Chapter 5—Production: The Structure (continued)
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Chapter
5—Production: The Structure
(continued)
6.
Ownership of the Product by Capitalists: Amalgamated Stages
Up
to this point we have discussed the case in which the owners of land
and labor, i.e., of the original factors, restrict their possible
consumption and invest their factors in a production process,
which, after a certain time, produces a consumers’ good to be
sold to consumers for money. Now let us consider a situation in which
the owners of the factors do not own the final product. How could this
come about? Let us first forget about the various stages of the
production process and assume for the moment that all the stages can be
lumped together as one. An individual or a group of individuals acting
jointly can then, at present, offer to pay money to the owners of land
and labor, thus buying the services of their factors. The factors then
work and produce the product, which, under the terms of their
agreement, belongs to the new class of product-owners. These
product-owners have purchased the services of the land and
labor factors as the latter have been contributing to production; they
then sell the final product to the consumers.
What has been the contribution of these product-owners, or
“capitalists,” to the production process? It is
this: the saving and restriction of consumption, instead of being done
by the owners of land and labor, has been done by the capitalists.
The capitalists originally saved, say, 95 ounces of gold which they
could have then spent on consumers’ goods. They refrained
from doing so, however, and, instead, advanced the
money to the original owners of the factors. They paid
the latter for their services while they were working, thus advancing
them money before the product was actually produced and sold to the
consumers. The capitalists, therefore, made an essential contribution
to production. They relieved the owners of the original
factors from the necessity of sacrificing present goods and waiting for
future goods. Instead, the capitalists have
supplied present goods from their own savings
(i.e., money with which to buy present goods) to the owners of the
original factors. In return for this supply of present goods, the
latter contribute their productive services to the capitalists, who
become the owners of the product. More precisely, the
capitalists become the owners of the capital structure, of the whole
structure of capital goods as they are produced. Keeping to
our assumption that one capitalist or group of capitalists owns all the
stages of any good’s production, the capitalists
continue to advance present goods to owners of factors as the
“year” goes on. As the period of time continues,
highest-order capital goods are first produced, are then transformed
into lower-order capital goods, etc., and ultimately into the final
product. At any given time, this whole structure is owned by the
capitalists. When one capitalist owns the whole structure, these
capital goods, it must be stressed, do him no good whatever.
Thus, suppose that a capitalist has already advanced 80 ounces over a
period of many months to owners of labor and land in a line of
production. He has in his ownership, as a result, a mass of fifth-,
fourth-, and third-order capital goods. None of these capital
goods is of any use to him, however, until the goods can be further
worked on and the final product obtained and sold to the consumer.
Popular literature attributes enormous “power” to
the capitalist and considers his owning a mass of capital
goods as of enormous significance, giving him a great
advantage over other people in the economy. We see, however, that this
is far from the case; indeed, the opposite may well be true. For the
capitalist has already saved from possible consumption and hired the
services of factors to produce his capital goods. The owners of these
factors have the money already for which they otherwise would
have had to save and wait (and bear uncertainty), while the capitalist
has only a mass of capital goods, a mass that will prove worthless to
him unless it can be further worked on and the product sold to the
consumers.
When the capitalist purchases factor services, what is the precise
exchange that takes place? The capitalist gives money (a present good)
in exchange for receiving factor services (labor and land), which work
to supply him with capital goods. They supply him, in other words, with
future goods. The capital goods for which he pays
are way stations on the route to the final product—the
consumers’ good. At the time when land and labor are hired to
produce capital goods, therefore, these capital goods, and
therefore the services of the land and labor, are future
goods; they represent the embodiment of the expected yield of a good in
the future—a good that can then be consumed. The capitalist
who buys the services of land and labor in year one to work on a
product that will eventually become a consumers’ good ready
for sale in year two is advancing money (a present good) in exchange
for a future good—for the present anticipation of a yield of
money in the future from the sale of the final product. A present good
is being exchanged for an expected future good.
Under the conditions of our example, we are assuming that the
capitalists own no original factors, in contrast to
the first case, in which the products were jointly owned by the owners
of these factors. In our case, the capitalists originally owned money,
with which they purchased the services of land and labor in order to
produce capital goods, which are finally transformed by land and labor
into consumers’ goods. In this example we have assumed that
the capitalists do not at any time own any of the co-operating labor or
land factors. In actual life, of course, there may be and are
capitalists who both work in some managerial capacity in the production
process and also own the land on which they operate. Analytically,
however, it is necessary to isolate these various functions. We may
call those capitalists who own only the capital goods and the final
product before sale “pure capitalists.”
Let us now add another temporary restriction to our
analysis—namely, that all producers’ goods and
services are only hired, never bought outright.
This is a convenient assumption that will be maintained long after the
assumption of specific factors is dropped. We here assume that the pure
capitalists never purchase as a whole a factor that in itself
could yield several units of service. They can only hire
the services of factors per unit of time. This situation is directly
analogous to the conditions described in chapter 4, section 7
above, in which consumers bought or “rented” the
unit services of goods rather than the goods as a whole. In a free
economy, of course, this hiring or renting must always occur in the
case of labor services. The laborer, being a free man, cannot
be bought; i.e., he cannot be paid a cash value for his total
future anticipated services, after which he is at the permanent command
of his buyer. This would be a condition of slavery, and even
“voluntary slavery,” as we have seen, cannot be
enforced on the free market because of the inalienability of personal
will. A laborer cannot be bought, then, but his services
can be bought over a period of time; i.e., he can be rented or hired.
7.
Present and Future Goods: The Pure Rate of Interest
We are deferring until later the major part of the analysis of the
pricing of productive services and factors. At this point we can see,
however, that the purchasing of labor and land services are
directly analogous. The classical discussion of productive income
treats labor as earning wages whereas land earns rents, and the two are
supposed to be subject to completely different laws. Actually, however,
the earnings of labor and land services are analogous. Both are
original and productive factors; and in the case in which land is hired
rather than bought, both are rented per unit of time rather than sold
outright. Generally, writers on economics have termed those capitalists
“entrepreneurs” who buy labor and land
factors in expectation of a future monetary return from the
final product. They are entrepreneurs, however, only in the
actual economy of uncertainty. In an evenly rotating economy, where all
the market actions are repeated in an endless round and there
is therefore no uncertainty, entrepreneurship disappears. There is no
uncertain future to be anticipated and about which forecasts are made.
To call these capitalists simply entrepreneurs, then, is tacitly to
imply that in the evenly rotating economy there will be no capitalists,
i.e., no group that saves money and hires the services of factors,
thereby acquiring capital and consumers’ goods to be sold to
the consumers. Actually, however, there is no reason why pure
capitalists should not continue in the ERE (the evenly
rotating economy). Even if final returns and consumer demand
are certain, the capitalists are still providing present goods to the
owners of labor and land and thus relieving them of the burden of
waiting until the future goods are produced and finally transformed
into consumers’ goods. Their function, therefore, remains in
the ERE to provide present goods and to assume the burden of waiting
for future returns over the period of the production process. Let us
assume simply that the sum the capitalists paid out was 95 ounces and
that the final sale was for 100 ounces. The five ounces accruing to the
capitalists is payment for their function of supplying present
goods and waiting for a future return. In short, the capitalists, in
year one, bought future goods for 95 ounces and then sold the
transformed product in year two for 100 ounces when it had become a
present good. In other words, in year one the market price of
an anticipated (certain) income of 100 ounces was only 95 ounces. It is
clear that this arises out of the universal fact of time preference and
of the resulting premium of a given good at present over the present
prospect of its future acquisition.
In the monetary economy, since money enters into all
transactions, the discount of a future good against a present
good can, in all cases, be expressed in terms of one good: money. This
is so because the money commodity is a present good and because claims
to future goods are almost always expressed in terms of future money
income.
The factors of production in our discussion have all been
assumed to be purely specific to a
particular line of production. When the capitalists have saved money
(“money capital”), however, they are at liberty to
purchase factor services in any line of production. Money,
the general medium of exchange, is precisely nonspecific. If,
for example, the saver sees that he can invest 95 ounces in the
aforementioned production process and earn 100 ounces in a year,
whereas he can invest 95 ounces in some other process and earn 110
ounces in a year, he will invest his money in the process earning the
greater return. Clearly, the line in which he will feel impelled to
invest will be the line that earns him the greatest rate
of return on his investment.
The concept of rate of return is necessary in order
for him to compare different potential investments for different
periods of time and involving different sums of money. For any amount
of money that he saves, he would like to earn the greatest amount of
net return, i.e., the greatest rate of net return. The absolute amount
of return has to be reduced to units of time, and this is done by
determining the rate per unit of time. Thus, a return of 20
ounces on an investment of 500 ounces after two years is 2 percent per
annum, while a return of 15 ounces on the same investment
after one year is a return of 3 percent per annum.
After data work themselves out and continue without change, the rate of
net return on the investment of money capital will, in the ERE, be the same
in every line of production. If capitalists can earn 3 percent per
annum in one production process and 5 percent per annum in another,
they will cease investing in the former and invest more in the latter
until the rates of return are uniform. In the ERE, there is no
entrepreneurial uncertainty, and the rate of net return is the pure
exchange ratio between present and future goods. This rate of return is
the rate of interest. This pure
rate of interest will be uniform for all periods of time and
for all lines of production and will remain constant in the ERE.
Suppose that at some time the rates of interest earned are not uniform
as between several lines of production. If capitalists are generally
earning 5 percent interest, and a capitalist is obtaining 7 percent in
a particular line, other capitalists will enter this line and bid away
the factors of production from him by raising factor prices. Thus, if a
capitalist is paying factors 93 ounces out of 100 income, a
competing capitalist can offer 95 ounces and outbid the first for the
use of the factors. The first, then, forced to meet the competition of
other capitalists, will have to raise his bid eventually to 95
(disregarding for simplicity the variation in percentages
based on the investment figure rather than on 100). The same
equalization process will occur, of course, between
capitalists and firms within the same line of
production—the same “industry.” There is
always competitive pressure, then, driving toward a uniform rate of
interest in the economy. This competition, it must be pointed
out, does not take place simply between firms in the same industry or
producing “similar” products. Since money is the
general medium of exchange and can be invested in all products, this
close competition extends throughout the length and breadth of the
production structure.
A fuller discussion of the determination of the rate of interest will
take place in chapter 6 below. But one thing should here be evident.
The classical writers erred grievously in their discussion of
the income-earning process in production. They believed that
wages were the “reward” of labor, rents the
“reward” of land, and interest the
“reward” of capital goods, the three
supposedly co-ordinate and independent factors of production.
But such a discussion of interest was completely fallacious. As we have
seen and shall see further below, capital goods are not
independently productive. They are the imputable creatures of
land and labor (and time). Therefore, capital goods generate no
interest income. We have seen above, in keeping with this
analysis, that no income accrues to the
owners of capital goods as such.
If the owners of land and labor factors receive all the income (e.g.,
100 ounces) when they own the product jointly, why do their owners
consent to sell their services for a total of five ounces less than
their “full worth”? Is this not some form of
“exploitation” by the capitalists? The answer again
is that the capitalists do not earn income from
their possession of capital goods or because capital goods generate any
sort of monetary income. The capitalists earn income in their
capacity as purchasers of future goods in exchange for
supplying present goods to owners of factors. It is this time
element, the result of the various individuals’
time preferences, and not the alleged independent
productivity of capital goods, from which the interest rate and
interest income arise.
The capitalists earn their interest income, therefore, by
supplying the services of present goods to owners of factors
in advance of the fruits of their production, acquiring their
products by this purchase, and selling the products at the
later date when they become present goods. Thus, capitalists
supply present goods in exchange for future goods (the capital goods),
hold the future goods, and have work done on them until they become
present goods. They have given up money in the present for a greater
sum of money in the future, and the interest rate that they have earned
is the agio, or discount on future goods as compared with present
goods, i.e., the premium commanded by present goods over future goods.
We shall see below that this exchange rate between present and future
goods is not only uniform in the production process, but throughout the
entire market system. It is the “social rate of time
preference.” It is the “price of time” on
the market as the resultant of all the individual valuations of that
good.
How the agio, or pure interest rate, is determined in the
particular time-exchange markets, will be discussed below.
Here we shall simply conclude by observing that there is some agio
which will be established uniformly throughout the economy and which
will be the pure interest rate on the certain expectation of
future goods as against present goods.
8.
Money Costs, Prices, and Alfred Marshall
In the ERE, therefore, every good sold to consumers will sell at a
certain “final equilibrium” price and at certain
total sales. These receipts will accrue in part to capitalists in the
form of interest income, and the remainder to owners of land and
labor. The payments of income to the producers have also been
popularly termed “costs.” These are clearly money
costs, or money expenses, and obviously are not the same thing as
“costs” in the psychic sense of subjective
opportunity forgone. Money costs may be ex post as well as ex ante. (In
the ERE, of course, ex ante and ex post calculations are always the
same.) However, the two concepts become linked when psychic
costs are appraised as much as possible in monetary terms. Thus,
payment to factors may be 95 ounces and recorded as a cost, while the
capitalist who earns an interest of five ounces considers 100 as an
opportunity cost, since he could have invested elsewhere and earned
five (actually, a bit higher) percent interest.
If, for the moment, we include as money
costs factor payments and interest,
then in the ERE, money
costs equal total money sales for every firm in every line of
production. A firm earns entrepreneurial profits when
its return is more than interest, suffers entrepreneurial losses
when its return is less. In our production process, consumers
will pay 100 ounces (money sales), and money costs are 100 ounces
(factor plus interest income) and there will be similar equality for
all other goods and processes. What this means, in essence, is that
there are no entrepreneurial profits or losses in the ERE, because
there is no change of data or uncertainty about possible
change. If total money sales equal total money costs, then it evidently
follows that total money sales per unit sold will
equal total money costs per unit sold. This follows from elementary
rules of arithmetic. But the money sales per unit are equal to the money
price of the good, by definition; while we shall call the
total money costs per unit the average money cost
of the good. It likewise follows, therefore, that price will
equal average money cost for every good in the ERE.
Strange as it may seem, a great many writers on economics have deduced
from this a curious conclusion indeed. They have deduced that
“in the long run” (i.e., in the ERE), the fact that
costs equal sales or that “cost equals price”
implies that costs determine price. The
price of the good discussed above is 100 ounces per unit, allegedly because
the cost (average money cost) is 100 ounces per unit. This is supposed
to be the law of price determination “in the long
run.” It would seem to be crystal clear, however, that the
truth is precisely the reverse. The price of the final product is
determined by the valuations and demands of the consumers, and this
price determines what the cost will be. If the
consumers value the product mentioned above so that its price is 50
ounces instead of 100 ounces, as a result, say, of a change in their
valuations, then it is precisely in the “long run,”
when the effects of uncertainty are removed, that “costs of
production” (here, factor payment plus interest payment) will
equal the final price. We have seen above how factor incomes are at the
mercy of consumer demand and fluctuate according to that demand. Factor
payments are the result of sales to consumers and do
not determine the latter in advance. Costs of production,
then, are at the mercy of final price, and not the other way around. It
is ironic that it is precisely in the ERE that this causative
phenomenon should be the clearest. For in the ERE we see quite
evidently that consumers pay and determine the final price of the
product; that it is through these payments and these payments
alone that factors and interest are paid; that therefore the amount of
the payments and the total “costs of production”
are determined by price and not vice versa. Money
costs are the opposite of a basic, determining factor; they
are dependent on the price of the product and on consumer demands.
In the real world of uncertainty it is more difficult to see this,
because factors are paid in advance of the sale of
the product, since the capitalist-entrepreneurs speculatively advance
money to the factors in the expectation of being
able to recoup their money with a surplus for interest and profit after
sale to the consumers.
Whether they do so or not
depends on their foresight regarding the state of consumer demand and
the future prices of consumers’ goods. In the real world of
immediate market prices, of course, the existence of entrepreneurial
profit and loss will always prevent costs and receipts, cost
and price, from being identical, and it is obvious to all that price is
solely determined by valuations of stock—by
“utilities”—and not at all by money cost.
But although most economists recognize that in the real world
(the so-called “short-run”) costs cannot
determine price, they are seduced by the habit of the individual
entrepreneur of dealing in terms of “cost” as the
determining factor, and they apply this procedure to the case
of the ERE and therefore to the inherent long-run tendencies
of the economy. Their grave error, as will be discussed
further below, comes from viewing the economy from the standpoint of an
individual entrepreneur rather than from that of an economist. To the
individual entrepreneur, the “cost” of factors is
largely determined by forces outside himself and his own sales; the
economist, however, must see how money costs are determined and, taking
account of all the interrelations in the economy, must recognize that
they are determined by final prices reflecting consumer demands and
valuations.
The source of the error will become clearer below when we consider a
world of nonspecific as well as specific factors. However, the
essentials of our analysis and its conclusion remain the same in that
more complex and realistic case.
The classical economists were under the delusion that the price of the
final product is determined by “costs of
production,” or rather they fluctuated between this doctrine
and the “labor theory of value,” which
isolated the money costs of labor and picked that segment of the cost
of production as the determinant of price. They slurred over the
determination of the prices of such goods as old paintings that already
existed and needed no further production. The correct relation
between prices and costs, as outlined above, was developed, along with
other outstanding contributions to economics, by the
“Austrian” economists, including the
Austrians Carl Menger, Eugen von Böhm-Bawerk, and Friedrich
von Wieser, and the Englishman W. Stanley Jevons. It was with the
writings of the Austrian School in the 1870’s and
1880’s that economics was truly established as a science.
Unfortunately, in the science of economics, retrogression
in knowledge has taken place almost as often as progression. The
enormous advance provided by the Austrian School, on this point as on
others, was blocked and reversed by the influence of Alfred Marshall,
who attempted to rehabilitate the classicists and integrate
them with the Austrians, while disparaging the contributions
of the latter. It was unfortunately the Marshallian and not the
Austrian approach that exerted the most influence over later writers.
This influence is partly responsible for the current myth among
economists that the Austrian School is effectively dead and has no more
to contribute and that everything of lasting worth that it had to offer
was effectively stated and integrated in Alfred Marshall’s Principles.
Marshall tried to rehabilitate the cost-of-production theory of the
classicists by conceding that, in the “short run,”
in the immediate market place, consumers’ demand
rules price. But in the long run, among the important reproducible
goods, cost of production is determining. According to
Marshall, both utility and money costs determine price, like blades of
a scissors, but one blade is more important in the short run, and
another in the long run. He concludes that
as
a general rule, the shorter the period we are considering, the greater
must be the share of our attention which is given to the influence of
demand on value; and the longer the period, the more important will be
the influence of cost of production on value. . . . The actual value at
any time, the market value as it is often called, is often more
influenced by passing events and by causes whose action is fitful and
shortlived, than by those which work persistently. But in long
periods these fitful and irregular causes in large measure efface one
another’s influence; so that in the long run
persistent causes dominate value completely.
The implication is quite clear: if one deals with
“short-run” market values, one is being quite
superficial and dwelling only on fitful and transient
causes—so much for the Austrians. But if one wants to deal
with the “really basic” matters, the really
lasting and permanent causes of prices, he must concentrate on
costs of production—pace the classicists.
This impression of the Austrians—their alleged
neglect of the “long period,” and
“one-sided neglect of costs”—has been
stamped on economics ever since.
Marshall’s analysis suffers from a grave methodological
defect—indeed, from an almost hopeless methodological
confusion as regards the “short run” and the
“long run.” He considers the “long
run” as actually existing, as being the permanent,
persistent, observable element beneath the fitful, basically
unimportant flux of market value. He admits (p. 350) that
“even the most persistent causes are, however,
liable to change,” but he clearly indicates that
they are far less likely to change than the fitful
market values; herein, indeed, lies their long-run nature. He
regards the long-run data, then, as underlying the transient market
values in a way similar to that in which the basic sea level underlies
the changing waves and tides.
For Marshall, then, the
long-run data are something that can be spotted and marked by an
observer; indeed, since they change far more slowly than the market
values, they can be observed more accurately.
Marshall’s conception of the long run is completely
fallacious, and this eliminates the whole groundwork of his theoretical
structure. The long run, by its very nature, never
does and never can exist. This does not mean that
“long-run,” or ERE, analysis is not important. On
the contrary, only through the concept of the ERE can we subject to
catallactic analysis such critical problems as entrepreneurial profit,
the structure of production, the interest rate, and the
pricing of productive factors. The ERE is the goal (albeit shifting in
the concrete sense) toward which the market moves. But the
point at issue is that it is not observable, or
real, as are actual market prices.
We have seen above the characteristics of the evenly rotating economy.
The ERE is the condition that comes into being and continues to obtain
when the present, existing market data (valuations,
technology, resources) remain constant. It is a theoretical
construct of the economist that enables him to point out in what
directions the economy tends to be moving at any given time; it also
enables the economist to isolate various elements in his analysis of
the economy of the real world. To analyze the determining
forces in a world of change, he must construct hypothetically
a world of nonchange. This is far different from, indeed, it
is the reverse of, saying that the long run exists or that it is
somehow more permanently or more persistently
existent than the actual market data. The actual market prices, on the
contrary, are the only ones that ever exist, and
they are the resultants of actual market data (consumer
demands, resources, etc.) that themselves change continually. The
“long run” is not more stable;
its data necessarily change along with the data on the market. The fact
that costs equal prices in the “long run” does not
mean that costs will actually equal prices, but that the
tendency exists, a tendency that is continually being disrupted
in reality by the very fitful changes in market data that
Marshall points out.
In sum, rather than being in some sense more persistent and more real
than the actual market, the “long run” of the ERE
is not real at all, but a very useful theoretical construct that
enables the economist to point out the direction in which the
market is moving at any given time—specifically,
toward the elimination of profits and losses if existing
market data remain the same. Thus, the ERE concept is especially
helpful in the analysis of profits and losses as compared to
interest. But the market data are the only actual reality.
This is not to deny, and the Austrians never did deny, that subjective
costs, in the sense of opportunity costs and utilities forgone, are
important in the analysis of production. In particular, the
disutilities of labor and of waiting—as expressed in the
time-preference ratios—determine how much of
people’s energies and how much of their savings will go into
the production process. This, in the broadest sense, will determine or
help to determine the total supply of all goods that will be produced.
But these costs are themselves subjective utilities, so that both
“blades of the scissors” are governed by the
subjective utility of individuals. This is a monistic
and not a dualistic causal explanation. The costs, furthermore, have no
direct influence on the relative amount of the stock of each
good to be produced. Consumers will evaluate the various
stocks of goods available. How much
productive energy and savings will go into producing stock of
one particular good and how much into producing another, in other
words, the relative stocks of each product, will depend in turn on
entrepreneurial expectations of where the greatest monetary profit will
be found. These expectations are based on the anticipated
direction of consumer demand.
As a result of such anticipations, the nonspecific
factors will move to the production of those goods where, ceteris
paribus, their owners will earn the highest incomes. An
exposition of this process will be presented below.
Marshall’s treatment of subjective costs was also highly
fallacious. Instead of the idea of opportunity costs, he had
the notion that they were “real costs” that could
be added in terms of measurable units. Money costs of production, then,
became the “necessary supply prices” that
entrepreneurs had to pay in order “to call forth an adequate
supply of the efforts and waitings” to produce a supply of
the product. These real costs were then supposed to be the fundamental,
persisting element that backstops money costs of production,
and allowed Marshall to talk of the more persisting, long-run, normal
situation.
Marshall’s great error here, and it has permeated the works
of his followers and of present-day writers, is to regard costs and
production exclusively from the point of view of an isolated
individual entrepreneur or an isolated individual industry,
rather than viewing the whole economy in all its interrelations.
Marshall is dealing, of
necessity, with particular prices of different goods, and he is
attempting to show that alleged “costs of
production” determine these prices in the long run.
But it is completely erroneous to tie up particular goods with
labor vs. leisure and with consuming vs. waiting costs, for the latter
are only general phenomena, applying and
diffusing throughout the entire economic system. The price
necessary to call forth a nonspecific factor is the highest
price this factor can earn elsewhere—an opportunity cost.
What it can attain elsewhere is basically determined by the state of
consumer demand elsewhere. The forgone leisure-and-consumption costs,
in general, only help to determine the size—the general
stock—of labor and savings that will be applied to
production. All this will be treated further below.
9.
Pricing and the Theory of Bargaining
We have seen that, for all goods, total receipts to sellers will tend
to equal total payments to factors, and this equality will be
established in the evenly rotating economy. In the ERE,
interest income will be earned at the same uniform rate by
capitalists throughout the economy. The remainder of income from
production and sale to consumers will be earned by the owners
of the original factors: land and labor.
Our next task will be to analyze the determination of the prices of
factor services and the determination of the interest rate, as they
tend to be approached in the economy and would be reached in the ERE.
Until now, discussion has centered on the capital-goods structure,
treated as if it were in one composite stage of
production. Clearly, there are numerous stages, but we have seen above
that earnings in production ultimately resolve themselves, and
certainly do so in the ERE, into the earnings of the original factors:
land and labor. Later on, we shall expand the analysis to include the
case of many stages in the production process, and
we shall defend this type of temporal analysis of production against
the very fashionable current view that production is
“timeless” under modern conditions and that the
original-factor analysis might have been useful for the primitive era
but not for a modern economy. As a corollary to this, we shall develop
further an analysis of the nature of capital and time in the
production process.
What will be the process of pricing productive factors in a world of
purely specific factors? We have been assuming that only services
and not whole goods can be acquired. In the case of labor this is true
because of the nature of the free society; in the case of land and
capital goods, we are assuming that the capitalist
product-owners hire or rent rather than own any of the productive
factors outright. In our example above, the 95 ounces went to all the
factor-owners jointly. By what principles can we
determine how the joint income is allocated to the various individual
factor services? If all the factors are purely specific, we can resort
to what is usually called the theory of bargaining.
We are in a very analogous situation to the two-person
barter of chapter 2. For what we have is not relatively determinate
prices, or proportions, but exchange ratios with wide zones between the
“marginal pairs” of prices. The maximum price of
one is widely separated from the minimum price of the other.
In the present case, we have, say, 12 labor and land factors, each of
which is indispensable to the production of the good. None of the
factors, furthermore, can be used anywhere else, in any other line of
production. The question for these factor-owners to solve is the
proportionate share of each in the total joint income. Each
factor-owner’s maximum goal is something slightly less than
100 percent of the income from the consumers. What the final decision
will be cannot be indicated by praxeology. There is, for all practical
purposes, no theory of bargaining; all that can be said is that since
the owner of each factor wants to participate and earn some income, all
will most likely arrive at some sort of voluntary contractual
arrangement. This will be a formal type of partnership agreement if the
factors jointly own the product; or it will be the implicit
result if a pure capitalist purchases the services of the factors.
Economists have always been very unhappy about bargaining situations of
this kind, since economic analysis is estopped from saying anything
more of note. We must not pursue the temptation, however, to
condemn such situations as in some way
“exploitative” or bad, and thereby convert
barrenness for economic analysis into tragedy for the economy. Whatever
agreement is arrived at by the various individuals will be beneficial
to every one of them; otherwise, he would not have so agreed.
It is generally assumed that, in the jockeying for proportionate
shares, labor factors have less “bargaining power”
than land factors. The only meaning that can be seen in the
term “bargaining power” here is that some
factor-owners might have minimum reservation prices for their factors,
below which they would not be entered in production. In that case,
these factors would at least have to receive the
minimum, while factors with no minimum, with no reservation price,
would work even at an income of only slightly more than zero. Now it
should be evident that the owner of every labor factor has some
minimum selling price, a price below which he will not work. In our
case, where we are assuming (as we shall see, quite unrealistically)
that every factor is specific, it is true that no
laborer would be able to earn a return in any other type of work. But
he could always enjoy leisure, and this sets a minimum supply price for
labor service. On the other hand, the use of land sacrifices no
leisure. Except in rare cases where the owner enjoys a valuable
esthetic pleasure from contemplating a stretch of his own land not in
use, there is no revenue that the land can bring him except a monetary
return in production. Therefore, land has no reservation price, and the
landowner would have to accept a return of almost zero rather than
allow his land to be idle. The bargaining power of the owner of labor,
therefore, is almost always superior to that of the owner of land.
In the real world, labor, as will be seen below, is uniquely the nonspecific
factor, so that the theory of bargaining could never apply to labor
incomes.
Thus, when two or more factors are specific to a given line of
production, there is nothing that economic analysis can say further
about the allocation of the joint income from their product;
it is a matter of voluntary bargaining between them.
Bargaining and indeterminate pricing also take place even
between two or more nonspecific factors in the rare case where the
proportions in which these factors must be
used are identical in each employment. In such
cases, also, there is no determinate pricing for any of the factors
separately, and the result must be settled by mutual bargaining.
Suppose, for example, that a certain machine, containing two necessary
parts, can be used in several fields of production. The two parts,
however, must always be combined in use in a certain fixed proportion.
Suppose that two (or more) individuals owned these two parts, i.e., two
different individuals produced the different parts by their
labor and land. The combined machine will be sold to, or used in, that
line of production where it will yield the highest monetary income. But
the price that will be established for that machine will
necessarily be a cumulative price so far as the two
factors—the two parts—are concerned. The price of
each part and the allocation of the income to the two owners must be
decided by a process of bargaining. Economics cannot here determine
separate prices. This is true because the proportions between
the two are always the same, even though the combined product can be
used in several different ways.
Not only is bargaining theory rarely applicable in the real world, but
zones of indeterminacy between valuations, and therefore zones
of indeterminacy in pricing, tend to dwindle radically in importance as
the economy evolves from barter to an advanced monetary economy. The
greater the number and variety of goods available, and the greater the
number of people with differing valuations, the more negligible will
zones of indeterminacy become.
At this point, we may introduce another rare, explicitly empirical,
element into our discussion: that on this earth, labor has been a far
scarcer factor than land. As in the case of Crusoe, so in the case of a
modern economy, men have been able to choose which land to use in
various occupations, and which to leave idle, and have found themselves
with idle “no-rent” land, i.e., land
yielding no income. Of course, as an economy advances, and
population and utilization of resources grow, there is a
tendency for this superfluity of land to diminish (barring discoveries
of new, fertile lands).
The term “pure rate of
interest” corresponds to Mises’ term
“originary rate of interest.” See
Mises, Human Action, passim.
Here the reader is referred to one
of the great works in the history of economic thought, Eugen von
Böhm-Bawerk’s Capital and Interest
(New York: Brentano’s, 1922), where the correct theory of
interest is outlined; in particular, the various false
theories of interest are brilliantly dissected. This is not to say that
the present author endorses all of Böhm-Bawerk’s
theory of interest as presented in his Positive Theory of
Capital.
Strictly, this assumption is
incorrect, and we make it in this section only for purposes of
simplicity. For interest may be an opportunity cost for an individual
investor, but it is not a money cost,
nor is it an opportunity cost for the aggregate of
capitalists. For the implications of this widely held error in economic
literature, see André Gabor and I.F.
Pearce, “The Place of Money Capital in the Theory of
Production,” Quarterly Journal of Economics,
November, 1958, pp. 537–57; and Gabor and Pearce,
“A New Approach to the Theory of the Firm,” Oxford
Economic Papers, October, 1952, pp. 252–65.
Cf. Menger, Principles
of Economics, pp. 149ff.
The very interesting researches by
Emil Kauder indicate that the essentials of the Austrian
marginal utility theory (the basis of the view that price determines
cost and not vice versa or mutually) had already
been formulated by French and Italian economists of the seventeenth and
eighteenth centuries and that the English classical school shunted
economics onto a very wrong road, a road from which economics
was extricated only by the Austrians. See
Emil Kauder, “Genesis of the Marginal Utility
Theory,” Economic Journal, September,
1953, pp. 638–50; and Kauder, “Retarded Acceptance
of the Marginal Utility Theory.”
Alfred Marshall, Principles
of Economics (8th ed.; London: Macmillan & Co.,
1920), pp. 349ff.
This analogy, though not used in
this context, was often used by classical economists as applied to
prices and “the price level,” an application
equally erroneous.
On this error in Marshall, see
F.A. Hayek, The Pure Theory of Capital (Chicago:
University of Chicago Press, 1941), pp. 21, 27–28. Marshall
is here committing the famous fallacy of “conceptual
realism,” in which theoretical constructs are mistaken for
actually existing entities. For other examples, cf. Leland B. Yeager,
“Some Questions on Growth Economics,” American
Economic Review, March, 1954, p. 62.
Marshall, Principles of
Economics, pp. 338ff.
We must hasten to point out that
this is by no means the same criticism as the neo-Keynesian charge that
economists must deal in broad aggregates, and not with individual
cases. The latter approach is even worse, since it begins with
“wholes” that have no basis in reality whatever.
What we are advocating is a theory that deals with all the individuals
as they interact in the economy. Furthermore, this is the
“Austrian,” and not the Walrasian approach, which
has recently come into favor. The latter deals with interrelations of
individuals (“the general equilibrium
approach”) but only in the ERE and with mathematical
abstractions in the ERE.
Little of value has been said
about bargaining since Böhm-Bawerk. See
Böhm-Bawerk, Positive Theory of Capital,
pp. 198–99. This can be seen in J. Pen’s
“A General Theory of Bargaining,” American
Economic Review, March, 1952, pp. 24ff. Pen’s own
theory is of little worth because it rests explicitly on an
assumption of the measurability of utility. Ibid.,
p. 34 n.
Contrast the discussion in most
textbooks, where bargaining occupies an important place in explanation
of market pricing only in the discussion of labor
incomes.
See Mises,
Human Action, p. 336.
Any zone of indeterminacy in
pricing must consist of the coincidence of an absolutely vertical
supply curve with an absolutely vertical market demand curve for the
good or service, so that the equilibrium price is in a zone rather than
at a point. As Hutt states, “It depends entirely upon the
fortuitous coincidence of . . . an unusual and highly improbable demand
curve with an absolutely rigid supply curve.” W.H. Hutt, The
Theory of Collective Bargaining (Glencoe, Ill.: The Free
Press, 1954), pp. 90, and 79–109.
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