Austrian Economics as Extraordinary Science

Thomas Kuhn in The Structure of Scientific Revolutions (Chicago: University of Chicago Press, 1970) made a distinction between normal and extraordinary science. Normal science is the day-to-day research activity of a community of scholars working and communicating with one another on the basis of certain shared principles and methods embodied in what Kuhn called a “paradigm” for that science. From time to time such a science may undergo revolutionary change, in the course of which the prevailing paradigm is replaced by a new one. Work involved in the search for and establishment of a new paradigm, as opposed to work proceeding within the framework of an accepted paradigm, is called extraordinary science.

We need not, on this occasion, enter the debate about the strict applicability of Kuhn’s analysis to the social sciences. It is enough for the moment to use his work as a source of useful analogy and metaphor. Taking this approach, we find that in contemporary economics, normal science is represented by work within the framework of the Keynesian-neoclassical synthesis. We can easily list many features characteristic of normal science. Communication among economists is primarily by means of journal articles presenting incremental contributions to knowledge rather than by means of books concerned with first principles. There is a well-established textbook tradition, and students are exposed to the original works of classical and contemporary economists only briefly and at a relatively advanced stage in their training. Economists go about their day-to-day work of establishing Edition: current; Page: [4] significant empirical facts, matching facts with theory, and extending applications of theory to new areas with little explicit attention to such fundamental questions as what constitutes a valid problem or a valid solution in economic analysis. Disputes arise, but underlying the disputes is fundamental agreement as to the kind of evidence or debate on which the dispute is, in principle, to be resolved.

In contrast to the majority of economists, the contributors to this volume on Austrian economics talk and act like people who are doing extraordinary science. They produce relatively more books and contribute fewer articles to established journals. They do not write textbooks; their students learn directly from the masters. They are very much concerned with methodological and philosophical fundamentals. And what makes the label extraordinary most applicable to their work is that they share a conviction that orthodox economics is at the point of breakdown, that it is unable to provide a coherent and intelligible analysis of the present-day economic world.

Students of contemporary economic thought ought not, however, allow the status of modern Austrian economics as extraordinary science to be settled entirely on the basis of the Austrian economist’s self-image. Others have seen things differently, among them Milton Friedman, a leading articulator of the orthodox paradigm. Speaking informally at the South Royalton conference, Friedman startled his audience with the bold assertion that “there is no Austrian economics—only good economics, and bad economics.” His intention, he went on to explain, was not to condemn Austrian economics as bad economics but rather to declare that the truly valuable and original contributions of Austrian-school economists (he was speaking of Friedrich A. Hayek in particular) could be smoothly incorporated into the mainstream of economic theory.

It seems to me that the question of the status of Austrian economics is not incapable of resolution and that, in fact, the papers presented here represent a sufficient sample on which to base such a conclusion. The question is whether or not Austrian economics possesses a paradigm truly distinct from that of the Edition: current; Page: [5] Keynesian-neoclassical orthodoxy. For, as Kuhn emphasized, an extraordinary science must not simply be critical of the established normal science paradigm; it must also present an alternative.

In analyzing the Austrian paradigm, I shall focus on three particular functions that, according to Kuhn, a paradigm must perform. First, a paradigm must tell the investigator what types of entities the world does and does not contain. Second, a paradigm must define what constitutes a legitimate problem for the science at hand. Third, it must specify the methods by which legitimate solutions to these problems may be reached.

The methodological principle about which Austrian-school writers are most insistent is that the basic building block of economic theory must be the individual human action. As Murray N. Rothbard put it, the whole of Austrian economic theory is the working out of the logical implications of the fact that human beings do engage in purposeful action (Rothbard, “Praxeology” [references to papers included in this volume are in abbreviated form]).

The term action, as used by Austrian theorists, takes on a precise technical sense that is perhaps best understood by contrasting actions with events. An event may be thought of as something that “just happens”—a change that takes place in the state of the world, such as a rock falling from a cliff and killing Smith. An action, in contrast, is something that happens as a result of purposeful intervention in the “natural” course of events; for example, Jones pushes a rock off a cliff for the purpose of murdering Smith, who is standing below. An action may be thought of as consisting of two components. The first component is the event, that the rock fell killing Smith. The second is the implied counterfactual proposition that if Jones had not intervened in the situation in order to carry out his purpose of murder, the rock would not have fallen, and Smith would be alive.

Orthodox economists, influenced by positivist and behaviorist methodological principles, are uncomfortable with the concept of action because the second, counterfactual component is not Edition: current; Page: [6] directly observable. As a consequence, orthodox theories tend to be couched exclusively in terms of observable events and the so-called empirical relationships among events. The Austrians, in marked contrast to the orthodox thinkers, believe that an economic explanation in terms of events alone cannot tell the whole story, because it necessarily omits an important component of reality—the concept of purposive action (see Kirzner, “On the Method”).

At the same time the Austrian economists criticize orthodox writers for omitting the concept of purposive action from their set of basic entities, they criticize them for admitting certain illegitimate constructs into their economic theories. Austrian writers are characteristically critical of the use of macroeconomic aggregates, especially when these appear as arguments in mathematical formulations that imply functional and/or causal relationships between aggregates. The concept of the quantity of capital is especially singled out for criticism in this regard (see Lachmann, “Toward a Critique”).

The question of what constitutes a legitimate problem for analysis receives careful attention in Kirzner’s paper on the methodology of Austrian economics (see his “On the Method,” below). Kirzner noted that the Austrian tradition assigns two tasks to economics. The first is that of “making the world intelligible in terms of human action.” The second is “to explain how conscious, purposeful human action can generate unintended consequences through social interaction” and to trace these unintended consequences. These tasks are both more and less ambitious than the tasks undertaken by orthodox economics. The Austrian-type explanation is more ambitious than the orthodox explanation in the sense that a picture painted in terms of human purposes is more complete than one painted only in terms of events. The Austrian enterprise is also more ambitious because it insists on laying bare the true causal relationships at work in the social world and is not content to simply establish empirical regularities among dubious statistical aggregates.

At the same time, Austrian explanatory systems are less ambitious precisely because they do not seek to establish quantitaive Edition: current; Page: [7] relationships among economic magnitudes. The Austrians are, in fact, quite insistent about the exclusion of such quantitative determinations from the range of legitimate economic problems. As Ludwig von Mises put it, in a passage quoted approvingly by Rothbard in his essay “Praxeology”:

The nature of the problems the Austrians undertake to solve and the entities which they employ determine the permissible methods of solving problems under the Austrian paradigm. The Austrian method, simply put, is to spin out by verbal deductive reasoning the logical implications of a few fundamental axioms. First among the axioms is the fact of purposeful human action. Supplementary axioms are that human beings are diverse in tastes and abilities, that all action takes place through time, and that people learn from experience. The epistemological status of these axioms is a matter of some dispute among Austrians, but Rothbard’s position—that they are in the last analysis empirical—appears to be the most acceptable (see his essay “Praxeology,” below).

Acceptance of the Austrian paradigm entails a radical rejection of econometrics as a tool of economic theory. It is easy to see why Austrians find econometrics useless as a tool for discovering or establishing economic laws. First, since the axioms from which economic laws are deduced are taken to be apodictically true (barring logical errors in the deductive process), the theories themselves must also be true and consequently cannot and need not be subjected to falsification by statistical methods. Second, Austrian theories are formulated in terms of action, and action, as was argued above, contains a counterfactual element, which is in principle not subject to direct observation or confirmation. Edition: current; Page: [8] Finally, the absence of constants in economic life makes any attempt at econometric determination of such constants futile.

In the abstract, such are the characteristics of the paradigm the Austrians, as would-be scientific revolutionaries, hold out as an alternative to the Keynesian-neoclassical orthodoxy. Whether this paradigm is to remain an empty program or has the substance for an alternative normal science tradition depends on its application to concrete analytical problems. With this in mind, let us briefly look at recent contributions of the Austrian school to the theory of prices and markets, of capital, and of money and economic fluctuations, as presented in the essays in this volume.

In the subject area orthodox theorists refer to as “microeconomics,” Israel Kirzner has made several recent and important contributions. In his book Competition and Entrepreneurship (Chicago: University of Chicago Press, 1974) and again in his essay “Equilibrium versus Market Process” (see below), Kirzner criticized neoclassical economics for devoting too much attention to the elaboration of the formal conditions for general equilibrium, and too little to an understanding of actual market processes through which resources are moved from lower to higher valued uses during periods of market disequilibrium. (Lachmann in his paper “On the Central Concept” went further than Kirzner and rejected the practical relevance of the concept of equilibrium altogether.) To understand market process, according to Kirzner, two types of economic decision making must be differentiated. The first is what he called “Robbinsian economizing,” that is, using known available resources in the most efficient manner to achieve given purposes with the object of allocating these resources so that no transfer of a marginal unit from one use to another can promise a net benefit. The second is entrepreneurial decision making, that is, being alert to previously unknown opportunities for buying low and selling high in situations where the planned activities of Robbinsian economizers are imperfectly coordinated. A theory couched purely in terms of Robbinsian economizing can at best identify the price-quantity configurations necessary to sustain an equilibrium. But it is only by introducing the concept of entrepreneurial Edition: current; Page: [9] action that one can explain how systematic changes in the information and expectations upon which market participants act lead them in the direction of the postulated equilibrium price and quantity relationships.

By contrasting the theory of general equilibrium with the theory of market process, we can understand more clearly the differences between the orthodox and the Austrian paradigm. The theory of general equilibrium poses a number of attractive puzzles for neoclassical economists, particularly those wishing to display their virtuosity in mathematical analysis. The variables of a general equilibrium model are all, in principle at least, empirically observable, and the types of decisions made by Robbinsian economizers can be neatly and accurately expressed in functional notation. But from the point of view of an Austrian theorist bent on making the world intelligible in terms of human action, the puzzles of general equilibrium are simply not the whole story. Far from being deterred by the fact that the decision-making processes of the entrepreneur are not easily expressed in mathematical notation, a writer like Kirzner is able to exercise his own virtuosity at verbal-deductive analysis and produce a variety of useful insights.

Lest it be thought that the matter of equilibrium versus market process is of no practical significance, the reader’s attention is directed to Kirzner’s discussion of the role of advertising. Neoclassical economics, with its emphasis on decision making based on given information and under perfect competition, has had difficulty finding a place for advertising in the economic world. Frequently, this theoretical untidiness has led the neoclassical economist to become critical of advertising on the policy level. Kirzner’s analysis, which at last makes advertising an integral part of the entrepreneurial role in the market process, provides the basis for a rather different and more supportive attitude toward advertising.

Turning now to recent Austrian work on capital theory, let us single out for attention the issue of the nature and measurability of an economy’s stock of capital. Sir John Hicks (in his paper “Capital Controversies: Ancient and Modern,” American Edition: current; Page: [10] Economic Review 64(May 1974): 307–16; and discussed by Kirzner, “The Theory of Capital”) divided economists into two broad groupings according to their definition of capital. According to Hicks, the “materialists” contend that the stock of capital is nothing more than an inventory of the stock of physical capital goods in an economy. This view has as a corollary that, in any two economies with identical physical stocks of capital goods, the economic measure of capital must be identical. To the “fundists,” on the other hand, capital is something other than mere physical goods, and the measure of capital must be a value measure derived in some way from the flow of future output.

According to Kirzner, Austrian economists can accept neither the materialist nor the fundist position on the question of the nature and measurement of capital. Materialism is rejected out of hand on the grounds that the physical heterogeneity of capital goods prohibits simply adding them up. The fundist point of view receives somewhat more sympathy, because it at least recognizes that the nature of capital goods is intimately bound up with valuation, that is, with future plans for the production of output. Nonetheless, Kirzner denied that there is any legitimate way of adding together these streams of future output to provide a meaningful measure of a nation’s capital stock. One problem, often discussed in the literature on capital theory, is that it is hard to find a unit of measurement for capital that is invariant to changes in relative prices. Equally important is the problem that at a given moment the plans of various individual economic agents, of which existing capital goods form a part, may well be incompatible. Suppose, for example, that individual A builds a house with the intention of living in it, and individual B builds a bomb for the purpose of blowing up A’s house. A counts on a future stream of housing services having a certain determinate value, and B counts on a future stream of destruction services also having a certain determinate value. But surely these two future value streams cannot legitimately be added together to get a measure of the economy’s current stock of capital, because it is logically impossible that both could be realized simultaneously. Thus, any attempt at adding up (future) value streams to get a Edition: current; Page: [11] measure of capital necessarily overstates the quantity of capital to the extent that current plans are imperfectly coordinated, which is equivalent to saying that a consistent measure of capital is possible only when the economy is in full equilibrium. The Austrian economists, of course, emphasize that it never is in full equilibrium.

In the controversy over the measurability of capital, the differences between the Austrian and the orthodox paradigm are once again evident. Neoclassical theorists, intent on constructing mathematical models of economic reality, are unable to proceed without grasping some single number, or “index,” and calling it the “quantity of capital.” Since they cannot dispense with such a number, they brush aside all theoretical objections and resort when pressed to such contrivances as the single product economy. To the Austrian economists, such constructions are the most arid of formalisms and do more to mask the true nature of economic reality than to provide useful insight. Instead, they prefer a concept of capital that identifies capital goods as physical objects directed toward specific purposes by individual agents, even if this approach means abandoning the possibility of measuring a nation’s capital stock altogether.

As our third illustration, let us look at the nature of Austrian-school contributions to the theory of money and economic fluctuations. The Austrian economists are characteristically averse to using the term macroeconomics when referring to this area of study. This very term smacks of illegitimate aggregates and the type of methodological holism they seek to avoid. From the earliest days, the hallmark of Austrian work in this area has been a microeconomic approach to macroeconomic problems. Ludwig von Mises’s Theory of Money and Credit (first German edition 1912; English edition, New Haven: Yale University Press, 1963), a pioneering contribution, identified the lack of coordination between individual expectations and the supply of money and credit as a prime cause of economic disturbance. Later work by Hayek extended the Misesian analysis and integrated the theory of the business cycle with the Austrian theory of production. Let us take a brief look at Hayek’s contribution in this area, as Edition: current; Page: [12] updated and applied by Gerald P. O’Driscoll, Jr., and Sudha R. Shenoy in their paper “Inflation, Recession and Stagflation” included in this volume.

O’Driscoll and Shenoy, together with other modern Austrian economists, hold that the major anomaly facing orthodox economics and defying explanation is the seemingly intractable inflationary stagnation that has beset the major industrial countries in the seventies. In their view, orthodox theories, Keynesian and monetarist alike, are formulated at too high a level of aggregation and are thus blind to the distorting effects of overexpansionary monetary policy on relative prices and the capital structure. In barest outline, their argument is that expansionary policies inject money into the economy, not uniformly, but at a specific point. The injection of new money creates a monetary “pull” on relative prices at this point. As a result of the effect of monetary expansion on relative prices, some businesses make profits that otherwise would have made losses, and some workers find jobs in places where there would otherwise have been none. If the injection of new money is by way of commercial bank loans to businessmen, the capital goods industries, and among them firms producing specific capital goods suitable for use in processes of relatively low labor intensity, are built up first. However, the expansion of these industries cannot be sustained without a concomitant decline in the fraction of current output consumed. Barring a fortuitous shift in consumption habits, the injection of new money must be continued. Because expectations adjust to any constant rate of injection, the needed degree of monetary pull on relative prices requires an accelerating rate of monetary expansion. This leaves policymakers in a dilemma. Either they must inflate without limit, or when they cease inflating, they must face the unemployment and drop in output that will inevitably accompany the liquidation of the unjustified investments made earlier. To use Hayek’s metaphor, the policymakers have a tiger by the tail.

Here again we see how the Austrian paradigm, with its principled rejection of aggregative analysis, has produced insights that in recent years orthodox economists have been quick to overlook. Edition: current; Page: [13] In the case of business cycle theory, however, the possibility is greater than in our previous examples that the essentials of Austrian theory can be co-opted into orthodox analysis. Orthodox theorists may well wish to recast Hayek’s theories in a form that would make them subject to econometric evaluation. If they are pleased with the results, one can easily imagine Hayek’s relative-price mechanism being spliced onto existing Keynesian or monetarist models, just as has happened to other microeconomic insights such as the theory of job search and the theory of inflationary expectations. If this takes place, the Austrian paradigm may not succeed in replacing that of the Keynesian-neoclassical orthodoxy.

Despite the fact that the gap between Austrian and orthodox economics may be narrower in the area last discussed than elsewhere, I think the evidence indicates that the modern Austrian school does present a truly distinct paradigm against the alternative of a distinction only between good economics and bad economics. The possession of a distinct paradigm may be thought of as necessary for a successful scientific revolution. It goes without saying, however, that it is not a sufficient condition. In concluding our analysis of Austrian economics as extraordinary science, let us consider some remarks Kuhn made regarding the nature of the debate between advocates of alternative paradigms:

The tendency of the advocates of alternative paradigms to talk through, rather than to, each other may be seen in the various Austrian critiques of mathematical economics and econometrics. In their attack on mathematical economics, at least two separate arguments can be discerned. One is that mathematical economics does not really achieve greater theoretical precision; instead it requires the translation of simple concepts into mathematical language followed by arduous retranslation into English (see Rothbard’s discussion in “Praxeology,” below). This line of criticism is not found only among Austrian economists; it was given a most eloquent expression by Alfred Marshall. The other strand of the Austrian critique of mathematical economics is the contention that those problems most amenable to mathematical treatment—general equilibrium theory, formal growth models, and the like—are in principle not interesting or legitimate economic problems. The problems important to Austrian theorists (for example, the puzzle of the nature of entrepreneurship) neither can be nor need be dealt with mathematically.

In the critique of econometrics, the tendency to talk through the opposition is perhaps more evident than anywhere else. Here again we can distinguish two strands of thought in Austrian writing. One, already discussed, concerns the absence of constants in human action and the absurdity of subjecting valid deductions from true axioms to superfluous empirical tests.

The other strand of the Austrian critique concerns the definition of the legitimate boundaries of economics as a science. At one point in discussing Austrian methodology, Rothbard (see his paper “Praxeology”) distinguished among three branches of intellectual inquiry. Economics is the discipline devoted to the logical implications of the axiom of human action. Technology deals with the choice of certain means for the achievement of certain ends. History deals with ends adopted in the past and means used (to try) to achieve them. Now, from these definitions, it is immediately clear that econometrics can serve no purpose in economics per se. That is the substance of the previously mentioned line of criticism. Yet this argument leaves open Edition: current; Page: [15] the possibility that econometrics could be a legitimate tool of technology and history. In collecting statistics on, say, past fluctuations in the prices and quantities of cotton, econometricians are not measuring constants in human behavior or testing economic theory, and they delude themselves if they think they are. Nonetheless, in principle the econometricians’ work, properly interpreted, may be valuable to noneconomists. For example, a historian trying to interpret patterns of economic activity in the southern United States might want to know the approximate ex post elasticity relationships in the cotton market in certain periods. Alternatively, a textile manufacturer, seeking profit maximization by the best means available, might employ an econometrician as a technologist to advise him concerning inventory strategy. In short, if econometricians would stop insisting that they were engaging in the discovery of economic laws, a variety of purely instrumentalist justifications for their work could be found without forcing a head-on confrontation with Austrian doctrine.

Praxeology: The Methodology of Austrian Economics

Praxeology is the distinctive methodology of the Austrian school. The term was first applied to the Austrian method by Ludwig von Mises, who was not only the major architect and elaborator of this methodology but also the economist who most fully and successfully applied it to the construction of economic theory.1 While the praxeological method is, to say the least, out of fashion in contemporary economics—as well as in social science generally and in the philosophy of science—it was the basic method of the earlier Austrian school and also of a considerable segment of the older classical school, in particular of J. B. Say and Nassau W. Senior.2

Praxeology rests on the fundamental axiom that individual human beings act, that is, on the primordial fact that individuals engage in conscious actions toward chosen goals. This concept of action contrasts to purely reflexive, or knee-jerk, behavior, which is not directed toward goals. The praxeological method spins out by verbal deduction the logical implications of that primordial fact. In short, praxeological economics is the structure of logical implications of the fact that individuals act. This structure is built on the fundamental axiom of action, and has a few subsidiary axioms, such as that individuals vary and that human beings regard leisure as a valuable good. Any skeptic about deducing from such a simple base an entire system of economics, I refer to Mises’s Human Action. Furthermore, since praxeology begins Edition: current; Page: [20] with a true axiom, A, all the propositions that can be deduced from this axiom must also be true. For if A implies B, and A is true, then B must also be true.

Let us consider some of the immediate implications of the action axiom. Action implies that the individual’s behavior is purposive, in short, that it is directed toward goals. Furthermore, the fact of his action implies that he has consciously chosen certain means to reach his goals. Since he wishes to attain these goals, they must be valuable to him; accordingly he must have values that govern his choices. That he employs means implies that he believes he has the technological knowledge that certain means will achieve his desired ends. Let us note that praxeology does not assume that a person’s choice of values or goals is wise or proper or that he has chosen the technologically correct method of reaching them. All that praxeology asserts is that the individual actor adopts goals and believes, whether erroneously or correctly, that he can arrive at them by the employment of certain means.

All action in the real world, furthermore, must take place through time; all action takes place in some present and is directed toward the future (immediate or remote) attainment of an end. If all of a person’s desires could be instantaneously realized, there would be no reason for him to act at all.3 Furthermore, that a man acts implies that he believes action will make a difference; in other words, that he will prefer the state of affairs resulting from action to that from no action. Action therefore implies that man does not have omniscient knowledge of the future; for if he had such knowledge, no action of his would make any difference. Hence, action implies that we live in a world of an uncertain, or not fully certain, future. Accordingly, we may amend our analysis of action to say that a man chooses to employ means according to a technological plan in the present because he expects to arrive at his goals at some future time.

The fact that people act necessarily implies that the means employed are scarce in relation to the desired ends; for, if all means were not scarce but superabundant, the ends would already have been attained, and there would be no need for action. Edition: current; Page: [21] Stated another way, resources that are superabundant no longer function as means, because they are no longer objects of action. Thus, air is indispensable to life and hence to the attainment of goals; however, air being superabundant is not an object of action and therefore cannot be considered a means, but rather what Mises called a “general condition of human welfare.” Where air is not superabundant, it may become an object of action, for example, where cool air is desired and warm air is transformed through air conditioning. Even with the absurdly unlikely advent of Eden (or what a few years ago was considered in some quarters to be an imminent “postscarcity” world), in which all desires could be fulfilled instantaneously, there would still be at least one scarce means: the individual’s time, each unit of which if allocated to one purpose is necessarily not allocated to some other goal.4

Such are some of the immediate implications of the axiom of action. We arrived at them by deducing the logical implications of the existing fact of human action, and hence deduced true conclusions from a true axiom. Apart from the fact that these conclusions cannot be “tested” by historical or statistical means, there is no need to test them since their truth has already been established. Historical fact enters into these conclusions only by determining which branch of the theory is applicable in any particular case. Thus, for Crusoe and Friday on their desert island, the praxeological theory of money is only of academic, rather than of currently applicable, interest. A fuller analysis of the relationship between theory and history in the praxeological framework will be considered below.

There are, then, two parts to this axiomatic-deductive method: the process of deduction and the epistemological status of the axioms themselves. First, there is the process of deduction; why are the means verbal rather than mathematical logic?5 Without setting forth the comprehensive Austrian case against mathematical economics, one point can immediately be made: let the reader take the implications of the concept of action as developed so far in this paper and try to place them in mathematical form. And even if that could be done, what would have been Edition: current; Page: [22] accomplished except a drastic loss in meaning at each step of the deductive process? Mathematical logic is appropriate to physics—the science that has become the model science, which modern positivists and empiricists believe all other social and physical sciences should emulate. In physics the axioms and therefore the deductions are in themselves purely formal and only acquire meaning “operationally” insofar as they can explain and predict given facts. On the contrary, in praxeology, in the analysis of human action, the axioms themselves are known to be true and meaningful. As a result, each verbal step-by-step deduction is also true and meaningful; for it is the great quality of verbal propositions that each one is meaningful, whereas mathematical symbols are not meaningful in themselves. Thus Lord Keynes, scarcely an Austrian and himself a mathematician of note, leveled the following critique at mathematical symbolism in economics:

Moreover, even if verbal economics could be successfully translated into mathematical symbols and then retranslated into English so as to explain the conclusions, the process makes no sense and violates the great scientific principle of Occam’s Razor of avoiding unnecessary multiplication of entities.7

Furthermore, as political scientist Bruno Leoni and mathematician Eugenio Frola pointed out,

Similarly, one of the first methodologists in economics, Jean-Baptiste Say, charged that the mathematical economists

More recently, Boris Ischboldin has emphasized the difference between verbal, or “language,” logic (“the actual analysis of thought stated in language expressive of reality as grasped in common experience”) and “construct” logic, which is “the application to quantitative (economic) data of the constructs of mathematics and symbolic logic which constructs may or may not have real equivalents.”10

Although himself a mathematical economist, the mathematician son of Carl Menger wrote a trenchant critique of the idea that mathematical presentation in economics is necessarily more precise than ordinary language:

Turning from the deduction process to the axioms themselves, what is their epistemological status? Here the problems are obscured by a difference of opinion within the praxeological camp, particularly on the nature of the fundamental axiom of action. Ludwig von Mises, as an adherent of Kantian epistemology, asserted that the concept of action is a priori to all experience, because it is, like the law of cause and effect, part of “the essential and necessary character of the logical structure of the human mind.”12 Without delving too deeply into the murky waters of epistemology, I would deny, as an Aristotelian and neo-Thomist, any such alleged “laws of logical structure” that the human mind necessarily imposes on the chaotic structure of reality. Instead, I would call all such laws “laws of reality,” which the mind apprehends from investigating and collating the facts of the real world. My view is that the fundamental axiom and subsidiary axioms are derived from the experience of reality and are therefore in the broadest sense empirical. I would agree with the Aristotelian realist view that its doctrine is radically empirical, far more so than the post-Humean empiricism which is dominant in modern philosophy. Thus, John Wild wrote:

Furthermore, one of the pervasive data of all human experience is existence; another is consciousness, or awareness. In contrast to the Kantian view, Harmon Chapman wrote that

If, in the broad sense, the axioms of praxeology are radically empirical, they are far from the post-Humean empiricism that pervades the modern methodology of social science. In addition to the foregoing considerations, (1) they are so broadly based in common human experience that once enunciated they become self-evident and hence do not meet the fashionable criterion of “falsifiability”; (2) they rest, particularly the action axiom, on universal inner experience, as well as on external experience, that is, the evidence is reflective rather than purely physical; and (3) they are therefore a priori to the complex historical events to which modern empiricism confines the concept of “experience”.15

Say, perhaps the first praxeologist, explained the derivation of the axioms of economic theory as follows:

Friedrich A. Hayek trenchantly described the praxeological Edition: current; Page: [26] method in contrast to the methodology of the physical sciences, and also underlined the broadly empirical nature of the praxeological axioms:

Similarly, J. E. Cairnes wrote:

Nassau W. Senior phrased it thus:

Commenting on his complete agreement with this passage, Mises wrote that these “immediately evident propositions” are “of aprioristic derivation . . . unless one wishes to call aprioristic cognition inner experience.”20 To which Marian Bowley, the biographer of Senior, justly commented:

It should be noted that for Mises it is only the fundamental axiom of action that is a priori; he conceded that the subsidiary axioms of the diversity of mankind and nature, and of leisure as a consumers’ good, are broadly empirical.

Modern post-Kantian philosophy has had a great deal of trouble encompassing self-evident propositions, which are marked precisely by their strong and evident truth rather than by being testable hypotheses, that are, in the current fashion, considered to be “falsifiable”. Sometimes it seems that the empiricists use the fashionable analytic-synthetic dichotomy, as the philosopher Hao Wong charged, to dispose of theories they find difficult to refute by dismissing them as necessarily either disguised definitions or debatable and uncertain hypotheses.22 But what if we subject the vaunted “evidence” of modern positivists and empiricists to analysis? What is it? We find that there are two types of such evidence to either confirm or refute a proposition: (1) if it violates the laws of logic, for example, implies that A = −A; or (2) if it is confirmed by empirical facts (as in a laboratory) that can be checked by many persons. But what is the nature of such “evidence” but the bringing, by various means, of propositions hitherto cloudy and obscure into clear and evident view, that is, Edition: current; Page: [28] evident to the scientific observers? In short, logical or laboratory processes serve to make it evident to the “selves” of the various observers that the propositions are either confirmed or refuted, or, to use unfashionable terminology, either true or false. But in that case propositions that are immediately evident to the selves of the observers have at least as good scientific status as the other and currently more acceptable forms of evidence. Or, as the Thomist philosopher John J. Toohey put it,

The action axiom, in particular, should be, according to Aristotelian philosophy, unchallengeable and self-evident since the critic who attempts to refute it finds that he must use it in the process of alleged refutation. Thus, the axiom of the existence of human consciousness is demonstrated as being self-evident by the fact that the very act of denying the existence of consciousness must itself be performed by a conscious being. The philosopher R. P. Phillips called this attribute of a self-evident axiom a “boomerang principle,” since “even though we cast it away from us, it returns to us again.”24 A similar self-contradiction faces the man who attempts to refute the axiom of human action. For in doing so, he is ipso facto a person making a conscious choice of means in attempting to arrive at an adopted end: in this case the end, or goal, of trying to refute the axiom of action. He employs action in trying to refute the notion of action.

Of course, a person may say that he denies the existence of self-evident principles or other established truths of the real world, but this mere saying has no epistemological validity. As Toohey pointed out,

The methodology of modern positivism and empiricism comes a cropper even in the physical sciences, to which it is much better suited than to the sciences of human action; indeed, it particularly fails where the two types of disciplines interconnect. Thus, the phenomenologist Alfred Schutz, a student of Mises at Vienna, who pioneered in applying phenomenology to the social sciences, pointed out the contradiction in the empiricists’ insistence on the principle of empirical verifiability in science, while at the same time denying the existence of “other minds” as unverifiable. But who is supposed to be doing the laboratory verification if not these selfsame “other minds” of the assembled scientists? Schutz wrote:

In this way, the modern empiricists ignore the necessary presuppositions of the very scientific method they champion. For Schutz, knowledge of such presuppositions is “empirical” in the broadest sense,

Having dealt with the nature of praxeology, its procedures and axioms and its philosophical groundwork, let us now consider what the relationship is between praxeology and the other disciplines that study human action. In particular, what are the differences between praxeology and technology, psychology, history, and ethics—all of which are in some way concerned with human action?

In brief, praxeology consists of the logical implications of the universal formal fact that people act, that they employ means to try to attain chosen ends. Technology deals with the contentual Edition: current; Page: [30] problem of how to achieve ends by the adoption of means. Psychology deals with the question of why people adopt various ends and how they go about adopting them. Ethics deals with the question of what ends, or values, people should adopt. And history deals with ends adopted in the past, what means were used to try to achieve them—and what the consequences of these actions were.

Praxeology, or economic theory in particular, is thus a unique discipline within the social sciences; for, in contrast to the others, it deals not with the content of men’s values, goals, and actions—not with what they have done or how they have acted or how they should act—but purely with the fact that they do have goals and act to attain them. The laws of utility, demand, supply, and price apply regardless of the type of goods and services desired or produced. As Joseph Dorfman wrote of Herbert J. Davenport’s Outlines of Economic Theory (1896):

Praxeology, as well as the sound aspects of the other social sciences, rests on methodological individualism, on the fact that only individuals feel, value, think, and act. Individualism has always been charged by its critics—and always incorrectly—with the assumption that each individual is a hermetically sealed “atom,” cut off from, and uninfluenced by, other persons. This absurd misreading of methodological individualism is at the root of J. K. Galbraith’s triumphant demonstration in The Affluent Society (Boston: Houghton Mifflin Co., 1958) that the values and choices of individuals are influenced by other persons, and therefore—supposedly—that economic theory is invalid. Galbraith also concluded from his demonstration that these choices, Edition: current; Page: [31] because influenced, are artificial and illegitimate. The fact that praxeological economic theory rests on the universal fact of individual values and choices means, to repeat Dorfman’s summary of Davenport’s thought, that economic theory does “not need to investigate the origin of choices.” Economic theory is not based on the absurd assumption that each individual arrives at his values and choices in a vacuum, sealed off from human influence. Obviously, individuals are continually learning from and influencing each other. As F. A. Hayek wrote in his justly famous critique of Galbraith, “The Non Sequitur of the ‘Dependence Effect’”:

That Austrian-school economics rested firmly from the beginning on an analysis of the fact of individual subjective values and choices unfortunately led the early Austrians to adopt the term psychological school. The result was a series of misdirected criticisms that the latest findings of psychology had not been incorporated into economic theory. It also led to misconceptions such as that the law of diminishing marginal utility rests on some psychological law of the satiety of wants. Actually, as Mises firmly pointed out, that law is praxeological rather than psychological and has nothing to do with the content of wants, for example, that the tenth spoonful of ice cream may taste less pleasurable than the ninth spoonful. Instead, it is a praxeological truth, derived from the nature of action, that the first unit of a good will be allocated to its most valuable use, the next unit to the next most valuable, and so on.30 On one point, and on one point alone, however, praxeology and the related sciences of human action take a stand in philosophical psychology: on the proposition that the human mind, consciousness, and subjectivity exist, and Edition: current; Page: [32] therefore action exists. In this it is opposed to the philosophical base of behaviorism and related doctrines and joined with all branches of classical philosophy and with phenomenology. On all other questions, however, praxeology and psychology are distinct and separate disciplines.31

A particularly vital question is the relationship between economic theory and history. Here again, as in so many other areas of Austrian economics, Ludwig von Mises made the outstanding contribution, particularly in his Theory and History.32 It is especially curious that Mises and other praxeologists, as alleged “a priorists”, have commonly been accused of being “opposed” to history. Mises indeed held not only that economic theory does not need to be “tested” by historical fact but also that it cannot be so tested. For a fact to be usable for testing theories, it must be a simple fact, homogeneous with other facts in accessible and repeatable classes. In short, the theory that one atom of copper, one atom of sulfur, and four atoms of oxygen will combine to form a recognizable entity called copper sulfate, with known properties, is easily tested in the laboratory. Each of these atoms is homogeneous, and therefore the test is repeatable indefinitely. But each historical event, as Mises pointed out, is not simple and repeatable; each event is a complex resultant of a shifting variety of multiple causes, none of which ever remains in constant relationships with the others. Every historical event, therefore, is heterogeneous, and therefore historical events cannot be used either to test or to construct laws of history, quantitative or otherwise. We can place every atom of copper into a homogeneous class of copper atoms; we cannot do so with the events of human history.

This is not to say, of course, that there are no similarities among historical events. There are many similarities, but no homogeneity. Thus, there were many similarities between the presidential election of 1968 and that of 1972, but they were scarcely homogeneous events, since they were marked by important and inescapable differences. Nor will the next election be a repeatable event to place in a homogeneous class of “elections”. Edition: current; Page: [33] Hence no scientific, and certainly no quantitative, laws can be derived from these events.

Mises’s radically fundamental opposition to econometrics now becomes clear. Econometrics not only attempts to ape the natural sciences by using complex heterogeneous historical facts as if they were repeatable homogeneous laboratory facts; it also squeezes the qualitative complexity of each event into a quantitative number and then compounds the fallacy by acting as if these quantitative relations remain constant in human history. In striking contrast to the physical sciences, which rest on the empirical discovery of quantitative constants, econometrics, as Mises repeatedly emphasized, has failed to discover a single constant in human history. And given the ever-changing conditions of human will, knowledge, and values and the differences among men, it is inconceivable that econometrics can ever do so.

Far from being opposed to history, the praxeologist, and not the supposed admirers of history, has profound respect for the irreducible and unique facts of human history. Furthermore, it is the praxeologist who acknowledges that individual human beings cannot legitimately be treated by the social scientist as if they were not men who have minds and act upon their values and expectations, but stones or molecules whose course can be scientifically tracked in alleged constants or quantitative laws. Moreover, as the crowning irony, it is the praxeologist who is truly empirical because he recognizes the unique and heterogeneous nature of historical facts; it is the self-proclaimed “empiricist” who grossly violates the facts of history by attempting to reduce them to quantitative laws. Mises wrote thus about econometricians and other forms of “quantitative economists”:

Elaborating on his critique of constants Mises added:

What, then, is the proper relationship between economic theory and economic history or, more precisely, history in general? The historian’s function is to try to explain the unique historical facts that are his province; to do so adequately he must employ all the relevant theories from all the various disciplines that impinge on his problem. For historical facts are complex resultants of a myriad of causes stemming from different aspects of the human condition. Thus, the historian must be prepared to use not only praxeological economic theory but also insights from physics, psychology, technology, and military strategy along with an interpretive understanding of the motives and goals of individuals. He must employ these tools in understanding both the goals of the various actions of history and the consequences of such actions. Because understanding diverse individuals and their interactions is involved, as well as the historical context, the historian using the tools of natural and social science is in the last analysis an “artist”, and hence there is no guarantee or even likelihood that any two historians will judge a Edition: current; Page: [36] situation in precisely the same way. While they may agree on an array of factors to explain the genesis and consequences of an event, they are unlikely to agree on the precise weight to be given each causal factor. In employing various scientific theories, they have to make judgments of relevance on which theories applied in any given case; to refer to an example used earlier in this paper, a historian of Robinson Crusoe would hardly employ the theory of money in a historical explanation of his actions on a desert island. To the economic historian, economic law is neither confirmed nor tested by historical facts; instead, the law, where relevant, is applied to help explain the facts. The facts thereby illustrate the workings of the law.

The relationship between praxeological economic theory and the understanding of economic history was subtly summed up by Alfred Schutz:

On the Method of Austrian Economics

One of the areas in which disagreement among Austrian economists may seem to be nonexistent is that of methodology. Yet I shall attempt to point out that even with respect to method there are differences of opinion among individual thinkers. Some light may be cast on these differences by drawing attention to two distinct strands of thought that run through the writings of Austrian economists on the question of method. By separating these strands and then focusing on each in turn, we may discover and define different perspectives on economic method and perhaps more clearly understand how these different perspectives grow out of the unique view of method shared by all Austrian economists.

The general outline of the Austrian position on methodology is well known. Austrian economists are subjectivists; they emphasize the purposefulness of human action; they are unhappy with constructions that emphasize equilibrium to the exclusion of market processes; they are deeply suspicious of attempts to apply measurement procedures to economics; they are skeptical of empirical “proofs” of economic theorems and consequently have serious reservations about the validity and importance of a good deal of the empirical work being carried on in the economics profession today. These are the general features of the position that we know very well; yet within this general view we can distinguish two independent strands of argument. It is upon this debate that I should like to focus my attention in this paper.

New Light on the Prehistory of the Austrian School

The most notable development in the historiography of the Austrian school in the post-World War II era has been the drastic reevaluation of what might be called its prehistory and, as a corollary, a fundamental reconsideration of the history of economic thought itself. This reevaluation may be summarized by briefly outlining the orthodox prewar paradigm of the development of economic thought before the advent of the Austrian school. The Scholastic philosophers were brusquely dismissed as medieval thinkers who totally failed to understand the market, and who believed on religious grounds that the just price was one that covered either the cost of production or the quantity of labor embodied in a product. After briefly outlining the bullionist and antibullionist discussion among the English mercantilists and lightly touching on a few French and Italian economists of the eighteenth century, the historian of economic thought pointed with a flourish to Adam Smith and David Ricardo as the founders of economic science. After some backing and filling in the mid-nineteenth century, marginalism, including the Austrian school, arrived in another great burst in the 1870s. Apart from the occasional mention of one or two English precursors of the Austrians, such as Samuel Bailey in the early nineteenth century, this completed the basic picture. Typical was the encyclopedic text of Lewis Haney: the Scholastics were described as medieval, dismissed as hostile to trade, and declared Edition: current; Page: [53] believers in the labor and cost-of-production theories of the just price.1 It is no wonder that in his famous phrase, R. H. Tawney could call Karl Marx “the last of the Schoolmen.”2

The remarkably contrasting new view of the history of economic thought burst upon the scene in 1954 in the monumental, though unfinished, work of Joseph Schumpeter.3 Far from mystical dunderheads who should be skipped over to get to the mercantilists, the Scholastic philosophers were seen as remarkable and prescient economists, developing a system very close to the Austrian and subjective-utility approach. This was particularly true of the previously neglected Spanish and Italian Scholastics of the sixteenth and seventeenth centuries. Virtually the only missing ingredient in their value theory was the marginal concept. From them filiations proceeded to the later French and Italian economists. In the Schumpeterian view, the English mercantilists were half-baked, polemical pamphleteers rather than essential milestones on the road to Adam Smith and the founding of economic science. In fact, the new view saw Smith and Ricardo, not as founding the science of economics, but as shunting economics onto a tragically wrong track, which it took the Austrians and other marginalists to make right. Until then, only the neglected anti-Ricardian writers kept the tradition alive. As we shall see, other historians, such as Emil Kauder, further demonstrated the Aristotelian (and hence Scholastic) roots of the Austrians amidst the diverse variants of the marginalist school. The picture is almost the reverse of the earlier orthodoxy.

It is not the purpose of this paper to dwell on Schumpeter’s deservedly well-known work, but rather to assess the contributions of writers who carried the Schumpeterian vision still further and who remain neglected by most economists, possibly from a failure to match Schumpeter in constructing a general treatise. The best development of the new history must be sought in fugitive articles and brief pamphlets and monographs.

The other relatively neglected contributions began contemporaneously with Schumpeter. One of the most important, and probably the most neglected, was The School of Salamanca by Edition: current; Page: [54] Marjorie Grice-Hutchinson, who suffered in the economics profession from being a professor of Spanish literature. Moreover, the book bore the burden of a misleadingly narrow subtitle: Readings in Spanish Monetary Theory.4 In fact, the book was a brilliant discovery of the pre-Austrian subjective-value-and-utility views of the late sixteenth-century Spanish Scholastics. But first Grice-Hutchinson showed that the works of even earlier Scholastics as far back as Aristotle contained a subjective-value analysis based on consumer wants alongside the competing objective conception of the just price based on labor and costs. In the early Middle Ages, Saint Augustine (354–430) developed the concept of the subjective-value scales of each individual. By the High Middle Ages, the Scholastic philosophers had largely abandoned the cost-of-production theory to adopt the view that the market’s reflection of consumer demand really sets the just price. This was particularly true of Jean Buridan (1300–58), Henry of Ghent (1217–93), and Richard of Middleton (1249–1306). As Grice-Hutchinson observed:

Even Henry of Langenstein (1325–83), who of all the Scholastics was the most hostile to the free market and advocated government fixing of the just price on the basis of status and cost, developed the subjective factor of utility as well as scarcity in his analysis of price. But it was the sixteenth-century Spanish Scholastics who developed the purely subjective and profree-market theory of value. Thus, Luis Saravia de la Calle (c. 1544) denied any role to cost in the determination of price; instead the market price, which is the just price, is determined by the forces of supply and demand, which in turn are the result of the Edition: current; Page: [55] common estimation of consumers on the market. Saravia wrote that, “excluding all deceit and malice, the just price of a thing is the price which it commonly fetches at the time and place of the deal.” He went on to point out that the price of a thing will change in accordance with its abundance or scarcity. He proceeded to attack the cost-of-production theory of just price:

Similarly the Spanish Scholastic Diego de Covarrubias y Leiva (1512–77) a distinguished expert on Roman law and a theologian at the University of Salamanca, wrote that the “value of an article” depends “on the estimation of men, even if that estimation be foolish.” Wheat is more expensive in the Indies than in Spain “because men esteem it more highly, though the nature of the wheat is the same in both places.” The just price should be considered not at all with reference to its original or labor cost but only with reference to the common market value where the good is sold, a value, Covarrubias pointed out, that will fall when buyers are few and goods are abundant and that will rise under opposite conditions.7

The Spanish Scholastic Francisco Garcia (d. 1659) engaged in a remarkably sophisticated analysis of the determinants of value and utility. The valuation of goods, Garcia pointed out, depends on several factors. One is the abundance or scarcity of the supply Edition: current; Page: [56] of goods, the former causing a lower estimation and the latter an increase. A second is whether buyers or sellers are few or many. Another is whether “money is scarce or plentiful,” the former causing a lower estimation of goods and the latter a higher. Another is whether “vendors are eager to sell their goods.” The influence of the abundance or the scarcity of a good brought Garcia almost to the brink, but not over it, of a marginal utility analysis of valuation.

The Spanish Scholastics also anticipated the Austrian school in applying value theory to money, thus beginning the integration of money into general value theory. It is generally believed, for example, that in 1568 Jean Bodin inaugurated what is unfortunately called “the quantity theory of money” but which would more accurately be called the application of supply-and-demand analysis to money. Yet he was anticipated twelve years earlier by the Salamanca theologian the Dominican Martin de Azpilcueta Navarro (1493–1587), who was inspired to explain the inflation brought about by the importation of gold and silver by the Spaniards from the New World. Citing previous Scholastics, Azpilcueta declared that “money is worth more where it is scarce than where it is abundant.” Why? Because “all merchandise becomes dearer when it is in great demand and short supply, and that money, in so far as it may be sold, bartered, or exchanged by some other form of contract, is merchandise and therefore also becomes dearer when it is in great demand and short supply.” Azpilcueta noted that “we see by experience that in France, where money is scarcer than in Spain, bread, wine, cloth, and labour are worth much less. And even in Spain, in times when money was scarcer, saleable goods and labour were given for very much less than after the discovery of the Indies, which flooded the country with gold and silver. The reason for this is Edition: current; Page: [57] that money is worth more where and when it is scarce than where and when it is abundant.”9

Furthermore, the Spanish Scholastics went on to anticipate the classical-Mises-Cassel purchasing-power parity theory of exchange rates by proceeding logically to apply the supply-and-demand theory to foreign exchanges, an institution that was highly developed by the early modern period. The influx of specie into Spain depreciated the Spanish escudo in foreign exchange, as well as raised prices within Spain, and the Scholastics had to deal with this startling phenomenon. It was the eminent Salamanca theologian the Dominican Domingo de Soto (1495–1560) who in 1553 first fully applied the supply-and-demand analysis to foreign exchange rates. De Soto noted that “the more plentiful money is in Medina the more unfavourable are the terms of exchange, and the higher the price that must be paid by whoever wishes to send money from Spain to Flanders, since the demand for money is smaller in Spain than in Flanders. And the scarcer money is in Medina the less he need pay there, because more people want money in Medina than are sending it to Flanders.”10 What de Soto was saying is that as the stock of money increases, the utility of each unit of money to the population declines and vice versa; in short, only the great stumbling block of failing to specify the concept of the marginal unit prevented him from arriving at the doctrine of the diminishing marginal utility of money. Azpilcueta, in the passage quoted above, applied the de Soto analysis of the influence of the supply of money on exchange rates, at the same time that he set forth a theory of supply and demand in determining the purchasing power of money within a country.

The de Soto-Azpilcueta analysis was spread to the merchants of Spain by the Dominican friar Tomás de Mercado (d. 1585), who in 1569 wrote a handbook of commercial morality in Spanish, in contrast to the Scholastic theologians, who invariably wrote in Latin. It was followed by García and endorsed at the end of the sixteenth century by the Salamanca theologian the Dominican Domingo de Bañez (1527–1604) and by the great Portuguese Jesuit Luís de Molina (1535–1600). Writing near the Edition: current; Page: [58] turn of the century, Molina set forth the theory in an elegant and comprehensive manner:

The outstanding revisionist work on the economic thought of the medieval and later Scholastics is that of Raymond de Roover. Basing his work in part on the Grice-Hutchinson volume, de Roover published his first comprehensive discussion in 1955.12 For the medieval period, de Roover particularly pointed to the early fourteenth-century French Ockhamite Scholastic Jean Buridan and to the famous early fifteenth-century Italian preacher San Bernardino of Siena (1380–1444). Buridan insisted that value is measured by the human wants of the community of individuals, and that the market price is the just price. Edition: current; Page: [59] Furthermore, he was perhaps the first to make clear in a pre-Austrian manner that voluntary exchange demonstrates subjective preferences, since he stated that the “person who exchanges a horse for money would not have done so, if he had not preferred money to a horse.”13 He added that workers hire themselves out because they value the wages they receive higher than the labor they have to expend.14

De Roover then discussed the sixteenth-century Spanish Scholastics, centered at the University of Salamanca, the queen of the Spanish universities of the period. From Salamanca the influence of this school of Scholastics spread to Portugal, Italy, and the Low Countries. In addition to summarizing Grice-Hutchinson’s contribution and adding to her bibliography, de Roover noted that both de Soto and Molina denounced as “fallacious” the notion of the late thirteenth-century Scholastic John Duns Scotus (1266–1308) that the just price is the cost of production plus a reasonable profit; instead that price is the common estimation, the interaction of supply and demand, on the market. Molina further introduced the concept of competition by stating that competition among buyers will drive prices up, while a scarcity of purchasers will pull them down.15

In a later article, de Roover elaborated on his researches into the Scholastic theory of the just price. He found that the orthodox view of the just price as a station-in-life, cost-of-production price was based almost solely on the views of fourteenth-century Viennese Scholastic Henry of Langenstein. But Langenstein, de Roover pointed out, was a follower of the minority views of William of Ockham and outside the dominant Thomist tradition; Langenstein was rarely cited by later Scholastic writers. While some of their passages are open to a conflicting interpretation, de Roover demonstrated that Albertus Magnus (1193–1280) and his great pupil Thomas Aquinas (1226–74) held the just price to be the market price. In fact, Aquinas considered the case of a merchant who brings wheat to a country where there is a great scarcity; the merchant happens to know that more wheat is on the way. May he sell his wheat at the existing price, or must he announce to everyone the imminent arrival of Edition: current; Page: [60] new supplies and suffer a fall in price? Aquinas unequivocally answered that he may justly sell the wheat at the current market price, even though he added as an afterthought that it would be more virtuous of him to inform the buyers. Furthermore, de Roover pointed to the summary of Aquinas’s position by his most distinguished commentator, the late fifteenth-century Scholastic Thomas de Vio, Cardinal Cajetan (1468–1534). Cajetan concluded that for Aquinas the just price is “the one, which at a given time, can be gotten from the buyers, assuming common knowledge and in the absence of all fraud and coercion.”16

The cost-of-production theory of just price held by the Scotists was trenchantly attacked by the later Scholastics. San Bernardino of Siena, de Roover pointed out, declared that the market price is fair regardless of whether the producer gains or loses, or whether it is above or below cost. The great early sixteenth-century jurist Francisco de Victoria (c. 1480–1546), founder of the school of Salamanca, as well as his followers insisted that the just price is set by supply and demand regardless of labor costs or expenses; inefficient producers or inept speculators must bear the consequences of their incompetence and poor forecasting. Furthermore, de Roover made clear that the general Scholastic emphasis on the justice of “common estimation” (communis aestimatio) is identical to “market valuation” (aestimatio fori), since the Scholastics used these two Latin expressions interchangeably.17

De Roover noted, however, that this acceptance of market price did not mean that the Scholastics adopted a laissez-faire position. On the contrary, they were often willing to accept governmental price fixing instead of market action. A few prominent Scholastics, however, led by Azpilcueta and including Molina, opposed all price fixing; as Azpilcueta put it, price controls are unnecessary in times of plenty and ineffective or positively harmful in times of dearth.18

In a comment on de Roover’s paper, David Herlihy noted that, in the northern Italian city-states of the twelfth and thirteenth centuries, the birthplace of modern commercial capitalism, the market price was generally considered just because it was “true” and “real,” if it was “established or utilized without deceit or Edition: current; Page: [61] fraud.” As Herlihy summed it up, the just price of an object is its “true value as determined by one of two ways: for objects that were unique, by honest negotiation between seller and purchaser; for staple commodities by the consensus of the market place established in the absence of fraud or conspiracy.”19

John W. Baldwin’s definitive account of the theories of just price during the High Middle Ages of the twelfth and thirteenth centuries amply confirmed de Roover’s revisionist insight. Baldwin pointed out that there were three important and influential groups of medieval writers: the theologians (whom we have been examining), the Roman lawyers, and the canon lawyers. For their part, the Romanists, joined by the canonists, held staunchly to the principle of Roman private law that the just price is whatever is arrived at by free bargaining between buyers and sellers. Baldwin demonstrated that even the theologians of the High Middle Ages before Aquinas accepted the current market price as the just price.21

Several years later, de Roover turned to the views of the Scholastics on the broader issue of trade and exchange.22 He conceded the partial validity of the older view that the medieval Church frowned on trade as endangering personal salvation; or rather that, while trade can be honest, it presents great temptation for sin. However, he pointed out that, as trade and commerce grew after the tenth century, the Church began to adapt to the idea of the merits of trade and exchange. Thus, while it is true that the twelfth-century Scholastic Peter the Lombard (c. 1100–60) denounced trade and soldiering as sinful occupations per se, a far more benevolent view of trade was set forth during the thirteenth century by Albertus Magnus and his student Thomas Aquinas, as well as by Saint Bonaventure (1221–74) and Pope Innocent V (1225–76). While trade presents occasions for sin, it is not sinful per se; on the contrary, exchange and the division of labor are beneficent in satisfying the wants of the citizens. Moreover, the early fourteenth-century Scholastic Richard of Middleton developed the idea that both the buyer and the seller gain by exchange, since each demonstrates that he prefers what he receives in exchange to what he gives up. Middleton Edition: current; Page: [62] also applied this idea to international trade, pointing out that both countries benefit by exchanging their surplus products. Since the merchants and citizens of each country benefit, neither party is exploiting the other.

At the same time, Aquinas and other theologians denounced “covetousness” and love of profit, mercantile gain being only justifiable when directed toward the “good of others”; furthermore, Aquinas attacked “avarice” as attempting to improve one’s “station in life.” But, as de Roover pointed out, the great early sixteenth-century Italian Thomist Cardinal Cajetan corrected this view by demonstrating that, if this were true, every person would have to be frozen in his current occupation and income. On the contrary, asserted Cajetan, people with unusual ability should be able to rise in the world. In contrast to such northern Europeans as Aquinas, Cajetan was quite familiar with the commerce and upward social mobility in the Italian cities. Furthermore, even Aquinas explicitly rejected the idea that prices should be determined by one’s station in life, pointing out that the selling price of any good tends to be the same whether the entrepreneur is poor or wealthy.

De Roover hailed the early fifteenth-century Scholastic San Bernardino of Siena as being the only theologian who dealt in detail with the economic function of the entrepreneur. San Bernardino wrote of the uncommon qualities and abilities of the successful entrepreneur, including effort, diligence, knowledge of the market, and calculation of risks, with profit on invested capital justifiable as compensation for the risk and effort of the entrepreneur. The acceptance of profit was immortalized in a motto in a thirteenth-century account book: “In the name of God and of profit.”23

De Roover’s final work in this area was a booklet on San Bernardino and his contemporary Sant’ Antonino (1389–1459) of Florence.24 In San Bernardino’s views of trade and the entrepreneur, the occupation of trade may lead to sin, but so may all other occupations, including that of bishops. As for the sins of traders, they consist of such illicit activity as fraud, misrepresentation of products, the sale of adulterated products, and the Edition: current; Page: [63] use of false weights and measures, as well as keeping creditors waiting for their money after a debt is due. As to trade, there are several kinds of useful merchants, according to San Bernardino: importer-exporters, warehousemen, retailers, and manufacturers.

San Bernardino described the rare qualities and virtues that go into the making of successful businessmen. One is efficiency (industria), which includes knowledge of qualities, prices, and costs and the ability to assess risks and estimate profit opportunities, which, he declared, “indeed very few are capable of doing.” Entrepreneurial ability therefore includes the willingness to assume risks (pericula). Businessmen must be responsible and attentive to detail, and trouble and toil are also necessary. The rational and orderly conduct of business, also necessary to success, is another virtue lauded by San Bernardino, as are business integrity and the prompt settlement of accounts.

Turning again to the Scholastic view of value and price, de Roover pointed out that, as early as Aquinas, prices were treated as determined, not by their philosophic rank in nature, but by the degree of the usefulness or utility of the respective products to man and to human wants. As de Roover wrote of Aquinas, “These passages are clear and unambiguous; value depends upon utility, usefulness, or human wants. There is nowhere any mention of labor as the creator or the measure of value.”25 A century before the Spanish Scholastics and a century and a half before the sophisticated formulation of Francisco Garcia, San Bernardino had demonstrated that price is determined by scarcity (raritas), usefulness (virtuositas), and pleasurability or desirability (complacibilitas). Greater abundance of a good will cause a drop in its value and greater scarcity a rise. To have value, furthermore, a good must have usefulness, or what we may call “objective utility”; but within that framework, the value is determined by the complacibilitas, or “subjective utility,” that it has to individual consumers. Again, only the marginal element is lacking for a full-scale pre-Austrian theory of value. Coming to the brink of the later Austrian solution to the classical economists’ “paradox of value,” San Bernardino noted that a Edition: current; Page: [64] glass of water to a man dying of thirst would be so valuable as to be almost priceless, but fortunately water, though absolutely necessary to human life, is ordinarily so abundant that it commands either a low price or even no price at all.

Correcting Schumpeter’s ascription of the founding of subjective utility to Sant’ Antonino and observing that he had derived it from San Bernardino, de Roover showed further that recent scholarship demonstrates that Bernardino derived his own analysis almost word for word from a late thirteenth-century Provencal Scholastic, Pierre de Jean Olivi (1248–98). Apparently, Bernardino did not give credit to Olivi because the latter, coming from another branch of the Franciscan order, was at that time suspected of heresy.26

Turning to the concept of the “just price,” de Roover made it clear that San Bernardino, following Olivi, held that price of a good or service to be “the estimation made in common by all the citizens of the community.” This he held explicitly to be the valuation of the market, since he defined the just price as “the one which happens to prevail at a given time according to the estimation of the market, that is, what the commodities for sale are then commonly worth in a certain place.”27

Wages were treated by the two Italian friars as equivalent to the prices of goods. For San Bernardino, “The same rules which apply to the prices of goods also apply to the price of services with the consequence that the just wage will also be determined by the forces operating in the market or, in other words, by the demand for labor and the available supply.” An architect is paid more than a ditchdigger, asserted Bernardino, because “the former’s job requires more intelligence, greater ability, and longer training and that, consequently, fewer qualify . . . . Wage differentials are thus to be explained by scarcity because skilled workers are less numerous than unskilled and high positions require even a very unusual combination of skills and abilities.”28 And Sant’ Antonino concluded that the wage of a laborer is a price which, like any other, is properly determined by the common estimation of the market in the absence of fraud.

During and after the sixteenth century, the Roman Catholic Edition: current; Page: [65] church and Scholastic philosophy came under increasingly virulent attack, first from Protestants and then from rationalists, but the result was not so much to eliminate any influence of Scholastic philosophy and economics as to mask that influence, since their proclaimed enemies would often fail to cite their writings. Thus, the great early seventeenth-century Dutch Protestant jurist Hugo Grotius (1583–1645) adopted much of Scholastic doctrine, including the emphasis on want and utility as the major determinant of value, and the importance of the common estimation of the market in determining price. Grotius, in fact, explicitly cited the Spanish Scholastics Azpilcueta Navarro and Covarrubias. Even more explicitly following the Spanish Scholastics of the sixteenth century were the Jesuit theologians of the following century, including the highly influential Flemish Jesuit Leonardus Lessius (1554–1623), a friend of Luis de Molina, and the even more influential Spanish Jesuit Cardinal Juan de Lugo (1583–1660), whose treatise was originally published in 1642 and was reprinted many times in the next three centuries. Also explicitly following the Scholastics and the Salamanca school in the seventeenth century was the Genoese philosopher and jurist Sigismundo Scaccia (c. 1618), whose treatise was widely reprinted, as well as Antonio de Escobar (c. 1652), author of a moral manual.

To return to what would be the dominant Protestant trend for later economic thought, Grotius’s legal and economic doctrines were followed closely in the later seventeenth century by the Swedish Lutheran jurist Samuel Pufendorf (1632–94). While Pufendorf followed Grotius on utility and scarcity and the common estimation of the market in determining value and price, and while he certainly consulted the writings of the Spanish Scholastics, it is the rationalist Pufendorf who dropped all citations to these hated Scholastic influences upon his teacher. Hence, when Grotian doctrine was brought to Scotland by the early eighteenth-century professor of moral philosophy at Glasgow Gershom Carmichael (1672–1729), who translated Pufendorf into English, knowledge of Scholastic influences was lost. Hence, with Carmichael’s great student and successor Francis Edition: current; Page: [66] Hutcheson, utility began to be weakened by labor and cost-of-production theories of value, until finally by the time Hutcheson’s student Adam Smith (1723–90) wrote the Wealth of Nations, pre-Austrian Scholastic influence had unfortunately dropped out altogether. Hence the view of Schumpeter, de Roover, and others that Smith and later Ricardo shunted economics onto a wrong track, which the later marginalists (including the Austrians) had to correct.

Scholastic doctrine had a more lasting influence on economists on the Continent, particularly in Catholic countries. Thus, the brilliant mid-eighteenth-century Italian the Abbé Ferdinando Galiani (1728–87) is often credited by historians with inventing full-blown the concept of utility and scarcity as the determinants of price. No one wished to stress Scholastic writings in that rationalistic age, but strong Scholastic influence is detectable in Galiani’s work, whose section on value even contains an explicit citation to the Salamanca Scholastic Diego Covarrubias y Leiva. Galiani’s uncle Celestino, who brought up the youthful economist, had been professor of moral theology before becoming an archbishop and was therefore undoubtedly familiar with the Scholastic literature on the subject, which filled the Italian libraries of the eighteenth century. Galiani’s contemporary Italian economist Antonio Genovesi (1712–69) was also directly influenced by Scholastic thought; he had served as professor of ethics and moral philosophy at the University of Naples.

From Galiani the central role of utility, scarcity, and the common estimation of the market spread to France, to the late eighteenth-century French abbé Étienne Bonnot de Condillac (1714–80), as well as to that other great abbé Robert Jacques Turgot (1727–81). Knowing only Galiani as his predecessor, Turgot echoed the Salamanca school in holding the prices of goods and the value of money, as the result of the “common estimation” of the market, to be built up out of the subjective valuations of individuals in that market. Francois Quesnay (1694–1774) and the eighteenth-century French physiocrats—often considered to be the founders of economic science—were also heavily influenced by the Scholastics, both in their natural Edition: current; Page: [67] law theory and in their emphasis on consumption and subjective value. Scholastic doctrine even appears in the fiercely anti-Catholic Encyclopedie, including the doctrine of natural law, as well as the analysis of price as determined by the current common estimation of the market. Even during the nineteenth century strong traces of Condillac and Turgot appear in Jean Baptiste Say (1767–1832), who upheld a utility model for the future.29

At about the same time as Schumpeter, Grice-Hutchinson, and de Roover published their researches, Emil Kauder set forth a similar revisionist viewpoint. Kauder traced the connection between the Scholastics and Galiani, first to the mid-sixteenth-century Italian politician Gian Francesco Lottini (1512–72).30 He showed that Lottini first worked out a rudimentary concept of time preference: that people estimate present wants higher than future. The next link was the late sixteenth-century Italian merchant Bernardo Davanzati (1529–1606), who applied subjective-value theory to money in 1588. Indeed, Schumpeter was soon to point out that Davanzati also solved the “paradox of value,” that water is very useful but not valuable on the market because it is highly abundant. Whether or not Davanzati was influenced by San Bernardino is not known.31 He was followed almost a century later by the Italian mathematics professor Geminiano Montanari (1633–87). Galiani was then definitely influenced by Davanzati.

Kauder then developed in an original way the great contributions of Galiani. For not only did Galiani comprehensively set forth the familiar theory of utility and scarcity as determinants of price—which lacked only the marginal principle to arrive at the Austrian theory—but he also went on to apply the utility theory to the value of labor and other factors of production. For the value of labor is, in turn, determined by the utility and scarcity of the particular kind of labor being considered. The highly skilled are paid much more than the common laborer, since nature produces only a small number of able men. But not only that; for Galiani it is not labor costs that determine value, but value—and consumer choice—that determines labor cost. Furthermore, Edition: current; Page: [68] Galiani touched on a pre-Böhm-Bawerk theory of interest, with interest being the difference between present and future money.32 Turgot then anticipated the Austrians in applying Galiani’s utility theory to a detailed analysis of isolated exchange, showing that both parties benefit in utility from the exchange. Turgot, furthermore, as Schumpeter pointed out, developed a time analysis of production and worked out a pre-Austrian general analysis of the law of eventually diminishing returns that was not to be matched until the end of the nineteenth century. Quite justly Schumpeter wrote that “it is not too much to say that analytic economics took a century to get where it could have got in twenty years after the publication of Turgot’s treatise had its content been properly understood and absorbed by an alert profession.”33 Instead, as Kauder pointed out, it was left to Condillac to offer a last-ditch and neglected defense of Galiani’s utility theory against the rising tide of British cost theory. In Condillac’s trenchant phrase, “A thing does not have value because it costs, as people suppose; instead it costs because it has a value.”34

In a fascinating companion article, Kauder speculated on the persistence of utility-and-subjective-value theory on the Continent, as compared to the rise and dominance of a quantity-of-labor-and-cost-of-production theory in Great Britain.35 He was particularly intrigued by the fact that the pre-nineteenth-century French and Italian subjectivists were all Catholics (and, of course, he might have added the medieval and sixteenth century Scholastics as well), while the British economists were all Protestants, or, more precisely, Calvinists. Kauder speculated that it was their Calvinist training that led John Locke and particularly Adam Smith to reject the Continental tradition (Smith knew Turgot and read Grotius) and to emphasize a labor theory of value. The Calvinists believed that work or labor was divine; could not this imprint have led Smith and the others to adopt a labor theory of economic value? Furthermore, Kauder pointed out that until the middle of the eighteenth century the French and Italian universities were dominated by Aristotelian philosophy, particularly as transmitted by the Jesuits and other Edition: current; Page: [69] religious orders. Kauder added that, in contrast to Calvinism, Aristotelian-Thomist philosophy did not glorify work or labor per se as divine; work may be necessary, but “moderate pleasure-seeking and happiness”—in short, utility—”form the center of economic actions.” Kauder concluded that “if pleasure in a moderate form is the purpose of economics, then following the Aristotelian concept of the final cause, all principles of economics including valuation must be derived from it.”36

Kauder admitted that his is a conjecture that cannot be proved, and also that it does not particularly hold for the nineteenth century. However, he did offer an intriguing explanation for Alfred Marshall’s failure to adopt the full marginal utility theory and, instead, his shunting of the theory aside in favor of a recrudescence of Ricardo’s objective cost-of-production theory. That explanation lies in Marshall’s undoubtedly strong Evangelical and Calvinist background.37

Finally, Emil Kauder convincingly demonstrated the direct influence of Aristotelian philosophy on the founders of the Austrian school and contrasted the result with the other marginalist schools of the late nineteenth century. First, in contrast to Jevons and Walras, who believed that economic laws are hypotheses dealing with social quantities, Carl Menger and his followers held that economics investigates, not the quantities of phenomena, but the underlying essences of such real entities as value, profit, and the other economic categories. The belief in underlying essences inherent in superficial appearances is Aristotelian, and Kauder pointed out that Menger studied and cited Aristotle extensively in his methodological work. He also noted the similarities discovered by Oskar Kraus between the Austrian and the Aristotelian theories of imputation. Kauder also pointed out that Menger applied the fundamental Aristotelian distinction between matter and form to economic theory: economic theory deals with the underlying form of events, while history and statistics deal with the concrete matter. The concrete historical cases are the exemplifications of general regularities, the Aristotelian matter that contains potentialities, while the economic laws “are the Aristotelian forms which actualize the Edition: current; Page: [70] potential, i.e., they provide the laws and concepts valid for all times and places.”38

Secondly, Menger held, in contrast to Jevons and Walras, that economic laws as expressed in mathematical equations are only arbitrary statements; on the contrary, genuine economic laws are “exact,” in Menger’s terminology meaning fixed laws that describe sequences invariable to time and place. Thus, Menger and the Austrians build up an “eternal structure of economics . . . stripped of all historical peculiarities.” In short, Menger and, following him, Böhm-Bawerk were Aristotelian social ontologists, maintaining the absolute and apodictic reality of economic laws. Kauder perceptively pointed out that in contemporary economics, “only von Mises, the most faithful student of the three [Austrian] pioneers, maintains the ontological character of economic laws. His theory of human action . . . is a ‘reflection about the essence of action.’ Economic laws provide ‘ontological facts.’”39

Finally, the Jevons-Walras mathematical method necessarily deals with “functions of interdependent phenomena,” whereas, for Menger and the Austrians, economic laws are genetic and causal, proceeding from the utility and the action of the consumer to the market result. As Kauder put it:

Kauder also pointed out that the characteristically Austrian method of proceeding by words from a Robinson Crusoe model and then proceeding step by step to a fully developed economy accords with the Aristotelian concept of entelechy, in which “the motion from the potentiality to the actualization determines not Edition: current; Page: [71] only the structure of the system but also the presentation of the thoughts.”41

In attempting to explain the Austrian choice among all the marginalists for philosophical realism and social ontology, Kauder pointed to the late nineteenth-century influences on the Austrian intellectual climate of Aristotle, Thomas Aquinas, and other schools of realistic philosophy. Most influential was Aristotle, who was studied carefully down to the middle of the nineteenth century, and who was often taught in the secondary schools in Austria. And while realism gave way to empiricism in the Austrian schools by the turn of the twentieth century, “the Viennese Schottengymnasium, the intellectual nursery of many famous Austrians including Wieser, required, even after 1918, the students to read Aristotle’s metaphysics in the original Greek.”42 In contrast, of course, the influence of Aristotelian philosophy in Britain or even France during the nineteenth century was virtually nil.

In recent decades, the revisionist scholars have clearly altered our knowledge of the prehistory of the Austrian school of economics. We see emerging a long and mighty tradition of proto-Austrian Scholastic economics, founded on Aristotle, continuing through the Middle Ages and the later Italian and Spanish Scholastics, and then influencing the French and Italian economists before and up till the day of Adam Smith. The achievement of Carl Menger and the Austrians was not so much to found a totally new system on the framework of British classical political economy as to revive and elaborate upon the older tradition that had been shunted aside by the classical school.

Philosophical and Ethical Implications of Austrian Economics

The title of this paper contains an apparent paradox: it assumes that Austrian economic theory can have philosophical and ethical implications, while the tradition within Austrian economics has been strongly in support of Wertfreiheit as a cardinal precept of scientific propriety. A good deal of what I have to say in this paper relates to the resolution of this paradox. Let us first rapidly review the history of the doctrine of value-freedom in economics.

Praxeology, Value Judgments, and Public Policy

Ethics is the discipline, or what is called in classical philosophy the “science,” of what goals men should or should not pursue. All men have values and place positive or negative value judgments on goods, people, and events. Ethics is the discipline that provides standards for a moral critique of these value judgments. In the final analysis, either such a discipline exists and a rational or objective system of ethics is possible, or else each individual’s value judgments are ultimately arbitrary and solely a creature of individual whim. It is not my province to try to settle one of the great questions of philosophy here. But even if we believe, as I do, that an objective science of ethics exists, and even if we believe still further that ethical judgments are within the province of the historian or social scientist, one thing is certain: praxeology, economic theory, cannot itself establish ethical judgments. How could it when it deals with the formal fact that men act rather than with the content of such actions? Furthermore, praxeology is not grounded on any value judgments of the praxeologist, since what he is doing is analyzing the fact that people in general have values rather than inserting any value judgments of his own.

What, then, is the proper relationship of praxeology to values or ethics? Like other sciences, praxeology provides laws about reality, laws that those who frame ethical judgments disregard only at their peril. In brief, the citizen, or the “ethicist,” may have Edition: current; Page: [90] framed, in ways which we cannot deal with here, general ethical rules or goals. But in order to decide how to arrive at such goals, he must employ all the relevant conclusions of the various sciences, all of which are in themselves value-free. For example, let us suppose that a person’s goal is to improve his health. Having arrived at this value—which I would consider to be rational and others would consider purely emotive and arbitrary—the person tries to discover how to reach his goal. To do so, he must employ the laws and findings, value-free in themselves, of the relevant sciences. He then extends the judgment of “good,” as applied to his health, on to the means he believes will further that health. His end, the improvement of his health, he pronounces to be “good”; he then, let us say, adopts the findings of medical science that x grams of vitamin C per day will improve his health; he therefore extends the ethical pronouncement of “good”—or, more technically, of “right”—to taking vitamin C as well. Similarly, if a person decides that it is “good” for him to build a house and adopts this as his goal, he must try to use the laws of engineering—in themselves value-free—to figure out the best way of constructing that house. Felix Adler put the relationship clearly, though we may question his use of the term social before science in this context:

Praxeology has the same methodological status as the other sciences and the same relation to ethics. Thus, to take a deliberately Edition: current; Page: [91] simple example: if our end is to be able to find gasoline when we pull up to the service station, and value-free praxeological law tells us—as it does—that, if the government fixes a maximum price for any product below then free-market price, a shortage of that product will develop, then (unless other goals supervene) we will make the ethical pronouncement that it is “bad” or “wrong” for the government to impose such a measure. Praxeology, like the other sciences, is the value-free handmaiden of values and ethics.

To our contention that the sciences, including praxeology, are in themselves value-free, it might be objected that it is values or ethics that directs the interest of the scientist in discovering the specific laws of his discipline. There is no question about the fact that medical science is currently far more interested in discovering a cure for cancer than in searching for a cure for some disease that might only have existed in parts of the Ukraine in the eighteenth century. But the unquestioned fact that values and ethics are important in guiding the attention of scientists to specific problems is irrelevant to the fact that the laws and disciplines of the science itself are value-free. Similarly, Crusoe on his desert island may not be particularly interested in investigating the science of bridge building, but the laws of that science itself are value-free.

Ethical questions, of course, play a far smaller role in applied medicine than they do in politics or political economy. A basic reason for this is that generally the physician and his patient agree—or are supposed to agree—on the end in view: the advancement of the patient’s health. The physician can advise the patient without engaging in an intense discussion of their mutual values and goals. Of course, even here, the situation is not always that clear-cut. Two examples will reveal how ethical conflicts may arise: first, the patient needs a new kidney to continue to live; is it ethical for the physician and/or the patient to murder a third party and extract his kidney? Second, is it ethical for the physician to pursue medical research for the possible good of humanity while treating his patient as an unwitting guinea pig? Edition: current; Page: [92] These are both cases where valuational and ethical conflicts enter the picture.

In economic and political questions, in contrast, ethical and value conflicts abound and permeate the society. It is therefore impermissible for the economist or other social scientist to act as if he were a physician, who can generally assume complete agreement on values and goals with his patient and who can therefore prescribe accordingly and with no compunction. Since, then, praxeology provides no ethics whatsoever but only the data for people to pursue their various values and goals, it follows that it is impermissible for the economist qua economist to make any ethical or value pronouncements or to advocate any social or political policy whatsoever.

The trouble is that most economists burn to make ethical pronouncements and to advocate political policies—to say, in effect, that policy X is “good” and policy Y “bad.” Properly, an economist may only make such pronouncements in one of two ways: either (1) to insert his own arbitrary, ad hoc personal value judgments and advocate policy clearly on that basis; or (2) to develop and defend a coherent ethical system and make his pronouncement, not as an economist, but as an ethicist, who also uses the data of economic science. But to do the latter, he must have thought deeply about ethical problems and also believe in ethics as an objective or rational discipline—and precious few economists have done either. That leaves him with the first choice: to make crystal clear that he is speaking not as an economist but as a private citizen who is making his own confessedly arbitrary and ad hoc value pronouncements.

Most economists pay lip service to the impermissibility of making ethical pronouncements qua economist, but in practice they either ignore their own criteria or engage in elaborate procedures to evade them. Why? We can think of two possible reasons. One is the disreputable reason that, if Professor Doakes advocates policy X and basically does so as an economics professor, he will be listened to and followed with awe and respect; whereas if he advocates policy X as plain Joe Doakes, the mass of the citizenry may come to the perfectly valid conclusion that Edition: current; Page: [93] their own arbitrary and ad hoc value judgments are just as good as his, and that therefore there is no particular reason to listen to him at all. A second and more responsible reason might be that the economist, despite his professed disbelief in a science of ethics, realizes deep down that there is something unfortunate—we might even say bad—about unscientific and arbitrary value judgments in public policy, and so he tries desperately to square the circle, in order to be able to advocate policy in some sort of scientific manner.

While squaring this circle is impossible, as we shall consider further, I believe that this putative uneasiness at making arbitrary value judgments is correct. While it is surely admirable (ethical?) for an economist to distinguish clearly and carefully between the value-free science and his own value judgments, I contend further that it is the responsibility of any scientist, indeed any intellectual, to refrain from any value judgment whatever unless he can support it on the basis of a coherent and defensible ethical system. This means, of course, that those economists who, on whatever grounds, are not prepared to think about and advance an ethical system should strictly refrain from any value pronouncements or policy conclusions at all. This position is of course itself an ethical one. But it relates to the ethical system that is the precondition of all science; for, even though particular scientific laws are themselves value-free, the very procedures of science rest on the ethical norm of honesty and the search for truth; that norm, I believe, includes the responsibility to lend coherence and system to all one’s pronouncements including valuational ones. I might add in passing that anyone conceding the necessity of honesty in science ipsofacto becomes willy-nilly a believer in objective ethics, but I will leave that point to the ethical subjectivists to grapple with.2

Let me clarify with an example. Henry C. Simons, after trenchantly criticizing various allegedly scientific arguments for progressive taxation, came out flatly in favor of progression as follows:

My point is that, while it was surely admirable for Simons to make the distinction between his scientific and his personal value judgments crystal clear, that is not enough for him to escape censure. He had, at the very least, the responsibility of analyzing the nature and implications of egalitarianism and then attempting to defend it as an ethical norm. Flat declarations of unsupported value judgments should be impermissible in intellectual, let alone scientific, discourse. In the intellectual quest for truth it is scarcely sufficient to proclaim one’s value judgments as if they must be accepted as tablets from on high and not be themselves subject to intellectual criticism and evaluation.

Suppose, for example, that Simons’s ethical or esthetic judgment was not on behalf of equality but of a very different social ideal. Suppose that instead he had come out in favor of the murder of all short people, of all adults under five feet six inches in height. And suppose that his sole defense of this proposal were the following:

One wonders if the reception accorded to Simons’s remarks by his fellow economists or social scientists would have been quite the same.4 Yet, of course, the logic of his stance would have been precisely the same.

More usual is an attempt by the economist to place himself in the status of the physician of our foregoing example, that is, as someone who is merely agreeing to or ratifying the values either of a majority in society or of every person in it. But even in these cases, it must be remembered that the physician is in no sense value-free, though he is simply sharing the value of his patient, and that the value of health is so deeply shared that there is no Edition: current; Page: [95] occasion for making it explicit. Nevertheless, the physician does make a value judgment, and, even if every person in society shares the same value and goal, the economist who goes along with such a value is still making a value judgment, even if indeed universally shared. He is still illegitimately going beyond the bounds of the economist per se, and his value judgments must still be supported by rational argument.

The weakest path to an economist’s adoption of social values is to appeal to the majority. Thus, John F. Due commented on the progressive income tax in his text on public finance:

But once again the fact that the majority of society might hold market inequality to be “unfair” does not absolve Due of the fact that, in ratifying that judgment, he himself made that value judgment and went beyond the province of the economist. Furthermore, on scientific standards, the ad hoc and arbitrary value judgments of the majority are no better than those of one person, and Due, like Simons, failed to support that judgment with any sort of argumentation. Furthermore, when we ratify the majority, what of the rights or the utilities of the minority? Felix Adler’s strictures against the utilitarian ethic clearly apply here:

Again, with Due as with Simons, one wonders about the treatment of such a position by the American intellectual community if his imprimatur on the “consensus of opinion in society today” Edition: current; Page: [96] had been applied instead to the treatment of the Jews in Germany in the 1930s.

Just as the physician who advises his client commits himself to the ethic of good health, so the economist who advises a client is not, much as he would like to think so, a mere technician who is not commiting himself to the value judgment of his client and his client’s goals. By advising a steel company on how to increase its profits, the economist is thereby committed to share in the steel entrepreneur’s value judgment that his greater profit is a desirable goal. It is even more important to make this point about the economist who advises the State. In so doing, he commits himself to the value judgments, not simply of the majority of the society as in the case of Due, but to the value judgments of the rulers of the State apparatus. To take a deliberately dramatic example, let us suppose that an economist is hired by the Nazis to advise the government on the most efficient method of setting up concentration camps. By agreeing to help make more efficient concentration camps, he is agreeing to make them “better,” in short, he is committing himself willy-nilly to concentration camps as a desirable goal. And he would, again, still be doing so even if this goal were heartily endorsed by the great majority of the German public. To underscore this point, it should be clear that an economist whose value system leads him to oppose concentration camps might well give such advice to the German government as to make the concentration camps as inefficient as possible, that is to sabotage their operations. In short, whatever advice he gives to his clients, a value commitment by the economist, either for or against his clients’ goals, is inescapable.7

A more interesting variant of the economist’s attempt to make value-free value judgments is the “unanimity principle,” recently emphasized by James M. Buchanan. Here the idea is that the economist can safely advocate a policy if everyone in the society also advocates it. But, in the first place, the unanimity principle is still subject to the aforementioned strictures: that, even if the economist simply shares in everyone else’s value judgment, he is still making a value judgment. Furthermore, the superficial attractiveness of the unanimity principle fades away Edition: current; Page: [97] under more stringent analysis; for unanimity is scarcely sufficient to establish an ethical principle. For one thing, the requirement of unanimity for any action or change begins with and freezes the status quo. For an action to be adopted, the justice and ethical propriety of the status quo must first be established, and of course economics can scarcely be prepared to do that. The economist who advocates the unanimity principle as a seemingly value-free pronouncement is thereby making a massive and totally unsupported value judgment on behalf of the status quo. A stark but not untypical example was the debate in the British Parliament during the early nineteenth century on the abolition of slavery, when early adherents of the “compensation principle” variant of the unanimity principle (which has its own additional and grave problems) maintained that the masters must be compensated for the loss of their investment in slaves. At that point, Benjamin Pearson, a member of the Manchester school, declared that “he had thought it was the slaves who should have been compensated.”8 Here is a striking example of the need in advocating public policy of some ethical system, of a concept of justice. Those ethicists among us who hold that slavery is unjust would always oppose the idea of compensating the masters and would rather think in terms of reparations to compensate the slaves for their years of oppression. But what is there for the value-free economist qua economist to say?

There are other grave problems with the compensation principle as a salvaging attempt to make it possible for value-free economists to advocate public policy. For the compensation principle assumes that it is conceptually possible to measure losses and thereby to compensate losers. But since praxeology informs us that “utility” and “cost” are purely subjective (psychic) concepts and therefore cannot be measured or even estimated by outside observers, it become impossible for such observers to weigh “social costs” and “social benefits” and to decide that the latter outweigh the former for any public policy, much less to make the compensations involved so that the losers are no longer losers. The usual attempt is to measure psychic losses in utility by the monetary price of an asset; thus, if a railroad damages the Edition: current; Page: [98] land of a farmer by smoke, it is assumed that the farmer’s loss can be measured by the market price of the land. But this ignores the facts that the farmer may have a psychic attachment to the land that puts its value far above the market price and that—especially in this kind of situation that does not involve direct action and exchange by the individuals—it is impossible to find out what the farmer’s psychic attachment to the land may be worth. He may say, for example, that his attachment to the land requires the compensation of $10 million, even though the market price is $100,000, but of course he may be lying. However, the government or other outside observer has no scientific way of finding out one way or another.9 Furthermore, the existence in the society of just one militant anarchist, whose psychic grievance against government is such that he cannot be compensated for his psychic disutility from the existence of government, is enough by itself to destroy the social-utility and compensation-principle case for any government action whatever. And surely at least one such anarchist exists.

Can praxeological economics, then, say nothing about social utility? Not quite. If we define an “increase in social utility” in the Paretian manner as a situation where one or more persons gain in utility while nobody loses, then praxeology finds a definite, but restricted, role for the concept. But it is a role where social utilities remain unmeasurable and incomparable between persons. Briefly, praxeology maintains that when a person acts, his utility, or at least his ex ante utility, increases; he expects to enjoy a psychic benefit from the act, otherwise he would not have done it. When, in a voluntary free-market exchange, for example, I buy a newspaper from a newsdealer for 15 cents, I demonstrate by my action that I prefer (at least ex ante) the newspaper to the 15 cents, while the newsdealer demonstrates by his action the reverse order of preference. Since each of us is better off by the exchange, both the newsdealer and I have demonstrably gained in utility, while nothing has demonstrably happened to anyone else. Elsewhere I have called this praxeological concept “demonstrated preference,” in which action demonstrates preference, in contrast to various forms of psychologizing, which tries Edition: current; Page: [99] to measure other person’s value scales apart from action, and to behaviorism, which assumes that such values or preferences do not exist.10 The compensation principle that I have been criticizing rests on the illegitimate psychologizing notion that a scientific economist-observer can know anything about someone else’s value scale except as it is demonstrated through such action as the purchase or sale of a newspaper. And since the compensation principle is necessarily divorced from demonstrated preference, it cannot be employed by the scientific economist. Incidentally, I might note here that “demonstrated preference” is very different from Samuelson’s famous concept of “revealed preference,” for Samuelson, in illegitimate psychologizing fashion, assumed the existence of an underlying preference scale that forms the basis of a person’s action and that remains constant in the course of his actions over time. There is, however, no warrant for the scientific economist to make any such assumption. All we can say is that an action, at a specific point of time, reveals some of a person’s preferences at that time. There is no warrant for assuming that such preference orderings remain constant over time.11

Now since praxeology shows, by the concept of demonstrated preference, that both the newsdealer and I gain in utility from the exchange, and nothing has demonstrably happened to anyone else, we can conclude scientifically, as praxeological economists, that social utility has increased from the sale and purchase of the newspaper—since we have defined social utility in the Paretian manner. It is true, of course, that third parties may well be grinding their teeth in hatred at the exchange. There may be people, for example, who through envy suffer a psychic loss because the newspaper dealer and/or I have gained. Therefore, if we employ the Paretian definition of “social utility” in the usual psychologizing sense, we can say nothing about social utility one way or the other. But if we confine the concept to its strict scientific compass in demonstrated preference, then we can state that social utility increases from the exchange. Still further, we may know as historians, from interpretive understanding of the hearts and minds of envious neighbors, that they Edition: current; Page: [100] do lose in utility. But we are trying to determine in this paper precisely what scientific economists can say about social utility or can advocate for public policy, and since they must confine themselves to demonstrated preference, they must affirm that social utility has increased.

Conversely, since every act of the State involves coercion, at least the coercion of taxation, and since in its every act there is at least one demonstrable loser in utility, we must also conclude that no act whatever of the State can increase social utility. Here, of course, is another good reason why the economic scientist cannot use the concept of “social utility” to establish any sort of unanimity principle or any other case for government action. It has been pointed out that, similarly, we cannot say that any action of the State decreases social utility, at least in the short run, and that too is correct.

We must emphasize, however, that the praxeological conclusion that the free market maximizes social utility is not sufficient to enable the praxeological economist to advocate the free market while abstaining from value judgments or from an ethical system. In the first place, why should an economist favor increasing social utility? This in itself requires an ethical or value judgment. And, secondly, the social-utility concept has many other failings, including the fact that while the envious and the egalitarian or the admirer of coercion per se may not be included in the social-utility concept, the contemporary historian knows that he is there, lurking in the wings; it therefore requires an ethical judgment, which cannot be supplied by praxeology, to overrule him. Furthermore, many of the strictures against the unanimity principle apply here too; for example, should we really be eager to preserve the utility of the slaveholder against loss? And if so, why?

Let us now turn to the position of Ludwig von Mises on the entire matter of praxeology, value judgments, and the advocacy of public policy. The case of Mises is particularly interesting, not only because he was a leader in the modern Austrian school and in praxeology, but also because he was, of all the economists in the twentieth century, the most uncompromising and passionate Edition: current; Page: [101] adherent of laissez-faire and at the same time the most rigorous and uncompromising advocate of value-free economics and opponent of any sort of objective ethics. How then did he attempt to reconcile these two positions?12

Essentially, Mises offered two very different solutions to this problem. The first is a variant of the unanimity principle. Essentially this variant affirms that an economist per se cannot say that a given governmental policy is “good” or “bad.” However, if a given policy will lead to consequences, as explained by praxeology, that every one of the supporters of the policy will agree is bad, then the value-free economist is justified in calling the policy a “bad” one. Thus, Mises wrote:

And again:

Now this is surely an ingenious attempt to allow pronouncements of “good” or “bad” by the economist without making a value judgment; for the economist is supposed to be only a praxeologist, a technician, pointing out to his readers or listeners that they will all consider a policy “bad” once he reveals its full consequences. But ingenious as it is, the attempt completely fails. For how could Mises know what the advocates of the particular policy consider desirable? How could he know what their value scales are now or what they will be when the consequences of the measure appear? One of the great contributions of praxeology, as I have pointed out above, is that the praxeologist, the Edition: current; Page: [102] economist, doesn’t know what anyone’s value scales are except as those value preferences are demonstrated by a person’s concrete action. In the case of my purchase of the newspaper, historians or psychologists may make more or less informed estimates of the newsdealer’s or my value scales through the process of interpretive understanding, but all that the economist can know scientifically and with certainty is the preferences relative to 15 cents or the newspaper as demonstrated through concrete action. Mises himself emphasized that

Given Mises’s own analysis, then, how can the economist know what the motives for advocating various policies really are or how people will regard the consequences of these policies?

Thus, Mises, qua praxeologist, might show that price control (to use his example) will lead to unforeseen shortages of a good to the consumers. But how could Mises know that some advocates of price control do not want shortages? They may, for example, be socialists, anxious to use the controls as a step toward full collectivism. Some may be egalitarians who prefer shortages because the rich will not be able to use their money to buy more of the product than poorer people. Some may be nihilists, eager to see shortages of goods. Others may be one of the legion of contemporary intellectuals who are eternally complaining about the excessive affluence of our society or about the great waste of energy; they may all delight in the shortages of goods. Still others may favor price control, even after learning of the shortages, because they or their political allies will enjoy well-paying jobs or power in a price-control bureaucracy. All sorts of such possibilities exist, and none of them are compatible with the assertion of Mises, as a value-free economist, that all Edition: current; Page: [103] supporters of price control—or of any other government intervention—must concede, after learning economics, that the measure is “bad.” In fact, once Mises conceded that even a single advocate of price control or any other interventionist measure may acknowledge the economic consequences and still favor it, for whatever reason, then, as a praxeologist and economist, he could no longer call any of these measures “bad” or “good” or even “appropriate” or “inappropriate” without inserting into his economic policy pronouncements the very value judgments that he himself held to be in admissible in a scientist of human action.16 He would no longer be a technical reporter to all advocates of a certain policy but an advocate participating on one side of a value conflict.

Moreover, there is another fundamental reason for advocates of “inappropriate” policies to refuse to change their minds even after hearing and acknowledging the praxeological chain of consequences. For praxeology may indeed show that all types of government policies will have consequences that most people, at least, will tend to abhor. But, and this is a vital qualification, most of these consequences take time, some a great deal of time. No economist has done more than Ludwig von Mises to elucidate the universality of time preference in human affairs—the praxeologic law that everyone prefers to attain a given satisfaction sooner than later. And certainly Mises, as a value-free scientist, could never presume to criticize anyone’s rate of time preference, to say that A’s was “too high” and B’s “too low.” But, in that case, what about the high-time-preference people in society who retort to the praxeologist: “Perhaps this high tax and subsidy policy will lead to a decline of capital; perhaps even the price control will lead to shortages, but I don’t care. Having a high time preference, I value more highly the short-run subsidies, or the short-run enjoyment of buying the current good at cheaper prices, than the prospect of suffering the future consequences.” And Mises, as a value-free scientist and opponent of any concept of objective ethics, could not call them wrong. There is no way that he could assert the superiority of the long run over the short run without overriding the values of the high-time-preference Edition: current; Page: [104] people; and that could not be cogently done without abandoning his own subjectivist ethics.

In this connection, one of Mises’s basic arguments for the free market is that, on the market, there is a “harmony of the rightly understood interests of all members of the market society.” It is clear from his discussion that he could not merely mean “interests” after learning the praxeological consequences of market activity or of government intervention. He also, and in particular, meant people’s long-run interests. As he stated, “For ‘rightly understood’ interests we may as well say interests ‘in the long run.’”17 But what about the high-time-preference folk, who prefer to consult their short-run interests? How can the long run be called “better” than the short run? Why is “right understanding” necessarily the long run?

We see, therefore, that Mises’s attempt to advocate laissez-faire while remaining value-free, by assuming that all of the advocates of government intervention will abandon their position once they learn of its consequences, falls completely to the ground. There is another and very different way, however, that Mises attempted to reconcile his passionate advocacy of laissez-faire with the absolute value-freedom of the scientist. This was to take a position much more compatible with praxeology, by recognizing that the economist qua economist can only trace chains of cause and effect and may not engage in value judgments or advocate public policy. In so doing, Mises conceded that the economic scientist cannot advocate laissez-faire but then added that as a citizen he can do so. Mises, as a citizen, proposed a value system but it is a curiously scanty one. For he was here caught in a dilemma. As a praxeologist he knew that he could not as an economic scientist pronounce value judgments or advocate policy. Yet he could not bring himself simply to assert and inject arbitrary value judgments. And so, as a utilitarian (for Mises, along with most economists, was indeed a utilitarian in ethics, although a Kantian in epistemology), he made only one narrow value judgment: that he desired to fulfill the goals of the majority of the public (happily, in this formulation, Mises did not presume to know the goals of everyone).

As Mises explained in his second variant:

In this second variant, Mises successfully escaped the self-contradiction of being a value-free praxeologist advocating laissez-faire. Granting in this variant that the economist may not make such advocacy, he took his stand as a citizen willing to make value judgments. But he was not willing, as Simons was, to simply assert an ad hoc value judgment; presumably he felt that a valuing intellectual must present some sort of system to justify such value judgments. But for Mises the utilitarian, his system is a curiously bloodless one; even as a valuing laissez-faire liberal, he was only willing to make the one value judgment that he joined the majority of the people in favoring their common peace, prosperity, and abundance. In this way, as an opponent of objective ethics, and uncomfortable as he must have been with making any value judgments even as a citizen, he made the minimal possible degree of such judgments; true to his utilitarian position his value judgment is the desirability of fulfilling the subjectively desired goals of the bulk of the populace.

A full critique of this position must involve a critique of utilitarian ethics itself, and this cannot be done here. But a few points may be made. In the first place, while praxeology can indeed demonstrate that laissez-faire will lead to harmony, prosperity, and abundance, while government intervention leads to conflict and impoverishment,19 and while it is probably true that most Edition: current; Page: [106] people value the former highly, it is not true that these are their only goals or values. The great analyst of ranked value scales and diminishing marginal utility should have been more aware of such competing values and goals. For example, many people, whether through envy or a misplaced theory of justice, may prefer far more equality of income than will be attained on the free market. Many people, pace the aforementioned intellectuals, may want less abundance in order to whittle down our allegedly excessive affluence. Others, as I have mentioned, may prefer to loot the capital of the rich or the businessman in the short run, while acknowledging but dismissing the long-run ill effects, because they have a high time preference. Probably very few of these people will want to push statist measures to the point of total impoverishment and destruction—although this may happen, as in the case of Communist China. But a majority coalition of the foregoing might well opt for some reduction in wealth and prosperity on behalf of these other values. They may well decide that it is worth sacrificing a modicum of wealth and efficient production because of the high opportunity cost of not being able to enjoy an alleviation of envy, or a lust for power, or a submission to power, or, for example, the thrill of “national unity,” which they might enjoy from a (short-lived) economic crisis.

What could Mises reply to a majority of the public who have indeed considered all the praxeological consequences and still prefer a modicum—or, for that matter, even a drastic amount—of statism in order to achieve some of their competing goals? As a utilitarian, he could not quarrel with the ethical nature of their chosen goals: for he had to confine himself to the one value judgment that he favored the majority’s achieving their chosen goals. The only reply that Mises could make within his own framework was to point out that government intervention has a cumulative effect, that eventually the economy must move either toward the free market or toward full socialism, which praxeology shows will bring chaos and drastic impoverishment, at least to an industrial society. But this, too, is not a fully satisfactory answer. While many programs of statist Edition: current; Page: [107] intervention—especially price controls—are indeed cumulative, others are not. Furthermore, the cumulative impact takes such a long time that the time preferences of the majority would probably lead them, in full acknowledgment of the consequences, to ignore the effect. And then what?

Mises attempted to use the cumulative argument to answer the contention that the majority of the public prefer egalitarian measures even knowingly at the expense of a portion of their own wealth. Mises’s comment was that the “reserve fund” was on the point of being exhausted in Europe, and therefore that any further egalitarian measures would have to come directly out of the pockets of the masses through increased taxation. Mises assumed that once this became clear, the masses would no longer support interventionist measures.20 In the first place, this is no argument against the previous egalitarian measures or in favor of their repeal. But secondly, while the masses might be convinced, there is certainly no apodictic certainty involved; the masses have in the past and presumably will in the future continue knowingly to support egalitarian and other statist measures on behalf of others of their goals, despite the knowledge that their income and wealth would be reduced. Thus, as William E. Rappard pointed out in his thoughtful critique of Mises’s position:

Rappard also noted that in his own country, Switzerland, the urban industrial and commercial majority of the country have repeatedly, and often at popular referendums, endorsed measures to subsidize the minority of farmers in a deliberate effort to retard industrialization and the growth of their own incomes. The urban majority did not do so in the “absurd belief that they were thereby increasing their real income.” Instead, “quite deliberately and expressly, political parties have sacrificed the immediate Edition: current; Page: [108] material welfare of their members in order to prevent, or at least somewhat to retard, the complete industrialization of the country. A more agricultural Switzerland, though poorer, such is the dominant wish of the Swiss people today.”22 The point here is that Mises, not only as a praxeologist but also as a utilitarian liberal, could have no word of criticism against these statist measures once the majority of the public take their praxeological consequences into account and choose them anyway on behalf of goals other than wealth and prosperity.

Furthermore, there are other types of statist intervention that clearly have little or no cumulative effect and that may even have very little effect in diminishing production or prosperity. Let us, for example, assume—and this assumption is not very farfetched in view of the record of human history—that the great majority of a society hate and revile redheads, perhaps, to cite Simons again, because they find redheads “evil or unlovely.” Let us further assume that there are very few redheads in the society. This large majority then decide that they would like very much to murder all redheads. Here they are; the murder of redheads is high on the value scales of the great majority of the public; there are few redheads so that there will be little loss in production on the market. How could Mises rebut this proposed policy either as a praxeologist or as a utilitarian liberal? I submit that he could not do so.

Mises made one further attempt to establish his position, but it was even less successful. Criticizing the arguments for state intervention on behalf of equality or other moral concerns, he dismissed them as “emotional talk.” After reaffirming that “praxeology and economics . . . are neutral with regard to any moral precepts,” and asserting that “the fact that the immense majority of men prefer a richer supply of material goods to a less ample supply is a datum of history; it does not have any place in economic theory,” he concluded by insisting that “he who disagrees with the teachings of economics ought to refute them by discursive reasoning, not by . . . the appeal to arbitrary, allegedly ethical standards.”23

But I submit that this will not do; for Mises would have to concede that no one can decide upon any policy whatever unless he makes an ultimate ethical or value judgment. But since this is so, and since according to Mises all ultimate value judgments or ethical standards are arbitrary, how then could he denounce these particular ethical judgments as “arbitrary”? Furthermore, it was hardly correct for Mises to dismiss these judgments as “emotional,” since for him as a utilitarian, reason cannot establish ultimate ethical principles, which can therefore only be established by subjective emotions. It was pointless for Mises to call for his critics to use “discursive reasoning” since he himself denied that discursive reasoning can be used to establish ultimate ethical values. Furthermore, the man whose ultimate ethical principles would lead him to support the free market could also be dismissed by Mises as equally “arbitrary” and “emotional,” even if he takes the laws of praxeology into account before making his ultimately ethical decision. And we have seen above that the majority of the public very often have other goals which they hold, at least to a certain extent, higher than their own material well-being.

The burden of this paper has been to show that, while praxeological economic theory is extremely useful for providing data and knowledge for framing economic policy, it cannot be sufficient by itself to enable the economist to make any value pronouncements or to advocate any public policy whatsoever. More specifically, Ludwig von Mises to the contrary notwithstanding, neither praxeological economics nor Mises’s utilitarian liberalism is sufficient to make the case for laissez-faire and the free-market economy. To make such a case, one must go beyond economics and utilitarianism to establish an objective ethics that affirms the overriding value of liberty and morally condemns all forms of statism, from egalitarianism to the murder of redheads, as well as such goals as the lust for power and the satisfaction of envy. To make the full case for liberty, one cannot be a methodological slave to every goal that the majority of the public might happen to cherish.

Equilibrium versus Market Process

A characteristic feature of the Austrian approach to economic theory is its emphasis on the market as a process, rather than as a configuration of prices, qualities, and quantities that are consistent with each other in that they produce a market equilibrium situation.1 This feature of Austrian economics is closely bound up with dissatisfaction with the general use made of the concept of perfect competition. It is interesting to note that economists of sharply differing persuasions within the Austrian tradition all display a characteristic dissenchantment with the orthodox emphasis on both equilibrium and perfect competition. Thus Joseph A. Schumpeter’s well-known position on these matters is remarkably close to that of Ludwig von Mises.2 Oskar Morgenstern, in a notable paper on contemporary economic theory, expressed these same Austrian criticisms of modern economic theory.3

On the Central Concept of Austrian Economics: Market Process

In setting up the market process as the central concept of Austrian economics, as opposed to the general-equilibrium approach of the neoclassical school, Austrian economists have a choice of strategies: They might, on the one hand, attempt to show the absurdity of the notion of general equilibrium, the arid formalism of the style of thought that gave rise to it, and its “irrelevance” to many urgent problems. They might, without denying the significance of equilibrating forces, stress the time aspect and show that the equilibrating forces can never do their work in time, that long before general equilibrium is established some change will supervene to render the data obsolete. They would, however, face the objection that the notion of market process requires equilibrating forces to make it work, an objection that, because it is a half-truth, might be hard to refute without drawing a distinction between “equilibrium of the individual” and “equilibrium of the economic system.”

In my view, however, Austrian economists should present their case for the market process by offering a fairly comprehensive account of the human forces governing it rather than by engaging in piecemeal discussions of its various interconnected aspects, which must, in the absence of the total picture, remain obscure. The defects of the neoclassical style become obvious if the Austrian economists simply point to facts the neoclassical conceptual tools are unable to explain.

What keeps the market process in perpetual motion? Why does it never end, denoting the final state of equilibrium of our system? If Austrian economists answered by saying, “Something unexpected always happens,” they would be accused of vagueness and reminded that only perpetual “changes in data” could have this effect. An attempt to show that continuous autonomous changes in demand or supply do account for the permanent character of the market process would involve a drawn-out discussion of the effects of ever-changing patterns of knowledge on the conduct of consumers and producers, a discussion in which Austrian economists would be at a serious disadvantage without prior elucidation of the term knowledge.

The market process is the outward manifestation of an unending stream of knowledge. This insight is fundamental to Austrian economics. The pattern of knowledge is continuously changing in society, a process hard to describe. Knowledge defies all attempts to treat it as a “datum” or an object identifiable in time and space.

Knowledge may be acquired at a cost, but is not always, as when we witness an accident or “learn by doing” for other than cognitive reasons. Sometimes, knowledge is jealously and expensively guarded; sometimes, it may be broadcast to reach a maximum number of listeners, as in advertising. Now knowledge, whether costly or free, may prove valuable to one and useless to another, owing to the complementarity of new and old knowledge and the diversity of human interests. Hence it is impossible to gauge the range of application of some bit of knowledge until it is obsolete. But we can never be certain that knowledge is obsolete since the future is unknown. All useful knowledge probably tends to be diffused, but in being applied for various purposes it also may change character, hence the difficulty of identifying it.

Knowledge then is an elusive concept wholly refractory to neoclassical methods. It cannot be quantified, has no location in space, and defies insertion into any complex of functional relationships. Though it varies in time, it is no variable, either dependent or independent. As soon as we permit time to elapse, we must Edition: current; Page: [128] permit knowledge to change, and knowledge cannot be regarded as a function of anything else. The state of knowledge of a society cannot be the same at two successive points of time, and time cannot elapse without demand and supply shifting. The stream of knowledge produces ever new disequilibrium situations, and entrepreneurs continually manage to find new price-cost differences to exploit. When one is eliminated by strenuous competition, the stream of knowledge throws up another. Profit is a permanent income from ever-changing sources.

Certain consequences of what has been said seem to concern the modus operandi of the market, but one appears to be significant for the methodology of all social sciences.

In the first place, how do we determine the true origin of any particular bit of knowledge? When and how do ill-founded surmises and half-baked ideas acquire the status of respectable knowledge? We can neither answer nor ignore these questions. Two things we may assert with reasonable confidence. As Karl Popper showed, we cannot have future knowledge in the present.1 Also, men sometimes act on the basis of what cannot really be called knowledge. Here we encounter the problem of expectations.

Although old knowledge is continually being superseded by new knowledge, though nobody knows which piece will be obsolete tomorrow, men have to act with regard to the future and make plans based on expectations. Experience teaches us that in an uncertain world different men hold different expectations about the same future event. This fact has certain implications for growth theory—in my view important implications—with which I deal in my paper “Toward a Critique of Macroeconomics” (included in this volume). Here we are concerned with the fact that divergent expectations entail incoherent plans. At another place I argued that “what keeps this process in continuous motion is the occurrence of unexpected change as well as the inconsistency of human plans. Both are necessary conditions.”2 Are we entitled, then, to be confident that the market process will in the end eliminate incoherence of plans which would thus prove to be only transient? What is being asked Edition: current; Page: [129] here is a fairly fundamental question about the nature of the market process.

The subject of expectations, a subjective element in human action, is eminently “Austrian.” Expectations must be regarded as autonomous, as autonomous as human preferences are. To be sure, they are modified by experience, but we are unable to postulate any particular mode of change. To say that the market gradually produces a consistency among plans is to say that the divergence of expectations, on which the initial incoherence of plans rests, will gradually be turned into convergence. But to reach this conclusion we must deny the autonomous character of expectations. We have to make the (diminishing) degree of divergence of expectations a function of the time sequence of the stages of the market process. If the stream of knowledge is not a function of anything, how can the degree of divergence of expectations, which are but rudimentary forms of incomplete knowledge, be made a function of time?

Unsuccessful plans have to be revised. No doubt planners learn from experience. But what they learn is not known; also different men learn different lessons. We might say that unsuccessful planners make capital losses and thus gradually lose their control over resources and their ability to engage in new enterprises; the successful are able to plan with more confidence and on a much larger scale. Mises used such an argument. But how can we be sure? History shows many examples of men who were “ahead of their times,” whose expectations were vindicated when it was too late, who had to give up the struggle for lack of resources when a few more would have brought them triumph instead of defeat. There is no reason why a man who fails three times should not succeed the fourth. Expectations are autonomous. We cannot predict their mode of change as prompted by failure or success.

What we have here is a difference of opinion on the nature of the market process. For one view the market process is propelled by a mechanism of given and known forces of demand and supply. The outcome of the interaction of these forces, namely, equilibrium, is in principle predictable. But outside forces in the Edition: current; Page: [130] form of autonomous changes in demand and supply continually impinge on the system and prevent equilibrium from being reached. The system is ever moving in the direction of an equilibrium, but it never gets there. The competitive action of entrepreneurs tending to wipe out price-cost differences is regarded as “equilibrating”; for in equilibrium no such differences could exist.

The other view, which I happen to hold, regards the distinction between external forces and the internal market mechanism as essentially misleading. Successive stages in the flow of knowledge must be manifest in both. Market action is not independent of expectations, and every expectation is an attempt “to catch a glimpse of future knowledge now.” To say that each market moves toward a price that “clears” it has little meaning where speculators are busy piling up and unloading stocks. The relationship between different markets in disequilibrium is infinitely complex. I shall say nothing more about it here, though I deal with some aspects of this complex problem in “Toward a Critique of Macroeconomics” (included in this volume).

Having set out to replace the paradigm of general equilibrium by that of the market process, why should we concentrate on the equilibrating nature of the latter—on showing that but for the perennial impact of external forces general equilibrium would be reached after all? It might be held, however, that every process must have a direction, and unless we are able to show that every stage of the market process “points” in the direction of equilibrium, no satisfactory theory of the market process is possible.

But this is not a convincing view. In the first place, though a process may have a direction at each point of time, it may change direction over time. The direction the process follows need not be the same throughout. Second and more important, two kinds of process have to be distinguished here. The first is a limited process, in the course of which we witness the successive modes of interaction of a set of forces, given initially and limited in number. Such a process may terminate or go on forever; whatever happens depends entirely on the nature of the (given) set of Edition: current; Page: [131] forces. The system may be subjected to random shocks from external sources, which it may take some time to absorb, such absorption interfering with the interaction of the forces. The second variety of process is the very opposite of the first. No initial set of forces delimits the boundaries of events. Any force from anywhere may at any time affect our process, and forces that impinged on it yesterday may suddenly vanish from the scene. There is no end or final point of rest in sight. Need I assert that history is a process of the second, not of the first, variety?

While our market process is not of the first kind, it is not completely unlimited. Two things may be said about it. The notion of general equilibrium is to be abandoned, but that of individual equilibrium is to be retained at all costs. It is simply tantamount to rational action. Without it we should lose our “sense of direction.” The market process consists of a sequence of individual interactions, each denoting the encounter (and sometimes collision) of a number of plans, which, while coherent individually and reflecting the individual equilibrium of the actor, are incoherent as a group. The process would not go on otherwise.

Walrasians, in using the same notion of equilibrium on the three levels of analysis—the individual, the market, and the entire system—succumbed to the fallacy of unwarranted generalization: they erroneously believed that the key that unlocks one door will also unlock a number of others. Action controlled by one mind is, as Mises showed, necessarily consistent. The actions of a number of minds in the same market lack such consistency, as the simultaneous presence of bulls and bears shows. Consistency of actions in a number of markets within a system constitutes an even greater presumption.

Finally, the divergence of expectations, apart from being an obstacle to equilibrium, has an important positive function in a market economy. It is an anticipatory device. The more extended the range of expectations, the greater the likelihood that somebody will catch a glimpse of things to come and be “right.” Those who take their orientation from the future rather than the present, the “speculators,” permit the future to make its impact on Edition: current; Page: [132] the market process earlier than otherwise. They contrive to inject a glimpse of future knowledge into the emergent market pattern. Of course they may make mistakes for which they will pay. Without divergent expectations and incoherent plans, however, it could not happen at all.

The Theory of Capital

It is not my purpose here to offer a concise Austrian theory of capital. Rather I shall present an Austrian perspective on several concepts fundamental to modern capital theory. I shall show how this perspective enables us to fit certain characteristically Austrian ideas about capital into the more comprehensive Austrian view of the way in which the market system operates. To clarify what constitutes the uniquely Austrian way of thinking about capital, I shall begin with a critical interpretation of a 1974 paper by Sir John Hicks. My use of Hicks’s work as a springboard also helps to explain why Hicks considered his book on capital theory to be “neo-Austrian” in character.1

On Austrian Capital Theory

To most economists today the words Austrian capital theory denote work in the line of succession of Eugen von Böhm-Bawerk. Sir John Hicks noted that the tradition originated before the last quarter of the nineteenth century and can even be traced to the Renaissance, yet described his book Capital and Time as A Neo-Austrian Theory inasmuch as it deals with production processes that take time to complete.1 How many know that Carl Menger regarded Böhm-Bawerk’s theory as “one of the greatest errors ever committed”?2

I wish to argue, however, that Böhm-Bawerk’s model, being essentially macroeconomic, does not provide an adequate basis for a capital theory that could properly be called Austrian. Work in constructing such a theory must start at the foundation, and this means at the level of individual action. Böhm-Bawerk never meant to be a capital theorist. He was essentially a Ricardian who asked a Ricardian question: “Why are the owners of impermanent resources able to enjoy a permanent income and what determines its magnitude?” The notion of a temporal capital structure consisting of a sequence of stages of production was a mere by-product of an inquiry into the causes and the magnitude of the rate of return on capital and not the main subject. In pursuit of this Ricardian inquiry Böhm-Bawerk battled on and failed like a Ricardian. In his model there are one factor of production, labor, and one final consumption good. Ricardo failed when trying to apply conclusions holding in a simple corn economy to a multicommodity world, in which the real wage rate Edition: current; Page: [146] depends on the workers’ expenditure pattern and relative prices of wage goods (hence on choice!). Böhm-Bawerk’s argument foundered on the same rock.

With a number of consumption goods, we need a price system which must be invariant to changes in the rate of interest that accompany the accumulation of capital. But such a price system cannot exist. Moreover, with the subsistence fund consisting of a number of goods, some of the capital invested will be malinvested if the composition of the fund does not correspond to the workers’ expenditure pattern. In the absence of perfect foresight on the part of the capital owners, some malinvestment is inevitable, and some of the capital accumulated vanishes from the scene.

There are other reasons for abandoning Böhm-Bawerk’s theory. As Samuelson pointed out3 and Hicks noted,4 the possibility of “reswitching” affects the “average length of the period of production” just as much as the “quantity of capital.” Moreover, to reduce the whole complex of relationships among capital resources—within firms as well as between firms in different industries and stages of processing, often with relations of complementarity in time but just as often not—to the single dimension of time is a bold idea (originating with Ricardo), but not a very good one. From an Austrian point of view, too much violence is done to the diversity of the world.

I suggest that we reverse the Ricardian approach to the problem of capital and make the capital structure the primary object of study by starting at the ground level, that is, at the microlevel where production plans are made and carried out.

On the other hand, can the rate of return on capital, Ricardo’s and Böhm-Bawerk’s primary object, have any place in a market economy if, in an Austrian mood, the variety of goods and services and its corollary, the heterogeneity of capital, are recognized? This rate of return is of central concern to the neoclassical theorists, from Irving Fisher to Robert Solow, and constitutes the main issue of controversy. For the neoclassical economist it is a dependant variable of the general-equilibrium system. To the contrary, the neo-Ricardians hold that it has to be determined Edition: current; Page: [147] outside this system since there can be no quantity of capital and hence no marginal product of it. In my view this controversy about a fictitious macroeconomic magnitude is a symptom of the arid macroeconomic formalism that afflicts both schools. For in a market economy a uniform rate of return on all capital invested does not exist.

If we follow Menger instead of Böhm-Bawerk, a distinction may be made between the rate of interest on loans and the rate of profit on capital invested. The former does exist, that is, there is a structure of interest rates determined daily in the loan market as its equilibrium price. The latter does not.5 There is also in a market economy a uniform rate of (dividend and earnings) yield on capital assets that the market assigns to the same class. But this uniform rate of yield has nothing to do with either Ricardo’s rate of profits or Fisher’s rate of return over cost. It reflects all capital gains and losses made since the inception of the company in question. It is precisely the diversity of such gains and losses recorded on the stock of different companies that permits the market to make the present rate of yield on all assets uniform. This Mengerian criticism of Böhm-Bawerk is confirmed by Hicks, the leading neoclassical thinker, who, having proclaimed the “’Austrian’ affiliation of my ideas” and paid a tribute to Böhm-Bawerk,6 nevertheless concluded on the last page of his book that “only in the steady state can we unambiguously determine the size of profits. Out of the steady state the profit that is allocated to a particular period depends on expectations . . . there is no such convention that is unambiguously right.”7 But the “steady state,” like all equilibria, is a fiction, and the real Austrian view has been Hicks’s final view all the time!

Our main task is to lay the foundation for a theory of the capital structure. Our capital theory, unlike Böhm-Bawerk’s, is not devised to serve as a basis for an interest theory. Its purpose is to make the shape, order, and coherence of the capital structure intelligible in terms of human action.

Starting with the facts of the heterogeneity of capital and following its logic, we find in every firm a capital combination—a combination of land, buildings, equipment, machines, and Edition: current; Page: [148] stocks of various goods. There are constraints on the possible modes of complementarity of these resources, some of them technological, some the results of the market situation. Relevant here are both the market for the products of the firm and those for labor and materials. Within these boundaries the manager-entrepreneur chooses a mode for the use of the capital under his control to maximize his profits. And since his decision involves the future as well as the present, he bases his plan on his expectations.

Since his capital combination could produce a number of different output streams of various composition, he has to choose among them. But his capital combination is not immutable; he can reshuffle it, discarding some capital goods and buying others. Entrepreneurial action with regard to capital, then, requires continuous “alertness” to change and a willingness to make frequent changes, the switching “on” or “off” of various output streams as well as the reshuffling of capital combinations. The firm and its resources are immersed in the stream of knowledge. Technical progress in the form of “learning by doing” probably takes place within the firm’s walls. But new knowledge usually reaches it by way of the markets for its products, factor services and alternative capital goods that might be added to, or used as substitutes in, the existing capital combinations.

A comparison may be made between the just described heterogeneity of capital and that in other models. Neoclassical writers like Samuelson and Solow apparently admit the heterogeneity of capital as a matter of fact and in principle, but eschew the consequences, whenever a problem germane to it arises, by means of such devices as the surrogate production function or the assumption of a one-commodity world. Neo-Ricardian criticism emphasizes the need for a price system invariant to interest changes but can carry the matter no farther since the dynamics of the market process is beyond its reach.

In commodity markets prices are fixed directly and incomes indirectly. Each firm with its capital combination is always in disequilibrium and by its action in this state contributes to the continuous reshaping of the capital structure.

The individuality of each firm rests on the varying interpretations it places on the ceaseless stream of knowledge, different segments in the minds of different manager-entrepreneurs finding expression in the specific composition of their capital combinations. In time, output streams are switched on and off, and the composition of capital combinations is modified. New investment is but a by-product of the regrouping of existing capital resources. Hence the futility of all attempts to “measure” capital.

In dealing with the capital structure of society and its complex relationships with the capital combinations of the firms, we should be aware of the prototypical relationship it reflects between an aggregate and its particles, between the macrostructure and its microelements. If we criticize the inadequacy of macromodels, we should be able to show that we can do better. We must be able to deal with them without losing sight of their microbasis.

The capital structure of society is an aggregate of capital combinations, but only in a state of general equilibrium can the capital goods belonging to different firms be regarded as additive, when they stand to each other in a relationship of complementarity. It is, however, a type of complementarity different from that governing capital goods within the same capital combination. We have to distinguish between the planned complementarity of the latter, the result of entrepreneurial choice and decision, and the unplanned complementarity of capital resources at various stages of production, which is an outcome of the operation of the market process.

The capital structure of society is never completely integrated. The competitive nature of the market process entails incoherence of plans and limits the coherence of the resulting order. A tendency toward the integration of the structure does exist. Capital goods that do not fit into any existing combination are useless to their owners, are “not really capital,” and will soon be scrapped. “Holes” in the existing complementarity pattern, on the other hand, must cause price-cost differences and thus call for their elimination. But expectations of early change in the Edition: current; Page: [150] present situation may impede the process of adjustment, and even when this does not happen, the forces of adjustment themselves may be overtaken by other forces.

One result of the recent discussion on “reswitching” is to the advantage of the Austrian school. As long as all capital is regarded as homogeneous, managers may respond to a marginal fall in the rate of interest by a marginal act of substitution of capital for labor. But heterogeneity of capital entails a regrouping of the existing capital combination; some capital goods may have to be discarded, others acquired. It is no longer a marginal adjustment that is called for but entrepreneurial choice and decision. As Pasinetti pointed out, “Two techniques may well be as near as one likes on the scale of variation of the rate of profit and yet the physical capital goods they require may be completely different.”8

In a world of disequilibrium, entrepreneurs continually have to regroup their capital combinations in response to changes of all kinds, present and expected, on the cost side as well as on the market side. A change in the mode of income distribution is merely one special case of a very large class of cases to which the entrepreneur has to give constant attention. No matter whether switching or reswitching is to be undertaken, or any other response to market change, expectations play a part, and the individuality of each firm finds its expression in its own way. Yet only “reswitching” has of late attracted the interest of theoreticians. There is more in the world of capital and markets than is dreamt of in their philosophy.

Toward a Critique of Macroeconomics

In reconstructing Austrian economics, I have recommended the concept of market process as the foundation of all economic life (see my paper “On the Central Concept,” included in this volume). In other words, we must start at the microlevel. How, then, shall we deal with such aggregates as income, consumption, and wages, which, according to the same terminology, must be regarded as macroeconomic magnitudes?

In my paper “On Austrian Capital Theory” (also included in this volume) I said that we may regard the relationship between the capital structure of society and its capital combinations as the prototype of the relationship between a macroeconomic magnitude and its microelements. In other words, the former must never be brought into an argument without giving a careful account of the latter; for changes in the constellation of the microelements will affect the macromagnitude itself.

However, in modern macroeconomic literature, whether neoclassical or neo-Ricardian, there is little awareness of this fundamental postulate. From the moment of inception, the macroeconomic aggregates in these writings seem to lead a life of their own, to be endowed with qualities sufficient to allow their adjustment to change in their environment, but change within them is ignored.

Among the macroeconomic aggregates, we have to distinguish between stocks and flows. While it is generally agreed that the former cannot in a world of uncertainty be measured, the reasons given are not satisfactory. Why, then, cannot capital be measured?

In stationary equilibrium capital can be measured; for here, but only here, the discounted present value of the highest income stream obtainable from a given capital resource must be exactly equal to its cost of reproduction if the same interest rate is used for both calculations. Otherwise there would be investment or disinvestment, neither of which is compatible with a stationary state.

Outside the equilibrium of the stationary state, replacement cost and present value of a discounted future income stream will diverge. If we regard the latter as the economically significant value—and few economists doubt that (bygones are bygones)—we still have no yardstick by which to measure the assets of different firms. The neo-Ricardians stress the role of the interest rate as a discount factor; every time it changes, so does capital value. True as this may be, the real reason for our inability to measure capital lies in the subjective nature of expectations concerning future income streams. If we tried to measure capital by asking each owner for his valuation of his capital stock (for example, fire insurance value), we would get a set of consistent answers, but every change in ownership would invalidate at least one answer. Such an attempt to extract measurable objective value from subjective valuation must fail. This does not mean, however, that in a more limited context and for more limited purposes similar attempts may not be more sucessful.

The second part of the argument is that, while stocks cannot be measured, flows can. All of modern macroeconomics—the theories about investment, income, exports, and wages, as well as the social accounting systems that are widely regarded as one of its triumphs—rests on the assumption that output and income streams can be measured. Can they? As we shall see, the main support for this assumption is superficial as well as highly misleading.

Here we have one of the most intricate problems of measurement we encounter in a multicommodity world. In a classical corn economy all stocks and flows have their physical measures, but in a multicommodity world gallons of brandy and of whiskey, surgical instruments and musical instruments cannot be Edition: current; Page: [154] added up. Like David Ricardo and Eugen von Böhm-Bawerk, we need a price system invariant to the very effects of the variations of the variables we wish to measure. Can such a system exist?

The market prices on which national income measurement is ostensibly based are presumably equilibrium prices. But what kind of equilibrium prices are they? Is consistent aggregation, which macroeconomic thought requires to make sense, possible on the basis of prices that may not be consistent? Walrasian-Paretian long-run equilibrium does provide a consistent price system, but the market prices at which output flows are evaluated in the national income statistics are no such long-run equilibrium prices. They are market-day-equilibrium prices at best. There is no reason why they should be consistent with each other. The whole argument for using average market prices over a year as a basis for the valuation of output flows appears to rest on a confusion between long-run, short-run, and market-day equilibrium. Only prices belonging to the first category are elements of a coherent price system and might be used for the purpose of consistent aggregation. All the others are not. An average of market-day-equilibrium prices over a long period is not the same thing as a Walrasian long-run equilibrium price. Yet the computation of the macroeconomic aggregates that are released daily by the media and are so prominent in the products of the textbook industry rests on such elementary confusion.

Even if such a coherent long-run equilibrium price system did exist and could be known, it would not last. Its data would not remain the same for long. The steady flow of knowledge will tomorrow produce a pattern of knowledge different from today’s, and apparent changes in demand and supply will entail a new set of equilibrium prices. Not without reason are we compelled to look for a paradigm to replace the general-equilibrium model.

In a market economy, on the other hand, we have in the stock exchange a center for the consistent daily evaluation of all the more important capital combinations. This, to be sure, is not objective measurement. The measurement of capital is forever Edition: current; Page: [155] beyond our reach. But it is something more than mere subjective evaluation. Stock exchange prices of capital assets reflect a balance of expectations. There are two classes of traders in the market, and in an asset market the fundamentum divisionis is the optimism or pessimism of expectations. Hence, market prices of securities (and the capital assets they represent) have social significance, we might say a “social objectivity,” which transcends the mere subjective expectations of buyers and sellers on which they are based. The objects of valuation are not individual capital goods but fractions of capital combinations that are the substrate of multiperiod plans. It is expectations about the success of multiperiod plans that bulls and bears are continuously expressing.

Stock exchange equilibrium is market-day equilibrium. Tomorrow’s set of equilibrium prices will be different from today’s. But as we are dealing with an exchange economy, not a production economy, the fact of change does not impair the consistency and significance of market valuation. Free access to all parts of the market, together with the speed at which brokers carry out their clients’ instructions, makes it possible to be at once a buyer of one kind of security and a seller of another. Arbitrage does the rest to produce a valuation of all company-owned assets that is consistent in that it reflects a balance of expectations between bulls and bears. The fact that tomorrow’s balance will be different from today’s faithfully reflects the flow of knowledge.

The difference between the commodity market and the securities market is instructive. Today’s potato price may not be consistent with today’s prices for other vegetables. If so, equilibrating forces that require time will come into operation. But today’s market equilibrium price may also be inconsistent with the long-run supply and demand for potatoes. The equilibrating forces released by the second disparity may impede or reinforce those released by the first. Certainly they require a different time dimension to be fully deployed. And the longer the time required by any force, the greater the probability that it will be affected by unexpected change. To opt for the market process against general equilibrium means to accept the implication that Edition: current; Page: [156] a fully coherent price system providing a basis for consistent aggregation can never exist.

We find here another reason why steady growth—uniform motion of that supermacroaggregate, the economic system—has to be regarded as absurd. Equilibrating forces in different markets, even if none is affected by unexpected change, require different time periods to do their work. This is obvious if we contrast agricultural produce markets with those for industrial goods. Steady growth, however, requires all equilibrating forces to operate within the same time period.

But the main argument against steady growth is a necessary consequence of the divergence of expectations. Equilibrium in a production economy requires an equilibrium composition of the capital stock.1 With at least some capital goods durable and specific, can we conceive of such a state? A growing economy is a changing economy. It exists in an uncertain world in which men have to formulate expectations on which to base their plans. Different men will characteristically have different expectations about the same future event, and they cannot all be right. Some expectations will be disappointed, and the plans based upon them will have to be revised. The capital invested will turn out to have been malinvested. But the existence of malinvested capital is incompatible with the equilibrium composition of the capital stock. Hence steady growth is impossible. “Macroequilibrium in motion” is not an acceptable paradigm and has to be replaced by the market process.

As has been noted, the stock exchange, a fundamental institution of the market economy, imparts an element of social objectivity to individual stock valuations. This is by no means its only, or even its only significant, function. It facilitates the take-over bid by means of which capital resources get into the hands of those who can promise their owners a higher return. Without a stock exchange such bids would of course still be possible. shareholders could be notified that, if their capital resources were used in a different way (by producing a different output stream), better results could be obtained. But in the absence of market prices shareholders would be without a yardstick to Edition: current; Page: [157] measure the advantage offered them. For the optimal use of existing resources in a socialist economy, an elaborate bureaucratic organization would be needed to shift resources from points of lower to points of higher usefulness.

Perhaps the most important economic function of the stock exchange is the redistribution of wealth by means of the capital gains and losses it engenders in accordance with the market view about the probable success or failure of present multiperiod plans. In certain neoclassical writings the present distribution of resources is a datum of the set of equilibrium prices and quantities at each point of time. Over time, however, the mode of distribution of wealth changes as reflected in capital gains and losses. In fact, the present mode of distribution of wealth is nothing less than the cumulative result of the capital gains and losses of the past. Devotees of a redistribution of wealth in the name of social justice should be aware that, even if the state by the use of coercion were able to produce a supposedly socially desirable mode of distribution today, the market, if permitted to exist, via capital gains and losses would produce a different mode tomorrow.

I have tried to show that—in contrast to an opinion apparently widely held—flows in a multicommodity world are all too often inconsistent aggregates, whereas stocks, while unmeasurable in an uncertain world, may in favorable circumstances be subjected to consistent evaluation. The former is particularly true of the Keynesian I=S, current investment, the “net addition to the capital stock.” If the stock is unmeasurable, how can we tell what is an addition to it? Gross investment is in principle measurable and would be in practice if we had a consistent price system for capital goods. But to divide this flow into net investment and replacement, we need an objective criterion.

Individual decisions by capital owners on such division may be consistent in the sense that the decisions of individual owners do not conflict, but not in the sense that the word measurement implies, that is, that different individuals measuring the same object get identical results. Each owner’s judgment of his investment expenditure for maintenance and replacement of his existing Edition: current; Page: [158] wealth on the one hand and for a “net addition” on the other rests on a subjective expectation about the future, as nobody explained more forcefully than Keynes in his unjustly neglected “Appendix on User Cost.”2 It follows that a macroeconomic magnitude investment as an objectively measurable, that is, consistently ascertainable, entity does not exist. What does exist is an aggregate of subjective valuations dependent on owners’ expectations and the distribution of ownership. An important part of what appears as investment in the official reports of government and business rests on subjective estimates of those who compile the statistics or of those who release the returns.

This imperfection in macroeconomics, like many others in an imperfect world, could be regarded as inherent in any application of abstract theory to a concrete situation. This defense, however, is not valid. We have to distinguish between defects due to the unsatisfactory nature of our material, that is, the state of our statistical sources, and defects due to muddled thinking. A cure for the former is no cure for the latter. Piero Sraffa on a famous occasion made this point with vigor and clarity. His position has been summarized as follows:

The Austrian Theory of Money

The Austrian theory of money virtually begins and ends with Ludwig von Mises’s monumental Theory of Money and Credit, published in 1912.1 Mises’s fundamental accomplishment was to take the theory of marginal utility, built up by Austrian economists and other marginalists as the explanation for consumer demand and market price, and apply it to the demand for and the value, or the price, of money. No longer did the theory of money need to be separated from the general economic theory of individual action and utility, of supply, demand, and price; no longer did monetary theory have to suffer isolation in a context of “velocities of circulation,” “price levels,” and “equations of exchange.”

In applying the analysis of supply and demand to money, Mises used the Wicksteedian concept: supply is the total stock of a commodity at any given time; and demand is the total market demand to gain and hold cash balances, built up out of the marginal-utility rankings of units of money on the value scales of individuals on the market. The Wicksteedian concept is particularly appropriate to money for several reasons: first, because the supply of money is either extremely durable in relation to current production, as under the gold standard, or is determined exogenously to the market by government authority; and, second and most important, because money, uniquely among commodities desired and demanded on the market, is acquired not to be consumed, but to be held for later exchange. Demandto-hold thereby becomes the appropriate concept for analyzing Edition: current; Page: [161] the uniquely broad monetary function of being held as stock for later sale. Mises was also able to explain the demand for cash balances as the resultant of marginal utilities on value scales that are strictly ordinal for each individual. In the course of his analysis Mises built on the insight of his fellow Austrian Franz Cuhel to develop a marginal utility that was strictly ordinal, lexicographic, and purged of all traces of the error of assuming the measurability of utilities.

The relative utilities of money units as against other goods determine each person’s demand for cash balances, that is, how much of his income or wealth he will keep in cash balance as against how much he will spend. Applying the law of diminishing (ordinal) marginal utility to money and bearing in mind that money’s “use” is to be held for future exchange, Mises arrived implicitly at a falling demand curve for money in relation to the purchasing power of the currency unit. The purchasing power of the money unit, which Mises also termed the “objective exchange-value” of money, was then determined, as in the usual supply-and-demand analysis, by the intersection of the money stock and the demand for cash balance schedule. We can see this visually by putting the purchasing power of the money unit on the y-axis and the quantity of money on the x-axis of the conventional two-dimensional diagram corresponding to the price of any good and its quantity. Mises wrapped up the analysis by pointing out that the total supply of money at any given time is no more or less than the sum of the individual cash balances at that time. No money in a society remains unowned by someone and is therefore outside some individual’s cash balance.

While, for purposes of convenience, Mises’s analysis may be expressed in the usual supply-and-demand diagram with the purchasing power of the money unit serving as the price of money, relying solely on such a simplified diagram falsifies the theory. For, as Mises pointed out in a brilliant analysis whose lessons have still not been absorbed in the mainstream of economic theory, the purchasing power of the money unit is not simply the inverse of the so-called price level of goods and services. In describing the advantages of money as a general Edition: current; Page: [162] medium of exchange and how such a general medium arose on the market, Mises pointed out that the currency unit serves as unit of account and as a common denominator of all other prices, but that the money commodity itself is still in a state of barter with all other goods and services. Thus, in the premoney state of barter, there is no unitary “price of eggs”; a unit of eggs (say, one dozen) will have many different “prices”: the “butter” price in terms of pounds of butter, the “hat” price in terms of hats, the “horse” price in terms of horses, and so on. Every good and service will have an almost infinite array of prices in terms of every other good and service. After one commodity, say gold, is chosen to be the medium for all exchanges, every other good except gold will enjoy a unitary price, so that we know that the price of eggs is one dollar a dozen; the price of a hat is ten dollars, and so on. But while every good and service except gold now has a single price in terms of money, money itself has a virtually infinite array of individual prices in terms of every other good and service. To put it another way, the price of any good is the same thing as its purchasing power in terms of other goods and services. Under barter, if the price of a dozen eggs is two pounds of butter, the purchasing power of a dozen eggs is, inter alia, two pounds of butter. The purchasing power of a dozen eggs will also be one-tenth of a hat, and so on. Conversely, the purchasing power of butter is its price in terms of eggs; in this case the purchasing power of a pound of butter is a half dozen eggs. After the arrival of money, the purchasing power of a dozen eggs is the same as its money price, in our example, one dollar. The purchasing power of a pound of butter will be fifty cents, of a hat ten dollars, and so forth.

What, then, is the purchasing power, or the price, of a dollar? It will be a vast array of all the goods and services that can be purchased for a dollar, that is, of all the goods and services in the economy. In our example, we would say that the purchasing power of a dollar equals one dozen eggs, or two pounds of butter, or one-tenth of a hat, and so on, for the entire economy. In short, the price, or purchasing power, of the money unit will be an array of the quantities of alternative goods and services Edition: current; Page: [163] that can be purchased for a dollar. Since the array is heterogeneous and specific, it cannot be summed up in some unitary price-level figure.

The fallacy of the price-level concept is further shown by Mises’s analysis of precisely how prices rise (that is, the purchasing power of money falls) in response to an increase in the quantity of money (assuming, of course, that the individual demand schedules for cash balances or, more generally, individual value scales remain constant). In contrast to the hermetic neoclassical separation of money and price levels from the relative prices of individual goods and services, Mises showed that an increased supply of money impinges differently upon different spheres of the market and thereby ineluctably changes relative prices.

Suppose, for example, that the supply of money increases by 20 percent. The result will not be, as neoclassical economics assumes, a simple across-the-board increase of 20 percent in all prices. Let us assume the most favorable case—what we might call the Angel Gabriel model, that the Angel Gabriel descends and overnight increases everyone’s cash balance by precisely 20 percent. Now all prices will not simply rise by 20 percent; for each individual has a different value scale, a different ordinal ranking of utilities, including the relative marginal utilities of dollars and of all the other goods on his value scale. As each person’s stock of dollars increases, his purchases of goods and services will change in accordance with their new position on his value scale in relation to dollars. The structure of demand will therefore change, as will relative prices and relative incomes in production. The composition of the array constituting the purchasing power of the dollar will change.

If relative demands and prices change in the Angel Gabriel model, they will change much more in the course of real-world increases in the supply of money. For, as Mises showed, in the real world an inflation of money is alluring to the inflators precisely because the injection of new money does not follow the Angel Gabriel model. Instead, the government or the banks create new money to be spent on specific goods and services. The Edition: current; Page: [164] demand for these goods thereby rises, raising these specific prices. Gradually, the new money ripples through the economy, raising demand and prices as it goes. Income and wealth are redistributed to those who receive the new money early in the process, at the expense of those who receive the new money late in the day and of those on fixed incomes who receive no new money at all. Two types of shifts in relative prices occur as the result of this increase in money: (1) the redistribution from late receivers to early receivers that occurs during the inflation process and (2) the permanent shifts in wealth and income that continue even after the effects of the increase in the money supply have worked themselves out. For the new equilibrium will reflect a changed pattern of wealth, income, and demand resulting from the changes during the intervening inflationary process. For example, the fixed income groups permanently lose in relative wealth and income.2

If the concept of a unitary price level is a fallacious one, still more fallacious is any attempt to measure changes in that level. To use our previous example, suppose that at one point in time the dollar can buy one dozen eggs, or one-tenth of a hat, or two pounds of butter. If, for the sake of simplicity, we restrict the available goods and services to just these three, we are describing the purchasing power of the dollar at that time. But suppose that, at the next point in time, perhaps because of an increase in the supply of dollars, prices rise, so that butter costs one dollar a pound, a hat twelve dollars, and eggs three dollars a dozen. Prices rise but not uniformly, and all that we can now say quantitatively about the purchasing power of the dollar is that it is four eggs, or one-twelfth of a hat, or one pound of butter. It is impermissible to try to group the changes in the purchasing power of the dollar into a single average index number. Any such index conjures up some sort of totality of goods whose relative prices remain unchanged, so that a general averaging can arrive at a measure of changes in the purchasing power of money itself. But we have seen that relative prices cannot remain unchanged, much less the valuations that individuals place upon these goods and services.3

Just as the price of any good tends to be uniform, so the price, or purchasing power of money as Mises demonstrated, will tend to be uniform throughout its trading area. The purchasing power of the dollar will tend to be uniform throughout the United States. Similarly, in the era of the gold standard, the purchasing power of a unit of gold tended to be uniform throughout those areas where gold was in use. Critics who point to persistent tendencies for differences in the price of money between one location and another fail to understand the Austrian concept of what a good or a service actually is. A good is not defined by its technological properties but by its homogeneity in relation to the demands and wishes of the consumers. It is easy to explain, for example, why the price of wheat in Kansas will not be the same as the price of wheat in New York. From the point of view of the consumer in New York, the wheat, while technologically identical in the two places, is in reality two different commodities: one being “wheat in Kansas” and the other “wheat in New York.” Wheat in New York, being closer to his use, is a more valuable commodity than wheat in Kansas and will have a higher price on the market. Similarly, the fact that a technologically similar apartment will not have the same rental price in New York City as in rural Ohio does not mean that the price of the same apartment commodity differs persistently; for the apartment in New York enjoys a more valuable and more desirable location and hence will be more highly priced on the market. The “apartment in New York” is a different and more valuable good than the “apartment in rural Ohio,” since the respective locations are part and parcel of the good itself. At all times, a homogeneous good must be defined in terms of its usefulness to the consumer rather than by its technological properties.

To extend the analysis, the fact that the cost of living may be persistently higher in New York than in rural Ohio does not negate the tendency for a uniform purchasing power of the dollar throughout the country. For the two locations constitute a different set of goods and services, New York providing a vastly wider range of goods and services to the consumer. The higher costs of living in New York are the reflection of the greater Edition: current; Page: [166] locational advantages, of the more abundant range of goods and services available.4

In his valuable history of the theory of international prices, C. Y. Wu emphasized the Mises contribution and pointed out that Mises’s explanation was in the tradition of Ricardo and Nassau Senior, who “was the first economist to give a clear explanation of the meaning of the classical doctrine that the value of money was everywhere the same and to demonstrate that differences in the prices of goods of similar composition in different places were perfectly reconcilable with the assumption of an equality of the value of money.”5 Pointing out that Mises arrived at this concept independently of Senior, Wu then developed Mises’s application to the alleged locational differences in the cost of living. As Wu stated, “To him [Mises] those who believe in national differences in the value of money have left out of account the positional factor in the nature of economic goods; otherwise they should have understood that the alleged differences are explicable by differences in the quality of the commodities offered and demanded.” Wu concluded with a quote from Mises’s Theory of Money and Credit: “The exchange-ratio between commodities and money is everywhere the same. But men and their wants are not everywhere the same, and neither are commodities.”6

If the tendency of the purchasing power of money is to be everywhere the same, what happens if one or more moneys coexist in the world? By way of explanation, Mises developed the Ricardian analysis into what was to be called the purchasing-power-parity theory of exchange rates, namely, that the market exchange rate between two independent moneys will tend to equal the ratio of their purchasing powers. Mises showed that this analysis applies both to the exchange rate between gold and silver—whether or not the two circulate side by side within the same country—and to independent fiat currencies issued by two nations. Wu explained the difference between Mises’s theory and the unfortunately better known version of the purchasing-power-parity theory set forth a bit later by Gustav Cassel. The Cassel version ignores the Austrian emphasis on Edition: current; Page: [167] locational differences in accounting for differences in value of technologically similar goods, and this in turn complements the broader Austrian and classical position that the purchasing power of money is an array of specific goods. This contrasts with Cassel and the neoclassicists, who think of the purchasing power money as the inverse of a unitary price level. Thus Wu stated:

Unfortunately, Cassel, instead of correcting the error in his concept of purchasing power, soon abandoned the full-parity doctrine in favor of a different and highly attenuated contention that only changes in exchange rates reflect changes in respective purchasing power—perhaps because of his desire to use measurement and index numbers in applying the theory.8

When he set out to apply the theory of marginal utility to the price of money, Mises confronted the problem that was later to be called “the Austrian circle.” In short, when someone ranks eggs or beef or shoes on his value scale, he values these goods for their direct use in consumption. Such valuations are, of course, independent of and prior to pricing on the market. But people demand money to hold in their cash balances, not for eventual direct use in consumption, but precisely in order to exchange those balances for other goods that will be used directly. Thus, money is not useful in itself but because it has a prior exchange value, because it has been and therefore presumably will be exchangeable in terms of other goods. In short, money is demanded Edition: current; Page: [168] because it has a preexisting purchasing power; its demand not only is not independent of its existing price on the market but is precisely due to its already having a price in terms of other goods and services. But if the demand for, and hence the utility of, money depends on its preexisting price or purchasing power, how then can that price be explained by the demand? It seems that any Austrian attempt to apply marginal utility theory to money is inextricably caught in a circular trap. For that reason mainstream economics has not been able to apply marginal utility theory to the value of money and has therefore gone off in multicausal (or noncausal) Walrasian directions.

Mises, however, succeeded in solving this problem in 1912 in developing his so-called regression theorem. Briefly, Mises held that the demand for money, or cash balances, at the present time—say day X—rests on the fact that money on the previous day, day X−1, had a purchasing power. The purchasing power of money on day X is determined by the interaction on day X of the supply of money on that day and that day’s demand for cash balances, which in turn is determined by the marginal utility of money for individuals on day X. But this marginal utility, and hence this demand, has an inevitable historical component: the fact that money had prior purchasing power on day X − 1, and that therefore individuals know that this commodity has a monetary function and will be exchangeable on future days for other goods and services. But what then determined the purchasing power of money on day X−1? Again, that purchasing power was determined by the supply of, and demand for, money on day X−1, and that in turn depended on the fact that the money had had purchasing power on day X−2. But are we not caught in an infinite regression, with no escape from the circular trap and no ultimate explanation? No. What we must do is to push the temporal regression to that point when the money commodity was not used as a medium of indirect exchange but was demanded purely for its own direct consumption use. Let us go back logically to the second day that a commodity, say gold, was used as a medium of exchange. On that day, gold was demanded partly because it had a preexisting purchasing power as a money, Edition: current; Page: [169] or rather as a medium of exchange, on the first day. But what of that first day? On that day, the demand for gold again depended on the fact that gold had had a previous purchasing power, and so we push the analysis back to the last day of barter. The demand for gold on the last day of barter was purely a consumption use and had no historical component referring to any previous day; for under barter, every commodity was demanded purely for its current consumption use, and gold was no different. On the first day of its use as a medium of exchange, gold began to have two components in its demand, or utility: first, a consumption use as had existed in barter and, second, a monetary use, or use as a medium of exchange, which had a historical component in its utility. In short, the demand for money can be pushed back to the last day of barter, at which point the temporal element in the demand for the money commodity disappears, and the causal forces in the current demand and purchasing power of money are fully and completely explained.

Not only does the Mises regression theorem fully explain the current demand for money and integrate the theory of money with the theory of marginal utility, but it also shows that money must have originated in this fashion—on the market—with individuals on the market gradually beginning to use some previously valuable commodity as a medium of exchange. No money could have originated either by a social compact to consider some previously valueless thing as a “money” or by sudden governmental fiat. For in those cases, the money commodity could not have a previous purchasing power, which could be taken into account in the individual’s demands for money. In this way, Mises demonstrated that Carl Menger’s historical insight into the way in which money arose on the market was not simply a historical summary but a theoretical necessity. On the other hand, while money had to originate as a directly useful commodity, for example, gold, there is no reason, in the light of the regression theorem, why such direct uses must continue afterward for the commodity to be used as money. Once established as a money, gold or gold substitutes can lose or be deprived of their direct use function and still continue as money; Edition: current; Page: [170] for the historical reference to a previous day’s purchasing power will already have been established.9

In his comprehensive 1949 treatise, Human Action, Mises successfully refuted earlier criticisms of the regression theorem by Anderson and Ellis.10 Subsequently criticisms were leveled at the theory by J. C. Gilbert and Don Patinkin. Gilbert asserted that the theory fails to explain how a new paper money can be introduced when the previous monetary system breaks down. Presumably he was referring to such examples as the German Rentenmark after the runaway inflation of 1923. But the point is that the new paper was not introduced de novo; gold and foreign currencies had existed previously, and the Rentenmark could and did undergo exchange in terms of these previously existing moneys; furthermore, it was introduced at a fixed relation to the previous, extremely depreciated mark.11 Patinkin criticized Mises for allegedly claiming that the marginal utility of money refers to the marginal utility of the goods for which money is exchanged rather than the marginal utility of holding money itself; he also charged Mises with inconsistently holding the latter view in the other parts of The Theory of Money and Credit. But Patinkin was mistaken; Mises’s concept of the marginal utility of money always refers to the utility of holding money. Mises’s point in the regression theorem is a different one, namely, that the marginal utility-to-hold is itself based on the prior fact that money can be exchanged for goods, that is, on the prior purchasing power of money in terms of goods. In short, that money prices of goods, the purchasing power of money, has first to exist in order for money to have a marginal utility to hold, hence the need for the regression theorem to break out of the circularity.12

Modern orthodox economics has abandoned the quest for causal explanation in behalf of a Walrasian world of “mutual determination” suitable for the current fashion of mathematical economics. Patinkin himself feebly accepted the circular trap by stating that in analyzing the market (“market experiment”) he began with utility while in analyzing utility he began with prices (“individual experiment”). With characteristic arrogance, Samuelson and Stigler each attacked the Austrian concern with Edition: current; Page: [171] escaping circularity in order to analyze causal relations. Samuelson fell back on Walras, who developed the idea of “general equilibrium in which all magnitudes are simultaneously determined by efficacious interdependent relations,” which he contrasted to the “fears of literary writers” (that is, economists who write in English) about circular reasoning.13 Stigler dismissed Böhm-Bawerk for his “failure to understand some of the most essential elements of modern economic theory, the concepts of mutual determination and equilibrium (developed by the use of the theory of simultaneous equations). Mutual determination . . . is spurned for the older concept of cause and effect.” Stigle added the snide note that “Böhm-Bawerk was not trained in mathematics.”14 Thus, orthodox economists reflect the unfortunate influence of the mathematical method in economics. The idea of mutual functional determination—so adaptable to mathematical presentation—is appropriate in physics, which tries to explain the unmotivated motions of physical matter. But in praxeology, the study of human action, of which economics is the best elaborated part, the cause is known: individual purpose. In economics, therefore, the proper method is to proceed from the causing action to its consequent effects.

In Human Action, Mises advanced the Austrian theory of money by delivering a shattering blow to the very concept of Walrasian general equilibrium. To arrive at that equilibrium, the basic data of the economy—values, technology, and resources—must all be frozen and understood by every participant in the market to be frozen indefinitely. Given such a magical freeze, the economy would sooner or later settle into an endless round of constant prices and production, with each firm earning a uniform rate of interest (or, in some constructions, a zero rate of interest). The idea of certainty and fixity in what Mises called “the evenly rotating economy” is absurd, but what Mises went on to show is that in such a world of fixity and certainty no one would hold cash balances. Everyone’s demand for cash balances would fall to zero. For since everyone would have perfect foresight and knowledge of his future sales and purchases, there would be no point in holding any cash balance at all. Thus, the Edition: current; Page: [172] man who knew he would be spending $5,000 on 1 January 1977 would lend out all his money to be returned at precisely that date. As Mises stated:

The very notion of a Walrasian general equilibrium is not simply totally unrealistic, it is conceptually impossible, since money and monetary exchange cannot be sustained in that kind of system. Another corollary contribution of Mises in this analysis was to demonstrate that, far from being only one of many “motives” for holding cash balances, uncertainty is crucial to the holding of any cash at all.

That such problems are now troubling mainstream economics is revealed by F. H. Hahn’s demonstration that Patinkin’s wellknown model of general equilibrium can only establish the existence of a demand for money by appealing to such notions as an alleged uncertainty of the exact moments of future sales and purchases, and to “imperfections” in the credit market—neither of which, as Hahn pointed out, is consistent with the concept of general equilibrium.17

With respect to the supply of money, Mises returned to the basic Ricardian insight that an increase in the supply of money Edition: current; Page: [173] never confers any general benefit upon society. For money is fundamentally different from consumers’ and producers’ goods in at least one vital respect. Other things being equal, an increase in the supply of consumers’ goods benefits society since one or more consumers will be better off. The same is true of an increase in the supply of producers’ goods, which will be eventually transformed into an increased supply of consumers’ goods; for production itself is the process of transforming natural resources into new forms and locations desired by consumers for direct use. But money is very different: money is not used directly in consumption or production but is exchanged for such directly usable goods. Yet, once any commodity or object is established as a money, it performs the maximum exchange work of which it is capable. An increase in the supply of money causes no increase whatever in the exchange service of money; all that happens is that the purchasing power of each unit of money is diluted by the increased supply of units. Hence there is never a social need for increasing the supply of money, either because of an increased supply of goods or because of an increase in population. People can acquire an increased proportion of cash balances with a fixed supply of money by spending less and thereby increasing the purchasing power of their cash balances, thus raising their real cash balances overall. As Mises wrote:

A world of constant money supply would be one similar to that of much of the eighteenth and nineteenth centuries, marked by the successful flowering of the Industrial Revolution with increased capital investment increasing the supply of goods and with falling prices for these goods as well as falling costs of production.19 As demonstrated by the notable Austrian theory of the business cycle, even an inflationary expansion of money and credit merely offsetting the secular fall in prices will create the distortions of production that bring about the business cycle.

In the face of overwhelming arguments against inflationary expansion of the money supply (including those not detailed here), what accounts for the persistence of the inflationary trend in the modern world? The answer lies in the way new money is injected into the economy, in the fact that it is most definitely not done according to the Angel Gabriel model. For example, a government does not multiply the money supply tenfold across the board by issuing a decree adding another zero to every monetary number in the economy. In any economy not on a 100 percent commodity standard, the money supply is under the control of government, the central bank, and the controlled banking system. These institutions issue new money and inject it into the economy by spending it or lending it out to favored debtors. As we have seen, an increase in the supply of money benefits the early receivers, that is, the government, the banks, and their favored debtors or contractors, at the expense of the relatively fixed income groups that receive the new money late or not at all and suffer a loss in real income and wealth. In short, monetary inflation is a method by which the government, its controlled banking system, and favored political groups are able to partially expropriate the wealth of other groups in society. Those empowered to control the money supply issue new money Edition: current; Page: [175] to their own economic advantage and at the expense of the remainder of the population. Yield to government the monopoly over the issue and supply of money, and government will inflate that supply to its own advantage and to the detriment of the politically powerless. Once we adopt the distinctively Austrian approach of “methodological individualism,” once we realize that government is not a superhuman institution dedicated to the common good and the general welfare, but a group of individuals devoted to furthering their economic interests, then the reason for the inherent inflationism of government as money monopolist becomes crystal clear.

As the Austrian analysis of money shows, however, the process of generated inflation cannot last indefinitely, for the government cannot in the final analysis control the pace of monetary deterioration and the loss of purchasing power. The ultimate result of a policy of persistent inflation is runaway inflation and the total collapse of the currency. As Mises analyzed the course of runaway inflation (both before and after the first example of such a collapse in an industrialized country, in post-World-War-I Germany), such inflation generally proceeds as follows: At first the government’s increase of the money supply and the subsequent rise in prices are regarded by the public as temporary. Since, as was true in Germany during World War I, the onset of inflation is often occasioned by the extraordinary expenses of a war, the public assumes that after the war conditions including prices will return to the preinflation normal. Hence, the public’s demand for cash balances rises as it awaits the anticipated lowering of prices. As a result, prices rise proportionately and often substantially less than the money supply, and the monetary authorities become bolder. As in the case of the assignats during the French Revolution, here is a magical panacea for the difficulties of government: pump more money into the economy, and prices will rise only a little! Encouraged by the seeming success, the authorities apply more of what has worked so well, and the monetary inflation proceeds apace. In time, however, the public’s expectations and views of the economic present and future undergo a vitally important change. They Edition: current; Page: [176] begin to see that there will be no return to the prewar norm, that the new norm is a continuing price inflation—that prices will continue to go up rather than down. Phase two of the inflationary process ensues, with a continuing fall in the demand for cash balances based on this analysis: “I’d better spend my money on X, Y, and Z now, because I know full well that next year prices will be higher.” Prices begin to rise more than the increase in the supply of money. The critical turning point has arrived.

At this point, the economy is regarded as suffering from a money shortage as evidenced by the outstripping of monetary expansion by the rise in prices. What is now called a liquidity crunch occurs on a broad scale, and a clamor arises for greater increases in the supply of money. As the Austrian school economist Bresciani-Turroni wrote in his definitive study of the German hyperinflation:

The sort of thinking that gripped the German monetary authorities at the height of the hyperinflation may be gauged from this statement by the president of the Reichsbank, Rudolf Havenstein:

The United States seems to be entering phase two of inflation (1975), and it is noteworthy that economists such as Walter Heller have already raised the cry that the supply of money must be expanded in order to restore the real cash balances of the public, in effect to alleviate the shortage of real balances. As in Germany in the early 1920s, the argument is being employed that the quantity of money cannot be the culprit for inflation since prices are rising at a greater rate than the supply of money.22

Phase three of the inflation is the ultimate runaway stage: the collapse of the currency. The public takes panicky flight from money into real values, into any commodity whatever. The public’s psychology is not simply to buy now rather than later but to buy anything immediately. The public’s demand for cash balances hurtles toward zero.

The reason for the enthusiasm of Mises and other Austrian economists for the gold standard, the purer and less diluted the better, should now be crystal clear. It is not that this “barbaric relic” has any fetishistic attraction. The reason is that a money Edition: current; Page: [178] under the control of the government and its banking system is subject to inexorable pressures toward continuing monetary inflation. In contrast, the supply of gold cannot be manufactured ad libitum by the monetary authorities; it must be extracted from the ground, by the same costly process as governs the supply of any other commodities on the market. Essentially the choice is: gold or government. The choice of gold rather than other market commodities is the historical experience of centuries that gold (as well as silver) is uniquely suitable as a monetary commodity—for reasons once set forth in the first chapter of every money-and-banking textbook.

The criticism might be made that gold, too, can increase in quantity, and that this rise in supply, however limited, would also confer no benefit upon society. Apart from the gold versus government choice, however, there is another important consideration: an increase in the supply of gold improves its availability for nonmonetary uses, an advantage scarcely conferred by the fiat currencies of government or the deposits of the banking system.

In contrast to the Misesian “monetary overinvestment” theory of business cycles, on which considerable work has been done by F. A. Hayek and other Austrian economists, almost nothing has been done on the theory of money proper except by Mises himself. There are three cloudy and interrelated areas that need further elaboration. One is the route by which money can be released from government control. Of primary importance would be the return to a pure gold standard. To do so would involve, first, raising the “price of gold” (actually, lowering the definition of the weight of the dollar) drastically above the current pseudoprice of $42.22 an ounce and, second, a deflationary transformation of current bank deposits into nonmonetary savings certificates or certificates of deposit. What the precise price or the precise mix should be is a matter for research. Initially, the Mises proposal for a return to gold at a market price and the proposal of such Austrian monetary theorists as Jacques Rueff and Michael Heilperin for a return at a deliberately doubled price of $70 an ounce seemed far apart. But the current (1975) Edition: current; Page: [179] market price of approximately $160 an ounce brings the routes of a deliberately higher price and the market price much closer together.23

A second area for research is the matter of free banking as against 100 percent reserve requirements for bank deposits in relation to gold. Mises’s Theory of Money and Credit was one of the first works to develop systematically the way in which the banks create money through an expansion of credit. It was followed by Austrian economist C.A. Phillips’s famous distinction between the expansionary powers of individual banks and those of the banking system as a whole. However, one of Mises’s arguments has remained neglected: that under a regime of free banking, that is, where banks are unregulated but held strictly to account for honoring their obligations to redeem notes or deposits in standard money, the operations of the market check monetary expansion by the banks. The threat of bank runs, combined with the impossibility of one bank’s expanding more than a competitor, keeps credit expansion at a minimum. Perhaps Mises underestimated the possibility of a successful bank cartel for the promotion of credit expansion; it seems clear, however, that there is less chance for bank-credit expansion in the absence of a central bank to supply reserves and to be a lender of last resort.24

Finally, there is the related question, which Mises did not develop fully, of the proper definition of the crucial concept of the money supply. In current mainstream economics, there are at least four competing definitions, ranging from M₁ to M₄. Of one point an Austrian is certain: the definition must rest on the inner essence of the concept itself and not on the currently fashionable but question-begging methodology of statistical correlation with national income. Leland Yeager was trenchantly critical of such an approach:

Money is the medium of exchange, the asset for which all other goods and services are traded on the market. If a thing functions as such a medium, as final payment for other things on the market, then it serves as part of the money supply. In his Theory of Money and Credit, Mises distinguished between standard money (money in the narrow sense) and money substitutes, such as bank notes and demand deposits, which function as an additional money supply. It should be noted, for example, that in Irving Fisher’s non-Austrian classic, The Purchasing Power of Money, written at about the same time (1913), M consisted of standard money only, while M¹ consisted of money substitutes in the form of bank demand deposits redeemable in standard money at par. Today no economist would think of excluding demand deposits from the definition of money. But if we ponder the problem, we see that if a bank begins to fail, its deposits are no longer equivalent to money; they no longer serve as money on the market. They are only money until a bank’s imminent collapse.

Furthermore, in the same way that M¹ (currency plus demand deposits) is broader than the narrowest definition, we can establish even broader definitions by including savings deposits of commercial banks, savings bank deposits, shares of savings and loan banks, and cash surrender values of life insurance companies, which are all redeemable on demand at par in standard Edition: current; Page: [181] money, and therefore all serve as money substitutes and as part of the money supply until the public begins to doubt that they are redeemable. Partisans of M₁ argue that commercial banks are uniquely powerful in creating deposits and, further, that their deposits circulate more actively than the deposits of other banks. Let us suppose, however, that in a gold-standard country, a man has some gold coins in his bureau and others locked in a bank vault. His stock of gold coins at home will circulate actively and the ones in his vault sluggishly, but surely both are part of his stock of cash. And, if it also be objected that the deposits of savings banks and similar institutions pyramid on top of commercial bank deposits, it should also be noted that the latter in turn pyramid on top of reserves and standard money.

Another example will serve to answer the common objection that a savings bank deposit is not money because it cannot be used directly as a medium of exchange but must be redeemed in that medium. (This is apart from the fact that savings banks are increasingly being empowered to issue checks and open up checking accounts.) Suppose that, through some cultural quirk, everyone in the country decided not to use five-dollar bills in actual exchange. They would only use ten-dollar and one-dollar bills, and keep their longer-term cash balances in five-dollar bills. As a result, five-dollar bills would tend to circulate far more slowly than the other bills. If a man wanted to spend some of his cash balance, he could not spend a five-dollar bill directly; instead, he would go to a bank and exchange it for five one-dollar bills for use in trade. In this hypothetical situation, the status of the five-dollar bill would be the same as that of the savings deposit today. But while the holder of the five-dollar bill would have to go to a bank and exchange it for dollar bills before spending it, surely no one would say that his five-dollar bills were not part of his cash balance or of the money supply.

A broad definition of the money supply, however, excludes assets not redeemable on demand at par in standard money, that is, any form of genuine time liability, such as savings certificates, certificates of deposit whether negotiable or nonnegotiable, and government bonds. Savings bonds, redeemable at par, are Edition: current; Page: [182] money substitutes and hence are part of the total supply of money. Finally, just as commercial bank reserves are properly excluded from the outstanding supply of money, so those demand deposits that in turn function as reserves for the deposits of these other financial institutions would have to be excluded as well. It would be double counting to include both the base and the multiple of any of the inverted money pyramids in the economy.

Inflation, Recession, and Stagflation

The major macroeconomic problem facing Western economies today is that of explaining why the supposedly mild inflations of the two decades following World War II turned into the intractable “stagflation” besetting theorist and policymaker alike. The two major analytical approaches to the problem, that of the Keynesians and that of the monetarists, have a serious failing in common: they ignore the real side of the economy and hence the real maladjustments brought about by a monetary policy that interferes with the coordination of economic activities. Both views implicitly assume that the real side of the economy is always in some sort of long-term equilibrium, in which money influences only the price level or money income and not the structure of relative prices or the composition of real output. As we intend to show, such a point of view belongs to a stage in the history of economic thought before the structure of output and the influence of prices on production had been worked out.

We shall also offer an exposition of an alternative analysis derived from the Austrian school of economic thought, especially from the writings of Friedrich A. Hayek. In so doing, we shall indicate how a Hayekian analysis of the effects of monetary changes on the structure of prices and outputs enables us to delve beneath the monetary surface to the real underlying phenomena and thereby call attention to the misallocation resulting from a monetary system that discoordinates economic activity.

Not all possible alternatives to the Austrian view will be covered. For instance, we shall not examine the extensive neo-Ricardian critiques of the current orthodoxy advanced by Joan Robinson, Nicholas Kaldor, and Piero Sraffa, since we regard these criticisms as part of a more general attack on subjectivist marginalist economics. Nor shall we consider in detail the work of Robert W. Clower and Axel Leijonhufvud, which in part complements our own work here.1 We would argue, however, that virtually all writers and all non-Austrian schools of thought have ignored the importance of Hayek’s work in explaining important features of the business cycle.

Austrian Economics in the Age of the Neo-Ricardian Counterrevolution

It is widely acknowledged today that economics is passing through a period of crisis, though its exact nature is in dispute. Austrian economists must assess the present position of, and the outlook for, their body of thought as well. A school of thought cannot decide on what to do without taking its bearings. Even were one to decide to do nothing but let one’s ship be swayed by the shifting winds, something might be said for a thorough study of weather charts! The student of contemporary affairs always suffers from the handicap that, unlike the historian, he does not know how far tomorrow’s changes will nullify the model he makes of today’s world. But this is a risk that has to be taken. It is not for nothing that we are living in a kaleidic society.

When making an assessment of the present situation of Austrian economics, our first task is, of course, to define it. What is Austrian economics? The perspective of the economic world that characteristically distinguishes Austrian thought from other (classical or neoclassical) thought can best be defined in terms of the three following postulates:

1. Economics has two tasks, one backward looking, the other forward looking. As G. L. S. Shackle pointed out:

We cannot know whether economists in the course of time will have to shoulder tasks other than these two. However, it is characteristic of the Austrian style of thought that the backward-looking task is regarded as the more important. It is more important to make the world of action as it unfolds intelligible than it is to deduce the unintended consequences of action. This postulate entails certain limits to the degree of abstraction we may employ and to our freedom in constructing models. Abstraction is necessary, useful, even inevitable, to let our minds grasp the essentials of a situation, but we must not abstract from those acts of the mind in choice and interpretation that shape and constitute the social world. We must reject mere formal entities as elements of models. Different men finding themselves in the same situation may give it widely differing interpretations. Austrian economics is always concerned with action, never solely with reaction. It rejects as mere formalism, whether neoclassical or neo-Ricardian, all those endeavours that in a quest for “formal uniformities” are ready to assign causal roles to entities like quantities and prices, and all those models in which the economic system assumes the appearance of a “goods circus.”2

2. The human mind can grasp many forms and patterns, structures as well as uniformities of sequence in nature. Only individuals, however, have minds and therefore can make plans and act. Hence, if our main task is to understand the world of human action, we must reject any explanation of events other than in terms of plans and action. To be sure, individuals acting are oriented to their environment, natural and human. But this orientation is always a matter of subjective perspective and interpretation. Moreover, where the environment is human, problems arise of multiple perspectives and interpretations, hence the difficulties with any notion of equilibrium involving interaction of many minds, and hence the superiority of the market process as a model of interaction.

3. It follows from (1) and (2) that formal entities that do violence to the dazzling diversity of the social world are alien to the Austrian style of thought. This means that Austrian economists must erect several sets of limits to abstraction. The diversity that matters is diversity of tastes, interpretations, and expectations. The Ricardians ignore the first, admit (with a bad conscience) the second, and do not know what to do with the third. Their neoclassical opponents assure us with some enthusiasm that they accept the first but have to ignore the second (since their formal apparatus offers no scope for the interpretative action of the human mind), and (wrongly) think they can cope with the third by using the formal apparatus of probability theory, clear though it is that this was originally developed to deal with a quite different set of problems.

There is no need for me to deal at great length with the neo-Ricardian counterrevolution of our day. Its numerous exponents in Cambridge and elsewhere are propagating its cause with considerable enthusiasm and remarkable polemical skill. Suffice it to say that, for the first time, the neoclassical ascendancy, established by John Bates Clark, Irving Fisher, Vilfredo Pareto, and Knut Wicksell around the turn of the century, appears seriously threatened. The defensive strategy adopted by such outstanding neoclassical leaders as John Hicks and Frank H. Hahn leaves the impression that they are only too well aware of the weakness inherent in the position they have inherited.

What is the Austrian position on this battleground? Let me outline it in terms of points of Austrian agreement and disagreement with the views held by the rival schools.

Austrian economists must disagree strongly with most of the ideas flaunted by the neo-Ricardians. Any return to the classical world of economic thought would nullify Menger’s work, as well as that of most of his successors. The strange dichotomy between cost of production determining price and demand determining quantity sold is quite untenable. In any circumstances other than those of constant cost, whatever the scale of output, demand must have some effect on price. The underlying methodological Edition: current; Page: [218] egalitarianism—the view of competition as a state of affairs in which all producers sell identical goods, the failure to understand that the contribution of each entrepreneur is an individual contribution—is also no more attractive. To watch neo-Ricardians handle expectations is, according to taste, a sad or an amusing spectacle: they play with them like children playing with ancient coins, the value and origin of which they fail to understand. The diversity of the world is to them a closed book. As radical subjectivists Austrians must stand in the forefront of the resistance to this counterrevolution.

We can, however, perhaps agree with them on several points: that general equilibrium is a precarious notion; that in reality it could never be attained; and that events taking place on the path to equilibrium must shape its final constellation. They, on their part, are unlikely to accept the notion of the market process.

The list of points of disagreement between Austrian and neo-classical economics is hardly shorter. A kaleidic world can offer no congenial habitat to the neoclassical mind, to which all time sequences at once appear in the familiar form of difference equations. Will they ever understand that “frequency distributions” e tutti quanti can have no place outside a homogeneous world, a world in which we are entitled to judge the unknown future by the standards of a known past? Or that “orthodox welfare analysis calmly assumes that the critically important social task of making all the scattered bits of information available to those making decisions has already been performed.”3 Without this assumption the vaunted Pareto optimum makes little sense. From time to time neoclassical economists are apt to flaunt consumers’ tastes, one of their data, as a mark of their individualism. But on closer inspection their individualism turns out to be a pseudoindividualism. The individual interests them only in his capacity as a possessor of given tastes, not as a possessor of a mind capable of probing and digesting experience, of acquiring and diffusing knowledge. Pareto saw quite clearly that real individuals, continuously having experiences bound to modify given tastes, can have no place in the neoclassical model, and that a photograph of their tastes is all that is required.4 It is thus only at Edition: current; Page: [219] a point in time that we can speak of utility functions of individuals.5 Their unpredictable change over time forms the basis of the kaleidic society and provides the rationale for the market process.

At present a good deal of soul-searching appears to be going on in the higher ranks of the neoclassical establishment. My own impression is that little will change. The very language in which criticism of neoclassical orthodoxy is presented inspires little confidence. When Hahn, after having noticed that “the argument will here turn on the absence of futures markets and contingent futures markets,” observed that “practical men and ill-trained theorists everywhere in the world do not understand what they are claiming to be the case when they claim a beneficent and coherent role for the invisible hand,”6 it is painfully obvious that he has paid no attention to Austrian economics. He apparently was unable to conceive of the function of the market in terms other than those of some kind of intertemporal Pareto optimum.

Also, we hear of a “state of nature” (but no state of culture) emanating “messages” received by the individuals acting. While admittedly individuals cannot be in equilibrium while they are learning (hence no equilibrium over time?), the neo-Darwinist language in which we are told how man, as he learns about his environment, makes a better adjustment to it, sounds rather forbidding. The fundamental obstacle to any rapprochement between Austrian and neoclassical economics is the fact that the latter cannot conceive of human action, but only of reaction to given circumstances.

What of the future? Austrian economists must evidently establish themselves as a third force outside the counterrevolution and the neoclassical establishment against which it is directed. This will be no easy task. Their numbers are small, their resources slender. The big foundations are closed to them. They have no academic foothold. Their only strategy can be to impress the world by the quality of their contributions. But this will hardly be enough. In the 1930s a hopeful flowering of Austrian economics was nipped in the bud; as Hicks put it, its “voice has Edition: current; Page: [220] been almost drowned in the fanfare of the Keynesian orchestra.”7 This must not happen again.

Owing to the current weakness of the Austrian position in the academic world, we must make optimal use of assets and exploit every opportunity. In this regard, I have three suggestions.

In the first place, two eminent contemporaries, Axel Leijonhufvud and Shackle, who do not, to my knowledge, regard themselves as Austrian economists, within the last six years made outstanding contributions that conform to what I have described as the main body of Austrian thought. It is for Austrian economists to make full use of the implications of their ideas.

Second, at times in the course of the counterrevolution, both sides present arguments with unmistakably Austrian implications of which their authors may be quite unaware. In such cases Austrian economists must appear on the scene at once to point them out. Otherwise the lesson will be lost. For example, when Luigi L. Pasinetti in his criticism of Robert Solow stated that “the two situations a and b that Solow compared differ not only by the single ‘consumption good’ he has hypothesised but also by the whole structure of capital goods“,8 the Austrian implications of this notion, are obvious. But neither of the rival sides appears to have taken much interest in them. In any case they go much beyond what is provided for in Hicks’s neo-Austrian model.

The best opportunity for the rehabilitation of Austrian economics today is, I regret to say, to be sought in the permanent inflation the Western world has suffered since the Second World War. This is certainly not the fault of Austrian economists; there has been no lack of warnings from their side.

We live in a world in which prices can only rise and never fall, because the public has come to believe that a widespread fall of money wage rates in the face of a falling demand for goods and services would be intolerable. A world, however, in which all relative price adjustments have to be made against a background of continuously rising money prices and wages is one in which money is no longer a store of value: it can only depreciate, never Edition: current; Page: [221] appreciate. The process of inflation must accelerate once everybody understands what is happening.

Faced with this situation neoclassical economists, on the whole, have (predictably?) behaved badly. Some have distinguished between cost-push and demand-pull inflations as though we were dealing with a succession of historical processes of inflation and not one indivisible process. Some would have us believe that there is a choice between a little more unemployment and a little more inflation. The facts of the inflation now accelerating all over the Western world speak for themselves, though the econometricians may not understand the language. A mind for which the economic world is a complex system of given variables seems quite unable to grasp a kaleidic world. The facts of a world of accelerating inflation elude it.

Some neoclassical economists have shown themselves to be rather uninhibited inflationists. According to Kenneth J. Arrow:

Solow expressed an even more striking view: “In a monetary economy, it is natural to amend the definition of a steady state to require a constant rate of inflation; since everything else is growing exponentially, the price level ought to be no exception.”10

Neo-Ricardians have been far more cautious about inflation. Hayek and Joan Robinson not merely agreed on the substance of the matter but actually, though no doubt unwittingly, used the same metaphor: “An inflationary economy is in the situation of a man holding a tiger by the tail.”11

Faced with this terrible but challenging situation Austrian economists today have a triple duty. They must tell the public that:

1. The real cause of the accelerating inflation lies in a change in the social climate that, engineered by the left intelligentsia, took place about a half-century ago and resulted in a taboo on downward adjustments of money wage rates.

2. A market economy requires a money that can serve as a store of value, a money in terms of which prices are as likely to fall as they may be to rise. (An absolutely stable price level is impossible.) No such money exists today.

3. None of the nostrums peddled by economists in many countries today involving price and wage controls will work, and they may well paralyze the market process.