Today, Money Is NOT an Effective Medium of Exchange, But a Tool of Government for Fleecing Us and for “Managing” the Economy

In fact, in endeavouring to design a better monetary order we at once encounter the difficulty of not really knowing what we want. What would be a really good money? To the present day, money is that part of the market order that government has not allowed to find its most effective form, and on which silly rulers and economists have doctored most. Yet it was not economists or statesmen who invented the market, though some have come to understand it a little; nor is it our present knowledge which can show us the best solutions, but the discoveries made by free experimentation. Those who chiefly needed money as an indispensable tool of trade, and who had first discovered it as a means for making most trade possible, were soon forced to use what money government gave them. And government jealously guarded its monopoly for quite different purposes than those for which money had been introduced. Today, money is not mainly an effective medium of exchange, but chiefly a tool of government for fleecing us and for ‘managing’ the economy. The result is that we are obliged to admit that we have little empirical evidence of how the various conceivable methods of supplying money would operate, and almost none about which kind of money the public would select if it had an opportunity to choose freely between several different and clearly distinguishable kinds of money. For this we must rely largely on our theoretical imagination, and try to apply to a special problem that understanding of the functioning of competition which we have gained elsewhere.

—F. A. Hayek, “The Future Unit of Value,” in The Collected Works of F. A. Hayek, vol. 6, Good Money, Part II: The Standard, ed. Stephen Kresge (Indianapolis: Liberty Fund, 1999), 240-241.

Gustav Cassel’s Fear of a Gold Shortage and His Stabilization Views Led to the Gold Exchange Standard and Cooperation Between Central Banks

The second important factor which determined the development of ideas on monetary policy was that the above-mentioned facts were partly contributory to the extraordinary influence exercised by two particular representatives of the mechanistic Quantity Theory of Money and the concept of a systematic stabilization of the price level, Irving Fisher and Gustav Cassel. The fluctuations in the value of money mentioned above necessarily aroused wide interest in Fisher’s proposal for stabilizing the value of gold, which he had been advocating for a long time; and the lively propaganda which was being circulated, particularly by the Stable Money Association which he had founded, had succeeded in making the concept of price stabilization as the objective of monetary policy into a virtually unassailable dogma. Cassel, who deserved the greatest credit for the stabilization of European currencies, contributed a further, extraordinarily effective argument in favour of the policy of stabilization, the influence of which upon actual developments it is impossible to overestimate. 

This was his prediction that gold production was not adequate for the annual increase of 3 per cent in the world stock of monetary gold which, on his calculations, would be required to maintain stability in the price level. 

Fear of the imminent shortage of gold, and the desire to arrive at a systematic policy for stabilizing the value of money, gave rise to two further ideas which dominated the period, and were expressed particularly in the resolutions of the conference on international economic relations in Genoa in 1922; a preference for the gold exchange standard as the object of stabilization in individual countries, and the recommendation of “Cooperation between Central Banks.” Both desires were to become extremely significant for the development of monetary policy over the next few years. Perhaps it is therefore appropriate at this point to also name the man who acquired special influence as the propagator of the ideas expressed by the Genoa Conference—even if he were not, as one might suspect, its instigator: R. G. Hawtrey of the British Treasury. 

—F. A. Hayek, “The Fate of the Gold Standard,” in The Collected Works of F. A. Hayek, vol. 5, Good Money, Part I: The New World, ed. Stephen Kresge (Indianapolis: Liberty Fund, 1999), 154.

To Combat the Depression by a Forced Credit Expansion Is to Attempt to Cure the Evil by the Very Means Which Brought It About

It seems certain, however, that we shall merely make matters worse if we aim at curing the deflationary symptoms and, at the same time (by the erection of trade barriers and other forms of state intervention), do our best to increase rather than to decrease the fundamental maladjustments. More than that: while the advantages of such a course are, to say the least, uncertain, the new dangers it creates are great. To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection—a procedure that can only lead to a much more severe crisis as soon as the credit expansion comes to an end. It would not be the first experiment of this kind that has been made. We should merely be repeating, on a much larger scale, the course followed by the Federal Reserve System in 1927, an experiment that Mr. A.C. Miller, the only economist on the Federal Reserve Board and at the same time its oldest member, has rightly characterized as “the greatest and boldest operation ever undertaken by the Federal Reserve System,” an operation that “resulted in one of the most costly errors committed by it or any other banking system in the last 75 years.” It is probably to this experiment, together with the attempts to prevent liquidation once the crisis had come, that we owe the exceptional severity and duration of the depression. We must not forget that, for the last six or eight years, monetary policy all over the world has followed the advice of the stabilizers. It is high time that their influence, which has already done harm enough, should be overthrown.

—F. A. Hayek, “Monetary Theory and the Trade Cycle,” in Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard, ed. Joseph T. Salerno (Auburn, AL: Ludwig von Mises Institute, 2008), 6-7.

It Was the Political Inability to Make That Choice That Led to the Debacle of the 1930s

The return of a universal gold standard would once again place money beyond the control of individual central banks. At that point, central bankers would once again have to choose between domestic monetary policy and the stability of the foreign exchange rate. It was the political inability to make that choice that led to the debacle of the 1930s. In his article “The Fate of the Gold Standard”, which appears as chapter 3, this volume, Hayek accused Keynes of the primary responsibility for the belief that the choice could be evaded. However, it was not only Keynes, but the whole of the economic literature devoted to the concept of the trade cycle that encouraged the belief that somehow or other the cycle could be minimized through monetary policy.

—Stephen Kresge, ed., editor’s introduction to The Collected Works of F. A. Hayek, vol. 5, Good Money, Part I: The New World, by F. A. Hayek (Indianapolis: Liberty Fund, 1999), 14.

It Was Keynes’s Use of Aggregates that Hayek Came to View as Being Keynes’s MOST DANGEROUS Contribution

 Both “The Economics of the 1930s as Seen from London” and “Personal Recollections of Keynes and the Keynesian Revolution” were written in the 1960s. In them, Hayek recounted that after the release of The General Theory he had a feeling, vague but enduring, that in order to do a full critique of Keynes he would need to do more than to criticize his model. Hayek disagreed with Keynes on both theory and policy. But it was Keynes’s methodological approach, specifically his use of aggregates, that Hayek came to view in retrospect as being his opponent’s most dangerous contribution. 

Now, it is easy to understand that Hayek might put things in this way in essays written in the 1960s. Macroeconomic modelling was then at its zenith, as was hubris about the economics profession’s ability to control the business cycle by applying fiscal ‘fine-tuning’. What doesn’t ring quite true in Hayek’s claim is that he was only vaguely becoming aware of this difference over methodology in the 1930s. As we saw in our discussion of Hayek’s earlier work on the United States economy, opposition to the use of statistical aggregates has long been a methodological principle among Austrians. Aggregates mask the movement of relative prices, and relative price movements are the central foci of Austrian theory.

—Bruce Caldwell, ed., editor’s introduction to The Collected Works of F. A. Hayek, vol. 9, Contra Keynes and Cambridge: Essays, Correspondence, by F. A. Hayek (Indianapolis: Liberty Fund, 1995), 42-43.

Hayek Secured the Capital-Theoretic Foundation of Austrian Theory By Replacing “Average Period of Production” with the “Structure of Production”

 By the time that Hayek published his next major theoretical work, The Pure Theory of Capital, the world was at war. Few in the profession even noticed the book. Furthermore, it was clear to Hayek that even after a prodigious effort he had not gotten very far. True enough, he had been able to clear away Böhm-Bawerk’s “average period of production” and replace it with the far more complex notion of a structure of production, thereby securing the capital-theoretic foundation of Austrian theory. But he had made no further progress towards building on this new foundation a fully dynamic theory of the cycle. Hayek never returned to this task, hoping that it would be completed by others. It remains unfinished.

—Bruce Caldwell, ed., editor’s introduction to The Collected Works of F. A. Hayek, vol. 9, Contra Keynes and Cambridge: Essays, Correspondence, by F. A. Hayek (Indianapolis: Liberty Fund, 1995), 42.

Monetary Theories of the Trade Cycle Are Generally Regarded as “Exogenous” (Instead of “Endogenous”) Theories

If we are to understand the present status of monetary theories of the trade cycle, we must pay special attention to the assumptions upon which they are based. At the present day, monetary theories are generally regarded as falling within the class of so-called “exogenous” theories, i.e., theories that look for the cause of the cycle not in the interconnections of economic phenomena themselves but in external interferences. Now it is, no doubt, often a waste of time to discuss the merits of classifying a theory in a given category. But the question of classification becomes important when the inclusion of a theory in one class or another implies, at the same time, a judgment as to the sphere of validity of the theory in question. This is undoubtedly the case with the distinction, very general today, between endogenous and exogenous theories—a distinction introduced into economic literature some twenty years ago by Bouniatian. Endogenous theories, in the course of their proof, avoid making use of assumptions that cannot either be decided by purely economic considerations, or regarded as general characteristics of our economic system—and hence capable of general proof. Exogenous theories, on the other hand, are based on concrete assertions whose correctness has to be proved separately in each individual case. As compared with an endogenous theory, which, if logically sound, can in a sense lay claim to general validity, an exogenous theory is at some disadvantage, inasmuch as it has, in each case, to justify the assumptions on which its conclusions are based.

Now as far as most contemporary monetary theories of the cycle are concerned, their opponents are undoubtedly right in classifying them, as does Professor Lowe in his discussion of the theories of Professors Mises and Hahn, among the exogenous theories; for they begin with arbitrary interferences on the part of the banks. This is, perhaps, one of the main reasons for the prevailing skepticism concerning the value of such theories. A theory that has to call upon the deus ex machina of a false step by bankers, in order to reach its conclusions is, perhaps, inevitably suspect. Yet Professor Mises himself—who is certainly to be regarded as the most respected and consistent exponent of the monetary theory of the trade cycle in Germany—has, in his latest work, afforded ample justification for this view of his theory by attributing the periodic recurrence of the trade cycle to the general tendency of central banks to depress the money rate of interest below the natural rate.

—F. A. Hayek, “The Fundamental Cause of Cyclical Fluctuations,” in Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard, ed. Joseph T. Salerno (Auburn, AL: Ludwig von Mises Institute, 2008), 75-76. 

The Pressure for More and Cheaper Money Is a Political Force Which Monetary Authorities Have NEVER Been Able to Resist

The pressure for more and cheaper money is an ever-present political force which monetary authorities have never been able to resist, unless they were in a position credibly to point to an absolute obstacle which made it impossible for them to meet such demands. And it will become even more irresistible when these interests can appeal to an increasingly unrecognizable image of St. Maynard. There will be no more urgent need than to erect new defences against the onslaughts of popular forms of Keynesianism, that is, to replace or restore those restraints which, under the influence of his theory, have been systematically dismantled. It was the main function of the gold standard, of balanced budgets, and of the limitation of the supply of ‘international liquidity’, to make it impossible for the monetary authorities to capitulate to the pressure for more money. And it was exactly for that reason that all these safeguards against inflation, which had made it possible for representative governments to resist the demands of powerful pressure groups for more money, have been removed at the instigation of economists who imagined that, if governments were released from the shackles of mechanical rules, they would be able to act wisely for the general benefit. 

—F. A. Hayek, “Choice in Currency,” in The Collected Works of F. A. Hayek, vol. 6, Good Money, Part II: The Standard, ed. Stephen Kresge (Indianapolis: Liberty Fund, 1999), 119-120.

Should We Rely on the Price Mechanism to Provide Us with an Indicator of the Relative Scarcity of the Various Factors of Production?

In discussions of war economics it is generally taken for granted that the monetary authorities should always employ all the means at their disposal to keep rates of interest as low as possible. That it is possible to postpone a threatened rise of interest rates for a long time cannot be doubted. The real problem is whether it is desirable to do so. For nearly two hundred years economists fought fairly consistently against the popular argument in favour of such a policy; and until two or three years ago, when these old arguments experienced a sudden recrudescence, it was commonly regarded as highly dangerous. For the time being the prompt rise of the Bank Rate at the outbreak of war has provided a temporary answer. But with the infinitely greater demands for capital during actual warfare the problem is bound to return in much more acute and pressing form. 

Basically, the question at issue is the same as that discussed in the article on pricing versus rationing in the last issue of The Banker. Should we rely on the price mechanism to provide us with an indicator of the relative scarcity of the various factors of production? Or should we deliberately make this price mechanism inoperative and try to substitute for it a detailed regulation of all productive activity by a central authority? And the argument that the rate of interest should be allowed to express the real scarcity of capital is fundamentally the same as that with respect to any other price. But this similarity was never easy to see, since in the case of capital we have not to deal with a single concrete resource but with a somewhat abstract concept. And the more recent discussions, confining themselves entirely to the monetary influences at work, hardly have increased the understanding of this problem.

—F. A. Hayek, “The Economy of Capital,” in The Collected Works of F. A. Hayek, vol. 10, Socialism and War: Essays, Documents, Reviews, ed. Bruce Caldwell (Indianapolis: Liberty Fund, 1997), 157.

Every Explanation of Economic Crises MUST Include the Assumption that Entrepreneurs Have Committed Errors

Every explanation of economic crises must include the assumption that entrepreneurs have committed errors. But the mere fact that entrepreneurs do make errors can hardly be regarded as a sufficient explanation of crises. Erroneous dispositions which lead to losses all round will appear probable only if we can show why entrepreneurs should all simultaneously make mistakes in the same direction. The explanation that this is just due to a kind of psychological infection or that for any other reason most entrepreneurs should commit the same avoidable errors of judgment does not carry much conviction. It seems, however, more likely that they may all be equally misled by following guides or symptoms which as a rule prove reliable. Or, speaking more concretely, it may be that the prices existing when they made their decisions and on which they had to base their views about the future have created expectations which must necessarily be disappointed. In this case we might have to distinguish between what we may call justified errors, caused by the price system, and sheer errors about the course of external events. Although I have no time to discuss this further, I may mention that there is probably a close connection between this distinction and the traditional distinction between ‘endogenous’ and ‘exogenous’ theories of the trade cycle.

—F. A. Hayek, “Price Expectations, Monetary Disturbances, and Malinvestments,” in The Collected Works of F. A. Hayek, vol. 5, Good Money, Part I: The New World, ed. Stephen Kresge (Indianapolis: Liberty Fund, 1999), 235-236.

An Elaboration of the Theory of Capital Is a Prerequisite for a Thorough Disposal of Keynes’s Argument

I ought to explain why I failed to return to the charge after I had devoted much time to a careful analysis of his writings—a failure for which I have reproached myself ever since. It was not merely (as I have occasionally claimed) the inevitable disappointment of a young man when told by the famous author that his objections did not matter since Keynes no longer believed in his own arguments. Nor was it really that I became aware that an effective refutation of Keynes’s conclusions would have to deal with the whole macroeconomic approach. It was rather that his disregard of what seemed to me the crucial problems made me recognize that a proper critique would have to deal more with what Keynes had not gone into than with what he had discussed, and that in consequence an elaboration of the still inadequately developed theory of capital was a prerequisite for a thorough disposal of Keynes’s argument. 

So I started on this task intending it to lead to a discussion of the determinants of investment in a monetary system. But the preliminary ‘pure’ part of this work proved to be much more difficult, and took me very much longer, than I had expected. When war broke out, making it doubtful that publication of such a voluminous work would be possible, I put out as a separate book what had been meant as a first step of an analysis of the Keynesian weaknesses, which itself was indefinitely postponed.⁷

__________

⁷F. A. Hayek, The Pure Theory of Capital

—F. A. Hayek, “The Keynes Centenary: The Austrian Critique,” in The Collected Works of F. A. Hayek, vol. 9, Contra Keynes and Cambridge: Essays, Correspondence, ed. Bruce Caldwell (Indianapolis: Liberty Fund, 1995), 251-252.

Economic Phenomena Are NOT Mass Phenomena of the Kind to Which Statistical Theory Is Applicable

The hope of becoming more ‘empirical’ by becoming more macroeconomic is bound to be disappointed, because these statistical magnitudes—which are alone ascertainable by ‘measurement’—do not also make them significant as the cause of actions of individuals who do not know them. Economic phenomena are not mass phenomena of the kind to which statistical theory is applicable. They belong to that intermediate sphere that lies between the simple phenomena of which people can ascertain all the relevant data and the true mass phenomena where one must rely on probabilities. 

—F. A. Hayek, “The Keynes Centenary: The Austrian Critique,” in The Collected Works of F. A. Hayek, vol. 9, Contra Keynes and Cambridge: Essays, Correspondence, ed. Bruce Caldwell (Indianapolis: Liberty Fund, 1995), 251.

Léon Walras Was Hired as a Professor of Economics in Lausanne Because, and Not in spite of, His Socialism

Walras, born in 1834, was the son of Auguste Walras (1801-1866), an amateur economist who favored a utility and scarcity value theory and agreed with James Mill about the desirability of the nationalization of land. Léon Walras borrowed the important elements of pure and social economics from his father but his analytical method belongs only to him. Nevertheless, the beginnings of Walras’s career were not easy. As a supernumerary pupil at the Paris Ecoles des Mines, he never got a degree and became, for his first job, a kind of secretary in a railway company. From 1864 to 1870 he devoted himself to the cooperative sector and wrote some of his most important pieces in social economy. He did not begin to lay the foundations of his mathematical economics until 1871, when he took the new chair of political economy just created in the same Vaud Canton which had honored Proudhon. Walras’s pure and social economies are not, however, unrelated. Besides, Walras was hired as a professor of economics in Lausanne because, and not in spite of, his socialism. Walras spent the rest of his life in Switzerland. Although he never managed to get a chair of economics in France, which he craved for many years, he lived long enough (until 1910) to contemplate the triumph of neoclassical economics and to enjoy the prestige of his own pure theory among a growing number of young disciples.

—Michel Herland, “Three French Socialist Economists: Leroux, Proudhon, Walras,” Journal of the History of Economic Thought 18, no. 1 (Spring 1996): 134-135. 

The Kornai–Lipták Two-Level Planning Idea Is Very Much Reminiscent of the Taylor–Lange Market Socialist Models

As noted above, Kornai’s earlier ‘‘critiques’’ of socialism were very much half-hearted in that, although they sought to bring a larger part of the socialist economy within the purview of markets or ‘‘quasi-markets,’’ they still saw a significant and important role for state ownership and central planning of the economy. One of Kornai’s most well-known contributions to this area was ‘‘Two-Level Planning,’’ which he coauthored with Tamás Lipták, who did the mathematical modeling in the paper (Kornai & Lipták, 1965). This work extended previous work Kornai conducted with Lipták, which used mathematical methods to tackle various aspects of efficient planning under market socialist type arrangements.

The Kornai–Lipták two-level planning idea is very much reminiscent of the Taylor–Lange market socialist models described 30–35 years earlier in the throws [throes] of the early stages of the socialist calculation debate with Austrian economists Ludwig von Mises and F. A. Hayek (see, for instance, Lange, 1936; Taylor, 1929). The Taylor–Lange model worked as follows: let there be a market in consumer goods and labor but leave the means of production in government’s hands. The central planning office will set prices for producer goods and on the basis of these ‘‘accounting prices’’ producers will be instructed to set price equal to marginal cost and to combine resources in such a way as to minimize average cost. Of course, the initial administered prices will be wrong. At these non-equilibrium prices some goods will sit unpurchased; for others there will be excess demand. The resulting shortages and surpluses will signal to planners how they need to modify prices to bring the economy into equilibrium. Through trial and error the planners will engage in a kind of Walrasian auctioneer tattonement [tâtonnement means “groping”] process that will eventually converge on or approximate general competitive equilibrium. This equilibrium will have the same efficiency properties that general competitive equilibrium has in the Walrasian world in which producers’ goods are privately owned. . .  

—Peter T. Leeson, “We’re All Austrians Now: János Kornai and the Austrian School of Economics,” in vol. 26, pt. A of Research in the History of Economic Thought and Methodology, ed. Warren J. Samuels, Jeff E. Biddle, and Ross B. Emmett (Bingley, UK: Emerald Group Publishing, 2008), 212-213.

If Only One Owner Establishes Prices, Then They Lose Their Basic Feature as a Denominator for the Competition Process

Socialism is a system organized by one owner, where there are no entrepreneurs competing for the most valuable use of resources. Even if one owner establishes some numerical system, this in no way differs from a straight ranking of all the possible ways of producing things. These centrally administered “prices” do not change anything since one owner establishes them, one owner acts upon them, and one owner changes them ex post. From the very beginning he employs the managers (there is no market for corporate control) and decides what in the accounting books is registered as profits and losses. In contrast, market economy prices are the result of different actions of competing owners and this is their nature: as a common denominator for different property assessments. If only one owner establishes prices, then they lose their basic feature as a denominator for the competition process and become only the expression of one owner’s preferences (hence they cannot be used as an independent economic indicator). Using prices in a socialist system is equivalent to a straight ordinal ranking of the processes by a central planner.

—Mateusz Machaj, “The Nature of Socialism,” in Property, Freedom, and Society: Essays in Honor of Hans-Herman Hoppe, ed. Jörg Guido Hülsmann and Stephan Kinsella (Auburn, AL: Ludwig von Mises Institute, 2009), 344-345.

Cost-Curve Theorists Erroneously Claim that a Firm Should Invest Up to the Point Were MR = MC (Marginal Revenue Equals Marginal Cost)

One fundamental such flaw is the artificial and even disastrous isolation of price theory from monetary and from time (and capital) phenomena. I know that questioning such isolation means bringing into question perhaps the very idea of a textbook devoted solely to price theory, but I’m afraid that this questioning must be done. The abstention from money is unfortunate but not fatal, but the abstention from time and capital analysis is, and this cannot be remedied by an appendix that Kirzner promises us on time. Problems of time, capital, interest must be infused into the price analysis. As a result of the failure to infuse, Kirzner ignores the vital “structure of production” analysis, which he claims makes little difference to one’s view of the economy. Further, the result of abstention from capital leads to all the crucial errors of the “cost-curve” analysis. For example, it is the claim of the “cost-curve” theorists (in the ranks of which Prof. Kirzner joins) that a firm will invest funds in production up to the point where “marginal revenue” equals “marginal cost.” Setting aside the equality fallacy which I will comment on below, this means, e.g. that if an output of 10 more units will bring in $100 of revenue and cost $99, the firm will produce the 10 more units. Now I submit that this is a critical fallacy. Why should the owner of the firm invest a $100 more for an expected return of (approximately) 1%, when he can invest the same $100 for, say, 8% elsewhere—or get 5% at a savings bank? Once we bring investment interest return, into the picture, we see that the whole elaborate cost-curve structure is totally faulty and should be tossed into the discard—but if that should occur, what in the world would happen to that dazzling display of quasi-mathematical pyrotechnics with which “modern” economics professors bedazzle their students?

—Joseph T. Salerno, “Varieties of Austrian Price Theory: Rothbard Reviews Kirzner,” Libertarian Papers 3 (2011): 7-8.

Mises’s Position on Socialist Calculation Emerged Out of His “The Theory of Money and Credit” (1912)

Finally, the unique root of Mises’s position, and one that distinguishes him and his “socialist impossibility” thesis from Hayek and the Hayekians, has been neglected until the present day. And this neglect has persisted despite Mises’s own explicit avowal in his memoirs of the root and groundwork of his calculation thesis. For Mises was not, like Hayek and his followers, concentrating on the flaws in the general equilibrium model when he arrived at his position; nor was he led to his discussion solely by the triumph of the socialist revolution in the Soviet Union. For Mises records that his position on socialist calculation emerged out of his first great work, The Theory of Money and Credit (1912). In the course of that notable integration of monetary theory and “micro” marginal utility theory, Mises was one of the very first to realize that subjective valuations of the consumers (and of laborers) on the market are purely ordinal, and are in no way measurable. But market prices are cardinal and measurable in terms of money, and market money prices bring goods into cardinal comparability and calculation (e.g., a $10 hat is “worth” five times as much as a $2 loaf of bread). But Mises realized that this insight meant it was absurd to say (as Schumpeter would) that the market “imputes” the values of consumer goods back to the factors of production. Values are not directly “imputed”; the imputation process works only indirectly, by means of money prices on the market. Therefore socialism, necessarily devoid of a market in land and capital goods, must lack the ability to calculate and compare goods and services, and therefore any rational allocation of productive resources under socialism is indeed impossible. 

—Murray N. Rothbard, “The End of Socialism and the Calculation Debate Revisited,” in Economic Controversies (Auburn, AL: Ludwig von Mises Institute, 2011), 843-844.

The Values of the Factors of Production (FoP) DO NOT Depend Solely on the Valuation of the Consumers’ Goods But Also on the Conditions of Supply of the Various FoP

 A recent statement by Joseph Schumpeter in his Capitalism, Socialism, and Democracy provides a clear illustration of one of the methodological differences which I have in mind. Its author is pre-eminent among those economists who approach economic phenomena in the light of a certain branch of positivism. To him these phenomena accordingly appear as objectively given quantities of commodities impinging directly upon each other, almost, it would seem, without any intervention of human minds. Only against this background can I account for the following (to me startling) pronouncement. Professor Schumpeter argues that the possibility of a rational calculation in the absence of markets for the factors of production follows for the theorist “from the elementary proposition that consumers in evaluating (‘demanding’) consumers’ goods ipso facto also evaluate the means of production which enter into the production of these goods.”

Taken literally, this statement is simply untrue. The consumers do nothing of the kind. What Professor Schumpeter’s “ipso facto” presumably means is that the valuation of the factors of production is implied in, or follows necessarily from, the valuation of consumers’ goods. But this, too, is not correct. Implication is a logical relationship which can be meaningfully asserted only of propositions simultaneously present to one and the same mind. It is evident, however, that the values of the factors of production do not depend solely on the valuation of the consumers’ goods but also on the conditions of supply of the various factors of production. Only to a mind to which all these facts were simultaneously known would the answer necessarily follow from the facts given to it. The practical problem, however, arises precisely because these facts are never so given to a single mind, and because, in consequence, it is necessary that in the solution of the problem knowledge should be used that is dispersed among many people.

—Friedrich A. Hayek, “The Use of Knowledge in Society,” in Individualism and Economic Order (Chicago: University of Chicago Press, 1948), 89-91. 

Hayek Chides Schumpeter on the Assumption of “Imputation” Outside the Market

The breathtaking naivete of the Orthodox Line should have been evident even in the 1940s. As Hayek later chided Schumpeter on the assumption of “imputation” outside the market, this formulation “presumably means . . . that the valuation of the factors of production is implied in, or follows necessarily from the valuation of consumers’ goods. But . . . implication is a logical relationship which can be meaningfully asserted only of propositions simultaneously present to one and the same mind.”

Economists were convinced of the Lange solution because they had already come under the sway of the Walrasian general equilibrium model; Schumpeter, for example, was an ardent Walrasian. In this model, the economy is always in static general equilibrium, a changeless world in which all “data” — tastes or value scales, alternative technologies, and lists of resources — are known to everyone, and where costs are known and always equal to price. The Walrasian world is also one of “perfect” competition, where prices are given to all managers. Indeed, both Taylor and Lange make the point that the Socialist Planning Board will be better able to calculate than capitalist markets, since the socialist planners can ensure “perfect competition,” whereas the real world of capitalism is shot through with various sorts of  “monopolies”! The socialist planners can act like the absurdly fictional Walrasian “auctioneer,” bringing about equilibrium rapidly by trial and error.

—Murray N. Rothbard, “The End of Socialism and the Calculation Debate Revisited,” Review of Austrian Economics 5, no. 2 (1991): 55-56.

Owing to Schumpeter’s Influence, Mises and Hayek Were Considered to Have “Lost” the Rational Economic Calculation Debate

Considering the extent to which Mises’ approach to economics ran completely counter to prevailing views during his lifetime, recent interest in his writings is nothing short of phenomenal. Two striking examples may suffice. For a long time, the most celebrated controversy in comparative economic systems theory — that is, the debate raging during the inter-war period over “rational economic calculation” in a socialist society, which was sparked off by a famous article by Mises — seemed to be a closed chapter in the history of economic thought. Not least owing to Schumpeter’s influence, Mises and Hayek were commonly considered to have “lost” the debate. Indeed, “victory” for the kind of market socialism espoused by Lange and Lerner was held to be so overwhelming that modern treatments of welfare economics do not even care to mention that there ever was such a controversy. (Layard and Walters (1978, p. 27) is illustrative of a general tendency.) Most recently, the standard account of the calculation debate has been seriously called into question, largely as a result of its iconoclastic reexamination by Don Lavoie (1985). 

—Stephan Boehm, “The Austrian Tradition: Schumpeter and Mises,” in Neoclassical Economic Theory, 1870-1930, ed. Klaus Hennings and Warren J. Samuels, Recent Economic Thought Series 20 (Boston: Kluwer Academic Publishers, 1990), 210. 

The Enthusiast for Macroeconomics and Co-Founder of the Econometric Movement, Joseph Schumpeter, Had Previously Supported ‘Methodological Individualism’

In 1908, when Joseph Schumpeter at the age of twenty-five published his Wesen und Hauptinhalt der theoretischen Nationalökonomie, it attracted much attention by the brilliance of its exposition. Moreover, though he had been trained at the University of Vienna and had been a leading member of the famous seminar of Eugen von Böhm-Bawerk, he had also absorbed the teaching of Léon Walras, who had received little notice by the Austrians and had adopted the positivist approach to science expounded by the Austrian physicist Ernst Mach. In the course of time he moved further away from the characteristic tenets of the Austrian school so that it became increasingly doubtful later whether he could still be counted as a member of that group.

Schumpeter was very much a ‘master of his subject’, in contrast to the ‘puzzlers’ or ‘muddlers’ who follow their own distinct ideas; he also showed a strong receptivity to the dominant opinions in his environment and the prevailing fashion of his generation. Nowhere does this show more clearly than in the still entirely Mengerian chapter of his early book, now translated into English for the first time and regarded as the classic exposition of a view which he later abandoned. Many of his students will be surprised to learn that the enthusiast for macroeconomics and co-founder of the econometrics movement had once given one of the most explicit expositions of the Austrian school’s ‘methodological individualism’. He even appears to have named the principle and condemned the use of statistical aggregates as not belonging to economic theory. 

That this first book of his was never translated is, I believe, due to his understandable reluctance to see a work distributed which, in part, expounded views in which he no longer believed. His reluctance to keep his brilliant first book in print, much less having it translated, can probably be explained by his awareness that his own distinct opinions emerged only in his second book on the Theorie der wirtschaftlichen Entwicklung, which came out four years after the first. Though the author may later no longer have been prepared to defend the ideas of his first work, they are certainly essential enough to the understanding of the development of economic theory. Indeed Schumpeter made a contribution to the tradition of the Austrian school which is sufficiently original to be made available to a wider public.

—F. A. Hayek, “Joseph Schumpeter (1883-1950),” in The Collected Works of F. A. Hayek, vol. 4, The Fortunes of Liberalism: Essays on Austrian Economics and the Ideal of Freedom, ed. Peter G. Klein (Chicago: University of Chicago Press, 1992), Kobo e-book.

The Problems of Process Analysis DEFY Any Mathematical Approach

Both the logical and the mathematical economists assert that human action ultimately aims at the establishment of such a state of equilibrium and would reach it if all further changes in data were to cease. But the logical economist knows much more than that. He shows how the activities of enterprising men, the promoters and speculators, eager to profit from discrepancies in the price structure, tend toward eradicating such discrepancies and thereby also toward blotting out the sources of entrepreneurial profit and loss. He shows how this process would finally result in the establishment of the evenly rotating economy. This is the task of economic theory. The mathematical description of various states of equilibrium is mere play. The problem is the analysis of the market process.

A comparison of both methods of economic analysis makes us understand the meaning of the often raised request to enlarge the scope of economic science by the construction of a dynamic theory instead of the mere occupation with static problems. With regard to logical economics this postulate is devoid of any sense. Logical economics is essentially a theory of processes and changes. It resorts to the imaginary constructions of changelessness merely for the elucidation of the phenomena of change. But it is different with mathematical economics. Its equations and formulas are limited to the description of states of equilibrium and nonacting. It cannot assert anything with regard to the formation of such states and their transformation into other states as long as it remains in the realm of mathematical procedures. As against mathematical economics the request for a dynamic theory is well substantiated. But there is no means for mathematical economics to comply with this request. The problems of process analysis, i.e., the only economic problems that matter, defy any mathematical approach. The introduction of time parameters into the equations is no solution. It does not even indicate the essential shortcomings of the mathematical method. The statements that every change involves time and that change is always in the temporal sequence are merely a way of expressing the fact that as far as there is rigidity and unchangeability there is no time. The main deficiency of mathematical economics is not the fact that it ignores the temporal sequence, but that it ignores the operation of the market process.

—Ludwig von Mises, Human Action: A Treatise on Economics, ed. Bettina Bien Greaves (Indianapolis: Liberty Fund, 2007), 2:355-356.

Those Suggesting a Quasi-Market for the Socialist System Have NEVER Wanted to Preserve Stock and Commodity Exchanges, Futures Trading, and Moneylenders as Quasi-Institutions

Nobody has ever suggested that the socialist commonwealth could invite the promoters and speculators to continue their speculations and then deliver their profits to the common chest. Those suggesting a quasi-market for the socialist system have never wanted to preserve the stock and commodity exchanges, the trading in futures, and the bankers and moneylenders as quasi-institutions. One cannot play speculation and investment. The speculators and investors expose their own wealth, their own destiny. This fact makes them responsible to the consumers, the ultimate bosses of the capitalist economy. If one relieves them of this responsibility, one deprives them of their very character. They are no longer businessmen, but just a group of men to whom the director has handed over his main task, the supreme direction of the conduct of affairs. Then they—and not the nominal director—become the true directors and have to face the same problem the nominal director could not solve: the problem of calculation.

—Ludwig von Mises, Human Action: A Treatise on Economics, ed. Bettina Bien Greaves (Indianapolis: Liberty Fund, 2007), 3:708-709.

The Capitalist System Is NOT a Managerial System; It Is an Entrepreneurial System

Our problem does not refer to the managerial activities; it concerns the allocation of capital to the various branches of industry. The question is: In which branches should production be increased or restricted, in which branches should the objective of production be altered, what new branches should be inaugurated? With regard to these issues it is vain to cite the honest corporation manager and his well-tried efficiency. Those who confuse entrepreneurship and management close their eyes to the economic problem. In labor disputes the parties are not management and labor, but entrepreneurship (or capital) and the salaried and wage-receiving employees. The capitalist system is not a managerial system; it is an entrepreneurial system. One does not detract from the merits of corporation managers if one establishes the fact that it is not their conduct that determines the allocation of the factors of production to the various lines of industry.

—Ludwig von Mises, Human Action: A Treatise on Economics, ed. Bettina Bien Greaves (Indianapolis: Liberty Fund, 2007), 3:708.

On a Particularly Important Flaw in the Orthodox or Textbook Version of the Economic Calculation Debate

 But a particularly important flaw in the orthodox story is, as Hayek tried to make clear during the debate, the curious disjunction between the “theoretical” and the “practical.” It is not simply that Barone and his mentor Pareto scoffed at the workability of the theoretical equations under Socialist planning. More important is the point that Mises and Hayek were implicitly attacking the relevance of the entire concept of Walrasian general equilibrium from which these equations flowed. For Mises and Hayek there was no disjunction between the “theoretical” and the “practical”; following the Austrian tradition, a theory that necessarily violated practical reality was an unsound theory. The fact that in a changeless world of perfect knowledge and general equilibrium a Socialist Planning Board could “solve” equations of prices and production was for Mises a worse than useless demonstration. Clearly, as Hayek would later develop at length, if complete knowledge of economic reality is assumed to be “given” to all, including a Planning Board, there is no problem of calculation or, indeed, any economic problem at all, whatever the economic system. The Mises demonstration of the impossibility of economic calculation under socialism and of the superiority of private markets in the means of production applied only to the real world of uncertainty, continuing change, and scattered knowledge.

—Murray N. Rothbard, “Ludwig von Mises and Economic Calculation Under Socialism,” in The Economics of Ludwig von Mises: Toward a Critical Reappraisal, ed. Laurence S. Moss (Kansas City: Sheed and Ward, 1976), 68.