The Myth of Overpopulation

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Overpopulation, either locally or globally, is often blamed on a number of apparent problems from the shortage of particular (usually “essential”) resources all the way up to the outright poverty of entire continents. Although few governments, most notably the Chinese, have enacted any strict policies in order to control their populations (except with regards to immigration), factoids such as the allegation that, if every single human wanted to enjoy a Western lifestyle we would need something like a dozen earths, attempt to create an unwarranted degree of hysteria.

The myth of overpopulation rests on the belief that humanity is akin to some kind of cancer which, as it grows exponentially, devours a fixed or arithmetically growing pool of resources that must be shared between everyone who has been unfortunate enough to have been born. This would have been the case in a hand-to-mouth society that preceded capitalism and the division of labour. There was effectively no production and the birth of each individual person constituted merely another mouth to feed. In other words, an increase in population led to an increase in demand for consumption without any corresponding increase in production, thus putting pressure on the existing stock of resources that had to be shared by everyone. Nevertheless, when it comes to shortages of goods in local markets today we can surmise that even if there was a fixed or otherwise relatively limited pool of resources that everyone had to share we couldn’t pin the blame for shortages on such a fact. In a free society, a particular good might be very expensive but it should never be the case that we cannot find anything. As the population increases the price of resources would rise and thus choke off demand for the least valuable uses. Shortages, rather, are always the result of government price controls that try to create the illusion of abundance without the reality, decimating the current supply and obliterating any incentive to produce more. That aside, however, the blatant reality for a capitalist society marked by the division of labour is that there is not a fixed or arithmetically growing pool of wealth and resources, and that the whole purpose of such a society is to grow, exponentially, the amount of wealth that is available. Indeed, as we shall see, humanity has succeeded in this endeavour to only a fraction of its capacity.

When the first human being trod the virgin soil of the earth, he found himself in a situation of almost unrelenting poverty. Mother Nature, as anyone trapped for an extended period of time in the wilderness has discovered, is far from a kind host, providing very little (except air to breathe and fruit on wild trees) by way of resources that can be consumed immediately for very little effort. Yet all of the matter contained in every resource that we enjoy today – buildings, cars, refrigerators, televisions, computers, clothing, medicines, and so – was, give or take a little, right there at the beginning of the world’s existence. Strictly speaking, no human being has ever created anything – rather he has merely transformed matter from one thing into another. So why, if all this matter was there from the very start, weren’t these wonderful things available to our first human? The reason is, of course, that a human must apply his labour in order to change the matter available in the world into useful resources that fulfil his ends. Yet the work of one man with his unaided body alone was not sufficient to create all of the wonderful things that we enjoy today. Indeed, it might take a single human being an entire day to hunt or catch enough fish for just one meal before the process must be repeated the following day. How can this be limitation be overcome?

The first answer is quite simply the very bugbear that is complained about – an increased population. A greater number of humans can together lift and carry a far greater amount than one man alone. Several or many men building a house would accomplish the task in a far shorter time than one man alone. More importantly, however, the widening of the division of labour as the population grows ensures that production stays ahead of population growth. Additional humans constitute an additional demand for consumption – ten humans may require ten houses whereas one human would require only one. But the fact that these men are also producers means that each can now fill his day by specialising in a particular task. One man, devoid of the ability to specialise, may take a year to build one house and he would have to undertake every single activity related to the building work on his own. With ten men, however, two may specialise in lumber felling, another two in transport, some in building, and the task of one the men may be solely to produce food and other supplies for the men doing direct work on the houses. The result of this is a greater degree and concentration of knowledge and an increased perfection of technique and expertise in each task. The resulting time saving means that, whereas one man would take one year to build one house, ten men would less than one year to build ten houses. Thus the rate of house building overtakes the rate of the increase in population. We therefore see that the quantity of labour has a marked effect on the accumulation of wealth and the transformation of matter into useful economic resources, provided that a society is distinguished by capitalism and the division of labour. To further emphasise this point, it is the twin effect of the consumption demand of the additional people coupled with the fact that these people are also producers that makes an ever increasing widening of the division of labour possible. If ten houses have to be produced then it might not be possible for one man to concentrate on any single task in order to fill his day; he might have to work in installing the wiring, the plumbing and the wallpaper. If one hundred houses have to be built then he might be able to concentrate on plumbing alone. If one thousand houses are built then he might be able to specialise on plumbing just bathrooms whereas someone else works on plumbing kitchens, for instance. The ever increasing volume of demand from an increasing population therefore begats an ever increasing division of labour when that population is put to work, and with it come all the benefits of specialisation and expertise.

Second, although it is flexible, the human body is a relatively weak and feeble creature, capable of moving and lifting only a tiny amount of matter at any one time. Regardless, therefore, of the quantity of labour available we can see that fifty men carrying sacks on their back would fail to transport as many goods in as short a space of time as, say, a railway locomotive hauling some wagons. The power of labour is therefore a further limiting factor on the number of resources that can be enjoyed. This power can only be increased by accumulating ever greater amounts of capital. All such goods – machines, tools, vehicles, and so on – are, fundamentally, merely extensions of the human body that enable its labour to accomplish more than it otherwise would. A man with an axe can fell a greater a number of trees than a man whose body is unaided by this implement. For centuries, humans could not labour to extract oil from the ground and refine it into petroleum. Yet with the capital available to construct drilling apparatus, oil rigs and refineries this is no longer the case. Indeed, most direct labour today is not concerned with the production of consumption goods at all. Rather, it is devoted to the production, augmentation and improvement of capital goods. In short, it is directed towards increasing the power of labour.

What we begin to see, therefore, is that it is not necessarily the scarcity of resources burdened by an ever increasing population that is the real obstacle to the growth of wealth and economic progress; rather, it is the scarcity of labour and the power of that labour as represented by the stock of capital goods which serve to enhance it. Goods are, to be sure, the original source of scarcity. We apply our labour only because the available quantity of a given resource exists in insufficient supply relative to the ends to which it could be devoted. Yet the power of our labour is a significant compounding factor on the degree of scarcity that we must endure. My body may only have enough capability in order to fetch a few buckets of water from a nearby stream – yet more than three quarters of the globe is covered in water. It is because the power of my labour is relatively weak that most of this water is either too far away or of insufficient quality to serve me any practical end. Only be improving the power of my labour – by being able to move greater distances, lift heavier volumes and develop processes of purification – could I hope to enjoy more water.

Such a circumstance is not limited to such a clearly abundant resource such as water. The entire world, right from the depths of the core of the Earth all the way up to the stratosphere is densely packed with matter. Our labour has only ever been able to harness a mere fraction of these resources, mostly skimmed from the Earth’s crust. As time goes on however, as population increases and with it capital accumulation and the widening of the division of labour, we harness the ability to tap into more and more of these resources. Hence, mines and oil fields that were once too costly to drill are now drilled (and, indeed, are more productive than the most productive fields of yesteryear); such mines could eventually reach depths of miles rather feet; and valuable elements can now be extracted from more complex ores. There is no reason to believe that this process cannot continue. Even today, the sea contains traces of elements such as gold which, in their totality, amount to a far greater quantity than all of that ever mined from beneath the land – 20 million tons compared to 175,000 tons respectively. Yet our labour is insufficient to take advantage of this fact. Indeed the sea remains one of the greatest untapped resources available to us. Unlike private land settlement which led to a prosperous agriculture and exploitation of the land, government has pretty much closed off areas of the sea to the possibility of settlement, preventing the development of a full-fledged aquaculture and robbing us of the ability to exploit this wonderful gift of nature.

It is for this reason – the increasing power of labour – that all predictions of resource depletion as a result of overpopulation (not to mention the ridiculousness of disingenuous “facts” such as the allegation that twelve earths are required to give everyone a Western lifestyle) – have failed. In the well known Ehrlich-Simon wager, for instance, economist Julian Simon made a bet in 1980 with biologist Paul Ehrlich that the price of five metals of Ehrlich’s choosing would have declined in price ten years later – indicating increasing availability of resources rather than increasing scarcity. Simon won the bet outright, in spite of a population increase of 800 million during that decade. Other peddlers of the overpopulation thesis, such as Albert Allen Bartlett, have labelled the views presented here as “cornucopian” or “the new flat earth” – mythical, whimsical and not based on any serious scientific understanding. What these people share in common is that they simply do not account for the future economic viability of production from what are currently viewed as uneconomic resources. For the clear result is that as population has increased we have been able to apply more labour with a greater power of that labour to a greater number of the world’s resources in ways that we were not able to do before. The ultimate goal, needless to say, would be something akin to molecular engineering – the ability to transform worthless matter such as dirt, trash or even air – into valuable resources. The futuristic “replicators” on TV shows such as Star Trek can apparently conjure goods such as a fully cooked meal out of thin air; yet the science behind would not be too difficult to imagine. We have already harnessed the ability to transform matter into energy through processes such as combustion. We can envisage that one day we could do the reverse and transform energy into matter. An inedible sack of coal could end up as a fabulous meal on your dining table.

Overpopulation does, however, give the appearance of being a problem as a result of government interference. Above we noted above, additional consumption demand represented by an increasing population serves in increase wealth provided that the additional population are also producers and therefore will act so as to widen the division of labour and the accumulation of capital. Yet the actions of government serve to swell consumption while choking off production. Pressure on resources and industries therefore arises from government control of these things. Britain’s decrepit healthcare, energy and transport systems are bursting at the seams as a result of demand and increasing costs, a direct result of inefficiency combined with prices that are too low which serve to swell consumption demand in these industries. Government pays its citizens to produce babies and thus increase the population, while an increasing immigrant population today is induced not by the freedom to pursue one’s own goals and to better one’s own life for oneself through hard work and productivity, but, rather, by generous welfare states. All of this causes a rising population that contributes to consumption but very little by way of production. In other words, if you set up the economic system to make consumption as care free as possible and production as costly as it could be then the excess of consumption and a deficit of production will give the illusion of overpopulation. Government therefore begins to look on its citizens as pests and parasites, wanton consumers of precious resources that are desperately running out. Yet the problem is not with resources; rather the problem is with the ability of the government to swell the ranks of consumers and its inability to increase the power of labour, together with its incessant stifling of anyone else who tries to do so. Every additional person who is born in the world is another mouth to feed, another person who will demand the consumption of resources. Yet that person could also be a producer who will widen the division of labour and help to grow the capital stock. Government succeeds only in breeding the consumer in a man while totally destroying in him the producer.

Turning to a related aspect, the fact that whole continents, such as Africa, are mired in poverty has nothing to do with the allegation that the richer countries refuse to “share” their wealth. If the richer countries did not have their wealth, it would not mean that poorer countries would have more – the wealth simply would not have been produced, period. Indeed, whatever wealth that does exist in poor places is often the result of Western enterprise or outright gift. These places do not lack resources; rather, they lack the institutions of private property and voluntary exchange that enable capitalism and the division of labour to flourish, and with them a greater command of labour over resources. Indeed, many of these countries are proceeding down the wrong path by setting up welfare states, trade unions and Keynesian economic (mis)management overseen by democratic institutions which are, of course, the very things that are destroying the standard of living in the West. The West achieved its greatest accomplishments in a pre-democratic, pre-welfare state and pre-union age before Marxism and socialism succeeded in leading the onslaught against capitalism and private property.

What we can see, therefore, is that overpopulation is not a fundamental economic problem. It is only an apparent problem in a society that is hampered by government intervention and the stifling of private property rights, the division of labour and capital accumulation. However, even if population started to put pressure on resources when, in a capitalist society, we reached the (unlikely) point where we were regularly turning over all of the matter in existence to meet our ends – we would still conclude that this would not be a problem worthy of any serious attention. Or at the very least, it would certainly not be a problem that merited any centralised, government control. For as population increases relative to the supply of resources, the latter become more expensive. The cost of raising a child therefore itself becomes prohibitively more expense and people would need to choose between devoting ever more valuable resources to themselves or to their children. Indeed one of the first of such resources to exert this pressure may well be land, assuming we have not, by then, invented the ability to produce more of it artificially. We could, of course, build upwards and end up living in skyscrapers but people may prefer to breed less and have more land available to themselves rather than to their children. Such choices may serve to relieve, naturally, any exponential growth in population figures. Even if, though, people desired to keep on having more children it would only indicate that they prefer the company of children to enjoying more resources for themselves. There is no objective standard by which to complain about the result of such a choice. Nevertheless, even when it comes to the question of land, humanity is currently so far from this point that we hardly need to bother mentioning it, except to try and concede to the overpopulation thesis its best possible case.

The illusion of overpopulation is exacerbated today by a fundamentally antagonistic attitude from what Murray Rothbard called the “professional foes of humanity”, the environmentalist movement1. Apart from this movement’s interference in one the most crucial markets for capital accumulation – the production of energy – the fundamentals of their philosophy view the earth as inherently beautiful and sacred, and any of humanity’s attempts to exploit it as sacrilege. Such a view is radically anti-human and can only hold that the problem with the Earth is that there are too many of these stupid, dirty, polluting, and wantonly consuming human beings. Given the influence that this movement holds it is no small wonder that such thinking permeates into more mainstream views. That aside, however, we can conclude from what we have learnt here that humans need not fear increases in population. What they should fear, however, is their government turning additional people into spoon fed eaters with shackled hands – consumers who cannot produce. It is this fact that puts a very real pressure of resources. It is therefore not overpopulation that is the real problem but, rather, “over-government”.

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1Murray N Rothbard, Government and Hurricane Hugo: A Deadly Combination, Llewellyn H Rockwell Jr, (ed.), The Economics of Liberty, pp 136-40.


Economic Myths #2 – Consumption Boosts Growth

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The belief that economic growth is boosted by consumption is based upon such a simple misunderstanding that a realisation of the truth will cause one to question why such a simple fact evaded you in the first place.

The confusion is based on a conflation of the desire to consume on the one hand with the act of consumption on the other. It is true that all economic growth, and all economic activity, is motivated by the desire to achieve consumption – in other words, to devote scarce resources in order to satisfy our most highly valued ends. Without any desire to consume or to satisfy any ends there would never be any economic activity whatsoever. The act of consumption, however, does not in and of itself fuel any economic growth. For consumption is the result of growth – i.e. of increased production – and not the initiator. Consumption is what we reward ourselves with once we have achieved growth and not that which we do in order to begin it. Stated in its simplest way you cannot consume a good unless it has first been produced.

At any one moment in time there is an array of produced goods available to us. Each of us faces a basic choice as to what to do with these goods – consume them now, or turn them into productive capital goods that will yield a greater output of consumption goods in the future. If we choose the first path – consumption – all we do is reduce the number of goods available to us and we are left with less. We may have achieved immediate satisfaction but we now have fewer resources left with which to produce more in the future. If I burn a log of wood to keep warm I cannot then use it as building material later. Rather it is gone forever and I will now have to labour in order to search for fresh building materials if I am to make good this loss. A farmer who decides to eat the seeds for crops in the spring will then have nothing to sow and come harvest time will have barren and empty fields rather than lush acres full of wheat. Beyond the point of providing nourishment and sustenance to the human body the act of consuming of these goods will not provide any growth. Consumption, for the most part, is the destruction of what we have. Growth is the transformation of what we have into something that will produce more for us in the future. If we choose the second option – that of turning our goods into productive resources – rather than destroying the resources available to us we will invest them in productive enterprises that raises the yield of consumer goods in the future.

The key to promoting growth, therefore, is not to encourage the act of consumption which equates with an act of destruction. Rather it is to encourage production and a direction of a greater proportion of our resources available today towards saving and investment so that we may consume more in the future. This is particularly important following a bust that results from a boom or bubble inflated by credit expansion. With so many malinvestments left starved of resources the best thing we can do to minimise the pain is to increase the proportion of saving and investing so that at least some of the doomed projects may realise a degree of viability. Instead our economic lords and masters do the precise opposite and encourage us to borrow, spend and consume which only exacerbates the losses experienced by those projects that were started in the boom. Growth must begin with saving, sound investment and production which is then rewarded by greater consumption. Consumption will never lead to growth and it is important for Austro-libertarians to point out this grave fallacy.

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“Austrian” Business Cycle Theory – An Easy Explanation

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Against the simple and straightforward siren song of “underconsumptionist” and “underspending” theories of boom and bust, “Austrian” business cycle theory (ABCT) can seem contrastingly complex and lacking in communicability. The former types of theory, associated with “mainstream” schools of economics, in spite of their falsehood, are at least advantaged by the veneer of plausibility. A huge glut of business confidence and spending will, it seems, naturally lead to an economic boom, a boom that can only come crashing down if these aspects were to disappear. For what could be worse for economic progress if people just don’t have the nerve do anything? Add in all the usual traits of “greed” and “selfishness” with which people take pride in adorning the characters of bankers and businessmen (again, with demonstrable plausibility) and you have a pretty convincing cover story for why we routinely suffer from the business cycle. ABCT, on the other hand, with its long chains of deductive logic, can seem more impenetrable and confusing. Is there a way in which Austro-Libertarians can overcome this problem?

“Austrian” economics is unique in that all its laws are deduced from a handful of self-evident truths, the most important being the action axiom, often peppered with a few additional assumptions or empirical truths (such as the desire for leisure time). The entire corpus of economic law – right from the isolated individual choosing between simple ends all the way up to complex structures of production, trade and finance – therefore forms a unified and logically consistent whole. This is not true, however, of “mainstream” schools of thought which tend, nowadays, to be splintered and scattered into separate, specialised areas of study that are based upon their own, individual foundations. The fissure between so-called “microeconomics” and “macroeconomics” is a prime case in point; while “Austrians” will read much that is agreeable in “microeconomics” (although it still contains many faults and general misunderstandings resulting from the lack of coherence and soundness that is furnished by deduction from the action axiom), “macroeconomics”, on the other hand, seems to be a completely different ball game, considering only “the economy as a whole” without reference to its individual components1. It is this fact that “Austrians” can use to give them the upper hand when explaining the business cycle. For in ABCT, the explanations of “macro” phenomena are little more than an extension of what is found in “micro” price theory.

The market price for a good is the price at which the quantity demanded equals the quantity supplied. Prices therefore serve to ration goods as a response to their scarcity, the goods available being traded from the hands of the most eager sellers to the most eager buyers. Those buyers who are not willing to pay the market price will go away empty handed and those sellers who are unwilling to sell at the market price will not be able to get rid of their goods. What happens, then, if this relationship is disturbed by a forced fixing of prices by the government? First, if the price is raised above the market price to create a price floor, the new price will attract more sellers into the market for that good because the price that they will receive for a sale is now the price at which they are willing to sell. However, at this heightened price there are fewer people wishing to buy the good. Some, who were not previously prepared to pay the lower, market price, are certainly not going to pay the higher price now. And those who would have paid the market price before may now decide that the new price is too high so they also do not buy. What results, therefore, is an increase in sellers and a decrease in buyers which can lead to only one thing – a surplus of unsold goods. The sellers may be very eager to sell at the new price but they will have a hard time finding anyone to sell to. Secondly, the opposite case, where the price is lowered below the market price (a price ceiling) creates, as one would expect, the opposite effect. This new price will attract more buyers into the market for that good because the price that they will pay for a purchase is now the lower price at which they are willing to buy. However, at this lowered price there are fewer people wishing to sell the good. Again, some, who were not, before, prepared to sell at the market price, are certainly not going to sell at the lower price now and those who would have sold at the market price may now decide that the new price is too low so they also do not sell2. What results, therefore, is a decrease in sellers and an increase in buyers which, clearly, leads only to a shortage of goods. Buyers will swarm into the marketplace eager to purchase the articles at the new, attractive price but, to their dismay, the shelves will be empty, cleared out by all of the more hasty buyers who got there before them3.

It is this latter scenario – that of artificially lowered prices – that is relevant for ABCT. For the business cycle is, according to “Austrians”, little more than price fixing on the widest scale, the fixing and the manipulation of what is possibly the most important price in the economy – the interest rate on the loan market. Rather than being the price at which a single good is traded, the interest rate is the price at which saved funds are borrowed and lent (i.e. demanded and supplied) in the economy.

When the stock of money is fixed, if one person wants to borrow (demand) money then another must have saved it in order to lend (supply) it. The resulting rate of interest is the point at which the quantity of money saved/lent equals the quantity of money borrowed. Any borrowers who want to borrow at a cheaper rate and any sellers who want to lend at a higher rate will find themselves priced out of the market for loanable funds, the sub-marginal buyers unable to borrow any money and the sub-marginal lenders unable to lend any. This situation produces a stable amount of saving, lending, borrowing and investment because the interest rate – the price of saved funds – is in harmony with the preferences of consumers, in particular, their preferences for allocating their funds towards either capital or consumer goods. The portion of his funds that the saver retains for consumption will be spent on consumer goods (i.e., present consumption) whereas the portion that he allocates towards saving and lending for investment will be spent on capital goods that will not provide any immediate consumption but will provide a greater amount of it in the future. At the market rate of interest goods and resources in the economy will be allocated in harmony with these desires. If, for example, a borrower wishes to borrow money to build a factory (a capital good) and his calculations reveal that the prevailing rate of interest is low enough for him to make a return on this enterprise, it means that savers are willing to lend a sufficient quantity of funds in order to make it viable. If, however, the prevailing interest is too high it means that savers are not willing to lend enough funds to build the factory – the money that could be spent on building the factory they would prefer to spend on their own, immediate consumption4.

What happens, then, if the rate of interest is set below the prevailing market rate? Exactly the same as what happens when prices are forcibly lowered for any single good. At this rate borrowers who before found the rate of interest too high for their ventures suddenly find that they can afford to borrow. The quantity of funds demanded, therefore, will rise at this new, low price. Savers, however, will be less willing to lend at this price. Certainly if they weren’t prepared to lend at the previous rate of interest they will not be induced to do so by an even lower rate and some savers who were prepared to lend at the market rate will not be prepared to do so at the new, artificially fixed rate. The increase in borrowers and decrease in sellers, therefore, causes a shortage of saved funds, or at least it should do so. Why, then, does this shortage not materialise immediately at the point that the interest rate is fixed? Why aren’t the banks empty of cash and why can they keep on lending and lending and lending? Why can this situation perpetuate for years and end in a calamitous crash that causes almost unrelenting havoc?

This is where a degree of complexity enters the explanation. What is really being borrowed and lent is not money but, rather, the real goods and resources that they can buy. We said above that if someone wishes to borrow money another person has to have saved it. But what this really means is that the saver has to have worked to produce real goods and resources in order to earn that money. He then lends that money to the borrower and the borrower uses that money to buy those goods that the lender produced and diverts them towards his enterprise. If, of course, saving, lending and borrowing took place with real goods, or if the supply of money was fixed, then obviously a forced lowering of the rate at which these goods could be borrowed would result in their shortage very quickly. But the fact that the saving and lending takes place through the mechanism of an easily expanded paper money supply creates a clever smokescreen. For our entire financial system rests not on the principal of every pound borrowed requiring a pound to be saved, but rather that pounds can be “created” out of thin air by the central bank and lent out even though someone has not saved. By printing fresh money (or its digital equivalent) the volume of borrowing can expand without a corresponding expansion of the volume of saving. This easy ability to produce more money to meet the higher demand for borrowing means that the artificially low interest rate never causes a shortage of money as we would normally expect when the price of any other good is fixed below its market price. A second problem, though, is that the real goods that this new money can buy have not increased in line with the increase of the supply of money, but, rather, have remained constant and there is, therefore, still only the same quantity of goods that have to be allocated towards either consumption or investment. Surely the artificially low interest rate will mean that there will be a shortage of real goods to devote towards investment?

Unfortunately, at the beginning, this is not so. For the newly printed money transfers purchasing power over goods out of the hands of those holding existing money and into the hands of those who have the new money. The result of this is that the borrowers of the new money – those who want to devote the goods purchased to capital investment – now have an advantage over those who wish to devote them to consumption. Let’s say, for example, that I earn £1000 in a given month. This means that I have worked for and created real goods in the economy on which I can spend this £1000. Let’s say that I allocate £750 towards consumption and £250 towards saving and investment. Therefore, what I want to achieve is to consume 75% of the goods on which I can spend the money and save and invest 25%. This £250, the 25% of the goods I wish to devote to saving and lending constitutes supply in the loan market that will help to set the market rate of interest. We can illustrate this allocation accordingly:

Consumption  £750   75%


Saving          £250   25%


TOTAL           £1000  100%

If, however, a commercial bank depresses the interest rate and simply prints an extra £500 to meet the new demand at this lower rate, what has happened now? There has been no change, remember, in the quantity of goods – the new money must be still be spent on these goods. The purchasing power of the existing money that I wished to spend on consumption therefore reduces and that of the new money that is to be spent on lending and investment correspondingly increases. All that happens therefore is that the proportion of goods that can be devoted to lending and, hence, to investment has now been forcibly increased from £250 to £750 – and increase from 25% to 50% of the new total stock of money, thus:

Consumption  £750   50%


Saving          £250   17%

New Money    £500   33%


TOTAL           £1500  100%

Newly printed money that enters the loan market therefore forces the economy onto a different consumption/investment ratio from that which is desired by consumers. The poor consumer will find that the newly created money has caused the prices of goods to rise; he is forced, therefore, to curtail his consumption in real terms. The goods that he can no longer afford to buy and consume will be purchased by the new borrowers who will devote them towards their capital enterprises. It is for this reason that none of the expected effects of price fixing occur and the economy proceeds along what appears to be a sustainable boom in capital investment. The problem, though, is that capital projects usually take several years to complete and rely on a continuous supply of goods throughout this time. But consumers don’t want to save voluntarily the amount necessary to complete these projects. The interest rate must therefore be constantly kept low and the new money reeling off the printers to meet it if the projects are to continue. It is only down the line when price inflation inevitably begins to accelerate and the central bank forces an increase in the interest rate and a corresponding reduction in growth of the money supply that the problems are revealed. For now the consumption/investment ratio once again begins to reflect the preferences of consumers – they want, if we remember, more consumption and less saving which means that lending and investment has to reduce. Hence half-finished capital projects have to be left incomplete. They have been starved of the resources necessary as they can no longer afford to purchase them at the new rate of interest. This precipitates a collapse in the prices  of capital assets, a collapse that causes widespread bankruptcy and liquidation of firms and enterprises that, hitherto, had seemed sustainable and profitable. Ludwig von Mises describes the perfect analogy:

The whole entrepreneurial class is, as it were, in the position of a master-builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure. It is obvious that our master-builder’s fault was not overinvestment, but an inappropriate employment of the means at his disposal5.

Mises’ last sentence is important. As the prices of capital goods were accelerating upwards during the boom and then suddenly come crashing down, there is a temptation to analyse this as “overinvestment”. While this is true and that “too much” has been devoted to long term investment projects it should be clear from our analysis that the real problem is malinvestment – a diversion of resources from desired consumer goods to capital goods.

Observant readers might say that it is actually the return to the market rate of interest and not the fixed rate that has caused the sudden shortage of capital goods. This would not be a correct interpretation. Artificially lower prices always give the illusion of plenty, of abundance and availability for everyone. It is just that with the fixed price of a particular good the illusion becomes obvious more quickly. But with fixing the rate of interest, because it takes effect through the mechanism of money, the illusion of plenty is obscured and, for a time, looks very sound. For this new money has the very real ability to divert resources away from consumption towards capital investment. Nothing more has been created but it looks like there has. Couple that with price inflation with higher nominal wages and people, at least, think that they are better off than they were before the “miracle” of artificially low interest rates. Real abundance and plenty, however, would not merely divert resources from consumption. Rather, resources for capital investment would exist independently of and in addition to those desired for consumption, as dictated by the desires of consumers.


What we have seen, therefore, is that ABCT sits coherently with the examination of individual price action and is little more than an extension of it. The business cycle is simply a case of price fixing writ large, causing widespread waste, chaos and misery when its effects are finally revealed. There are no separate bases or foundations of this “macro” sphere of economic theory. There are, however, certain special features that make this form of price fixing especially insidious and long-lasting – that of the easy ability to print fresh money to meet the new, low rate of interest, permitting purchasing power to be transferred to new borrowers and, hence, the real diversion of resources. As soon as this situation ceases the smokescreens vanish to reveal the waste and futility of these diversions.

Whenever, therefore, one has difficulty in either understanding or explaining ABCT, think back to what you know about simple price fixing. In fixing the rate of interest, the most important price in the economy, “Austrian” economics, with its strict deductive logic from the action axiom, will tell you that the results will be the same.

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1Murray N Rothbard, Man, Economy, and State with Power and Market, p. 269 (n. 19).

2This isn’t just stinginess on the part of sellers; rather, the cause of their unwillingness to sell will be, in the long run, that they simply cannot – the lower price will usually not be sufficient for them to recoup the costs of production so they have to abandon the particular line altogether.

3These results were seen during the high inflation of the 1970s in the US when price controls led to long queues at gasoline station because the demanded quantity of gasoline could not be supplied at the artificially low price.

4An interesting question is whether the interest rate may strictly be considered a “price”. In the exchange of goods, the price of a good is the quantity of another good that is fetched in exchange. For example, if one apple sells for two oranges, then the “orange” price of an apple is two oranges (and the “apple” price of an orange is 0.5 apples). In the complex economy, of course, every good is exchanged for money so we always reckon prices in terms of the quantity of money received in exchange. However, whatever the other good that is received, it makes no sense to compare the two physically heterogeneous goods in terms of magnitude. For how does one calculate the “difference” between two apples and one orange, or between £2.00 and a bag of oranges? In the exchange of a present good for a future good, which is what happens in the loan market, this is not the case, however. If a borrower agrees with a lender to borrow £100 today and to pay back £110 in one year’s time, strictly the price of one unit of present money is 1.1 units of future money (or the price of 1 unit of future money is approximately 91p of present money). But because the two goods are physically homogenous we can compare the two magnitudes – 1.0 and 1.1 – in order to derive a rate or ratio between them of 10%. We would therefore state that the interest rate per annum in this scenario is 10%. This rate is therefore not strictly a price but an expression of two prices – the price of present money in terms of future money and the price of future money in terms of present money. However, it should be clear that a manipulation of the rate of interest would have the effect of fixing the actual prices of present and future money. If, for example, the interest rate is forcibly lowered to 5% then the price of one unit of present money is now 1.05 units of future money rather than 1.1 units of future money. The resulting effects of price fixing will therefore be felt in this scenario. Hence, it makes sense to speak of the rate of interest as a price just like any other and, indeed, this is how it is treated by acting humans in the loan market.

5Ludwig von Mises, Human Action, p. 557.

Means, Ends, Production and Consumption

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One of the apparent weaknesses of economics (of any school of thought) is that as soon as one gets past the “Robinson Crusoe” stage of an isolated individual and proceeds to the elaborate explanations of production, exchange, and the division of labour, it becomes extremely easy to forget that at the start of every economic system, at the bottom of every theory, is the individual acting man, the person who has ends that he achieves with means through actions. There are two, seemingly contradictory (although actually related) dangers from this oversight. First, by separating the categories of production, consumption, saving, investment, entrepreneurship and so forth into separate personae under the division of labour, we forget that these qualities are inherent in the action of all human beings and are simply abstractions from the different categories of action applied to different groups in order to demonstrate their role in the economic system as a whole. What results, therefore, is atomistic appreciation of these different categories, so that, for example, we talk of the needs of “producers” or of the welfare of “employees” or of interests of “borrowers” or of “savers” being punished, and so on. Secondly, we can go to the opposite extreme and only look at the whole economy, concluding erroneously that what is “good” for the economy (if such a thing can be said) is also good for the individual human beings who make up that economy. These two dangers we will explore in turn.

 The Atomised Categories of the Economy

When looking at an individual human being, it is not outrageously difficult to understand how the object of each human being is to achieve his most highly valued ends with the scarce means available to him. We do not need to enter a deep, praxeological analysis to understand how the individual human will, all else being equal, seek to maximise his gains and minimise his costs. He will attempt to inflate the former and deflate the latter as far as it is possible for him so to do. It is also clear that the final object of all of his action is consumption – the enjoyment of the fruits of his toil, the benefit of which he predicts will outweigh the disutility of that toil. If, therefore, in a situation of isolation, a human decides to plough a field, plant seeds and then sow the resulting crop we can readily understand that he will seek to achieve the highest yield of crop possible while ploughing the field and sowing the seeds in a manner that bears him the lightest labour and the lowest cost. If he is able to achieve the same yield with a lower cost or a higher yield with the same cost, he will, all else being equal, proceed to do so. Hence, if he is suddenly gifted a tractor that halves his ploughing time, we can understand easily why he will make use of it. If he can purchase a new type of seed that doubles the crop yield but with no extra work then, again, no one will have any difficulty in appreciating this. The idea that we will always take the shortest route to the same end or the same route to a higher end can be empathetically understood by any human – we are always trying to spend less and have more, cut down on X and increase Y, all to yield the highest benefit for the minimum cost1.

What we can also readily appreciate in this scenario is the different categories of action inherent in the single, lone human. He is a consumer, a producer, an entrepreneur, a saver, an investor, and a capitalist. He must carry out all of these activities with the means available to him on his own behalf. And hence it should be obvious that all of these activities are carried on not for their own sake but for the valuable ends and the improvements to his life that they achieve. If all of the ends could be achieved with no work, production, no saving, no investment and no capital accumulation whatsoever few would doubt that he would be in a far better position. How many of us would turn down the opportunity to purchase anything we wanted without having to go to work each day? Judging by the fact that more than half of the eligible population play the national lottery, it stands to reason that this would be few. It would, therefore, be absolutely absurd for us to say that a person’s life would be made better by loading additional burdens onto the ones that already exist. Who in their right mind would say that our lone human would be better off digging the soil with his bare hands rather than with a tractor and plough? Or that he is better off having to transport water on his shoulders than with the aid of pipes and irrigation? This would only mean that he would endure more work, more hardship but for the same end. No one in his right mind would advocate such a course of action. Additionally, no one would ever say (all else being equal) that a person has “produced too much”. We would not take the fruits of our labour and burn a half of it because the extra productivity means that we might not have to work next week. The result of this would be that a person forces himself to endure the same work for a lesser end. Again, all of this is readily understandable and no person would advocate such courses of action and expect to be taken seriously.

Unfortunately, however, this appears to be the approach that we take as soon as the division of labour comes into play and we examine the economy as a whole. For now, when considering the economy in such a manner, while all persons will still retain their multi-faceted characteristics2, the roles of consumer, producer, saver, investor, entrepreneur and so on are not concentrated in an individual but are split out so as to understand them in the new context of the division of labour and exchange. This is, of course, highly useful as it is only by utilising this approach that we can hope to gain any understanding of economic phenomena in the world in which we live, a world that is certainly not isolated but where each individual relies heavily on the productivity of everyone else. However, there is a danger in compartmentalising these activities and considering them only in isolation. With our lone human, we noted that less work means the same enjoyment for a lower burden of effort. A labour saving device, such as machine to pick fruit, for example, would obviously be of a benefit to him. But in the whole economy where the roles of consumer and producer are split, if such a device is introduced, the relative benefits and burdens appear to be split also. Hence, person X, the purchaser and consumer of fruit, is benefited by the lower cost of the product that the machine has permitted. But person Y, who might have been a fruit picker before the machine was introduced, might now find himself completely out of a job (or he may find that at least the demand for his services is drastically reduced) with apparently no corresponding benefit. The conclusion that is often drawn is that there has been a great harm and that “something must be done” to alleviate the plight of the formerly employed fruit pickers. This becomes manifest in a number of policy considerations such as “make work” rules, subsidies, campaigns against machinery and so on, many of which are instigated under union pressure.

The errors of these conclusions come from looking only at the production element of the economy and ignoring the consumer element. For no one in their right mind would say that an individual human should “make more work” for himself or destroy productive machinery to “give him a job”. It is obvious that such things would be a detriment to his ability to consume the fruits of labour. Nor would he be able to subsidise himself by taking money out of one of his pockets and putting it into the other. The very aim of every individual person is to gain as much as he can while doing less work, not more. Yet this is precisely what we do when looking at the economy as a whole. If productive machinery is allowed to displace jobs then this means that the consumers benefit with lower prices and/or increased product. To ward off the loss of jobs by artificially restricting the saving of labour is simply to “benefit” the production end of the economy but to “burden” the consumer end. But the whole point of production is consumption. These people, being kept in jobs that are unneeded, are in no way contributing towards the benefits of consumption. Their work continues as a deadweight cost and there is neither dignity nor achievement in perpetuating their pointless labour. Furthermore, while it is true that they will suffer unemployment in the meantime, the increased supply of free labour will cause wages to fall temporarily. This means that new lines of employment, those that were not previously economic when the people’s labour was desired to pick fruit, are now suddenly viable. New entrepreneurs will rush in to hire the spare labour and devote it to their new enterprises. One must not forget that there will be a degree of hardship during the transition, particularly if one was in a now redundant job for many decades or if a particular skill or talent has now become obsolete. But by deploying the labour to new lines of work, the array of consumer goods now increases. The labour saving device enables more consumption for lower prices, the final end of production, rather than stifling it in the production of the same goods for the same prices. In his role as a consumer every person will feel this benefit over time as real wages increase as a result of the increased productivity.

All of this goes to show that, far from failing to explain anything noteworthy, the economics of the isolated man – so-called “Robinson Crusoe” economics – must be thoroughly borne in mind if one wishes to avoid these misunderstandings.

The Broad View of the Economy

The second error we outlined above was of the opposite ilk – that, rather than looking at parts of the economy in compartmentalised components, one looks only at the whole economy and only thinks in terms of hermetically sealed aggregates and totals. With the individual, lone human we noted that anything that increases his consumption and reduces the burden of production is of a benefit to him. When he is, in effect, his own “mini-economy” all burdens are felt by him and all benefits are enjoyed by him; the one is weighed against the other in the same mind. If, for example, a person desires more to bake more bread and to achieve this he is going to deliberately curtail his production of meat then there is no problem in saying that the burden of the reduction of meat is offset by the increase in bread, for this individual feels both the burden of less meat and the benefit of more bread. His action demonstrates that he prefers bread to meat. This is not the case in the economy as a whole, where roles are concentrated under the division of labour and burdens and benefits are scattered across many – literally millions of – different people. It is a mistake to assume that there is any one, particular event that will be “good for the economy as a whole”. For the economy is just a number of people trading and co-operating peacefully; it is not an entity in its own right, it does not feel, it does think, it does not desire and feels neither pleasure nor pain. While we can, for example, say that a decline in meat production offset by a rise in steel production is a benefit “for the economy as whole” in the sense that the individual members of this economy have chosen to prefer steel over meat (and that jobs in the meat industry will shift to steel production), it is not the case that some broad measures of “output” and “input” leads to the conclusion that all is well. The most pervasive manifestation of this error is the almost ubiquitous obsession with GDP, a figure that is calculated from numerous aggregates that bear no relationship whatsoever with the underlying desires of the acting humans. A particularly crucial element in this aggregates is that of government spending. If GDP starts to fall, say, from the onset of a recession, then Government can simply prop it up by increasing its share of the GDP pie. But it does not follow from this that there is any benefit from this spending. It can only be concluded that an exchange is beneficial if the parties to exchange are volunteers. They only exchange because their action demonstrates that they desire the good that is gained more than the good that is given up. Government spending, however, is funded by taxation3, a compulsory exchange, not a voluntary one. Because the exchange was compulsory it demonstrates that the tax-paying party would prefer not to have his money in the hands of the government. If he did so prefer he would have paid it across voluntarily. When the government spends this money, therefore, it can only do so in ways that are less valuable to those people who provided the funding. There is no sense in which anyone is “better off”. The big aggregate numbers may look impressive following this expenditure but what has not been realised is that they are completely severed from the preferences of the individual people. The situation is no different from one man holding a gun to another’s head and forcing the latter to devote his productive resources to churn out stuff that he doesn’t want. The effort, the production and the physical results may look impressive but there is no point in producing anything if it does not satisfy someone’s most urgently desired needs. What has been gained, like Bastiat’s famous broken window, has simply been at the expense of something that was more highly desired. The same is true also of so-called “infrastructure” spending, which ignores the intricate web of the capital structure. This has been dealt with in detail here. Suffice it to say for the moment that government spending on capital goods does not help the economy; rather, the effect is to divert the economy from a path on which it was meeting the needs of individual people onto a path where it must adapt itself to the new capital resource. Lines of production that depend upon that resource will become profitable, but only at the expense of other, more highly desired lines that have to be abandoned because their funding was compulsorily diverted to government capital expenditure.

The same fallacy – of viewing the economy only as a whole – is evident in the whole saga of the business cycle and credit expansion.  For while the forced lowering of the rate of interest swells the aggregate numbers – everyone is employed, stock markets climb, skyscrapers start shooting up, etc. – what has been forgotten is the underlying preferences of the individuals in the economy. They are not willing to devote the resources necessary to sustain the new capital structure which is precisely why, when the credit expansion stops, the whole lot comes tumbling down. Indeed, the entire approach of mainstream economists seems to be that the economy is doing well as long as somebody, somewhere, is spending on something, i.e. as long as there is some kind of “activity” then there is no cause for alarm. Their failure to acknowledge the wastefulness of the boom and the necessity of the bust demonstrates their lack of comprehension of the fact that spending the scarce resources at our disposal on stuff that is simply not wanted is emphatically not economising activity – it is just waste. The lesson from the 2008 financial crisis should be that you cannot build houses if people are not prepared to pay for the bricks.

The Praxeological Method

These two errors – of looking at the economy too narrowly and then too broadly – can only be avoided by following the praxeological method. For both errors have their root in the failure to grasp the same basic point – that all economising activity is initiated by humans who desire, choose and act so as to devote the scarce resources available to best meet their most highly valued ends. By understanding this crucial fact one would never focus too narrowly and advocate a programme to help certain producers at the expense of others; but neither also would one look too broadly and conclude that what appears to be some kind of economic activity – expressed through aggregates, totals and figures – is always a good thing. Human choice, actions and ends are the foundation of economic understanding and it is vital that is restored to its rightful place in economic thought.

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1We do not, of course, have to assume that every human wants to “have more” in the sense of material fulfilment; rather that every human wishes to meet his ends for the lowest costs whatever the substance of these ends may be.

2A labourer, for example, must, to a degree, possess entrepreneurial skill in choosing the employer from which his labour will yield the highest return; he will also be a saver and investor if, for example, he saves some of his income in a pension fund. And everyone, whatever their broader role in the economy, is also a consumer.

3Even if it is funded by borrowing not only must these borrowed funds be repaid with tax loot but also government borrowing crowds out private borrowing.

Capital – The Lifeblood of the Economy

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It is the gravest deficiency of mainstream economics that it fails to understand the necessity, role and structure of capital in the economy, a failure that permeates through to lay debates concerning production, income, wealth and redistribution. This essay will explain why this deficiency will lead to economic ruin unless its errors are comprehended and corrected.


It is self-evident that everything desired by humans that is not the free gift of nature at the immediate point of consumption must, in some way, be worked for. By “worked for” we mean that the human consciously strives to devote means to bringing about an end that would not otherwise exist. The benefits of air, for example, must be “worked for” in the sense that the body has to contract the diaphragm to inhale. But to the extent that this is not a conscious process, that the human does not knowingly have to divert resources to meet this end means that air is, to all intents and purposes, a free good. Very few, if any, other goods meet this criteria and the environment of the first human that walked on the Earth was one of unrelenting scarcity, a complete and utter dearth of anything necessary, enjoyable or desirable for that human being’s existence.

An isolated human, therefore, has to work to produce his goods. The extent of his success determines his productivity or, to put it more starkly, his income. If, at the start of the day, he has nothing and he labours to produce three loaves of bread then by sunset we may say that his productivity, or his income, is three loaves of bread per day. Productivity does not rise proportionally with effort. It may be possible to achieve a high level of productivity with relatively little effort or, conversely, to waste ones efforts on boondoggles that turn out to be a complete failure. While it is generally true, therefore, that harder work will begat a greater level of productivity it is not necessarily true – humans must direct their efforts in the most appropriate way to enable the greatest productivity, not necessarily in the hardest way.

Let us take, then, the first human on Earth who has nothing except air to breathe and nature’s gift of his body which empowers him with the ability to labour. Let us say that, at this point, his wealth, his accumulated stock of produced goods, is zero. It will be the task of his existence to increase this level of wealth. How does and how should he go about this?1 Let us say that his first desire is to find firewood to burn and keep warm. So on the morning of day one of his existence he has no logs to burn and his wealth is zero. Off he goes on a brief expedition and, using only the body that nature has given him, he returns in the evening with three logs. His productivity, or his income for the day, is therefore three logs. We may also say that his wealth has increased from zero to three logs. However, he then makes the decision to burn all of the three logs to keep him warm for the night. His act of burning the logs is his consumption. He has used the three logs as consumer goods to directly yield him a satisfaction in his mind. However, with the arrival of morning, he is in exactly the same position that he was in on the previous morning – his stock of wealth is once again zero. So off he goes on another expedition and returns again, with three logs. Once again his income is three logs and his wealth has expanded by three logs. But again he burns them overnight, meaning that yet again his stock of wealth on day three is back to zero.

It is therefore the case that one’s stock of wealth is directly related to the amount of it that is consumed. The more of one’s produced product (income) that is consumed, the less overall wealth one has.

Let us say that, within a week, our human grows weary of collecting three logs every single day only to see them vanish again overnight. He wants to increase his wealth. What can he do? It should be self evident that the only thing he can do is to reduce his consumption; if, he wants to be wealthier at the start of tomorrow than he was at the start of today he needs to reduce his level of consumption by abstaining from burning one or more logs. Let us say that he decides to burn only two logs and sets aside one. The following morning, therefore, his wealth is now one log, whereas the previous morning it was zero logs. He is now wealthier today than he was twenty four hours ago, this increase of wealth being owed to the fact that our human he has engaged in an act of saving2. With his saved wealth he can do one of two things. The first possibility is that he can hoard it. If he hoards it then all this means is that, while his wealth will increase as his act of hoarding continues, the human’s consumption of the wealth that he is accumulating daily is merely delayed. This method of saving does not, in and of itself, permit wealth to grow and from this perspective serves little purpose. If all else is equal, he might as well burn the third log today and enjoy the extra warmth rather than leave it lying around for a future date3. However, the second thing that he can do is to take his saved logs and invest them. To invest means rather than consuming his wealth directly the human takes it and uses it as a tool of production of further goods. This must be the result of a transformation of the goods into such a tool. Let us say that the human saves enough logs to invest in the production of a wheelbarrow and that, for one week, he labours to construct the wheelbarrow. The finished wheelbarrow is now a capital good – a good used in the production of further goods. The aim, in this case, is for the wheelbarrow to be used to transport logs that will then, in turn, be burnt as firewood. Let us say that with the aid of the completed wheelbarrow he is now able to bring home six logs per day rather than the initial three. By aid of the capital good he is therefore able to increase his production of other goods. His wealth therefore increases by more than it would have done so without the aid of the capital good.

What, therefore, are the inherent qualities of this act of saving and investment? What, in particular, will induce the human to engage in it? There are several aspects to note:

  • It requires abstinence from direct consumption of the good that will be transformed into a capital good;
  • The abstinence is for a period of time, that is the time taken to transform the goods into capital goods that yield further goods for consumption;
  • In order to justify the period of abstinence, the yield of goods from the capital goods must be higher than it would have been without the capital good.

This final point is of crucial importance. For what will determine the human’s propensity to save/invest on the one hand and his propensity to consume now on the other? The answer will be his willingness to trade the period of waiting in which the capital good will be constructed against the increased quantity of goods that will result. He will start to save at a point when the increased quantity of goods yielded is more valuable to him than the utility gained from direct consumption now of the capital good. He will stop saving when consuming now will yield him more utility than waiting for an increased quantity of goods in the future. This propensity to wait is called his time preference. If time is relatively more valuable to him than an increased quantity of goods then he has a high time preference. If the increased quantity of goods is relatively more valuable than the waiting time then he has a low time preference.

Increasing Capital – the Structure of Production

The consequences of the increased yield of consumer goods – in this, case, from three logs per day to six logs per day – and the resulting increase in wealth means that our human yet again has to face the same choice as he did with his original stock of wealth – to consume or save (hoard/invest). Only now, however, he has to make this choice with an increased quantity of goods. What will be the possibilities?

  • He could choose to consume and save at the same rate as he did previously, that is one saved log per two consumed. Out of a total of six logs he will, therefore save two logs per day and consume four;
  • He could choose to consume at an increased rate and save at a reduced rate. One day of doing this would be to save the same quantity of logs as he was before (one) and consume the remainder (five); however, he could also increase the quantity he saves while decreasing the rate, for example by saving one and a half logs and consuming four and a half.
  • He could choose to save at an increased rate and consume at a reduced rate, for example by consuming the same quantity of logs as he did before (two) and saving the remainder (four); however, he could also increase the quantity he consumes while decreasing the rate, for example by consuming three logs and saving three.

The precise consequences of each choice are unimportant, merely that each will occur at a different rate depending on what is chosen. It should be self-evident that more saving will begat more capital goods and more consumption but only after the period of waiting; more consumption will mean more goods can be enjoyed today at the expense of relatively fewer in the future. But in practice, we might add, it tends to be the case that the wealthier a person becomes the more he tends to follow the third scenario, specifically by increasing the quantity he consumes while decreasing the rate. The rich, for example, consume a much greater quantity of goods than poorer people do but as a proportion of their wealth they consume less. This will have important consequences as we shall see when we consider the effects of taxation and redistribution below.

However, let us assume that, whatever choice the human makes, there will be a rate of saving that permits investment to continue. What will happen now?

As the level of production is now dependent upon a capital good, the rate of saving must, at the very least be able to maintain this capital good. Capital goods are not consumed directly but they are consumed in the process of production through wearing down. While no new wheelbarrow will need to be produced, of course, a level of saving that permits its parts to be repaired or replaced will be necessary. If the human is not able to maintain his capital goods what happens? It means that he is using it for the purposes of production the results of which are consumed to the detriment of repairing and replacing the capital stock; in short he is engaging in capital consumption. It should be self evident that if the capital is lost, production must decline and so too will the standard of living. The dangers of capital consumption will become clearer when we discuss it below4.

However, let us assume that our lone human is able to maintain the existing capital stock and also has enough further saving that does not need to be used for this purpose. What will happen? He will, of course, invest in further capital goods to increase his production of consumer goods. Let us say that, satisfied with the utility gained from and his ability to maintain his wheelbarrow, he decides instead to invest his logs in the production of tools. Let us say that he fashions from a log directly an axe handle. But the axe head cannot be made out of wood. He must acquire and fashion metal in order to complete the axe. Aren’t the saved logs useless for this purpose? Not at all; for while the saved logs cannot be used directly in the production of the axe head, they can be used indirectly in order to sustain our human during the production of the axe head. In short, let’s say he goes on an expedition far from home in order to acquire the material to fashion the axe head. He takes the saved logs with him and burns them at night to keep him warm. To the extent that the venture is successful and he returns from the expedition with the material to fashion the axe head, then the consumption of the logs has been compensated by the acquisition of the axe head. The axe head can then be used to fell entire branches or even trees which can then be transported in the wheelbarrow for our human to consume. Let us say that, once again, his output doubles as a result of the introduction of the axe, meaning that he now takes home twelve logs each day.

What does this addition of another capital good – the axe – demonstrate? In the first place, it once again demonstrates the requirement of waiting during the production of the additional capital good, waiting that must be sufficiently offset (in the valuations of the human) by the resulting increased level of production. But there are two more crucial aspects:

  • That, in terms of providing for the human’s needs, it is relatively less important to stress the amount of capital he possesses as compared to its precise structure. The new capital structure is intricately woven and the stages are dependent upon each other. For example, if he had two axes and no wheelbarrow, he could fell a lot of trees but would lack the means to transport them. If he had two wheelbarrows and no trees then he could transport a lot of logs but he wouldn’t be able to fell enough trees to fill and use two wheelbarrows. As we can see therefore, capital growth manifests itself as increasing the stages of an intricate production structure through the passage of time. Any interference with the precise structure of capital would be as detrimental as capital consumption; in the complex economy a corollary would be all of the world’s factories, tools and machines, consisting only of tractors. It would not be hard to see that, in spite of the overall level of capital being very high, the specific glut of tractors and corresponding shortage of absolutely anything else would lead to a very severe degree of impoverishment;
  • That the logs used in discovery and fashioning of the axe head, by not being used directly as a capital goods, were used as a fund to produce a capital good. The majority of capital investment is, in fact, the use of a fund of saved products that are consumed in the production of other products and these latter products are the capital goods. In the complex economy we can see how wages, for instance, which are consumed by workers are paid out of saved funds in return for their production of goods which are either sold or used as capital goods (or both if the buyer uses them as capital goods), just in the same way that the logs were consumed in production of the axe head.

This method of saving and investment in capital goods is frequently termed in “Austrian” literature as “roundabout” methods of production; that an increase in capital leads to a longer production structure with multiple stages (in our case hacking of logs off the trees with tools, collection of logs in the wheel barrow, followed by consumption). However a more appropriate description would be that increased saving and investment in capital goods results in a process of production that takes more time for a greater quantity of produced products.

Further Increases in the Structure of Production – The Source of Wealth

This outline of a simple economy consisting of our lone human and two stages of production should illustrate how that human can further increase his wealth. Assuming he continues to save at a rate above that which permits him to maintain the existing capital goods (the wheelbarrow and the axe) he can continue to expand the stages of production of logs or begin to invest in the lower stages of production of other goods. He might, for example, use one log to build a fishing net to catch fish, thus increasing his quantity of fish to add to his wealth. He then might be able to use quantity of saved fish and saved logs to sustain him in building a boat which permit him to catch and even greater quantity of fish. It is this process of capital accumulation, its maintenance and its regulation into a particular structure that is the cause of the increase of wealth. Relatively speaking, the more capital that our human has, the more tools, equipment, machines, etc. that he fashions by abstaining from the consumption of the goods that make them (and by waiting for them to be completed), the wealthier he is.

It should not be difficult to abstract from this simple illustration the workings of a complex economy. The only substantial differences are the existence of the division of labour and the resulting necessity of trade which serve as the most complicating factor in trying to visualise the complex, growing economy. For in such an economy people, on the whole, do not produce goods for their own consumption but rather they concentrate on the production of a specific good (or service) which they then trade in return for other goods. The other goods, of course, are never traded directly but with the aid of a medium of exchange, money, so that you sell the goods that you produce for money and then take money to buy the goods and services that you want to consume5. Each and every single day, then, any person who goes to work engages in production of a produced product. If you are a baker you produce bread, if you are a butcher you produce meat, if you are a fishmonger you produce fish. But no one butcher, baker or fishmonger directly consumes his own product, rather he trades it for money which he then uses to buy the goods he wants. So the baker, for example, may sell bread to the fishmonger who will pay for it with money. The baker may then use the money he receives to buy meat from the butcher. From the point of view of the economy as a whole, the situation is no different from that of the economy with the lone individual. We will remember that, in the latter situation, if our loner produced three logs per day and burnt (consumed) three logs per day then on the morning of the following day he is in exactly in the same position regarding his personal wealth as he was the previous morning. If, in our complex economy, the butcher, baker and fishmonger produce, respectively, on one day three cuts of meat, three loaves of bread and three fish, then if after trade these are all consumed by somebody at the end of the day, then tomorrow the economy as whole will be in exactly the same position as it was at the start of the previous day. If, however, some of these products are saved then tomorrow the economy as a whole will be wealthier than it was at the start of the previous day6.

Saving and investment in the complex economy will not, of course, take place in the form of hoarding the physical products like it did in the simple economy. Rather, let’s say that that the baker sells three loaves of bread to the butcher and receives in exchange for them money. His saving takes place in the form of saving money rather than goods directly. His investment will come in the form of spending this money on goods that are used for investment – i.e. are transformed into capital goods – rather than for consumption. For example, let’s say that he takes his saved money (we shall call it £100) and buys fish from the fishmonger. In exactly the same way as the logs sustained the lone human in constructing the axe head, the fish provide sustenance for the baker while he increases his capital at his bakery – let’s say he invests in a new oven. The fish, therefore, provided a fund which was used to construct a new capital good, the oven which will produce more consumer goods. In his own mind, however, the baker will not reckon in terms of fish, ovens, or the extra amount of bread that is produced as a result of the oven’s construction. Rather, he will say that he has an investment of £100, an investment whose return will be measured not by the physical quantity of extra bread produced but by the increased money he will receive from being able to sell the extra bread. It is this extra money that, in his own mind, compensates him for the waiting time in constructing the capital good. If we say, for example, that he invested his £100 at the start of the year and by the end of the year his sales had increased by £10 then we may that the return is 10% per year. This return is known as interest, the compensation for the waiting time between the point of saving and the point that the increased quantity of consumer goods is available for consumption (and in this case, when the baker has the money from the increased sales).

Another possibility is that rather than expanding his existing business the baker creates a new one; or he could lend the saved funds to somebody else to invest in their business. Let’s say that he lends the money to a new entrepreneur, the candlestick maker. The candlestick maker has himself also saved £100. for his new business and so, together with his own saving and the money lent to him by the baker, he has a total investment in his firm of £2007. The candlestick maker will then take that money and spend it on the fish (or other goods) that will sustain him in producing the capital goods needed for his new candlestick business. Let us say that this business is successful and, at the end of the year, the resulting sales means that the value of the business has increased from the initial £200 to £220 – the original £200 capital and £20 return on that capital as a result of increased sales. This £20 will be divided between the baker and the candlestick maker depending on the terms of their investment, but overall the firm has received interest of 10% per annum.

We have, of course, left out of this simplistic calculation the fact of depreciation – the wearing down of the capital goods during their use in production. Suffice it to say here that at the end of the year the original amount of saving reckoned in money terms will be less than £200 owing to the depreciation of the capital goods in the venture. More on this can be read here].

Another aspect we have deliberately ignored is entrepreneurial profit and loss. The rate of return that any one person needs to receive to induce him to save and invest is the interest return – the compensation for waiting. We have assumed in all of the illustrations above that any saving and investment will for sure result in the return that is expected. But this is never the case in real life – the actual return may be greater than, less than, or equal to what was expected. In all cases, then, the actual return will consist of:

Interest + Profit/Loss8

Going back to our original lone human, he may find that his wheelbarrow actually is only enough to bring him an extra two logs per day whereas he originally wanted three. His return will therefore consist of an interest return of three logs and a profit/loss of negative one log. Or, he may be delightfully surprised to find that his wheelbarrow is enough to bring in four logs per day in which case he will earn interest of three logs and profit/loss of one log. Or, the most disastrous of all outcomes would be that he finds the wheelbarrow is a complete hindrance and, in fact, means that he is able to harvest fewer logs than he was with his bare hands! Let’s say he can only bring home two. In that what is earned is interest of three logs and profit and loss of negative four logs. The real loss that he experiences is much higher than the nominal loss of logs – four and one respectively – as, at the time he decided to save and invest, he needed a return of three logs to justify the waiting time. Although he only appears to lose one log by erroneous construction of the wheelbarrow his actual loss is much greater because of the waiting time he endured. In our complex economy, profit and loss takes the form of having to anticipate that other people will want to purchase the additional produce that is enabled by the capital good. If the actual selling price of the final goods is more than what was needed to induce an entrepreneur to save and invest then this represents an entrepreneurial profit. If it is less than he suffers an entrepreneurial loss9.

It is not necessary for the reader to dwell too much on the intricacies of profit and loss in order to understand the role of capital in increasing wealth. An elaboration is offered here merely for the sake of a degree of completion. Interest, however, is vital in understanding the role of capital. It must be emphasised again that people will begin to save and invest in capital goods when the resulting outlay of consumer goods is higher than what could be produced without the capital goods, and this outlay must be sufficient to compensate for the waiting time in which the capital goods are constructed. In short, people must make a choice between having fewer goods to consume today or more goods to consume at a future date. The number of additional goods that a person wants to appear at the future date to induce saving is his interest return. Whether this return actually appears or not and to what degree determines his profit and loss. But it is this desire to consume more in the future, to abstain from consumption today for a lot more of it tomorrow, that enables the economy to grow and for wealth to expand. There is no other way than by saving and investment in capital goods.

In the complex economy, of course, everyone can be savers and investors and we do so in a multitude of different ways and through different channels. Anyone who earns a wage and then spends a portion of it on his monthly outgoings (i.e. consumption) and uses the remainder to, say, deposit in a savings account, or to buy bonds or shares is investing in capital goods and increasing the capital stock of the economy. If it is saved in a savings account, the bank will lend that money to companies who will use it to invest in the capital goods, the return on which will enable the bank to pay interest to the depositor. If stocks or bonds are bought then money is advanced to a company directly. The crucial aspect is that by saving money, you are not consuming. By investing it you are turning those goods that could have been consumed today into capital goods that will produce more goods to be consumed in the future.

Having therefore examined in some detail the role of capital in wealth accumulation and raising the standard of living, let us proceed to analyse some aspects of Government interference that will affect the rate of saving and investment.


Taxation is the deliberate confiscation by the Government of that which has been produced. It must be emphasised that all taxation, whatever name it is given, however one may attempt to justify it, must be a taxation of produce. There must be something that has been produced that the Government can come along and take. In our example of the lone human, the Government would have come along and taken some of his logs, i.e. confiscated his produce directly. In the complex economy the Government tends not to confiscate produce directly but rather money which it then spends on produce, i.e. the produce that the taxed individual could have bought is diverted, by way of money, to the Government.

From our analysis of saving and investment above we also know that there are only two types of produce that can be taxed – that which is produced today (income) and that which was saved and invested (capital, or wealth). There is nothing else that can be taxed and all taxes are either taxes on income or on wealth. What are the implications and results of each? Let us deal with the material effects first of all. If the Government taxes income, that is, the presently produced product, we know from our analysis above that it can do so up to a point which still permits enough saving to maintain the existing capital stock. If it does this, the present level of production can continue as the capital goods will keep functioning. However, for the remainder of the produce that is confiscated, there will be less saved in the hands of private individuals and entrepreneurs to invest and increase the capital stock. Capital growth, therefore, will be retarded. And even if the private individuals would not have saved this income but would have consumed it, it is still the case that they have suffered a loss from the fact that the produce is directed towards Government ends rather than their own. The important point is, however, that taxation retards the ability of private individuals to grow capital and increase production and, hence, the standard of living must either stagnate or improve less quickly.

It is no answer to this charge to assert that Government might take this money and spend it on allegedly “important” capital projects such as roads, schools, hospitals, and other spending on what they like to call “infrastructure”. As we noted above it is not the capital stock that is so important but rather the capital structure. For the invested capital must take a form in which it meshes cleanly with the rest of the existing capital and its produce supports the production of goods further down the chain of production. It would, for example, be useless to bring a fishing net to a cattle ranch. The only way to determine whether capital contributes to the capital structure is through the pricing, profit and loss system – that capital that is successfully producing generally needed products to create further products will turn a profit for the enterprise. But how does Government, devoid of the need for profit and loss, know that, say, a factory or a road must be built? What if it diverts its taxed resources to building a grand factory but there are no machines to put in this factory? How does it know how large the factory should be, what it should produce, etc.? No Government has any method of gauging these criteria. Our lone human, we noted, needed in his capital structure an axe to fell trees and a wheelbarrow to transport the logs. Having instead two axes or two wheelbarrows would have been of no use to him. Precisely the same is encountered when Government produces roads when there are no cars, hospitals but no operating equipment, tractors but no plough, railway locomotives but no wagons. Such was frequently the case in the former Soviet Union where buildings and machinery frequently were lying incomplete because a crucial part had received underinvestment and hence was simply missing. It is true, of course, that the capital structure that remains in private hands will adapt to the capital that Government has forced upon it. If a Government produces a road, for example, it becomes more economical to increase the production of cars in order to fill it. But all this means is that private investment has been forced to adapt to what the Government has produced whereas these Government projects are frequently sold to the public as being necessary to “boost the economy” etc. Instead the capital structure has been twisted and distorted from the form that it would have taken had it been left alone and the structure that is in fact produced is serving ends that are relatively less valuable than those that would have been served in the absence of the Government interference. As Bastiat would put it, the Government may be able to point to its wonderful roads that are full of cars (that which is seen), but what is not seen is all that was not produced as a result of this diversion of funds10. It is for this reason that, economically, all Government spending must be regarded as waste spending.

However, what if the Government initiates an even higher level of income taxation, a level that does not permit enough saving to main the existing capital stock? Then, disaster will strike. For now the existing capital stock will start to wear down and cannot be replaced. As the capital structure collapses, production will decline and so too will the standard of living. Production processes will become shorter and less roundabout as the produce that could have maintained them is siphoned off into Government consumption. The situation is exactly the same as if the lone human consumed the logs that should have been diverted to maintaining his wheelbarrow. He enjoys, for the moment, the additional consumption of the log but at the expense of a severely reduced level of consumption in the future. But when the Government taxes income at such a level the private citizens do not even get to enjoy this temporary upswing of consumption, merely the bureaucrats and politicians whose lifestyles it is supporting.

Within this category of taxation of income we may place all of the everyday taxes from which people suffer – income taxes, sales taxes, excise taxes, corporation taxes, capital gains taxes, dividend taxes, VAT, etc. Anything that is a tax on productivity or newly produced good is a tax on income.

Finally, we consider the horror of horrors – when Government doesn’t tax the presently produced product but instead directly taxes the existing stock of capital. Within this category fall inheritance taxes, property taxes and wealth taxes. The results of such action should be obvious as it deliberately sets about consuming the capital stock. It dismantles the factories, machines and tools and diverts them towards Government consumption and even if the Government diverts them to “investment” then this will simply be of the same kind of Government “investment” that we just outlined with regard to income taxes. Wealth taxes are the most ruinous and destructive, attacking the very means of production and leading to a rapid decline in output and the standard of living. The situation is precisely analogous to our lone human chopping up his wheelbarrow and using it as firewood – there is a temporary increase in enjoyment today that must be offset by a very rapid decrease tomorrow.

It is at this point that we should consider all “soak the rich” taxation rhetoric and practice. For it is usually the point of view of politicians and the non-rich that the wealthy provide an inexhaustible slush fund that can be plundered and pillaged to serve whatever “needs” might be desired. Earlier we noted that there is a tendency (although not strictly a necessity) that as income increases the proportion of that income that a person devotes to consumption decreases and the proportion that is devoted to saving and investment increases. Therefore, while the rich consume more in terms of quantity than a poorer person, as a percentage of their overall income they consume far less. A person earning an income of £1 000 per month might consume £800 worth and save £200, a consumption rate of 80% and a saving rate of 20%. However a person earning £10 000 per month might consume £3 000 and save £7 000 – a consumption rate of 30% and a saving rate of 70%. So while the rich person is visibly consuming more in terms of quantity he is saving and investing a very great deal more. This saving and investment is obviously channelled into capital goods, goods which are used in the production of consumer goods that other people can buy. By increasing the supply of consumer goods the prices of these items drop and so they become more affordable to everyone else and the general standard of living increases. To the extent that the “rich become richer” through this process it is only because they invest in those capital goods that produce the wares that are most eagerly sought for by the masses. Indeed the only way to really become rich under conditions of free exchange is to abstain from consumption and divert your savings to that which people most want to buy11.

If the Government therefore sets about taxing the rich to what extent can it do so? It should be clear from our analysis that it can tax the proportion of the rich person’s assets that comprise his consumption spending. If this is done then what the rich man would have spent on fine dining, chauffeurs, exotic holidays etc. is simply diverted to Government spending. The capital structure remains untouched. But the amount of consumption spending by the rich is extremely limited; indeed if all of it was to be confiscated and distributed to the world’s poor there would barely be enough to give everyone a handful of pennies. Therefore, if taxes on the rich are to be increased then they must start attacking the saved wealth of the rich, that is the capital structure. In short, factories, machines, and tools – the very things that were churning out affordable products that the masses wanted to buy – are liquidated and diverted to Government uses, either to Government consumption or to a form of investment that, as we noted above, must necessarily be less valuable than that which existed before. The very worst thing that can be done is to tax the capital stock and distribute it in welfare for then the saved wealth of society is quite literally transferred from those who saved and invested it to those who consume and destroy it. With fewer machines and tools there will be less production, with less production there will be fewer goods, with fewer goods there are higher prices and with higher prices there is less that everyone is able to buy.

We might conclude this section, therefore, by saying that from the point of view of the standard of living, all taxation will retard its level or growth. However, that form of taxation which decays the existing capital stock is the most destructive. Wealth taxes, inheritance taxes, property taxes and their ilk should be firmly resisted.

It is not sufficient, however, to merely consider the material effects of a policy of taxation, wherever it may fall. We also need to consider the psychic effects. It is self-evident that all taxation is a confiscation from one set of persons and a distribution to another set of persons. Those who have had their goods confiscated must be producers; those who receive in distribution must be (relative) non-producers. Indeed, usually some kind of non-productive status is what qualifies a person as a recipient of welfare spending – poverty, illness, disability, etc. It is an axiom of human action that all humans devote their energies to that which has the most benefit for the smallest cost. We endure the toil of labour because the loss experienced in doing so we deem to be worthwhile for the value that is gained as a result. The same is true of consumption and investment. Each has its own benefits and costs. The benefit of consumption is the enjoyment that it provides to the mental faculties; its cost is the labour expended in production of the article to be consumed and that, once it is consumed, it is gone forever and cannot be devoted to an alternative or additional use and further needs must be met by increased production. The benefit of investment is an increased yield of consumer goods in the future; its cost is the pain of having to deny oneself the consumption today of the goods that will be added to the capital stock.

If there is any change in the relative proportions of these benefits and costs it follows that certain activities will become more attractive (i.e. more valuable) and others will become less attractive. Yet this is precisely what the effects of taxation are, effects that fall heavily upon the impetus to produce, consume, or invest. We noted earlier that a person will start to invest at the point that the increased quantity of goods that results from the investment is sufficient to compensate him for the waiting time necessary to produce the capital good. Yet if the fruits of this productivity are taxed it means that the yield is reduced. To the individual saver and investor, the benefit of saving and investment has declined, but the costs remain the same – he must still expend the same amount of labour and must endure the same amount of waiting time but only now for a smaller yield. The value, therefore, of investing will, to him, decline and consumption will become relatively more attractive. There will therefore be less investment and more consumption, lower output and the standard of living will decline. It gets worse, however, when we look to the recipients of taxed income or wealth. For in a world where there is no tax, the enjoyment of consumption must be outweighed by the costs of production and the incentive to invest. Only if the value of consumption is higher than the toil of production and the yield from investment will consumption be carried on. But if one now receives an income free of the necessity to produce, both of these costs are removed. For now, why should one labour to produce when he can simply receive the benefit – the enjoyment – for free? And why should he invest when he can simply demand another article from the Government once he has consumed the first? And even if he did invest his income from other people’s taxes, this will simply be taxed away anyway. Why bother?

In short, therefore, taxation reduces the relative value of production and investment. It increases the relative value of consumption. There will therefore be less production and investment and more consumption, the stock of capital will decline, output will decline and the standard of living will lower also.


Regulation is, in common social democratic discourse, deemed to be a necessary tempering (or tampering, one might say) of the otherwise capitalist economy, the wise overlords stepping in and ensuring that people do not compromise “safety”, “quality” or whatever in their supposedly lustful pursuit of profits. We will leave to one side any discussion of the fact that regulation is itself a service that consumes scarce resources and that the benefits of a regulation must be offset by its cost – hence it is a market activity just the same as any other. Rather, we shall focus exclusively on the effects of Government (i.e. forced) regulation upon saving and investment in the capital stock.

The effect of a regulation is to ban a certain activity from being carried on by otherwise free individuals; an example would be a restriction on to whom a certain product can be sold, perhaps by age or income. Or, it can take the effect of a requirement to do so something, usually before something else can be done. For example, it may be required to provide a list of ingredients or a nutritional breakdown on an item of food before it can be sold. However sensible they may seem the effect of regulations is to limit the ends to which capital may be devoted.

Let us first of all consider regulations that take the form of bans. As we noted above the incentive to save is dependent upon the fruits of production that are the result of the investment. In a free market a person can invest in whatever he thinks people will want to buy. By advancing goods and services to meet people’s ends he earns a return. The public could, for example, in the saver’s estimation be demanding more of goods X, Y and Z. He will invest in the line of production that he believes will yield the highest return. But what happens if the Government then intercedes with a regulation? It is effectively saying to the investor “you may invest in goods X or Y, but not in good Z”. In other words, an entire avenue of investment opportunity is closed off even though both the public and the investor may wish to trade the good Z. What then happens if Z was the most profitable investment? Then, by having to invest in the relatively less profitable X or Y, the value of saving and investing to the investor will reduce. Therefore, there will be less saving and less investment. Indeed he might even decide that the profit opportunities afforded by X or Y to be insufficient to reward him for the waiting time between the act of saving and the receipt of returns. He may just decide to consume entirely that which he would have invested. The amount of capital investment therefore decreases and so too does the standard of living. But even if he does invest in X or Y this is not what the buying public are demanding – they want Z and no extra amount of X or Y will compensate for this loss.

However, the more common type of regulation is of the second kind – that a product may be invested in but there are regulatory requirements that must be met before one can do so. Let us take the typical type of regulation on which the Government feels itself qualified to pronounce judgment and that is health and safety. If the public demands food, for example, it may be perfectly happy to buy food that comes without any detail of ingredients or nutritional breakdown. The Government then decides that people aren’t giving enough thought to their health (probably as a result of them being able to get free healthcare, which has been dealt with in detail here). So the Government then steps in and says to the investor “OK, you can invest in food but to do so you must provide a list of ingredients, a nutritional breakdown and, with every sale, you must provide a free fact sheet of how to live healthily.” The effects of such an edict should be clear – for every article that is now sold, the investor must spend additional money on analysing every article of food for its ingredients and nutritional content and must spend even more money further on producing the factsheet. Yet the public are not demanding these things so they will not be willing to pay any more for the articles that are purchased. The effect of this regulation, then, is to increase the amount of capital that is needed to produce the same return. Or, to put it another way, the same amount of capital produces a lower return. So once again, then, the value of investing to the investor is lowered and there will be less of it. By heaping on to production artificial, deadweight costs that serve no one capital is simply consumed purposelessly. It is conceivable that regulation may cripple an industry so much that it deters all investment and investors will simply stop producing the regulated products altogether. In practice what tends to happen is that regulation forces out the smaller investors, the upstart companies, while the big players are able to absorb the added costs. The economy is then left with a few key providers in each sector who are able to raise prices and lower quality as a result of this insulation from competition.

Regulation is therefore one of the most powerful ways in which capital investment can be restricted, possibly even more so than taxation.


The final aspect of Government intervention into saving and investment we will consider is that of uncertainty. Whereas before we were analysing the effects of known Government policies on taxation or regulation, here we will look at what happens when someone simply doesn’t know, or cannot be sure of, precisely what the Government will do.

Rothbard describes succinctly the role of uncertainty in human action:

[A] fundamental implication derived from the existence of human action is the uncertainty of the future. This must be true because the contrary would completely negate the possibility of action. If man knew future events completely, he would never act, since no act of his could change the situation. Thus, the fact of action signifies that the future is uncertain to the actors. This uncertainty about future events stems from two basic sources: the unpredictability of human acts of choice, and insufficient knowledge about natural phenomena. Man does not know enough about natural phenomena to predict all their future developments, and he cannot know the content of future human choices. All human choices are continually changing as a result of changing valuations and changing ideas about the most appropriate means of arriving at ends. This does not mean, of course, that people do not try their best to estimate future developments. Indeed, any actor, when employing means, estimates that he will thus arrive at his desired goal. But he never has certain knowledge of the future. All his actions are of necessity speculations based on his judgment of the course of future events. The omnipresence of uncertainty introduces the ever-present possibility of error in human action. The actor may find, after he has completed his action, that the means have been inappropriate to the attainment of his end.12

It follows from this excerpt that an increased degree of uncertainty leads to an increased possibility of error – that there is an increased likelihood that the scarce goods used in attainment of the end will, in fact, not attain the end and will be wasted. And, as Rothbard highlights, part of the composition of this uncertainty stems from future human choice, in our case the choices of the Government actors.

We noted above that the effect of Government taxation and regulation is to render less valuable the act of saving and investment to the individual. If he knows that he will be taxed and regulated to nth degree then he can, at least, factor this in to his calculations and act accordingly. If, however, the Government creates an aura of uncertainty – that an individual investor may find his fruits taxed or regulated not necessarily to the nth degree but may be to the n + 1st degree, or the n – 1st degree, or to a whole other range of possible degrees, then this weighs heavily on his mind in deciding whether to save and invest. Indeed heaping on uncertainty effectively increases the psychic costs of an action. The greater the degree of uncertainty and the more likely it is that his decision to invest will result in error (the error in this case being that he will suffer a more crippling degree of taxation or regulation than he would prefer) the more costly it becomes. Hence, the relative attractiveness of consumption increases. Indeed, consumption renders neutral this uncertainty – if something is consumed then the Government, for sure, can’t come along later and attempt to tax it away. There will, therefore, be more consumption and less saving and investment. The capital stock will not grow as fast and neither also will the standard of living.

Uncertainty, often labelled “regime uncertainty”, has been an important factor following the 2008 financial crisis and the subsequent malaise. Precisely because nobody knows precisely what the Government will try next, whether it be stimulus, taxes, regulations, capital controls, inflation or whatever, nobody is willing to take the risk to save and invest. Indeed, in the US, the huge increase of excess bank reserves – i.e. banks simply holding onto cash – following the expansion of the monetary base is at least partly explained by the phenomenon of increased uncertainty.


What we have realised through our analysis, therefore, is that capital accumulation is the source of increased wealth and an increased standard of living. Where there are strong private property rights to this capital and its fruits then capital accumulation will, all else being equal, be encouraged. Where these rights are compromised by taxation and regulation, they will be discouraged. Further, as our discussion of uncertainty entails, it is not sufficient that these rights are left uncompromised today but there must also be an expectation that they will not be compromised in the future.

We have not said much about Government-induced credit expansion that leads to business cycles. The effect of credit expansion is to divert goods away from consumption and to invest them in more roundabout production processes. This looks, on the face of it, as if the Government is doing a benevolent thing – it is causing us to increase the capital stock! But as we noted above, the return on capital must be sufficient to justify the waiting time. If people are not willing to endure this waiting time then investment cannot occur. Indeed credit expansion is forced saving and investment in an increased capital stock. When the credit expansion halts it is not possible to continue this diversion of goods into building and maintaining this capital structure; rather the latter now becomes fully dependent upon the consumption/saving preferences of consumers. But these preferences are not sufficient to carry out the level of investment required. The capital structure is revealed as malinvestment and must be unwound. Tragically, the Government, in ignorance of what we have learnt here about waiting times and the necessity for a precise capital structure that meets the needs of consumers, responds to this series of events by trying to boost consumption, even though it is not consumption that needs a shot in the arm. If anything, there needs to be more saving and investing so that at least some of the projects that were embarked upon during the credit expansion can be justified.

All in all the effects of Government upon capital accumulation and the creation of wealth are a disaster. All that is needed for these things to occur is private property and free exchange and Government, if we are to endure at all, should concentrate on guaranteeing these institutions.

1Strictly it is a necessity of human action that it seeks improvement to the current condition. Therefore, simply moving an object out of one’s way or to where one would prefer it to be is an act of “production” and an increase in “wealth” from the acting human’s point of view. But for the sake of simplicity we will discuss production, income and wealth as alluding to driving towards an increase in the number of material, tangible goods that the human can enjoy.

2Here we may briefly consider what the purpose of increasing wealth is. Excluding the possibility that someone gains utility simply from owning a lot of stuff, it can only be to consume in the future. The ultimate aim of all production is consumption, if not by yourself then by your heirs. Production that does not eventually result in consumption gains nothing. This is important for understanding what the human does with his saved wealth.

3We must add emphatically that hoarding is not unproductive and typically takes place in times of uncertainty – when one does not know whether he might suddenly need to call upon extra resources – or to cater for a known period of un-productivity, such as storing food for the Winter.

4Technically speaking if the level of “saving” is insufficient to maintain capital then there is a net dis-saving. As Mises puts it: “The immediate end of acquisitive action is to increase or, at least, to preserve the capital. That amount which can be consumed within a definite period without lowering the capital is called income. If consumption exceeds the income available, the difference is called capital consumption. If the income available is greater than the amount consumed, the difference is called saving. Among the main tasks of economic calculation are those of establishing the magnitudes of income, saving, and capital consumption.” Ludwig von Mises, Human Action, Scholar’s Edition, p. 261. However for the purposes of this essay we shall define income as the produced product and saving as the portion of the income that is not consumed, regardless of whether the rate of saving is sufficient to maintain the capital stock.

5Money as well as being the medium of exchange is also is the facilitator of economic calculation without which a complex economy could not exist. Money is also a good in its own right but there is not space here to dwell on the fascinating reasons how and why it comes into existence. Interested readers should consult Ludwig von Mises, The Theory of Money and Credit.

6A word of extreme caution in necessary when discussing the economy in the aggregate. Simply because we say that x amount of produce is consumed or y amount of produce is invested does not mean that it does not matter precisely who is consuming and who is investing. For it matters very much to the particular individuals concerned. If, for example, the baker purchases three cuts of steak from the butcher with the intent to consume all of them but the fishmonger steals them and consumes two but saves one, even though the fishmonger has “saved” one steak that would have been consumed by the baker we can in no way say that the economy is “better off”. The loss of utility of steak consumption to the baker cannot be compared or measured against the gain of utility to the fishmonger who consumes two steaks and saves one. Similarly if a slave is forced to labour to produce bread in the bakery and he gets nothing in return we cannot say that the economy is better as a result for there has been a very real loss to the slave in spite of the bread produced. We can only assume that there are gains in utility when there is voluntary exchange and any analysis of the economy as a whole which results in conclusions of one state of affairs being “better” or “wealthier” than the other must be made under the assumption of voluntary production and exchange.

7Whether someone is a stockholder or a lender to a firm or enterprise is a legal difference, not an economic one. They are both advancing saved funds to further the firm’s ventures but on different terms.

8There is also the possibility of additional compositions of return that we will ignore here. See Murray N Rothbard, Man, Economy, and State, Scholar’s Edition, pp 601-5, although it remains doubtful whether some of these can be distinguished conceptually from existing categories of return.

9Calculated profit and loss in the complex economy is measured against the societal rate of interest which is determined by the societal time preference rate. The societal interest rate is the price at which all willing borrowers can borrow money and all willing lenders can lend it and the success of failure of an enterprise will, by and large, be judged against this rate.

10Claude Frédéric Bastiat, That Which Is Seen and That Which Is Not Seen.

11Capitalism, in contrast to socialist and Marxist myths, has always been a system of production for the masses, of increasing the outlay of basic, everyday items that are sold inexpensively to everyone. Very little of capitalist production is devoted to luxury production for the rich.

12Rothbard, p.7, (italics in original).

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All too often one hears the repeated lament that the reason for boom and bust, widespread poverty, the increased inequality of incomes, endless warfare and whatever else happens to be plaguing the world today in the eyes of the saintly commentator are because people are afflicted by greed. “If only people weren’t so greedy then everything would be fine!” chants the typical appeal.

However even a brief thought will reveal the empty nature of this word as a basis for criticism of the current social, political and economic order. This is not to suggest for a moment that the order is perfect or even right, nor that some people are not endowed with malicious intent. Merely that pursuing the problem with reference to “greed” is simply meaningless.

There seem to be two strands to any accusation of “greed”. First, that the alleged perpetrator desires to “possess wealth, goods, or objects of abstract value with the intention to keep it for one’s self, far beyond the dictates of basic survival and comfort” (as Wikipedia puts it) – i.e. that greed is the desire for some form of excess. Secondly, that only some people are afflicted by this menacing motivation whereas the rest of us are apparently content to languish in undemanding modesty.

Taking the first problem, if some people want or desire some kind of excess then we are entitled to ask excess of what. If something is excessive then what we are measuring, what is the unit of measurement and at what point of the scale is acceptability divided from excess?

One plausible possibility is that we attempt to gauge the value that a person’s desires or possessions would bring to him/her subjectively, what might be called “psychic income”. But why should this condemn a person as being the epitome of moral filth? If I get an immense amount of utility out of something that is, to all intents and purposes, useless to other persons what harm is this causing? Is it wrong for me to gain pleasure where others do not? What if I possess an object that gives me unimaginable psychic income, that makes me the happiest person alive, yet is, to everyone else, of little or no value? What has it got to do with anyone else that I enjoy this thing so much? This may sound like an exaggeration, but when you consider that many people have in their possession objects that to them carry great moral sentiment – wedding rings, photo albums, etc. – whose market value is but a pale reflection of the value they hold for the owner then it is not so far fetched.

In any case, even if gaining “undue utility” from an object was reprehensible, how do we measure this excess of subjective value? What is the cut off point? Utility is ordinal not cardinal – we can only rank things in order of how much we value them, not in precise quantities of value. A simple order never gives us any clue about how much something is valued, only how it is valued relative to anything else.

A second possibility is that we attempt to determine a person’s greed by the market value of his desires or possessions. But the market value of an object is simply a hypothetical price that someone might pay if offered the object for sale. It is dependent entirely upon the valuation of everyone else and is subject to constant and unceasing change. Indeed, strictly, market prices are only estimates. Real prices are historical events that bear no relation to future events. But leaving that aside let’s assume that a person’s possessions and/or desires command an exceptionally high market price. All this tells us is that everyone else values those possessions or desires extremely highly also. Why is a person to be condemned for this? Is it my fault if everyone also wants what I want or have? What if my family photo album was discovered to contain the prized, lost work of a celebrated artist or my wedding ring was found to contain a precious mineral and suddenly these objects, overnight, go from being practically worthless to potentially fetching millions of pounds in a sale. Am I now guilty for wanting or possessing these objects? Why should the fact that other people have changed their view of my possessions condemn me as being “greedy” for wanting to retain this property for myself? Should I be divested of my photo album and my wedding ring and the proceeds distributed to combat my alleged greed?

This unravelling of any accusation of greed begins to show the true motivation of the accusers – that it is really based on their envy rather than the possessor’s “greed”. This leads onto the next problem which is the idea that only some people are greedy – the “haves”. Everyone else is spared the condemnation. But would any of the latter turn down the offer to have their wealth increased beyond the so-called “dictates of basic survival and comfort”, even if it meant that no one else’s was? According to more than 32 million people play the UK National Lottery each week, well over half the eligible population. All of these people want to advance their own wealth to a great height (at least several million pounds worth in the regular lottery game while the jackpots in “Euromillions” game can run to over £100m after repeated rollovers) while leaving everyone else’s in exactly the same place. “Greed” therefore appears not to be an isolated motivation but one that is shared commonly.

Indeed, it is part of the human condition to always seek improvement to the current state of affairs as they are appraised by the individual. Every human action is an attempt to substitute more desirable ends for less desirable ends with the means available. To seek an end to this is to replicate the fallacy on which so many political philosophies have foundered – that the natural condition of man, with all of his qualities and faults, can somehow be moulded or changed. Any viable political philosophy must account for the true nature of man, warts and all. Further, as a result of humans’ unceasing appetite for improvement “the dictates of basic survival and comfort” change with each generation. In the second decade of the twenty-first century no one thinks that you are greedy if you can afford a house, a car, a telephone, a refrigerator and an annual foreign holiday. In the same decade of the twentieth century such possession would have been the utmost display of ostentatious luxury. As demand is often elastic it has always been the case that what has started out as luxury consumption of the rich has inspired entrepreurial activity to mass production until supply can be increased so heavily that even the poor can afford what was once a symbol of great wealth. Any attempted measure, therefore, of “the dictates of basic survival and comfort” is entirely arbitrary.

There are numerous related fallacies to the so-called greed problem. One is the idea that because one person has something another person must necessarily be without – that one person’s gain is necessarily another’s loss. If I have an iPad does that mean that someone does not have an iPad? No, it does not. I have an iPad because I went to work and created goods or services that I exchanged for money which, in turn, I exchanged for the iPad. The iPad only comes into existence because I created the resources that enabled me to purchase it. If I did not it would not mean that someone else would have it – it simply wouldn’t exist. Now there are definitely people in the world who do not fund their lifestyles from such production and voluntary trade but rather from violent appropriation of other people’s product, and some of them are very rich. But this should be dealt with for what it is and condemned accordingly. Per se one individual being a “have” does not mean that another is a “have-not”.

Another thread that seems to weave itself through social and political commentary is the idea that the net wealth of the rich is sitting around in a bank account somewhere, ready to be enjoyed as luxury consumption. This could not be further from the truth. The productive rich (as opposed to those who live off Government privilege and violently appropriated revenues) are rich because they have abstained from consuming what they have and invested it in real, productive assets – factories, machines, equipment, and things that must be run by people with jobs. Their increased net wealth reflects the success of this enterprise. It means more jobs for the rest of us to go to every day and cheaper goods for us to buy when we go shopping. The rich are rich precisely because their investment decisions have proved to be so productive. If this wealth was to be liquidated and distributed amongst everyone else in the name of “sharing” or “combating greed” then you would have to destroy the entire productive apparatus of the economy and place it in the hands of those who do not have the capacity to save rather than consume and, even if they did wish to save, have no or less of a proven ability to direct resources to their most productive uses. In contrast the amount of consumption spending by the rich, if distributed equally, would barely be enough to give everyone a few extra pennies.

In sum all of this reveals that it is a mistake to concentrate on people’s motivations or desires in achieving their ends. If somebody does something that inflicts no violence on either me or my property or if I trade with him peacefully and voluntarily then it is no business of mine why that other person engaged in those activities. What matters to me is the method of achieving those ends. Let us, therefore, banish any more talk of “greed” and focus instead on ensuring that more of our “greedy” entrepreneurs and businessmen make their wealth the honest way – voluntary trade, saving and capital investment that provides us with jobs and affordable products – rather than through violently enforced Government privilege, tax revenue and bailouts that definitely leaves them richer and us poorer.


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