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Man, Economy, and State at 50

Mises Daily: Tuesday, September 11, 2012 by

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[This review originally appeared in the Freeman, September 2012.]

Based on art by Tim Kelly done for TheFreemanOnline.org
Based on art by Tim Kelly done for TheFreemanOnline.org

This year marks the 50th anniversary of the 1962 publication of Murray Rothbard's grand treatise, Man, Economy, and State (MES). I was humbled when asked to write an appreciation of this indispensable work of Austrian economics. Rather than discussing the book's obvious role in the modern revival of Austrian ideas, I decided to focus on the book itself.

Rothbard originally intended his work to be a textbook treatment of Ludwig von Mises's own magnum opus, Human Action, which had come out in 1949. Indeed, Herbert C. Cornuelle, president of the Volcker Fund, was the one to pitch this idea to Rothbard that very year. Rothbard prepared an outline and a sample chapter on money, then received the blessing of Mises himself to go forward.

However, as Joseph Stromberg chronicles in exquisite detail in his introduction to the Mises Institute's Scholar's Edition of MES (2004), upon embarking on the project Rothbard eventually realized that a mere textbook would not be adequate. Cornuelle had visited Rothbard and asked if he thought the work should become a treatise in its own right. Rothbard pondered the question and eventually wrote in response (in February 1954),

The original concept of this project was as a step-by-step, spelled-out version of Mises' Human Action. However, as I have been proceeding, the necessary elaborations on the sometimes sparse framework of Mises has led inevitably to new and original presentations. Now that I have been proceeding to the theory of production where the whole cost-curve situation has to be faced, Mises is not much of a guide in this area. It is an area which encompasses a large part of present-day textbooks, and therefore must be met, in one way or another.… A further complication has arisen. A textbook, traditionally, is supposed to simply present already-received doctrine in a clear, step-by step manner. But not only would my textbook fly in the face of the doctrine as received by 99 percent of present-day economists, but there is one particularly vital point on which Mises, and all other economists, will have to be revised: monopoly theory.

Thus we see that Rothbard eventually realized that he was writing a brand new treatise, resting on the Misesian edifice to be sure, but one that was Rothbard's own. Not only did Rothbard differ from Mises on certain key points (some of which will be discussed below), but even where their treatments were compatible, Rothbard's was the clearer and more systematic.

The fundamental difference between Human Action and MES is that the latter is completely self-contained. The intelligent layperson with no prior exposure to any economics can read just Rothbard's treatise and walk away understanding the core of orthodox Austrian theory. In contrast, Mises's classic work assumes a great deal of background knowledge on the part of the reader, including Kantian philosophy, the classical theory of value, and Böhm-Bawerkian capital and interest theory(!). None of this is meant to belittle Mises's work but merely to underscore that I personally always point the dedicated newcomer to MES first, and only then to Human Action.

Rothbard initially follows in Mises's footsteps by categorizing economics as a subset of praxeology, which is the science of human action. According to Rothbard, starting from the basic axiom that human beings act — that they consciously use means to (attempt to) achieve desired goals — one can logically deduce the entire body of economic principles or laws.

It is interesting to read Rothbard's description (in a March 1951 letter to Cornuelle) of his method of attack:

What I have in mind for a textbook would be a pioneering project.… At each step, the reader would be enlightened through simple, hypothetical examples, until, slowly but relentlessly, he would find himself equipped to tackle the economic problems of the day.… [T]hrough this method, even the most confirmed socialist, would step-by-step, beginning with simple praxeological axioms, at the end, suddenly find himself realizing the absurdity of his socialist and interventionist beliefs. He would become a libertarian in spite of himself.

At this point, let me clarify something that I know, from firsthand experience, has puzzled many students of the Austrian movement. Sometimes in their zeal for doctrinal purity, self-described Rothbardians will label one group of economists "Misesians" to distinguish them (presumably) from other economists who are not Misesians. This strikes some as odd, since Rothbard himself differed with Mises on areas such as monopoly theory, the feasibility of free-market legal and defense services, and the possibility of constructing a rational system of ethics.

Whether helpful or otherwise, what Rothbardians mean by "Misesian" concerns the important issue of the very foundation of economic law. If an economist thinks that economic principles are logical deductions from self-evident axioms — analogous to geometry — then he or she is a "Misesian" in this sense.

On the other hand, if an economist thinks that tentative economic laws must be used to generate falsifiable predictions that are then (if possible) subjected to empirical tests — analogous to the physical sciences — then he or she would be classified as a (non-Misesian) positivist, even though such an economist might reach similar free-market policy conclusions with this alternate method.

Following Mises, Rothbard and his modern disciples argue that sound economic theory is logically antecedent to empirical investigation. If trying to understand the causes of the Great Depression, for example, one can't simply "let the facts speak for themselves," because there are infinite possible facts one could assemble for the purpose. (What was the mass of the moon on February 16, 1923, at exactly noon GMT, and might it have had something to do with the 1929 stock market crash?) Indeed, the very concepts of money, interest rates, and so forth are themselves theory-laden; one needs to have a praxeological foundation to even perceive such categories, because they don't exist "out there" in "the real world" the way a naive positivist might suggest.

Professor Joseph Salerno once told Rothbard that Rothbard had incorporated the capital theory of Eugen von Böhm-Bawerk into his exposition far more thoroughly than Mises had done in his own works. For those of us who read MES in our youth, we take this for granted, but Salerno's observation is perfectly correct: Rothbard takes the crucial yet at times mind-numbingly dry treatments of Austrian capital theory from the masters (mainly Carl Menger, Böhm-Bawerk, and F.A. Hayek) and distills them into a very readable discussion. He caps it all off with a beautiful diagram (appearing in the beginning of chapter 6, "Production: The Rate of Interest and Its Determination") that I have described as the superior Austrian version of the mainstream's "Circular Flow Diagram."

Figure 41

Rothbard's diagram takes the famous Hayekian triangle illustrating the structure of production and rotates it 90 degrees to the right, so that what is considered the earliest, or "highest," stage of production actually is the highest bar on the diagram. At each step moving downward, the goods-in-process have moved through another period of work, where further inputs of land, labor, and capital goods have been applied, transforming the capital goods ever closer to the ultimate consumer goods.

Rothbard's ingenious construction allows for an "economy-wide" accounting, where the capitalists earn the correct rate of return on their investments each period and where the net incomes earned by the capitalists, land owners, and laborers each period sum to the total spent on the finished consumer goods emerging from the bottom of the production "pipeline" that period.

I say that Rothbard's diagram is the answer to the mainstream "circular flow" because it does everything the latter does — namely, it shows how money "circulates" around the economy so that one person's expenditure is another's income — but it does so much more. In Rothbard's diagram, one can immediately see the distinction between net and gross investment. Because Rothbard wanted (initially) to depict a steady-state equilibrium (what Mises called the "evenly rotating economy," or ERE), there is no net saving or investment in the economy depicted in Rothbard's schematic. Using traditional mainstream tools (income = consumption + investment + government spending + net exports, or Y = C+I+G+Nx), we would therefore conclude that this hypothetical economy, with no government or foreign market, was driven 100 percent by domestic consumer spending. Yet, as the diagram makes crystal clear, each period it takes far more gross investment than consumer spending (318 ounces of gold versus 100 ounces) just to keep the system running smoothly. If the capitalists for some reason decided not to plow back most of their gross earnings into replenishing their supplies and hiring new land and labor factors, then the complex structure would soon break down and the consumption goods would stop shooting out of the pipeline.

In addition to illustrating the long-run equilibrium relationships among time preference (the higher valuation of present goods versus comparable future goods), factor pricing, and the stages of production, Rothbard's diagrammatic exposition also makes it easy to show the impact of a decrease in time preference. In this case, consumers restrict their spending on final consumption goods, the "spread" or mark-up narrows between the prices of capital goods in each successive stage of production, and the entire structure becomes taller, so that the original land and labor inputs are invested for a longer average period. These processes were described by Böhm-Bawerk and Hayek, of course, but Rothbard's exposition makes the whole affair much more comprehensible to a beginner.

If I have spent an unusual amount of time discussing a single diagram from Rothbard's thousand-plus-page tome, it is because I think it encapsulates literally weeks of study on the Austrian approach to economics. I have spent almost entire lectures walking my students through the diagram to make sure they understand exactly how it works and to see just how much knowledge is packed into its deceptively simple appearance. I don't think it's an exaggeration to say that if one comprehends exactly what Rothbard is doing in that simple diagram, then one will grasp the Austrian critique of Alan Greenspan and Ben Bernanke.

Throughout the book Rothbard makes original contributions, but they are often in the form of making a received point a little more crisply, or by filling in a gap in the standard case for a familiar conclusion. When it comes to monopoly theory, however, Rothbard overturns the tables and starts from scratch.

He begins his treatment by challenging the very notion of "consumers' sovereignty" as developed by William Hutt. Hutt (and later Mises) used the term to convey the notion that the "customer is always right" and that through their spending decisions the consumers in a market economy ultimately allocate resources to competing ends.

Rothbard rejected the term on the grounds of both accuracy and strategy. Strictly speaking, it was simply not true to say that consumers were somehow "sovereign" over producers. Yes, consumers were free to withhold their money, but by the same token business owners were free to withhold their products, and workers were free to withhold their labor. Instead of exhibiting consumers' sovereignty, Rothbard felt the free market demonstrated individual self-sovereignty.

Rothbard also disliked the term for strategic reasons, because the notion of "consumers' sovereignty" could be used as an ideal benchmark with which to criticize the performance of the real-world market. That is precisely what happened (with the related notion of "perfect competition") in mainstream welfare economics.

During his preliminary discussion of monopoly, Rothbard makes some brilliant observations. For example, he points out that most economists and the general public are horrified by the formation of a cartel, while they look with favor on the creation of a corporation. Yet the processes are quite similar, involving individuals pooling their resources into a unified enterprise. Rothbard also generalizes Mises's calculation argument as originally applied to a socialist state to show that no single firm could ever encompass the entire economy.

After this and other warm-up sections, Rothbard goes for the throat: He denies the very existence of a so-called competitive price with which to contrast the allegedly inefficient "monopoly price." Instead Rothbard offers the free-market price, the only benchmark that can be discussed coherently.

In addition to his positive exposition of sound Austrian economics, Rothbard fills MES with critiques of rival doctrines. I am particularly fond of his discussion of Keynesian economics. The critiques have lost some of their force over the decades, because a typical Keynesian textbook no longer bases its policy conclusions on the arguments that were common when Rothbard was writing. Even so, Rothbard's demonstrations are a joy to behold.

My personal favorite is his reductio ad absurdum of the multiplier (based on a similar argument by Henry Hazlitt). After reviewing the standard Keynesian case (at the time) that new investment spending will have a "multiplier" impact on total income, Rothbard uses the same approach to "prove" that the reader of his book has a much higher multiplier still. Specifically, Rothbard sets out a few equations showing that "Social Income" is equal to the "Income of the Reader" plus the "Income of everyone else." Then he uses some empirical observation to discover that the "Income of everyone else" is 0.99999 times "Social Income." After some algebra, Rothbard concludes that "Social Income" is 100,000 times the "Income of the Reader." The consistent Keynesian, Rothbard notes, should then advocate that the government print up dollars and hand them to the reader of Rothbard's book, because the "reader's spending will prime the pump of a 100,000-fold increase in the national income."

Fifty years after its initial publication, Murray Rothbard's grand treatise still holds up. If anyone considers himself or herself a fan of Austrian economics and has yet to try Man, Economy, and State, I promise you are in for a treat.