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Chapter 8—Production: Entrepreneurship and Change (continued)

4. Capital Accumulation and the Length of the Structure of Production

     We have been demonstrating that investment lengthens the structure of production. Now we may consider some criticisms of this approach.

     Böhm-Bawerk is the great founder of production-structure analysis, but unfortunately he left room for misinterpretation by identifying capital accumulation with adopting “more round­about” methods of production. Thus, consider his famous ex­ample of the Crusoe who must first construct (and then maintain) a net if he wishes to catch more than the number of fish he can catch without any capital. Böhm-Bawerk stated: “The roundabout ways of capital are fruitful but long; they procure us more or better consumption goods, but only at a later period of time.”[24] Calling these methods “roundabout” is definitely paradoxical; for do we not know that men strive always to achieve their ends in the most direct and shortest manner possible? As Mises demon­strates, rather than speak of the higher productivity of round­about methods of production, “it is more appropriate to speak of the higher physical productivity of production processes re­quiring more time” (longer processes).[25]

     Now let us suppose that we are confronted with an array of possible production processes, based on their physical produc­tivities. We may also rank the processes in accordance with their length, i.e., in terms of the waiting time between the input of the resources and the yielding of the final product. The longer the waiting period between first input and final output, the greater the disutility, ceteris paribus, since more time must elapse before the satisfaction is attained.

     The first processes to be used will be those most productive (in value and physically) and the shortest. No one has maintained that all long processes are more productive than all short proc­esses.[26] The point is, however, that all short and ultraproductive processes will be the first ones to be invested in and established. Given any present structure of production, a new investment will not be in a shorter process because the shorter, more productive process would have been chosen first.

     As we have seen, there is only one way by which man can rise from the ultraprimitive level: through investment in capital. But this cannot be accomplished through short processes, since the short processes for producing the most valuable goods will be the ones first adopted. Any increase in capital goods can serve only to lengthen the structure, i.e., to enable the adoption of longer and longer productive processes. Men will invest in longer processes more productive than the ones previously adopted. They will be more productive in two ways: (1) by producing more of a previously produced good, and/or (2) by producing a new good that could not have been produced at all by the shorter processes. Within this framework these longer processes are the most direct that must be used to attain the goal—not more roundabout. Thus, if Crusoe can catch 10 fish per day directly without capital and can catch 100 fish per day with a net, building a net should not be considered as a “more roundabout method of catching fish,” but as the “most direct method for catching 100 fish a day.” Furthermore, no amount of labor and land without capital could enable a man to produce an automobile; for this a certain amount of capital is required. The production of the requisite amount of capital is the shortest and most direct method of ob­taining an automobile.

     Any new investment will therefore be in a longer and more productive method of production. Yet, if there were no time preference, the most productive methods would be invested in first, regardless of time, and an increase in capital would not cause more productive methods to be used. The existence of time pref­erence acts as a brake on the use of the more productive but longer processes. Any state of equilibrium will be based on the time-preference, or pure interest, rate, and this rate will determine the amount of savings and capital invested. It determines capital by imposing a limit on the length of the production processes and therefore on the maximum amount produced. A lowering of time preference, therefore, and a consequent lowering of the pure rate of interest signify that people are now more willing to wait for any given amount of future output, i.e., to invest more proportionately and in longer processes than heretofore. A rise in time preference and in the pure interest rate means that people are less willing to wait and will spend proportionately more on consumers’ goods and less on the longer production processes, so that investments in the longest processes will have to be aban­doned.[27]

     One qualification to the law that increased investment length­ens production processes appears when investment turns to a type of good which is less useful than the goods previously acquired, yet which has a shorter process of production than some of the others. Here the investment in this process was checked, not by the length of the process, but by its inferior (value) productivity. Yet even here the structure of production was lengthened, since people have to wait longer for the new and the old goods than they previously did for the old good. New capital investment al­ways lengthens the overall structure of production.

     What of the case where a technological invention permits a more productive process with a lesser amount of capital invest­ment? Is this not a case in which increased investment shortens the production structure? Up to this point we have been assuming technological knowledge as given. Yet it is not given in the dy­namic world. Technological advance is one of the most dramatic features of the world of change. What then of these “capital-sav­ing” inventions? One interesting example was cited by Horace White in a criticism of Böhm-Bawerk.[28] Oil was produced first by ships hunting in the Arctic for whales, the whale oil being processed from the whales, etc., an obviously lengthy production process. Later an invention permitted people to bore for oil in the ground, thereby immeasurably shortening the production period.

     Aside from the fact that, empirically, most inventions do not shorten physical production processes, we must reply that the limits at any time on investment and productivity are a scarcity of saved capital, not the state of technological knowledge. In other words, there is always an unused shelf of technological projects available and idle. This is demonstrable by the fact that a new invention is not immediately and instantaneously adopted by all firms in the society. Therefore, any further investment will lengthen production processes, many of them more productive because of superior technique. A new invention does not auto­matically impel itself into production, but first joins the unused array. Further, in order for the new invention to be used, more capital must be invested. The ships for whaling have already been built; the oil wells and machinery, etc., must be created anew. Even the newly invented method will yield a greater product only through further investment in longer processes. In other words, the only way to obtain more oil now is to invest more capital in more machinery and lengthier production periods in the oil­-drilling business. As Böhm-Bawerk pointed out, White’s criticism would apply only if the invention were progressively capital-sav­ing, so that the product would always increase with the shortening of the process. But in that case, boring for oil with one’s bare hands, unaided by capital, would have to be more productive than drilling for oil with machinery.[29]

     Böhm-Bawerk drew the analogy of an agricultural invention applied to two grades of land, one grade previously yielding a marginal product of 100 bushels of wheat, the lower grade yield­ing 80 bushels. Now suppose use of the invention raises the mar­ginal product of the lower-grade land to 110 bushels. Does this mean that the poorer land now yields more than the fertile land and that the effect of agricultural inventions is to make poorer lands more productive than fertile ones? Yet this is precisely analogous to White’s position, which maintains that inventions may cause shorter production processes to be more productive! As Böhm-Bawerk pointed out, it is obvious that the source of the error is this: inventions increase the physical productivity of both grades of land. The better land becomes still better. Simi­larly, perhaps it is true that an invention will cause a shorter process to be more productive now than a longer process was previously. But this does not mean that it is superior to all longer processes; longer processes using the invention will still be more productive than the shorter ones. (Boring for oil with machinery is more productive than boring for oil without machinery.)

     Technological inventions have received a far more important place than they deserve in economic theory. It has often been assumed that production is limited by the “state of the arts”—by technological knowledge—and therefore that any improvement in technology will immediately show itself in production. Tech­nology does, of course, set a limit on production; no production process could be used at all without the technological knowledge of how to put it into operation. But while knowledge is a limit, capital is a narrower limit. It is logically obvious that while cap­ital cannot engage in production beyond the limits of existing available knowledge, knowledge can and does exist without the capital necessary to put it to use. Technology and its improve­ment, therefore, play no direct role in the investment and pro­duction process; technology, while important, must always work through an investment of capital. As was stated above, even the most dramatic capital-saving invention, such as oil-drilling, can be put to use only by saving and investing capital.

     The relative unimportance of technology in production as com­pared to the supply of saved capital becomes evident, as Mises points out, simply by looking at the “backward” or “underde­veloped” countries.[30] What is lacking in these countries is not knowledge of Western technological methods (“know-how”); that is learned easily enough. The service of imparting knowledge, in person or in book form, can be paid for readily. What is lack­ing is the supply of saved capital needed to put the advanced methods into effect. The African peasant will gain little from looking at pictures of American tractors; what he lacks is the saved capital needed to purchase them. That is the important limit on his investment and on his production.[31]

     A businessman’s new investment in a longer and more phys­ically productive process will therefore be made from a sheaf of processes previously known but unusable because of the time­-preference limitation. A lowering of time preferences and of the pure interest rate will signify an expansion of saved capital at the disposal of investors and therefore an expansion of the longer processes, the time limitation on investment having been weak­ened.

     Some critics charge that not all net investment goes to length­ening the structure—that new investments might duplicate pre­-existing processes. This criticism misfires, however, because our theory does not assume that net saving must be invested in an actually longer process in some specific line of production. A longer production structure can just as well be achieved by a shift from consumption to investment that will lengthen the ag­gregate production structure by greater investment in already ex­isting longer processes, accompanied by less investment in existing shorter processes. Thus, in the case of Crusoe mentioned above, suppose that Crusoe now invests in a second net, which will permit him to catch a total of 150 fish a day. The structure of production is now lengthened even though the second net may be no more productive than the first. For the total period of production, from the time he must build and re­build his total capital until his product arrives, is now consider­ably longer. He must now cut down again on present consump­tion (including leisure) and work on his second net.[32]

5. The Adoption of a New Technique

     At any given time, then, there will be a shelf of available and more productive techniques that remain unused by many firms continuing with older methods. What determines the ex­tent to which these firms adopt new and more productive tech­niques?

     The reason that firms do not scrap their old methods imme­diately and begin afresh is that they and their ancestors have in­vested in a certain structure of capital goods. As times and tastes, resources, and techniques change, much of this capital investment becomes an ex post entrepreneurial error. If, in other words, in­vestors had been able to foresee the changed pattern of values and methods, they would have invested in a far different man­ner. Now, however, the investment has been made, and the re­sulting capital structure is a given residue from the past that supplies the resources they have to work with. Since costs in the present are only present and future opportunities forgone, and bygones are bygones, existing equipment must be used in the most profitable way. Thus, there undoubtedly would have been far less investment in railroads in late nineteenth-century Amer­ica if investors had foreseen the rise of truck and plane compe­tition.[33] Now that the existing railroad equipment remains, how­ever, decisions concerning how much of it is to be used must be based on current and expected future costs, not on past expenses or losses.

     An old machine will be scrapped for a new and better sub­stitute if the superiority of the new machine or method is great enough to compensate for the additional expenditure necessary to purchase the machine. The same applies to the shifting of a plant from an old location to a superior new location (superior because of greater access to factors or consumers). At any rate, the adoption of new techniques or locations is limited by the usefulness of the already given (and specific) capital-goods struc­ture. This means that those processes and methods will be adopted at any time which will best satisfy the desires of the consumers. The fact that investment in a new technique or location is un­profitable means that the use of capital in the new process at the cost of scrapping the old equipment is a waste from the point of view of satisfying consumer wants. How fast equipment or lo­cation is scrapped as obsolescent, then, is not decided arbitrarily by businessmen; it is determined by the values and desires of consumers, who decide on the price and profitability of the vari­ous goods and on the values of the necessary nonspecific factors used to produce these goods.[34]

     As is often true, critics of the free market have attacked it from two contradictory points of view: one, that it unduly slows down the rate of technological improvement from what it could and should be; and, two, that it unduly accelerates the rate of technological improvement, thereby unsettling the peaceful course of society. We have seen that a free market will, as far as the knowledge and foresight of entrepreneurs permit, produce so that factors are best allocated to satisfy the wishes of con­sumers. Improvement in productivity through new techniques and locations will be balanced against the opportunity costs for­gone in value product from using the existing old plant.[35] And ability in entrepreneurial foresight will be assured as much as possible by the market’s process of “selection” in “rewarding” good forecasters and “penalizing” poor ones proportionately.


     Under the stimulus of the late Professor Schumpeter, it has been thought that the essence of entrepreneurship is innovation —the disturbance of peaceful, unchanging business routine by bold innovators who institute new methods and develop new products. There is, of course, no denying the importance of the discovery and institution of more productive methods of obtain­ing a product or of the development of valuable new products. Analytically, however, there is danger of overrating the impor­tance of this process. For innovation is only one of the activities performed by the entrepreneur. As we have seen above, most entrepreneurs are not innovators, but are in the process of in­vesting capital within a large framework of available technologi­cal opportunities. Supply of product is limited by supply of cap­ital goods rather than by available technological know-how.

     Entrepreneurial activities are derived from the presence of un­certainty. The entrepreneur is an adjuster of the discrepancies of the market toward greater satisfaction of the desires of the con­sumers. When he innovates he is also an adjuster, since he is ad­justing the discrepancies of the market as they present them­selves in the potential of a new method or product. In other words, if the ruling rate of (natural) interest return is 5 percent, and a business man estimates that he could earn 10 percent by instituting a new process or product, then he has, as in other cases, discov­ered a discrepancy in the market and sets about correcting it. By launching and producing more of the new process, he is pur­suing the entrepreneurial function of adjustment to consumer de­sires, i.e., what he estimates consumer desires will be. If he suc­ceeds in his estimate and reaps a profit, then he and others will continue in this line of activity until the income discrepancy is eliminated and there is no “pure” profit or loss in this area.

6. The Beneficiaries of Saving-Investment

     We have seen that an increase in saving and investment causes an increase in the real incomes of owners of labor and land factors. The latter is reflected in increases in the capital value of ground lands. The benefits to land factors, however, accrue only to particular lands. Other lands may lose in value, although there is an aggregate gain. This is so because usually lands are relatively specific factors. For the nonspecific factor par excellence, namely, labor, there is, on the contrary, a very gen­eral rise in real wages. These laborers are “external beneficiar­ies” of increased investment, i.e., they are beneficiaries of the actions of others without paying for these benefits. What bene­fits do the investors themselves acquire? In the long run, they are not great. In fact, their rate of interest return is reduced. This is not a loss, however, since it is the outcome of their changed time preferences. Their real interest return may well be increased, in fact, since the fall in the interest rate may be offset by the rise in the purchasing power of the monetary unit in an expanding economy.

     The main benefits gained by the investors, therefore, are short-­run entrepreneurial profits. These are earned by investors who see a profit to be gained by investing in a certain area. After a while, the profits tend to disappear as more investors enter this field, although changing data are always presenting new profit opportunities to enterprising investors. But the short-run bene­fits earned by the workers and landowners are more certain. The entrepreneur-capitalists take the risks of speculating on the un­certain market; their investment may result in profits, in break­ing even with no profits at all, or in suffering outright losses. No one can guarantee profits to them.[36]Aggregate new invest­ment will result in aggregate net profits, to be sure, but no one can predict with certainty in what areas the profits will appear. On the other hand, the workers and landowners in the fields of new investment gain immediately, as new investment bids up wages and rents in the longer processes. They gain even if the investment turns out to have been uneconomic and unprofitable. For in that case, the error in satisfying consumers is borne by the heavy losses of the capitalist-entrepreneurs. In the meanwhile, the workers and landowners have reaped a gain. This is hardly a clear gain, however, since consumers have, as a whole, suffered in real income through entrepreneurial error in producing the wrong kind of goods. Yet it is obvious that the brunt of the loss from making the error is suffered by the entrepreneurs.

7. The Progressing Economy and the Pure Rate of Interest

     It is clear that a feature of the progressing economy must necessarily be a fall in the pure rate of interest. We have seen that in order for more capital to be invested, there must be a fall in the pure rate of interest, reflecting general declines in time preferences. If the pure rate remains the same, this is an indication that there will be no new investment or disinvestment, that time preferences are generally stable, and that the economy is stationary. A fall in the pure rate of interest is a corollary of a drop in time preferences and a rise in gross investment. A rise in the pure rate of interest is a corollary of a rise in time pref­erences and net disinvestment. Hence, for the economy to keep advancing, time preferences and the pure rate of interest must continue to fall. If the pure rate of interest remains the same, capital will only just be maintained at its same real level.

     Since praxeology never establishes quantitative laws, there is no way by which we can determine any sort of quantitative re­lation between changes in the pure rate of interest and the amount that capital will change. All we can assert is the quali­tative relation.

     It should be noticed what we are not saying. We are not as­serting that the pure rate of interest is determined by the quan­tity or value of capital goods available. We are not concluding, therefore, that an increase in the quantity or value of capital goods lowers the pure rate of interest because interest is the “price of capital” (or for any other reason). On the contrary, we are asserting precisely the reverse: namely, that a lower pure rate of interest increases the quantity and value of capital goods avail­able. The causative principle is just the other way round from what is commonly believed. The pure rate of interest, then, can change at any time and is determined by time preferences. If it is lowered, the stock of invested capital will increase; if it is raised, the stock of invested capital will fall.

     That a change in the pure rate of interest has an inverse ef­fect on the stock of capital is discovered by deduction from ac­cepted axioms and not inferred from uncertain and complex em­pirical data.[37] The law is not deduced, for example, by observ­ing that the market rate of interest in backward nations is higher than in advanced nations. It is clear that this phenomenon is at least partly due to the higher entrepreneurial risk component in the backward countries and is not necessarily caused by dif­ferences in the pure rate of interest.

8. The Entrepreneurial Component in the Market Interest Rate

     In the ERE, as we have seen, the interest rate throughout the economy will be uniform. In the real world there is an ad­ditional entrepreneurial (or “risk”) component, which adds to the interest rate in particularly risky ventures, and in accordance with the degree of risk. (Since “risk” has an actuarially “certain” con­notation, we may better call it “degree of uncertainty.”) Thus, suppose that the basic social time-preference rate, or pure rate of interest, in the economy is 5 percent. Capitalists will buy 100 ounces of future goods to sell less remotely future goods one year later at 105 ounces. Thus, a 5-percent return is a “pure” return, i.e., it is the return assuming that the 105 ounces will definitely be accru­ing. The pure rate, in other words, abstracts from any entrepre­neurial uncertainty. It gauges the premium of present over fu­ture goods on the assumption that the future goods are known as certain to be forthcoming.

     In the real world, of course, nothing is absolutely certain, and therefore the pure rate of interest (the result of time preference) can never appear alone. Now suppose that in one particular ven­ture or industry it is fairly certain that 105 ounces will be earned from the sale of a product one year in the future. Then, with a social time preference rate of 5 percent, the capitalist-entrepreneurs will be willing to pay 100 ounces for factors and reap a 5-percent re­turn. But suppose that there is another possible venture consid­ered very risky by entrepreneurs. The product is expected to sell for 105 ounces, but there are definite possibilities that the price of the product might plummet. In that case, the entrepreneurs will not be willing to pay 100 ounces for factors. They would have to be compensated for the extra risks that they run; the price of the factors might finally be 90 ounces. Thus, the riskier a given venture appears ex ante, the higher will be the expected interest return that capitalists will require before they make the investment.

     On the market, then, a whole structure of interest rates will be superimposed on the pure rate, varying positively in accord­ance with the expected risks of each venture. The counterpart of this structure will be a similar variety of interest rates on the loan market, which, as usual, is derivative from the goods mar­ket.[38] In the long run, of course, the tendency, given no changes of data, will be for people to realize that such and such a ven­ture is pretty consistently yielding a higher than 5-percent return. The risk component for this venture will then fall, other entrepre­neurs will enter this type of venture, and the interest rate will tend to fall back to 5 percent again. Thus, the varying risk structure of interest does not invalidate the tendency toward uniformity of the interest rate. On the contrary, any variety is something of an index of the various “risks” of uncertainty which still remain in the market and which would be eliminated if data were frozen and an ERE were reached. If data did remain constant, then the uniformity of the ERE would ensue. It is because data are al­ways changing and thus setting up new uncertainties in place of the old that we do not have the uniformity of the ERE.

9. Risk, Uncertainty, and Insurance

     Entrepreneurship deals with the inevitable uncertainty of the future. Some forms of uncertainty, however, can be converted into actuarial risk. The distinction between “risk” and “uncer­tainty” has been developed by Professor Knight.[39] “Risk” occurs when an event is a member of a class of a large number of homogeneous events and there is fairly certain knowledge of the fre­quency of occurrence of this class of events. Thus, a firm may produce bolts and know from long experience that a certain al­most fixed proportion of these bolts will be defective, say 1 percent. It will not know whether any given bolt will be de­fective, but it will know the proportion of the total number de­fective. This knowledge can convert the percentage of defects into a definite cost of the firm’s operations, especially where enough cases occur within a firm. In other situations, a given loss or hazard may be large and infrequent in relation to a firm’s oper­ations (such as the risk of fire), but over a large number of firms it could be considered as a “measurable” or actuarial risk. In such situations, the firms themselves could pool their risks, or a specialized firm, an “insurance company,” could organize the pooling for them.

     The principle of insurance is that firms or individuals are sub­ject to risks which, in the aggregate, form a class of homogene­ous cases. Thus, out of a class of a thousand firms, no one firm has any idea whether it will suffer a fire next year or not; but it is fairly well known that ten of them will. In that case, it may be advantageous for each of the firms to “take out insurance,” to pool their risks of loss. Each firm will pay a certain premium, which will go into a pool to compensate those firms which suf­fer the fires.

     As a result of competition, the firm organizing the insurance service will tend to obtain the usual interest income on its in­vestment, no more and no less.

     The contrast between risk and uncertainty has been brilliantly analyzed by Ludwig von Mises. Mises has shown that they can be subsumed under the more general categories of “class prob­ability” and “case probability.”[40]  “Class probability” is the only scientific use of the term “probability,” and is the only form of probability subject to numerical expression.[41] In the tangled lit­erature on probability, no one has defined class probability as cogently as Ludwig von Mises:

Class probability means: We know or assume to know, with regard to the problem concerned, everything about the behavior of a whole class of events or phenomena; but about the actual singular events or phenomena we know nothing but that they are elements of this class.[42]

     Insurable risk is an example of class probability. The business­men knew how many bolts would be defective out of a total number of bolts, but had no knowledge as to which particular bolts would be defective. In life insurance the mortality tables reveal the proportion of mortality of each age group in the pop­ulation, but they tell nothing about the particular life expect­ancy of any given individual.

     Insurance firms have their problems. As soon as something spe­cific is known about individual cases, firms break down the cases into subaggregates in an effort to maintain homogeneity of classes, i.e., the similarity, as far as is known, of all individual members in the class with respect to the attribute in question. Thus, cer­tain subgroups within one age group may have a higher mor­tality rate because of their occupation; these will be segregated, and different premiums applied to the two cases. If there were knowledge about differences between subgroups, and insurance firms charged the same premium rate to all, then this would mean that the healthy or “less risky” groups would be subsidizing the riskier. Unless they specifically desire to grant such subsidies, this result will never be maintained in the competitive free market. In the free market each homogeneous group will tend to pay premium rates in proportion to its actuarial risk, plus a sum for interest income and for necessary costs for the insurance firms.

     Most uncertainties are uninsurable because they are unique, single cases, and not members of a class. They are unique cases facing each individual or business; they may bear resemblances to other cases, but are not homogeneous with them. Individuals or entrepreneurs know something about the outcome of the par­ticular case, but not everything. As Mises defines it:

Case probability means: We know, with regard to a particular event, some of the factors which determine its outcome; but there are other determining factors about which we know nothing.[43]

Estimates of future costs, demands, etc., on the part of entrepre­neurs are all unique cases of uncertainty, where methods of spe­cific understanding and individual judgment of the situation must apply, rather than objectively measurable or insurable “risk.”

     It is not accurate to apply terms like “gambling” or “betting” to situations either of risk or of uncertainty. These terms have unfavorable emotional implications, and for this reason: they re­fer to situations where new risks or uncertainties are created for the enjoyment of the uncertainties themselves. Gambling on the throw of the dice and betting on horse races are examples of the deliberate creation by the bettor or gambler of new uncertain­ties which otherwise would not have existed.[44] The entrepreneur, on the other hand, is not creating uncertainties for the fun of it. On the contrary, he tries to reduce them as much as possible. The uncertainties he confronts are already inherent in the mar­ket situation, indeed in the nature of human action; someone must deal with them, and he is the most skilled or willing can­didate. In the same way, an operator of a gambling establishment or of a race track is not creating new risks; he is an entrepreneur trying to judge the situation on the market, and neither a gam­bler nor a bettor.

     Profit and loss are the results of entrepreneurial uncertainty. Actuarial risk is converted into a cost of business operation and is not responsible for profits or losses except in so far as the actuarial estimates are erroneous.

[24]Böhm-Bawerk, Positive Theory of Capital, p. 82.

[25]Mises, Human Action, pp. 478–79.

[26]See Hayek, Pure Theory of Capital, pp. 60ff. Similarly, there are numerous long processes which are not productive at all or which are less productive than shorter processes. These longer processes will obviously not be chosen at all. In sum, while all new investment will be in longer processes, it certainly does not follow that all longer processes are more productive and therefore worthy of investment. For Böhm-Bawerk’s stric­tures on this point, see Eugen von Böhm-Bawerk, Capital and Interest,  Vol. 3: Further Essays on Capital and Interest (South Holland, Ill.: Libertarian Press, 1959), p. 2.

[27]It should be clear that, as Mises lucidly put it,

Originary [pure] interest is not a price determined on the market by the interplay of the de­mand for and the supply of capital or capital goods. Its height does not depend on the extent of this demand and supply. It is rather the rate of originary interest that determines both the demand for and the supply of capital and capital goods. It determines how much of the avail­able supply of goods is to be devoted to consumption in the immediate future and how much to provision for remoter periods of the future. (Mises, Human Action, pp. 523–24)

[28]Eugen von Böhm-Bawerk, “The Positive Theory of Capital and Its Critics, Part III,” Quarterly Journal of Economics, January, 1896, pp. 121–35. See also idem, Further Essays on Capital and Interest, pp. 31ff.

[29]Böhm-Bawerk, “The Positive Theory of Capital and Its Critics, Part III,” pp. 128ff.

[30]Mises, Human Action, pp. 492ff.

[31]The futility of “Point 4” and “technical assistance” in furthering produc­tion in the backward countries should be evident from this discussion. As Böhm-Bawerk commented, in discussing advanced techniques: “There are always thousands of persons who know of the existence of the ma­chines, who would be glad to secure the advantage of their use, but who do not dispose of the capital necessary for their purchase.” Böhm-Bawerk, “The Positive Theory of Capital and Its Critics, Part III,” p. 127. See also idem, Further Essays on Capital and Interest, pp. 4–10.

[32]As Hayek states:

It is frequently supposed that all increases in the quantity of capital per head . . . must mean that some commodities will now be produced by longer processes than before. But so long as the processes used in different industries are of different lengths, this is by no means a neces­sary consequence. . . . If input is transferred from industries using shorter processes to industries using longer processes, there will be no change in the length of the period of production in any industry, nor any change in the methods of production of any particular commodity, but merely an increase in the periods for which particular units of input are invested. The significance of these changes in the investment periods of particular units of input will, however, be exactly the same as it would be if they were the consequence of a change in the length of particular processes of production. (Hayek, Pure Theory of Capital, pp. 77–78)

Also see Hayek, Prices and Production, p. 77, and Böhm-Bawerk, Further Essays on Capital and Interest, pp. 57–71.

[33]And if there had been fewer land grants and other governmental sub­sidies to railroads! Thus, see E. Renshaw, “Utility Regulation: A Re­examination,” Journal of Business, October, 1958, pp. 339–40.

[34]See Mises, Human Action:

The fact that not every technological improvement is instantly applied in the whole field is not more conspicuous than the fact that not every­one throws away his old car or his old clothes as soon as a better car is on the market or new patterns become fashionable. (p. 504) 

Also see ibid., pp. 502–10. Specifically, the old equipment will continue in use as long as its operating costs are lower than the total costs of install­ing the new equipment. If, in addition, total costs (including replace­ment costs for wear and tear on capital goods) are greater for the old equipment, then the firm will gradually abandon old equipment as it wears out and will invest in the new technique. For an extensive discus­sion, see Hayek, Pure Theory of Capital, pp. 310–20.

[35]“Technocrats” condemn the market for rewarding investments according to their (marginal) value-productivity instead of their (marginal) physi­cal productivity. But we see here an excellent example of a technique more physically productive but less value-productive, and for a very good reason: that the given specific capital goods already produced lend an advantage to the old technique, so that “out-of-pocket” operating costs of the old technique are lower, until the equipment wears out, than total costs for the new project. Consumers are benefited by continuing the old techniques while they remain profitable, for then factors are spared for more valuable production elsewhere.

[36]As will be seen below, actuarial risks can be “insured” against, but not the entrepreneurial uncertainty of the market.

[37]It is evident that Mises’ strictures in Human Action, p. 530, apply to the doctrine that the quantity of capital determines the pure rate of interest, and not to the present argument.

[38]The loan market will diverge from the “natural” market to the extent that conditions for repayment of loans, etc., establish such differences. The two would be the same if the loans were clearly recognized as entrepreneurial, so that in cases where there was no deliberate fraud, the borrower would not be considered criminal if he did not repay the loan. However, if, as discussed in chapter 2 above, there are no bank­ruptcy laws and defaulting borrowers are considered criminal, then ob­viously the “safety” of all loans would increase in relation to “natural” investments, and the interest rates on loans would decline accordingly. In the free society, however, there would be nothing to prevent borrowers and lenders from agreeing, at the time the contract is made, that bor­rowers would not be held criminally responsible and that the loan would really be an entrepreneurial one. Or they could make any sort of ar­rangement in dividing gains or losses that they might choose.

[39]Knight, Risk, Uncertainty, and Profit, pp. 212–55, especially p. 233.

[40]Mises, Human Action, pp. 106–16, which also contains a discussion of the fallacies of the “calculus of probability” as applied to human action.

[41]See Richard von Mises, Probability, Statistics, and Truth (2nd ed.; New York: Macmillan & Co., 1957).

[42]Mises, Human Action, p. 107.

[43]Ibid., p. 110.

[44]There is a distinction between gambling and betting. Gambling refers to wagering on events of class probability, such as throws of dice, where there is no knowledge of the unique event. Betting refers to wagering on unique event about which both parties to the bet know something—such as a horse race or a Presidential election. In either case, however, the wagerer is creating a new risk or uncertainty.

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