how an argument that can be used against a world of liberty can be used in favour of it.

7Ludwig von Mises, Human Action: A Treatise on Economics, p.676.

8It is upon this foundation that Mises’ examination of concrete economic policies, where he moves from the wertfrei into the world of value judgments – the effectiveness of the policies themselves from the point of view of those who promote them – is  based.

9Because the incessant tendency is now reaching a chronic level the ability to postpone the day of reckoning has become ever more difficult and most of the more recent glory-seekers are now living to reap what they sow. Former Federal Reserve Chairman Alan Greenspan is a pertinent example.

10George Reisman, Capitalism: A Treatise on Economics, p. 17.


Economic Myths #15 – Unemployment

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One of the key indicators of the economic “performance” of any given country is its rate of unemployment. Low rates of unemployment are understood as a sign of prosperity while high rates are taken as a sign of recession and stagnation. Indeed, during the Great Depression, unemployment reached as high as 25% in the United States. Politicians are particularly keen to monitor the rate of unemployment as low unemployment lends credence to the economic policies of those in power while high unemployment stocks the arsenal of those in the opposition. Given also that entire economic dogmas such as the so-called trade-off between full employment and inflation, not to mention the generation-long post-war Keynesian consensus are, at least, part rooted in the concept of unemployment, one would expect unemployment to be a unique and important category in economic theory.

This short essay will not explore in detail the government induced causes or aggravations of unemployment such as the minimum wage and excessive regulations heaped upon the shoulders of employers. Such topics have been examined countless times over by many economists, “Austrian” or otherwise. Rather, what we wish to concentrate on here is the validity of the very term “unemployment” itself and to determine whether it is really a useful concept in shaping so-called “economic policy” or whether it is really redundant and meaningless.

In the first place, as “Austrians” we must be highly suspicious of any concept that is an aggregation and is not explicitly linked to any notion of individual human action. All voluntary actions are, as we know, the result of the best choice of ends available with scarce means. A man who has several million pounds stashed in his bank account may be content to spend all of his time in leisure and would be “unemployed”. Yet aside from any moral wrangling over the worth of such a lifestyle we would hardly view this as a problem. But what about those lesser privileged folk – the ones who are not working but nevertheless have the outward appearance of needing an income from some kind of employment? Shouldn’t we classify these people as “unemployed” and doesn’t this state of unemployment indicate an egregious case of market failure?

The question turns on whether employment at the terms of the available opportunities is worthwhile for the individual person. If there are jobs available yet he refuses to accept them then it indicates that he is not satisfied with the terms of those opportunities. Perhaps it is the wrong industry, it is in wrong the place, or – most likely – the wage offered isn’t high enough for him. He therefore chooses to abstain and holds out for a better opportunity to appear in the future. From the point of view of individual satisfaction with the scarce means available, the outcome of seeming “unemployment” is therefore optimal. Indeed, labour, like anything else, is a resource that is available for an individual to use. Not all resources are deployed 100% of the time as it would be wasteful to do so. Everyone, for example, owns possessions that are not being used at the current moment – food in the fridge, clothes in the wardrobe, books and DVDs on the shelf, etc. Clearly it would be wasteful – nay, ridiculous – to try and use all of these “unemployed” resources at once. They are more valuable being kept in abeyance ready for utilisation when an opportune moment appears, i.e. when the person believes that use of them would yield more benefit than leaving them idle. More widely, there are always buildings to let, oil in the ground, trees that are left standing, water in lakes and reservoirs, and so on. All of these resources remain idle because an opportunity valuable enough for deploying them has not yet arisen. Indeed, consistent requirement for all resources to be utilised would mean that shops should be empty of all goods as they have already been purchased and consumed, and ultimately everything in the world should be consumed right now. To put it at its most basic, a person actively searching for the right job is not, in his mind, unemployed in the sense of carrying out a wasteful activity.

The inability to see labour as a resource that is deployed at the choosing of the individual labourer leads to many related fallacies and reveals the dangers of looking only at surface phenomena and appearance. An individual does not view employment as an end itself – work for work’s sake. Rather, all employment is action aimed at diverting scarce means available to their most highly valued ends. Employment per se is not a goal or achievement. No one would dig a hole in the ground and fill it up again unless the act of doing so led to a valuable end. Governments and people succumb to the illusion of economic activity brought about by “employment” and the apparent lack of it by “unemployment”, with any focus on providing “full employment” never stopping to ask whether the activity in which employment will be created is worthwhile or is wasteful. The most grievous example of this this is, of course, the forced lowering of interest rates to provoke an artificial investment boom. There will be lots of employment, everyone will be engaged in lots of activity and wages will be rising rapidly. But it is clear that everyone’s endeavours are ultimately wasteful and lie on a doomed path. So-called full employment policies are therefore nothing more than a surface coating to prevent social unrest, to make people feel as though they are doing something worthwhile and to put money into their hands that they can spend. To the extent that these actions create no new wealth, however, they should properly be regarded as welfare and not as employment. The wheels may be turning but the carriage goes nowhere and it is simply expending fuel on motionless activity. Far more difficult would be for governments to concentrate on policies that promote full production instead of full employment as this would, of course, require a dramatic reduction in the size and scope of government power and interference.

We submit, therefore, that unemployment is a meaningless concept at least when applied to the unfettered free market. It may have some relevance in economies where governments impede the ability of the supply of labour to meet demand through minimum wages and the like. Apart from shutting out a good number of low-productive persons from the labour market entirely, such interferences ultimately distort people’s views as to which terms of employment are achievable – they hold out for high wages because there is the illusion that that is what their labour is worth. They do not realise, however, that supply is unwilling to meet demand at that inflated level and hence their search for employment is in vain. All of this, however, is simply a particular application of price theory. If the price of any good is fixed too high it will remain unemployed. There is, therefore, no special concept of unemployment applying only to labour that attracts a different body of theory. Furthermore, the whole question of “nominal rigidity” or so-called “sticky wages” is beside the point when it comes to economic theory. If the demand for a particular good – in this case, labour – should drop it is entirely open for the particular labourers to express incredulity at this fact and to stubbornly hold out for wages that will never meet a willing demand. This is not, however, evidence of the market’s “failure to clear”. It is simply that the supply curve remains stuck to the left. There is an misconception that the market is “efficient” because it “values” everything correctly – a doctrine that underpins so-called “efficient market hypothesis”. But the “efficiency” of the market – the  nexus of voluntary exchanges between individual people – comes from its superior ability to channel goods to where they are most highly valued; it has nothing to do with whether a good should be valued or whether any particular valuation is correct. A good could be utterly useless but if a significant enough people chase a small supply it will command a relatively high price. The market will place this ware in the hands of those who value it the most, but the source of that value is the human mind and this valuation can be and often is erroneous. If people remain unemployed, holding out for unrealistically high wages, the fault lies in their incorrect assessment of the value of their labour, not in any market’s failure. Needless to say, however, the causes of these erroneous valuations are government interferences. It is because government creates such macroeconomic calamity that price bubbles and collapses occur and so-called “sticky prices” are a phenomenon associated with post-boom deflations. Having become accustomed to high wages, it is natural for workers to become frustrated and resistant when supply for these wages suddenly dries up and they not only have to face the prospect of lower wages but also a mass shift out of the capital goods industries – where they may have developed significant, specialist skills in the meantime – to consumer goods industries. In a genuine free market it is highly unlikely that workers would be faced with these problems. However, none of this really has much to do with economic theory, the purpose of which is to expound the formal characteristics of human action rather than the substance of those actions. Rather, sticky wages is more a topic for psychology, the field of human action that studies why people make the valuations that they do.

We conclude, therefore, by emphasising that there is no special category of “unemployment” as it applies solely to labour. Any “unemployment” of labour is explained either as the willing choice of the individual worker to withhold his labour from the market (and thus, to him, the best possible outcome), or as the result of government price fixing which is merely a particular instance of the economic effects of that wider category of interference.

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Austro-Libertarianism – Three Next Steps

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Austro-libertarianism undoubtedly has a long history of scholarship of which it can proudly exemplify as not only providing a coherent body of truthful insights into the way in which the world really works, but also provides a foundation for a just and prosperous society.

However, far from resting on any laurels (and I doubt any scholar in this tradition would ever believe that we are at the stage where we can do such a thing), this essay will suggest three areas of development to which scholars in the Austro-libertarian tradition may wish to focus their research.

Pure Praxeology

The first area is to reconceive “Austrian” economics as a pure (or at least “purer” theory) of praxeology. Although “Austrian” economics is noted for deriving its laws from the theory of individual human action, economics traditionally – not least because concepts such as exchange, production, prices, money, and so on are the complex phenomena that we wish to study and understand the nature of – concentrates only on action above the level of the bilateral exchange of wares for a money income. Our economic categorisations and concepts therefore rest on that limitation. “Austrian” treatises, although they begin quite properly by explaining how economic theory is derived from the action axiom (together also with extremely useful chapters on unilateral or “Robinson Crusoe” exchange), soon begin to espouse their theories in terms of these more aggregative concepts, only occasionally returning to individual action in order to emphasise a particular point1.

A simple example to illustrate this point is the economist’s approach to the classification of goods. A “consumer good” is one that is purchased by a consumer for money without any further sale for money expected. Bread, for example, is treated as a consumer good because it generally goes through no further monetary exchange prior to being consumed. At the individual level, however, the bread may only be a capital good in making, say, a sandwich. Labour is combined with the bread and other goods – say cheese and tomatoes – in order to produce the final consumer good of a cheese and tomato sandwich. We can say the same thing about cutlery and crockery, paper and ink and so on. All of these goods are used at the level below that of exchange for money by individuals to produce further goods. “Land”, on the other hand, is treated as the natural resources which are a gift to all humans, not just an individual human being. However, a good produced by another human being may, to the individual who happens to stumble upon it, comprise “land” in the sense that it is a free gift to him and that he has not had to exert any productive effort in order to bring it into the condition in which he finds it. If, for example, I find an abandoned car in perfect working order and (assuming there are no competing ownership claims), even though the car is a produced good, as far as my action and my computation of costs and benefits towards that action goes, the car is a gift of nature and is in exactly the same condition as, say, a tree that has grown naturally.

It is easy to see why any loss of the connection to individual action can quickly lead economists in the “Austrian” tradition and their fellow travellers down wrong paths. Murray N Rothbard provides an extensive critique of W H Hutt’s aggregative concept of “consumer sovereignty” – the idea that all consumers are sovereign over producers and that the latter exist only for the benefit of the former and not for themselves2. The market place is where everybody seeks to benefit himself through voluntary exchange, and there is not, in fact, a distinct class of labourers, of producers and of consumers with one being “sovereign” over the other. Rather, everybody at differing points of the day (even from minute to minute) participates in a different economic category – a man is a labourer when he goes to work; he is a consumer when he stops by at the shop on his way home; he is a capitalist if he purchases some shares for his pension, and so on. Questions of “sovereignty” – the boundaries of rule – concern only the political arena. Concentration on the basis of economic law in individual human action would have avoided any fallacy and prevented a resort to parcel phenomena into homogenous, collective blocks. However, Rothbard hardly escapes the same danger to which Hutt succumbed, building his entire theory of production using the economic fiction of the Evenly Rotating Economy (ERE), an economy in which all economic activity is repeated and known. Thus, entrepreneurial profit and loss is eliminated. This model allows (or, perhaps, forces) Rothbard to conclude that capital goods earn no net rents and that all rents are paid back to the original factors of production – land and labour – a theme that is oft repeated throughout his entire treatise. It is submitted here, however, that regardless of how such an approach may be helpful in illustrating the complexity of the structure of production, any firm or even implied conclusions drawn from it are likely to be grossly misleading and can only lead to error. The most dangerous false step from this presentation is to assume that the ownership of land – as an original factor – provides essentially free income to those who happen to hold it. Needless to say Rothbard takes great pains to rebut this conclusion, but his attempt could be condensed, with a slight modification, to a single paragraph:

As the only income to ground land that is not profit or interest, we are left with the original gains to the first finder of land. But, here again, there is capitalization and not a pure gain. Pioneering—finding new land, i.e., new natural resources—is a business like any other. Investing in it takes capital, labor, and entrepreneurial ability. The expected rents of finding and using are taken into account when the investments and expenses of exploration and shaping into use are made. Therefore, these gains are also capitalized backward in the original investment, and the tendency will be for them too to be the usual interest return on the investment. Deviations from this return will constitute entrepreneurial profits and losses. Therefore, we conclude that there is practically nothing unique about incomes from ground land and that all net income in the productive system goes to wages, to interest, and to profit3.

The correct position, therefore, is that “things” do not “earn” anything. All actions, whether they involve the dispensation of labour, land or capital goods, require the sacrifice of one state of affairs (“costs”) in the pursuit of another state of affairs. It is hoped that the ends brought about are more valuable than the ends given up. The creation of this value if the action is successful (or its destruction if it is not) is the product of entrepreneurial judgment. All income from any action is therefore paid out to cover costs, interest or entrepreneurial profit and loss. All net rents in the economy accrue only to this latter element – successful entrepreneurial judgment with the means at one’s disposal, whether this is your labour, land that you own, or a capital good that you hold. All of these things that can be bought or sold for more or less money than is sufficient to cover their costs plus interest. It is only by remaining firmly anchored to action at the individual level that this realisation can remain in focus4.

Coupled with this endeavour of better preserving the link between the complex phenomena in the economy with individual action is a greater emphasis on “Austrian” methodology not as a separate topic but one to be espoused during the course of the treatise. The reason for this is that a “vulgar” conception of “Austrianism” would state that all economic theory and all of the laws of economics are deduced logically from the action axiom and one or two subsidiary axioms. Truths derived empirically have little or no place in “Austrian” economics. This is not, however, altogether true. Only the core theory concerning the action axiom and its immediately related categories, in addition to some of the more fundamental laws (such as the law of marginal utility) are deduced logically. However, there is a great body of “Austrian” economic law that requires the ascertainment of empirical facts. We cannot, for example, derive economic laws of bilateral exchange without ascertaining the existence of more than one human being, an endeavour which any individual cannot simply deduce. We cannot have an “Austrian” approach to the economic effects of taxation unless one group of persons had, in fact, attempted to tax another group. We cannot have an “Austrian” business cycle theory without first assuming the existence of banks, the practice of fractional reserve banking, a loan market and even money itself must be presupposed. Although the regression theorem, for instance, is a valid praxeological law5, it would only exist if we first of all knew that money existed and that people had chosen to use a good as a general medium of exchange. Now it is true, of course, that these laws would remain valid and true even if the substantive human choices upon which they rely had not been made. If we imagined a world without money, for example, and pondered its existence merely as a hypothetical we could still derive “Austrian” laws concerning it without it ever actually existing. The actual phenomena in existence simply direct our interest to them as those are the areas that matter in our lives and hence are the things we wish to study and understand. No doubt it is also quite impossible to try and “imagine” alternative institutions and choices that have never existed and to apply to them the core “Austrian” theory, especially as our own experience of real concepts such as money, exchange, prices, banking and so on often provides an illustrative tool to our theoretical insights. However, it is more accurate to speak of the entire endeavour of “Austrian” economics not solely as a body of economic law that is deduced logically, but as the application of the core theory, deduced from the action axiom, to the substantive institutional choices that humans have made, the existence of which is verified empirically6. More prominent highlighting of the “Austrian” method and the source of each parcel of knowledge during the course of a treatise would aid greatly any misunderstanding in this regard.


The second area of fertile development in “Austro-libertarianism” is the necessity to sever or more sharply delineate the relationship, often casually assumed not only in political philosophy but also in the opinions of lay persons, between legal norms and moral norms. That is, the question of what should be legal – in other words, those norms which may be enforced by the imposition of violence – should be separated from the question of what is good, worthy or preferable. It is submitted that this is one of the greatest barriers to a proper understanding of the role of violence in interpersonal morality, and has been dealt with in detail by the present author here, here and here. Many people happily recognise the illegitimacy of the legal (violent) enforcement against themselves of norms that other people value as moral ends which, as the hapless victims of this enforcement, they themselves do not (or at the very least, they would complain about it). But, because of the prevalence of the legitimising effect of democracy and the blurring of any distinct line between the governors and the governed, most would not think twice to advocacy of the legal (violent) enforcement of ends that they deem good against other people. Indeed, the criterion for what should be legally enforced boils down to little more than what most people think should be legally enforced. Libertarians need to create an understanding that the proper role of violent enforcement is restricted to preserving the physical integrity of each individual’s person and property – and as moral agency requires such integrity in order for a person to choose and act, such an insight is crucial for any proper understanding of interpersonal morality. The examination of whether something is bad, unpleasant or a vice must be separated from the question of whether its prevention should be enforced legally; and, equally and oppositely, the examination of that which should be peacefully permitted by the law should be separated from the question of whether such acts are good and noble things. In addition to aiding moral and political philosophy, this would be of a benefit to libertarianism specifically as it would render inert the perceived support for all of those bad and unpleasant things – drugs, prostitution, gambling, blackmail, and so on – which are non-violent but are nevertheless not necessarily things that we would wish to see in our society7.


The final area for development in Austro-libertarianism, this time in the field of economic history and anthropology, is to engage in a rigorous study of the effects of inflation and inflationism throughout history. “Austrian” scholars have certainly charted well the purely economic effects but, in the opinion of the present author, an exhaustive study of the social, cultural, political, and aesthetic effects of inflation is yet to be written, at least in the “Austrian” tradition. As Henry Hazlitt notes:

[Inflation]…discourages all prudence and thrift. It encourages squandering, gambling, reckless waste of all kinds. It often makes it more profitable to speculate than to produce. It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls. It ends invariably in bitter disillusion and collapse8.

Apart from the wide “macro” effects of inflation – not least of which include the birth of odious ideological movements and regimes and their ability to fund wars and conflict – also of interest is how inflation effects us at the individual level. For example, how many of our day-to-day products that we enjoy today are the result of genuine development by a capitalist economy and how many are simply substitutes developed in an era of inflation to enable people to attempt to salvage some of their previous standard of living? Products such as instant coffee, condensed milk; synthetic clothing; plastic bottles; and so on. How many genuine labour saving products were developed not because people genuinely wanted to save time but because inflation had either reduced their income to such a degree that time came at a premium or because inflation had induced impatience and a present-oriented fervour? Indeed the latter may have had distinct ramifications beyond the economic – the birth of adolescence as a distinct demographic; the sexualisation of society; the preference for entertainment ahead of learning; the attraction to style rather than to substance; the prominence of sound bites and “tweets” rather than in-depth analysis; the emphasis on youth and adaptability to an ever changing world rather than on age and accumulated wisdom. All of these things have significant consequences for which inflation much at least be partly responsible. Further, how much does inflation distort our views of reality and of what is possible? Inflation, as Hazlitt noted, makes speculation rather than production profitable – the image of productivity and wealth creation rather than the very thing itself. It makes big or easy wins more attractive than patient investment in a lifelong endeavour. But at the extreme we might say that we have attempted to replace reality itself with dreamed ideals. Government, has taken over and replaced real money (gold and silver) with a fake paper counterfeit. Having replaced reality with one form of fakery, we expect government to be able to legislate to replace reality with our pseudo visions, to carry out the miracle of transforming stones into bread. Thomas Nast’s cartoon, Milk Tickets for Babies in Place of Milk (below), concerning the inflation during the American Civil War, perhaps captures the foundation of this mindset in artistic form. The cartoon contains representations of reality that are passed off, for example, by Acts of Congress as reality itself. As English professor Paul A Cantor explains:

Nast’s illustration brilliantly captures [the confusion of] things with representations of things. Like Magritte [in the painting The Treachery of Images], Nast reminds us that a picture of a cow is not actually a cow, but he is not making a merely aesthetic statement. He is drawing a more serious analogy between the duplicity involved in artistic representation and the duplicity involved in the government printing money and forcibly establishing it as legal tender, an analogy embodied in the parallel “This is a Cow By Act of the Artist” and “This is Money by the Act of Congress”9.

Given that “Austrians” lead in the way in a providing a genuine understanding of the definition and effects of inflation it would be appropriate for an historian versed in “Austrian” theory to undertake a full study along the lines that we have suggested here.

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1It is also the case that most “Austrian” scholars writing today received their initial education in the mainstream economics tradition and only later “turned” to “Austrianism”. Thus one senses a tendency, if not a persistency, to lapse into the comfort of aggregative and pseudo-concepts, at best obscuring the essential connection to individual human action, and at worst completely losing it and ending up in the rhetoric of collectivist and societal-oriented action.

2Murray N Rothbard, Man, Economy and State with Power & Market, p. 631-6

3Ibid., p.530, emphasis added.

4The present author is not enthusiastic about the excessive use of equilibrium constructs and they should, at the most, be used as a tool in order to distinguish one concept from another, an endeavour that would be impossible without such a construct. Nevertheless, it is possible that a dynamic equilibrium – a fiction in which there is change and entrepreneurial profit and loss but where all forecasts of the particular entrepreneur in the model are correct – together with a focus on the costs of land acquisition and of the dispensation of labour would have created a better illustration than the ERE. But whatever model is used, it is submitted that the illustration of every stage of production, whether it is with land, labour or capital, necessitates the elements of costs, interest and entrepreneurial judgment and that, contra to Rothbard’s assertion that the mental construction of the ERE is necessary in explaining the structure of production, a much clearer grasp of reality can be and, indeed, is attained without omitting any of the crucial elements.

5Although this is disputed. See Gary North, The Regression Theorem as Conjectural History, Ch. 7 in Jörg Guido Hülsmann (ed.), The Theory of Money and Fiduciary Media – Essays in Celelbration of the Centennial.

6If anyone should doubt this and remain steadfastly wedded to the idea that “all” of “Austrian” economics is deduced logically this then he should attempt to present an “Austrian” treatise written in formal logic.

7The present author has dealt with the so-called “thick” or “thin” libertarian debate here.

8Henry Hazlitt, Economics in One Lesson, p.157.

9Paul A Cantor, Hyperinflation and Hyperreality: Thomas Mann in Light of Austrian Economics, The Review of Austrian Economics, Vol. 7, No. 1 (1994), 3-29.


“Austrian” Business Cycle Theory and the Rate of Interest

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In an earlier essay, the present author explained “Austrian” Business Cycle Theory (ABCT) as an analogy to basic price theory, namely the specific law that a price ceiling for a specific good will lead to a shortage of that good. Here we will build on this analogy with an elaboration of what is meant by “the interest rate” with an additional emphasis that stresses the mismatch between the rate of saving and the rate of investing.

The reason for this new elaboration is that ABCT typically concentrates on “the rate of interest”, explaining the business cycle as an effect of “the market rate” of interest falling below “the natural rate”. This has opened “Austrians” up for criticism because any adherence to the pure time preference theory of interest runs into the problem of there being many “natural” rates for different capital goods and so we never know precisely which rate it is that is being undercut by credit expansion1. Moreover we might as well also point out that different borrowers pay a multiplicity of interest rates and that is dependent upon their specific contract so there is no, single “uniform” rate paid by every borrower.

What will be demonstrated here is that, while ABCT’s emphasis on interest rates is valid and is necessary to explain why particularly lengthier, roundabout projects will be engaged in, the most important aspect is that credit expansion simply permits borrowers to access funds for durations that lenders are not willing to lend for and it is this lack of harmony – made clear by our analogy to the results of price fixing – that is the key to unlocking the business cycle.

Robinson Crusoe Economics

In the situation where we have a lone human being (who, for argument’s sake, we shall call John), the fact of scarcity results in the necessity for John to choose which ends he will pursue and which he will discard. There are costs and benefits related to everything he does – such are the logical implications of the action axiom – but exchange of these costs and benefits is unilateral. If John decides to pick apples instead of picking oranges, the benefit he derives from picking apples comes at the cost of picking oranges. He cannot pursue both ends – he therefore exchanges picking oranges for picking apples, albeit unilaterally and in his own mind. This is the nature of basic, simple choices between presently available goods and services.

If John wishes to increase his consumption by investing in capital goods he must also make an exchange, but an exchange of a different nature. At any one moment John will have an array of resources available to him. His basic choice over these resources is whether to consume them now or to invest them to yield consumer goods in the future. It is plainly clear that John cannot do both at the same time – he cannot consume resources and invest them. If he wishes to invest the resources in a capital project that will yield consumer goods in one year’s time then he must be prepared to abstain from the consumption of the resources that he will invest in that project for one year’s time. If the period of investment will be two years then he must be prepared to abstain from consumption for two years, and so on. The precise length of time for which he will abstain from consumption and engage in investment is determined by his relative weighting of the value of time against the value of the quantity of consumer goods yielded – if the quantity of future consumer goods is more valuable to him than the waiting time then he will invest, wait and then enjoy the larger quantity of consumer goods when the investment project reaches its completion; if time is more valuable to him than the additional quantity of future goods then he will not invest but consume the lower available quantity of goods now. The result of such a valuation is summarised simply by the term “time preference”.

Is it possible for John, in his lonely world, to experience the unilateral equivalent of boom and bust? Will he experience a sudden spurt of investment followed by a downturn in his investment activity? The answer is yes, he could, because his capacity to keep on investing is connected solely to his willingness to carry on with the abstinence from consumption of the resources that are required for the investment project to come to fruition. If, half way through his investment project, he changes his mind and his desire for consumption increases so that he must divert resources away from the investment project then he will experience something of a bust – the project must now be liquidated as it has been starved of resources for completion. The viability of the investment project is wholly dependent upon his willingness to abstain from consumption and invest those resources that he could have consumed. The investment therefore turns out to be a malinvestment, unconnected to his consumption/waiting preferences as they are now revealed to be.

Bilateral Exchange

In an economy of more than one person, exchange of a simple good is now bilateral rather than unilateral but it is still based upon the same principles. We make a choice of what to receive in exchange and what to give in exchange. Normally, of course, we give money in exchange rather than a concrete good but we can think of the real cost as being other goods that the money could have bought. If, for example, I only have enough money to buy an apple or an orange and I choose to buy the apple, the cost of me buying the apple is the orange which I could have bought had I not purchased the apple. We can say that I exchanged the orange for the apple, even though the actual physical exchange involved not the orange but, rather, the money that could have been used to purchase it. It is clear, moreover, that I cannot have both the apple and the orange at the same time – or both the apple and the money used to buy it at the same time. I must choose between them because of the eternal condition of scarcity. Only an increase in wealth can alleviate this so that a person is in a position to be able to afford both an apple and an orange.

The market price of a good is the price at which the quantity of the good demanded is equal to the quantity supplied – in other words, it is the price where the number of willing buyers is equal to the number of willing sellers, the level where those who wish to give up in exchange equals the number of those who wish to receive. There is, therefore, not only a harmony of interests at the market price but also the market price regulates the amount of consumption of a certain good that is sustainable by the current level of wealth. Attempts at price controls interfere drastically with this harmony. Artificially lowering the price of, say apples, may, on paper, make it appear as though one now has enough money to buy both an apple and an orange rather than just an apple. The problem, however, is that at the new, sub-market price for apples, the number of willing buyers exceeds the number of willing sellers; the shrunk supply will be bought rapidly by the swollen demand and, therefore, shortages will ensue and there will be no apples left anywhere. This much is standard economic theory. What we can note, however, is that price controls are solely an attempt to allow people to have their cake and eat it – that, whereas at the market price, they could only afford an apple or an orange, the fixed, low price attempts to give them the ability to afford both the apple and the orange at the same time but without any corresponding increase in wealth. On our Robinson Crusoe island we noted that John could not enjoy apples and oranges at the same time because his wealth was insufficient to do this. Any attempt to do so would be at variance with reality and he would end up having to choose between them anyway. Exactly the same law operates in bilateral exchange. Simply trying to forcibly change the prices that emerge in bilateral exchange cannot defy reality and the whole scheme collapses precisely because the objective of providing more and cheaper goods cannot be sustained – you cannot have more of something without increasing wealth. People will find that all of the apples are gone and all that will be left is oranges so they are in the same position as before with only one fruit being available to them, except now without a choice of one or the other. Sustainable trade cannot exist under terms where the suppliers are not willing to offer goods for sale to the demanders.

A further feature of general buying and selling that we might note for our comparison with lending and borrowing that we shall explore in a moment is that every buyer pays the same price as every other buyer and every seller sells for the same price as every other seller. One buyer’s dollars are as good as any other’s and one seller’s good is interchangeable with another’s. In other words, except in cases where there is favouritism or prejudice for the individual personalities, there is insufficient qualitative difference between the different buyers and sellers to make an impact upon price.

Bilateral Investment

On our Robinson Crusoe island we noted that if John wished to increase his consumption in the future he had to abstain from the consumption of resources today in order to use them in investment projects that will yield consumer goods in the future. John’s level of investment was precisely correlated with the amount that he refused to consume and channelled into his project.

In the complex economy, where the abstinence (or saving) on the one hand and the investment on the other is carried out by different people the transaction is effected through the market for lending and borrowing. The market for money loans is actually little different from the sale and purchase of ordinary goods, except that what is being traded and at which prices is a little more difficult to understand. Specifically, what is being traded is not a hard good such as an apple or an orange; rather, it is the purchasing power over resources. A lender, in making a loan to a borrower, transfers his purchasing power over resources today in exchange for the borrower transferring an (at least nominally) higher purchasing power over resources at a point in the future. The market price for these loans – that is, the rate of interest that the borrower pays – is the price at which all willing lenders would be able to lend to all willing borrowers.

There are several key aspects of this market that must be highlighted. First, all loans contracts are for a specific duration which, for argument’s sake, we will say is three years. The lender here must be prepared to sacrifice his purchasing power over resources for three years. During this time, the borrower will use the resources purchased for his investment and will arrange himself to be in a position to transfer back purchasing power in three years’ time. More specifically, what this means is that the lender gives up his power to consume the resources that his purchasing power would afford him and transfers them to a person who wishes to invest them for a three year period that will yield consumer goods at the end of that period, thus earning him an income and the wherewithal to transfer back the purchasing power to the lender. This is the fuel of sustainable growth because the lender relinquishes consumption for exactly the same period as the borrower engages in investment. The basic theory is therefore nothing different from John on the Robinson Crusoe island. Just as John had to abstain from consumption for the duration of his investment project, so too must the lender be prepared to do the same so that the borrower’s project can be completed.

One notable difference of this market when compared to the market for simple, present goods, is that the rate of interest paid by different borrowers will be different rather than uniform for all borrowers. This is because the business of lending money contains an entrepreneurial element. The borrower is making a business decision that his investment will accrue enough income to enable him to pay back the capital and the interest. The lender, wishing to maximise the chance that he will receive his money back, shares this entrepreneurial burden and hence adjusts the rate of interest he charges to different borrowers. The riskiest borrowers – those whose entrepreneurial efforts appear the least likely to succeed – will pay higher rates of interest than the less risky borrowers. There are two possible ways of analysing this. Either we can say that there exists a single market for money loans which, all else being equal, every borrower would pay the same “core” interest rate determined by supply and demand for loanable funds with the difference between the actual rates constituting an entrepreneurial profit and loss element for the lender. Or, we could suggest that the qualitative difference between borrowers creates distinct markets for different categories of lending that attract different rates. In the markets for lending that contain the least risky borrowers the supply of loanable funds will be relatively high so interest charges will be low; in the markets with the most risky borrowers, however, supply will be relatively lower to demand resulting in higher interest charges to these borrowers. We shall use both analyses below although we will conclude with a preference for the latter – that of distinct markets that attract different rates. However, the most important fact that we need to concentrate on is that, whichever analysis we use, all lenders are prepared to fund all borrowers’ enterprises for the duration of their projects under whatever interest rate is agreed and hence these projects can be fully funded to completion.

The fact that the exchange between borrowers and lenders is facilitated by an intermediary – usually a bank – makes little difference to this situation. The bank simply borrows from the lender (or “saver”) at a certain rate and lends to the borrower at a slightly higher rate, the difference between the rates compensating the bank for its efforts in channelling the savings of ordinary people into the profitable projects of borrowers. The key aspect, again, is that there are real funds that can fuel all projects through to their completion under the terms agreed.

Credit Expansion

In order to understand the effects of credit expansion, let us first of all posit the case where a direct lender creates a mismatch with a borrower. Let’s say that a lender is prepared to lend for three years whereas the borrower thinks (erroneously) that he is borrowing for five years. The borrower’s project takes five years to complete and he needs purchasing power over resources for five years as his project will not earn an income to transfer back that purchasing power before five years is up. If, after three years, the lender, wishing to take back his purchasing power for present consumption, calls in the loan the borrower will have a shock. His project is only 3/5ths complete. Only two options are possible. Either the lender must change his priorities and save for the full duration of the investment project; or the borrower must liquidate the investment in order to pay back the lender2. If the latter option is necessary then we have a mini boom-bust between these two individuals; the investment is revealed to be a malinvestment as the borrower was not willing to lend purchasing power over resources for a time sufficient to complete the investment project. In order to create a sustainable investment project the lender must be prepared to advance purchasing power to the borrower for the full duration of the project. If he is not then the project cannot continue.

Now let us examine what happens when an intermediary bank engages in credit expansion and brings about effectively the same thing. The borrower is now a depositor of the bank and the borrower borrows from the bank rather than directly from the lender. Above we cited two possible analyses of the loan market – either there is a “core” rate of interest governed by supply and demand for loanable funds with individual variations in loan contracts representing the entrepreneurial risk that the lender takes; or, there are distinct markets for different types of loan, each of which attracts a different rate. We will use both analyses here.

On the eve of the credit expansion all willing lenders will have lent, through the bank, to all willing borrowers at whatever terms in the individual contracts. The willing lenders will be prepared to lend the funds for exactly the duration of the loans of the willing borrowers. Let us call these fulfilled borrowers Group A. When the bank expands credit, however, it gives the impression to unfulfilled borrowers – let’s call them Group B – that the supply of loanable funds has expanded. Under the first analysis, if the supply of funds expands then the “core” interest rate will reduce as the fresh funds have to find new, willing borrowers as those who were prepared to pay the highest charges have already been loaned to. This brings down the total amount of interest (“core” interest +/- the entrepreneurial charge) that Group B borrowers pay. Before credit expansion a core interest charge of (for example) 10% plus an entrepreneurial element of 5% would have given a Group B borrower a total interest charge of 15%, which may have been too high for him to take out a loan. Now, however, if the effects of credit expansion reduce the “core” interest charge to 5% leaving the entrepreneurial element unchanged then the total rate payable will be 10%, at which rate he may become a willing borrower. Hence the number of willing borrowers begins to expand. Under the second analysis, where there are distinct markets for different loans to different categories of borrower, expanding the volume of credit will expand the number of markets to which funds can be lent. As all of the Group A markets are fully lent to the new funds must seek out new, unfulfilled markets in Group B. This has the effect of bringing down the individual interest rates in these markets. Before credit expansion, the interest rate in these markets was infinitely high as supply in these markets was zero. Now, credit expansion has created supply that moves into these markets and depresses the interest rate to a level at it may reach demand. Hence loans will start to be made in these new markets.

To the present author, the second analysis seems preferential for visualising clearly the reconciliation between ABCT with the multiplicity of interest rates that are paid by borrowers. Indeed, while separating out the “core” rate from the entrepreneurial rate may be easy to conceptualise to a degree3, the idea of lowering rates is less straightforward to perceive when we think of the market as a unified whole. Conceiving them as separate rates in distinct markets which are individually depressed by credit expansion removes this conceptual difficulty4.

Under both analyses however, we can see that increased credit expansion leads to loans at rates that are lower than those that would be paid on the unhampered market. It is important to realise, though, that the contracted interest rates paid by borrowers in Group B – the new borrowers – may actually be higher than the rates paid by Group A. What we may observe is new borrowers in Group B paying what appear to be increasingly higher rates rather than increasingly lower rates. But the crucial point for ABCT is that the rates paid by Group B are lower than those that they would pay on the unhampered market. Such rates do not have to be lower than Groups A’s and thus it is still true to say that, overall, credit expansion has lowered interest rates.

How is it, though, that Group B borrowers, if they may pay higher rates than Group A borrowers, channel these funds into longer, more roundabout investment projects? Wouldn’t the interest rates have to be lower than Group A’s in order to accomplish this? The comparison to Group A’s rate is not relevant, however. It is still the case that extending loans to Group B will cause an overall lengthening of the structure of production as funds that previously were earmarked for consumption will now be channelled into investment5.

However, whatever the duration of a loan and whatever terms on which is it advanced the cardinal fact remains as follows: lenders are not prepared to devote real resources towards the investment projects of the borrowers for the entirety of their duration. Just as in the same way as price controls in our example above tried to give people the ability to have their cake and eat it – afford both one apple and one orange at the same time even though the level of wealth could not sustain these purchases – and just as in the same way that John on the Robinson Crusoe island not consume his resources and invest them at the same time, so too is credit expansion a societal wide attempt to indulge in both consumption and investment simultaneously. The borrower thinks his new money allows him to purchase resources for investment whereas the lender, not having relinquished his purchasing power, thinks that he can still use his original money for consumption. What happens in practice, of course, is that the credit expansion forcibly transfers purchasing power from the lender to the borrower. The increased money supply causes an increase in the prices of capital goods and a relatively weaker increase in the prices of consumer goods. The lender still loses out, therefore, as he must now pay higher prices for the things that he wished to consume – in just the same way as he would lose out from price controls when he sees that the shelves are empty. As the cycle gets underway, higher doses of credit expansion are necessary to maintain purchasing power in the hands of the borrowers as prices rise sharply and inflation premiums begin to be written into loan contracts. Once the inflation gets out of control and the credit expansion is halted or reduced funds are cut off to the borrowers in Group B as they must now rely upon the genuine saving of lenders. But lenders are not prepared to lend real purchasing power under the terms that these borrowers are willing to pay. Thus, starved of resources to complete their projects, Group B borrowers must liquidate their half-finished investments which are now revealed, after the true consumption/saving preference of lenders becomes apparent, to be malinvestments. The bust phase of the cycle therefore sets in.


What we have seen from this analysis, therefore, is that while the “Austrian” claim that “credit” expansion lowers “the interest rate” leading to the business cycle can be elaborated and defended to account for multiple rates paid by multiple borrowers, the primary fact is that lenders are not prepared to lend purchasing power over resources to the borrowers for the duration of their investments. It is this lack of harmony in the use of resources which is the key to understanding the start of the boom and the eventual collapse and this should be the focus of anyone wishing to understand and expound “Austrian” Business Cycle Theory.

View the video version of this post.

1See, for example, the relatively well known Hayek-Sraffa debate. “Austrian” economist Robert P Murphy has stated that “Austrians”, or at least those who ascribe to the pure time preference theory of interest, are yet to provide a sufficient answer to Sraffa’s objections. Robert P Murphy, Multiple Interest Rates and Austrian Business Cycle Theory, unpublished.

2We are, of course, ignoring the real-world possibility of refinancing.

3Although the length of time may itself be an element that is accounted for in risk.

4It is also the case that, even if all else was equal, there would not be one “core” interest rate in the loan market anyway as different lending periods would also attract different rates. Again, the second analysis overcomes this problem as different time periods would constitute individual markets.

5From a simple cost account point of view, the longer a particular business enterprise takes to come to fruition the harder it becomes to fund interest charges on the borrowing that has funded it. An uncompounded interest charge of 10% on a loan of $1m for a project that will last one year will result in a total repayment of $1.1m, something that might be manageable. If the same loan at the same rate was made for ten years, however, the borrower will to pay twice the capital – $2m – back at the maturity date; a cripplingly high cost for even the most profitable of projects. If the interest rate is reduced to 2%, however, the ten-year borrower would only pay back a total of $1.2m, which would be more manageable.


Some Common Objections to “Austrian” Economics

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“Austrian” economics is a heterodox school of thought – its theorems and, more crucially, its methods at arriving at those theorems are not embraced as mainstream by the majority of the economics profession. Economics is, like all academia, a largely government controlled and funded science and it is probably no surprise that a school of thought that lays bare the consequences of government action is met with little enthusiasm. Nevertheless it is appropriate to examine and rebut some of the substantive objections to “Austrian” economics so that proponents of this school of thought can more sharply attune themselves when responding to them.

“Austrian” Economics is Old!

The charge that “Austrian” economics is old or outdated rests on the fallacy that progress always moves in a single direction and that everything that is known today either contains or is built upon that which is known yesterday. Hence there is no need to examine the “old” stuff. Yet the history of knowledge has seldom been one of a continued and unbroken progress. Rather, crucial insights have been lost and areas of study have been shunted on to false and wrongheaded directions, both in the natural sciences and in the social sciences, with intellectual vested interests often replacing open minded hypothesising. The history of science abounds with false paradigms of which flat earth theory and the geocentric universe are only the most patently obvious; more recently, however, it has been suggested that the conclusions reached by the theory of relativity are better explained by traditional classical physics1, and libertarians themselves have pointed out that the conventional approaches to medicine in areas such as HIV/AIDs and cancer is more concerned with propping up the profits of big pharma than in developing a genuine scientific understanding of these ailments. This is not, of course, the place to validate any of these challenges but they do serve as a warning that what we might regard as absolutely true and correct today may not be and that we have led ourselves down a blind alley. Speaking more generally, the twentieth century was possibly the most bloodthirsty and unstable in history, contrasted with the less eventful and unfairly stigmatised “dark ages” where state power was less firmly entrenched. Democracy has become the leading orthodoxy whereas faith in earlier systems of government is at an all-time low, even though democracy’s ethical superiority is far from clear. In economics itself, Rothbard has suggested that the foundation of economic thought built by Adam Smith obliterated many important insights of the earlier thinkers such as Cantillon and Turgot, even going so far as to blame Smith for the injection into economics of the labour theory of value2. The revolution in Keynesian thought and positivist methodology in the first half of the twentieth century also pushed economics from a path on which it shared much in common with the earlier “Austrian” school. Indeed the curious and scarcely challenged acceptance of Keynes’ General Theory completely blew from the water the “Austrian” explanation of business cycles as it applied to the Great Depression. As Henry Hazlitt later quipped, “what is original in the book is not true and what is true is not original” and the entire tome was never properly debated – merely accepted3. Indeed, economics today suffers from a distinct splintering into hermetically sealed units that seldom interact with each other or acknowledge a common foundation. In addition to the wedge between micro and macroeconomics, we seem to have labour economics, industrial economics, oil economics, financial economics, international economics, and so on. Most of these bubbles are little more than statistic-gathering lobbying channels to favour key industries rather than areas of study that are influential upon core economic theory. Furthermore, intellectual thought has often had a dismal record at being ahead of reality – until the 1990s Marxism was rife in academic circles and as late as 1989 Paul Samuelson, in the 13th edition of his bestselling economics textbook, stated that the Soviet economic system was “proof that…a socialist command economy can function and even thrive”. To ignore an old area of thought, or to refuse to dust the cobwebs off long-ignored treatises is not necessarily an exercise that is conducive to the preservation and growth of knowledge and, indeed, more than risks violating the first duty of the scholar – to preserve that which is already known to be true. More Menger and Mises would do far more for the economics profession than 2014 journal articles by PhDs and Nobel Prize winners.

“Austrian” Economics is too Political!

The charge that “Austrian” economics is too political may at first appear surprising given that its primary theorist, Ludwig von Mises, was extremely clear on his support for the wertfrei science and only spoke of his passion for laissez-faire in his capacity as a citizen and not as an economist, or so he claimed. Although it is true that most of those who embrace “Austrian” economists are libertarians in one form or another, this charge is more likely to originate from the fact that “Austrian” economics leads to the radical and stark conclusions that government would not benefit the average citizen, nor would it succeed in doing anything that which most people want government to do. Such results are intolerable for government advocates and hence they try to paint “Austrian” economics as having a political bias. Unfortunately, such an attitude reveals the political bias inherent in their own schools of thought. Indeed, the entirety of the mainstream, with its experimental method and drive towards socially engineered outcomes, is inherently statist, normally considering only which government action is the right one. It seldom asks itself the questions whether any government action is appropriate at all. Most macroeconomic research is funded by the US Federal Reserve and it is hardly likely that such an institution, the actions of which are so central to the “Austrian” theory of the business cycle, will be willing to engage its critics on its payroll. A little more broadly, the defects in Marx’s economic thought – his misconception of economic classes and his inability to defend his labour theory of value against the uniformity of profit levels in capital-intensive and labour-intensive industries – can be attributed not the fact that not that he was simply a bad thinker but that his thinking was subservient to his political ends4. Indeed, one of his staunchest critics, Eugen von Böhm-Bawerk, still praised Marx as “an intellectual force of the very highest order” in the book where he laid waste to Marx’s labour theory of value5. At the very least, therefore, “Austrian” economics is no more politicised than any other school of thought.

Austrian Economics is not Empirical!

The familiar charge that “Austrian” economics is deduced from the action axiom and does not make use of experimentally tested hypotheses is one of the primary dividing lines between the “Austrian” school and the mainstream. The present author has recently explained the “Austrian” method and we will not repeat here what we have examined already. Rather, we will concentrate now upon a more subtle criticism which is that, although “Austrian” economics makes the claim to be a deductive science, it must nevertheless make use of empirical facts and that both Human Action and Man, Economy and State are rife with empirical assumptions. Aren’t “Austrians”, therefore, completely misstating their own method? This criticism, however, confuses core theory on the one hand, which is formal and deductive, with the application of that theory to substantive choices that humans have made on the other. The core of “Austrian” theory – actions, ends, means, choices and the laws that are derived from them such as supply and demand, marginal utility, and so on – are deduced from the action axiom. Yet the interest in our field of study is the effects of the complex phenomena that exist in the world and the existence of certain human choices need to be taken as empirical facts in order to analyse them. If we are to have a theory of money humans must have chosen to use money; if we are to have a theory of banking, the fractional reserve system and of business cycles, humans must have chosen to use banks; if we are to have a theory of production then humans must have chosen to engage in investment and roundabout production rather than leading a hand to mouth existence. Indeed, even the existence of other humans is an empirical fact (albeit a highly certain one) that is necessary for any theory of bilateral exchange. Examination of all of these areas, which make use of the empirically validated, substantive choices that humans have made, are nothing more than application of the core, deductive economic theory to real life situations simply because these are the things that we are interested in knowing about. The conclusions reached would still be true even if those choices had never been made, but the fact that they were made is what brings them to the forefront of our attention.

A related charge from the empiricist camp is that, as a deductive science whose truths are valid a priori, “Austrian” economics can only yield analytical truths – endless tautologies that are merely elaborated definitions of the original axiom. Hence it has nothing new to say and if we wish to learn synthetic truths about reality then we must go out into the world and observe. The so-called analytic-a priori/synthetic-a postierori distinction is a convenient way for methodological objectors to the “Austrians” to attempt to dispose of valid truths that they cannot otherwise refute. If, as it is claimed, nothing about reality can be known without empirical validation, then surely that epistemological claim, which is asserted as a law of reality, applies to itself? To be consistent with what it says, this statement too would have to be tested empirically to see if it is a true law of reality. Otherwise, by its own standard, it is merely an analytical assertion which, while it may be true in and of itself, says nothing of reality at all. Regardless of this however, the wider allegation that “Austrian” economics says nothing of reality is rendered false when we consider that the action axiom itself is a law of reality. Any action demonstrates an undeniable recognition of the harmony between means and ends as they exist in the universe. A human may deny that the matrix of means and ends constitutes reality but this action of denial, which must make use of them, demonstrates that he does not hold this to be so. In denying that the action axiom is a law of reality, the person is trying to create an end in the real universe using available means that are suitable for this purpose. If the action axiom says nothing about reality then neither too do the ends that he attempts to create have anything to do with reality and so they can safely be ignored. If he was in genuine denial that the nexus of means and ends constituted reality then he would keep his mouth shut and refrain from any action whatsoever. If, therefore, the action axiom is a law of reality then so too are the laws that are deduced from them also laws of reality. Indeed it is precisely because the “Austrian” method begins with action in the world that it is firmly grounded as a school that deals with reality and with phenomena as we find them. It is patently not an epistemology that babbles on about metaphysics, imaginary constructs and ethereal musings.

Austrian Economists do not make Predictions!

The previous objection – that “Austrian” economics can say nothing about reality – is joined at the hip with this final objection that we shall consider here, that “Austrian” economists do not make predictions. One of the more sophisticated guises of this objection runs something like this: if “Austrian” economics says absolutely and necessarily true things about reality, how is it possible, when it comes to applying them to a real world situation, their validity, or emergence, becomes contingent? How is it that these can be undeniably true laws about the world yet we do not know when they are going to make their appearance and cannot be used to make predictions?

The answer to this is that “Austrian” economics can be used to make predictions – it is just that the formal laws of human action are not sufficient to make those predictions about human behaviour. Such a limitation does not invalidate the necessary truth of those laws. The fundamental categories of action are necessarily true because we cannot conceive of a mode of action in which they would be untrue. We cannot, for example, ever imagine an action that is not the result of a choice to use ends towards means. Thus, the laws that are deduced from these fundamental categories must also be absolutely true.

Looking for a moment to the natural sciences, all scientific propositions are conditional statements of the “if-then” variety, the appearance of which in the real world is contingent upon the actual conditions they require being present. A chemist may be able to tell you that, provided that two atoms of hydrogen and one atom of oxygen are present under certain conditions then they will join to form a molecule of water. Undoubtedly this law will be very useful in making predictions as we now know what will happen when certain conditions are present. But to make a prediction of future events we also need to know whether such conditions will be satisfied at X point in the future – and this is an entirely separate question. The law by itself, therefore, is not enough to make a prediction. To make predictions, we first need to study the outcome that will result when a certain configuration of variables is present; and then we need to determine whether that precise configuration will occur at some point in time. The fact that we need to carry out both tasks has no bearing on the truth or validity of the law. Carrying out the second task – attempting to determine whether certain conditions will be present – may be more straightforward for a natural scientist to do, given that unconscious matter has no will of its own. But outside of controlled laboratory conditions, even predictions of this nature have proved immensely difficult. We cannot predict the weather accurately more than about a week in advance, nor earthquakes in time to evacuate affected populations. It has previously been predicted by scientists that a rocket would never be able to leave the Earth’s atmosphere; that rail travel at high speed would not be possible because passengers would die of asphyxia; and even Einstein once predicted that Nuclear energy would be unobtainable. All of this is before we even consider the science behind the whole climate change saga and the truly abysmal scientific predictions made in fields where human action has been a variable, such as “peak oil” and other resource depletion. None of these predictions has anything to do with what happens when certain conditions are present – rather, they are predictions about whether the required conditions will be present for a particular outcome.

Natural scientists may give the appearance that both elements of prediction are a unified whole as they can predict both elements in their role as scientists by following the same method of empirical observation. When we turn to human action, however, the formal, qualitative laws of praxeology will bind human action within a certain framework. We can say that if X conditions are present then Y result will occur. These laws can be used to predict outcomes. But a whole and complete prediction of human action requires also a prediction of the substance of human choices and of the conditions in which humans will find themselves – about which, praxeology has nothing to say. Thus the praxeologist in his role as a praxeologist, does not, unlike the natural scientist, make predictions. Given the difficulty, as we just outlined, of making predictions about unconscious matter, how much more difficult must it be to make predictions of human behaviour where quantitative and substantive predictions concerning human action cannot be made with scientific certainty? The difficulty in predicting human behaviour, caused by the volition of human choice, does not, though, have any bearing upon the necessary truth of the laws of praxeology – and if anything, those laws are the mainstays in making such predictions. The fact also that the laws cannot be expressed quantitatively is also no bearing on their necessary truth – human action proceeds in whole, discrete steps and any change in conditions must be sufficient to make a change in a human’s rank of values. Whether and what point such a change will be made also cannot be reduced to scientific certainty but must, rather, be based firmly on our empathetic understanding of our fellow human beings and their response to the conditions in which they find themselves, which much also be predicted. If this was not true then profit would not exist in the world. For if every human desire and the consequent action was predictable with scientific certainty then every resource would be bid up exactly to the level of its cost. It is precisely the task of the entrepreneur to estimate future human desires and choices and to direct resources accordingly. Where he correctly estimates the conditions his application of the appropriate praxeological law will render his prediction correct.

Neither also is “Austrian” economics, however much its theorems may be necessarily true, not weaker because it lacks substantive prediction and quantitative measurement. The boundaries of science are that which can be known in the universe and “Austrian” economics restricts itself to formal, qualitative laws of action precisely because that is all that can be known with scientific certainty. To acknowledge the limits of scientific endeavour is simply intellectual honesty and not a weakness. It remains incumbent upon the mainstream to explain why they think that “science” is about making known that which is simply unknowable.

We can conclude this piece by stating that “Austrians” themselves sometimes, at the very least, give the appearance of making predictions in their capacity as “Austrian” economists. The forecasts of wild inflation and five figure gold prices that have not come to pass since the 2008 crash should remind “Austrian” economists who are desperate to display the truthfulness of their insights that these are entrepreneurial judgments and not scientific facts.

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1See, for example, Petr Beckmann, Einstein Plus Two

2Murray N Rothbard, An Austrian Perspective on the History of Economic Thought, Vol. I, Economic Thought Before Adam Smith, Ch. 16.

3Henry Hazlitt, The Failure of the New Economics – An Analysis of the Keynesian Fallacies, pp. 4-9.

4Murray N Rothbard, An Austrian Perspective on the History of Economic Thought, Vol. II, Classical Economics, p. 317.

5Eugen von Böhm-Bawerk, Karl Marx and the Close of his System, p. 77-78. In this passage, Böhm-Bawerk states that the belief of Marx, and of the classical economists, in the labour theory of value was a “cherished philosophical principle” that was not routed in strict, scientific analysis.



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