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Human Action at Sixty

March 12, 2009

Tags Free MarketsMedia and CultureHistory of the Austrian School of EconomicsPraxeology

[Presented at a session on "Human Action After Sixty Years" at the Eastern Economic Association in New York City, February 26-March 1, 2009.]

Happy 60th Human Action

In September of 2009, it will be sixty years since the appearance of Ludwig von Mises's Human Action, a Treatise on Economics, one of the truly great "classics" of modern economics. Often a "classic" means a famous book considered to have made important contributions to a discipline that is reverentially referred to but is rarely ever read. In economics, Adam Smith's Wealth of Nations is the typical example of such a work. Every economist has heard of the "invisible hand" and the notion of self-interest furthering the public interest through the incentive mechanism of the market, but probably few economists nowadays have actually read more than a handful of snippets and brief passages from Smith's treatise.

However, Human Action uniquely stands out as a classic in the literature of economics. Not only among Austrian economists but also for a growing number of other people, Mises's brilliant treatise continues to be read and taken seriously as a cornerstone for understanding the nature of the free society and the workings of the market economy.

It has taken on even more significance in these early years of the 21st century precisely because of the economic crisis through which the world is presently passing. It rings just as relevant today as when it was published six decades ago because the issues that Mises dealt with in Human Action and in many of his other works still dominate the public-policy discourses of our own time.

A central concept through much of the book is Mises's insistence on the essential importance of economic calculation. In the early decades of the 20th century, socialists of almost all stripes were certain that the institutions of the market economy could be done away with — either through peaceful means or violent revolution — and replaced with direct government ownership or control of the means of production with no loss in economic productivity or efficiency.

Mises's landmark contribution was to demonstrate that only with market-based prices expressed through a medium of exchange could rational decision making be undertaken for the use and application of the myriad means of production to assure the effective satisfaction of the multitudes of competing consumer demands in society.

"Monetary calculation is the guiding star of action under a system of division of labor," Mises declared in Human Action. "It is the compass of the man embarking on production."[1] The significance of the competitive process, as Mises had expressed it in his earlier volume Liberalism, is that it facilitates "the intellectual division of labor that consists in the cooperation of all entrepreneurs, landowners, and workers as producers and consumers in the formation of market prices. But without it, rationality, i.e., the possibility of economic calculation, is unthinkable."[2]

Such rationality in the use of means to satisfy ends is impossible in a comprehensive system of socialist central planning. How, Mises asked, will the socialist planners know the best uses for which the factors of production under their central control should be applied without such market-generated money prices? Without private ownership of the means of production, there would be nothing (legally) to buy and sell. Without the ability to buy and sell, there would be no bids and offers, and therefore no haggling over terms of trade among competing buyers and sellers. Without the haggling of market competition there would, of course, be no agreed-upon terms of exchange. Without agreed-upon terms of exchange, there are no actual market prices. And without such market prices, how will the central planners know the opportunity costs and therefore the most highly valued uses for which those resources could or should be applied? With the abolition of private property, and therefore market exchange and prices, the central planners would lack the necessary institutional and informational tools to determine what to produce and how, in order to minimize waste and inefficiency.

Therefore, Mises declared in 1931,

From the standpoint of both politics and history, this proof [of the "impossibility" of socialist planning] is certainly the most important discovery by economic theory … It alone will enable future historians to understand how it came about that the victory of the socialist movement did not lead to the creation of the socialist order of society.[3]

At the same time, Mises demonstrated the inherent inconsistencies in any system of piecemeal political intervention in the market economy. Price controls and production restrictions on entrepreneurial decision making bring about distortions and imbalances in the relationships of supply and demand, as well as constraints on the most efficient use of resources in the service of consumers. The political intervener is left with the choice of either introducing new controls and regulations in an attempt to compensate for the distortions and imbalances the prior interventions have caused, or repealing the interventionist controls and regulations already in place and allowing the market once again to be free and competitive. The path of one set of piecemeal interventions followed by another entails a logic in the growth of government that eventually would result in the entire economy coming under state management. Hence, interventionism consistently applied could lead to socialism on an incremental basis.[4]

The most pernicious form of government intervention, in Mises's view, was political control and manipulation of the monetary system. Contrary to both the Marxists and the Keynesians, Mises did not consider the fluctuations experienced over the business cycle to be an inherent and inescapable part of the free-market economy. Waves of inflations and depressions were the product of political intervention in money and banking. And this included the Great Depression of the 1930s, Mises argued.

Under various political and ideological pressures, governments had monopolized control over the monetary system. They used the ability to create money out of thin air through the printing press or on the ledger books of the banks to finance government deficits and to artificially lower interest rates to stimulate unsustainable investment booms. Such monetary expansions always tended to distort market prices resulting in misdirections of resources, including labor, and malinvestments of capital. The inflationary upswing that is caused by an artificial expansion of money and bank credit sets the stage for an eventual economic downturn. By distorting the rate of interest — the market price for borrowing and lending — the monetary authority throws savings and investment out of balance, with the need for an inevitable correction.

The "depression" or "recession" phase of the business cycle occurs when the monetary authority either slows downs or stops any further increases in the money supply. The imbalances and distortions become visible, with some investment projects having to be written down or written off as losses, with reallocations of labor and other resources to alternative, more profitable employments, and sometimes significant adjustments and declines in wages and prices to bring supply and demand back into proper order.[5]

The Keynesian revolution of the 1930s, which then dominated economic-policy discussions for decades following the Second World War, was based on a fundamental misconception of how the market economy worked. What Keynes called "aggregate demand failures" (to explain the reason for high and prolonged unemployment) distracted attention from the real source of less-than-full employment: the failure of producers and workers on the "supply side" of the market to price their products and labor services at levels that potential demanders would be willing to pay. Unemployment and idle resources were a pricing problem, not a demand-management problem. Mises considered Keynesian economics basically to be nothing more than a rationale for special-interest groups, such as trade unions, who didn't want to adapt to the reality of supply and demand, and what the market viewed as their real worth.[6]

Thus Mises's conclusion from his analysis of socialism and interventionism, including monetary manipulation, was that there is no alternative to a thoroughgoing, unhampered, free-market economy — and one that included a market-based monetary system such as the gold standard.[7] Both socialism and interventionism are, respectively, unworkable and unstable substitutes for capitalism. The classical liberal defends private property and the free-market economy, he insisted, precisely because it is the only system of social cooperation that provides wide latitude for freedom and personal choice to all members of society, while generating the institutional means for coordinating the actions of billions of people in the most economically rational manner.

The apparent "triumph" of capitalism over collectivism, following the demise of the Soviet bloc in the 1990s, was mostly an illusion. Governments in the Western world did not reduce their size or intrusiveness in the economic affairs of their citizens. The interventionist welfare state has remained alive and well.[8]

But the heart of the interventionist system is government control of the monetary system — indeed, it has remained an untouched system of monetary central planning through the institution of central banking. During the Second World War, the German free-market economist Gustav Stolper, then in exile in America from war-torn Europe, pointed out that,

Hardly ever do the advocates of free capitalism realize how utterly their ideal was frustrated at the moment the state assumed control of the monetary system…. A "free" capitalism with government responsibility for money and credit has lost its innocence. From that point on it is no longer a matter of principle but one of expediency how far one wishes or permits governmental interference to go. Money control is the supreme and most comprehensive of all government controls short of expropriation.

Stolper went on to say,

there is today only one prominent liberal theorist consistent enough to advocate free, uncontrolled competition among the banks in the creation of money. Mises, whose intellectual influence on modern neo-liberalism was very strong, has hardly made one proselyte for that extreme conclusion.[9]

Fortunately, over the last thirty years, Mises's analysis and defense of gold-backed, private competitive banking in place of government-monopoly central banking has finally begun to win over a growing number of Austrian and other advocates.

Monetary manipulation by central banks inserts one of the most disruptive distortions into the process of economic calculation. Interest rates — which are meant to inform market participants about the availability of savings relative to the demands for investment expenditures, and which facilitate the intertemporal coordination of resource use over periods of time relative to the demands of income earners for consumption in the present versus the future — send out misinformation to both producers and consumers under the pressure of monetary expansion.

In the wake of Federal Reserve monetary mischief, once again, over the last several years, the imbalances and distortions generated by monetary policies have resulted in the current economic crisis. And now, in the face of the inescapable need for the rebalancing and recoordination of misdirected resources and malinvested capital, the "ghost of Keynes past" has been resurrected.

The focus on aggregate output and employment declines over the last year, which is guiding government policy, hides from view the underlying microeconomic relations that are at the core of the market process. How can the multitudes of market participants discern where and to what extent market errors have been made under the pressure of past monetary and interest-rate manipulations if the price system is not permitted to perform its job of telling the truth about the reality of supply and demand? That is, the degree to which resources have been misallocated and wrongly priced during the boom. Or the extent to which men, material, and savings-backed financial funds must realign themselves to restore a properly understood full-employment economy that has market-based sustainability.

"Contrary to both the Marxists and the Keynesians, Mises did not consider the fluctuations experienced over the business cycle to be an inherent and inescapable part of the free-market economy."

How can people know what to do and where to do it in the social system of division of labor if the crucial tool of economic calculation is undermined by government bailouts, subsidies, price floors, capital-market interventions, and the continuing monetary manipulation that threatens further misdirections of capital and labor, and runs the danger of serious price inflation in the months and years ahead?

In the present economic crisis, the argument is constantly made that many banks are too big to fail, that depositors need to have their various types of bank accounts protected and guaranteed, and that the repercussions of allowing the financial markets to adjust to the postboom reality would be too harsh. Mises responded to these types of arguments in 1928, even before the Great Depression began, including a warning about what today is understood as "moral hazard," the danger of reinforcing the repetition of bad decisions by the government bailing out mistakes made in the market:

In any event, the practice of intervening for the benefit of banks, rendered insolvent by the crisis, and of the customers of these banks, has resulted in suspending the market forces which could serve to prevent a return of the expansion, in the form of a new boom, and the crisis which inevitably follows. If the banks emerge from the crisis unscathed, or only slightly weakened, what remains to restrain them from embarking once more on an attempt to reduce artificially the interest rate on loans and expand circulation credit? If the crisis were ruthlessly permitted to run its course, bringing about the destruction of enterprises which were unable to meet their obligations, then all entrepreneurs — not only banks but also other businessmen — would exhibit more caution in granting and using credit in the future. Instead, public opinion approves of giving assistance in the crisis. Then, no sooner is the worst over, than the banks are spurred on to a new expansion of circulation credit.[10]

Just as there was a huge shift toward more and bigger government in the years leading up to Mises's writing of Human Action, so today we appear to be on the threshold of a similar expansion of governmental presence and domination of even more of social life, especially in health care, education, and the energy sector — as well as a much greater control over the financial and capital markets.

But where will all the money come from to fund this new gargantuan largess for expanded political paternalism? In the Austria of the interwar period of the 1920s and 1930s, Mises had witnessed and explained the consequences from unrestrained government spending that finally resulted in the "eating of the seed corn" — capital consumption.[11] Mises warned of this danger, too, in the pages of Human Action, and the fact that there must be a point at which the interventionist welfare state will have exhausted "the reserve fund" of accumulated wealth, after which the consumption of capital becomes the only basis upon which to continue to feed the fiscal demands of the redistributive state.[12] Those currently in political power in Washington seem hell-bent on bringing this about in the decades ahead.

When Friedrich A. Hayek reviewed the German-language predecessor to Human Action, shortly after it appeared in 1940, he emphasized its astonishingly unique qualities:

There appears to be a width of view and an intellectual spaciousness about the whole book that are much more like that of an eighteenth-century philosopher than that of a modern specialist. And yet, or perhaps because of this, one feels throughout much nearer reality, and is constantly recalled from the discussion of the technicalities to the consideration of the great problems of our time … It ranges from the most general philosophical problems raised by all scientific study of human action to the major problems of economic policy of our time … [T]he result is a really imposing unified system of a liberal social philosophy. It is here also, more than elsewhere, that the author's astounding knowledge of history as well as of the contemporary world helps most to illustrate his argument.[13]

$40 $36

 

The years since the original appearance of Human Action in 1949 have done nothing to diminish the validity of Hayek's interpretation. Indeed, the social, political, and economic conditions of our world today give Ludwig von Mises's treatise a refreshing relevance matched by few other works written over the last century. That is what results in it being read by more and more people today, rather than simply being one of those many "classics" collecting dust on a shelf.

If enough people discover and rediscover the timeless truths in the pages of Human Action, the ideas of Ludwig von Mises may well assist us in stemming this growing tide toward an even larger leviathan state.

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Notes

[1] Ludwig von Mises, Human Action, A Treatise on Economics (Chicago: Henry Regnery, 3rd ed., 1966), p. 229.

[2] Ludwig von Mises, Liberalism, the Classical Tradition (Indianapolis, IN: Liberty Fund, [1927] 2005), p. 50.

[3] Ludwig von Mises, "On the Development of the Subjective Theory of Value," [1931] Epistemological Problems of Economics [1933] (New York: New York University Press, 1981), p. 157.

[4] Mises, Critique of Interventionism [1929] (Irvington-on-Hudson, NY: Foundation for Economic Education, 1998) pp. 1–31, 97–106; Interventionism: An Economic Analysis [1941] (Irvington-on-Hudson, NY: Foundation for Economic Education, 1996); Human Action, pp. 716–79; Planning for Freedom (South Holland, Ill: Libertarian Press, 4th ed., 1980), pp. 1–49.

[5] Ludwig von Mises, The Theory of Money and Credit (Indianapolis, IN: Liberty Classics, 1981 [1912; revised eds., 1934, 1953]); "Monetary Stabilization and Cyclical Policy" [1928] Percy L. Greaves, ed., The Causes of the Economic Crisis, and Other Essays Before and After the Great Depression (Auburn, Ala.: The Ludwig von Mises Institute, 2006) pp. 53–153; Human Action, pp. 398–478, 538–86, 780–803.

[6] For Mises's analysis of the causes and cures for the Great Depression, see Ludwig von Mises, "The Causes of the Economic Crisis" [1931] in The Causes of the Economic Crisis, pp. 155–81; and on Keynesian economics, see Mises, "Stones into Bread, The Keynesian Miracle" [1948], and "Lord Keynes and Say's Law" [1950] in Planning for Freedom, pp. 50–71; for a detailed comparison of the Austrian and Keynesian analyses of the causes and cures of the Great Depression, see Richard M. Ebeling, "The Austrian Economists and the Keynesian Revolution: The Great Depression and the Economics of the Short-Run" in Richard M. Ebeling, ed. Human Action, A 50-Year Tribute (Hillsdale, MI: Hillsdale College Press, 2000), pp. 15–110.

[7] See Richard M. Ebeling, Austrian Economics and the Political Economy of Freedom (Northampton, MA: Edward Elgar, 2003), ch. 5: "Ludwig von Mises and the Gold Standard," pp. 136–58.

[8] On some of the reasons why capitalism has not triumphed, in spite of the failure of socialist central planning everywhere it has been tried, see Richard M. Ebeling, "Is the 'Specter of Communism' Still Haunting the World?" Notes from FEE (March 2006).

[9] Gustav Stolper, This Age of Fable: The Political and Economic World We Live In (New York: Reynal & Hitchcock, 1942), pp. 7–8.

[10] Ludwig von Mises, "Monetary Stabilization and Cyclical Policy" [1928] in The Causes of the Economic Crisis, p. 127.

[11] On Mises's writings as a policy analyst with the Vienna Chamber of Commerce in the interwar period, including his explanation of the consumption of capital in Austria due to monetary and fiscal policy, see Richard M. Ebeling, "The Economist as the Historian of Decline: Ludwig von Mises and Austria Between the Two World Wars" in Richard M. Ebeling, ed., Globalization: Will Freedom or World Government Dominate the International Marketplace? (Hillsdale, Michigan, Hillsdale College Press, 2002), pp. 1–68.

[12] Mises Human Action, pp. 855–61.

[13] F. A. Hayek, review of "Nationalökonomie: Theorie des Handelns and Wirtshaftens," Economic Journal (April 1941), pp. 125, 126, 127; reprinted in Peter Klein, ed., The Collected Works of F. A. Hayek, Vol. 4: The Fortunes of Liberalism, Essays on Austrian Economics and the Ideal of Freedom (Chicago: University of Chicago Press, 1992), pp. 149, 151, 152.


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