Chapter 9—Production: Particular Factor Prices
and Productive Incomes (continued)
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Chapter 9—Production:
Particular Factor Prices
and Productive
Incomes (continued)
4.
The Economics of Location and Spatial Relations
One very popular subdivision of economics has been
“international trade.” In a purely free
market, such as we are analyzing in the bulk of this work,
there can be no such thing as an “international
trade” problem. For nations might then possibly continue as
cultural expressions, but not as economically meaningful
units. Since there would be neither trade nor other barriers
between nations nor currency differences, “international
trade” would become a mere appendage to a general study of
interspatial trade. It would not matter whether the trade was within or
outside a nation.
The laws of the free market that we have been enunciating apply,
therefore, to the whole extent of the market, i.e., to the
“world” or the “civilized
world.” In the case of a completely isolated
country, the laws would apply throughout that area. Thus, the pure
interest rate will tend to be uniform throughout the world, prices for
the same good will tend to be uniform throughout, and,
therefore, so will wages for the same type of labor.
Wage rates will tend toward uniformity for the same labor in different
geographical areas in precisely the same way as from industry to
industry or firm to firm. Any temporary differential will induce
laborers to move from the low- to the high-wage area and businesses to
move from the latter to the former, until equilibrium is reached. Once
again, just as in the more general case considered above, workers may
have particular positive or negative attachments toward working in a
certain area, just as we saw they may have toward
working in a certain industry. There may be a general psychic benefit
from living and working in a certain place, and a psychic disutility
involved in working at some other location. Since it is psychic,
not money, wage rates that are being equalized, money wage rates will
be equalized throughout the world plus or minus
negative or positive psychic attachment components.
That the prices of each good will be uniform throughout the world rests
on a precise definition of the term “good.”
Suppose, for example, that wheat is grown in Kansas and that the bulk
of the consumers of the wheat are in New York. The wheat in Kansas,
even when ready for shipment, is not the same good
as the wheat in New York. It may be the same physical-chemical bundle,
but it is not the same good vis-à-vis
its objective use-value to the consumers. In short, wheat in Kansas is
a higher-stage capital good than wheat in New York (when the
consumer is in New York rather than in Kansas). Transporting the wheat
to New York is a stage in the process of production. The price of wheat
in Kansas will then tend to equal the price of wheat in New York minus
the necessary costs of transport from Kansas to New York.
What determines how people and businesses will be distributed over the
face of the earth? Obviously, the major factor is the marginal
productivity of labor. This will differ from location to location in
accordance with the distribution of natural resources and the
distribution of capital equipment inherited from ancestors.
Another factor influencing location will be positive or
negative attachments to certain areas, as we have seen above.
The actual dispersal over the face of the earth is caused chiefly by
the distribution of productive land and natural resources over the
earth’s surface. This has been one of the chief forces
limiting the concentration of industry, the size of each firm, and
population in purely industrial areas.
In considering the location of industry, entrepreneurs must account for
costs of transportation from raw material sites to the centers of
consumer population. Certain areas of the world will tend to have
higher costs of transportation than other parts. Wheat is further away
in New York than in Kansas, and the theater further away in Kansas.
Some areas may enjoy lower transport costs for the bulk of
consumers’ goods, while others may have higher transport
costs. Thus, Alaska will probably have higher transport costs for its
consumers’ goods than less remote areas such as San
Francisco. Therefore, to obtain the same products, Alaskan consumers
must be willing to pay higher prices in Alaska than in San Francisco,
even though purchasing power and prices are uniform throughout the
world. As a result, the “cost component” for anyone
working in Alaska will be a certain positive amount. Because
of the transport problem, the same money wage in Alaska will buy fewer
goods than in San Francisco. This increased “cost of
living” establishes a positive cost component in the wage, so
that for similar labor a worker would require a higher money wage to
work in Alaska than elsewhere.
If the costs attached to a geographical area are particularly high or
low, a positive or a negative cost component will be attached
to the wage rate in that area. Instead of saying that money wage rates
for the same type of labor will be equalized throughout the
world, we must say rather that there will be a tendency for
equalization of money wage rates plus or minus
the attachment component, and plus or minus
the cost component, for every geographic area.
The purchasing power of the monetary unit will also be
equalized throughout the world. This case will be treated
below in chapter 11 on Money.
The tendency of an advancing market economy, of course, is to lower
transportation costs, i.e., to increase labor productivity in the
transport field. Other things being equal, then, the cost components
tend to become relatively less important as the economy
progresses.
We have seen that a “good” must be considered as
homogeneous in use-value, and not in
physical substance.
Wheat in Kansas
was a different good from wheat in New York. Some economists
have taken the law that all goods tend to be uniform in price
throughout the world economy to mean that all physically
homogeneous things will be equal in price. But a difference in position
with respect to consumers makes a physically identical thing a
different good. Suppose, for example, that two firms are producing a
certain product, say cement, and that one is located in Rochester and
one in Detroit. Let us say that the bulk of the consumers of cement are
in New York City.
Let us call the cement produced in Rochester, Cr,
and the cement produced in Detroit, Cd.
Now, in equilibrium, the price of Cr
in New York City will equal the price of Cr
in Rochester plus the freight cost from Rochester to New York. Also, in
equilibrium, the price of Cd
in New York City will equal the price of Cd
in Detroit plus the freight cost from Detroit to New York. Which cement
prices will be equal to each other
in equilibrium? Many writers maintain that the price of Cr in
Rochester will be equal to the price of Cd
in Detroit, i.e., that the “mill prices,” or the
“f.o.b. prices,” of cement will be equal in each of
the two localities in equilibrium. But it is clear that these writers
have adopted the confusion of treating “good” in
the technological rather than in the use-value sense.
We must, in short, take the point of view of the consumer—
the man who uses the good—and he is in New York City. From
his point of view, cement in Detroit is a far different good from
cement in Rochester, since Rochester is closer to him and freight costs
are greater from Detroit. From his point of view, the homogeneous
goods are: Cr in New York City and Cd
in New York City. Wherever it comes from, cement at the place
where he must use it is the homogeneous good for the consumer.
Therefore, in equilibrium, it is Cr in New York
City that will be equal to Cd
in New York City—and these are the “delivered
prices” of cement to the consumer.
Substituting this equality
in the above equations, we see that it implies that the price of Cr in
Rochester, plus freight cost from Rochester to New York, will equal the
price of Cd
in Detroit, plus freight cost from Detroit to New York. The freight
costs at any time are readily calculable, and ceteris paribus,
they will be greater for longer distances. In other words, in
equilibrium on the free market, the price of Cr
in Rochester is equal to the price of Cd
in Detroit plus the differential
in freight costs for the longer as compared to the shorter distance to
the consumer. Generalizing, the “mill
price” of cement at a shorter distance from the
consumer will equal the “mill price” of cement at
the longer distance plus the freight differential.
This is applicable not only to cement, but to every product in
the economic system, and not only to products serving ultimate
consumers, but also to those to be “consumed” by
lower-order capitalists.
In proportion as firms are more distantly located from the
consumer, they will then not be able to remain in business
unless their average costs at the mill are sufficiently lower than
those of their competitors to compensate for the increased freight
costs. This is not, as might be thought, a
“penalty” on the “technological
superiority” of the distant firm, for the latter is inferior
with respect to the important economic factor of location. It is
precisely this mechanism that helps to determine the location
of firms and assures that firms will be economically located in
relation to the consumer. The influence of the
location-difference factor in the price of a product will, of course,
depend upon the proportion that freight costs bear to the other costs
of producing the good. The higher the proportion, the greater the
influence.
A firm with a location closer to the consumer market therefore
has a spatial advantage conferred by its location. Given the same costs
in other fields as its competitors, it earns a profit from its superior
location. The gains of location will be imputed to the site value of
the ground land of the plant. The owner of the site obtains its
marginal value product. Therefore, gains to a firm resulting from
improvement in locational advantage, as well as losses resulting from a
locational disadvantage, will accrue as changes in ground rent and
capital value to the owner of the specific site, whether the owner be
the firm itself or someone else.
5.
A Note on the Fallacy of “Distribution”
Ever
since the days of early classical economics, many writers have
discussed “distribution theory” as if it were
completely separate and isolated from production theory.Yet we have seen
that “distribution” theory is simply production
theory. The receivers of income earn wages, rent, interest,
and increases in capital values; and these earnings are the prices of
productive factors. The theory of the market determines the prices and
incomes accruing to productive factors, thereby also
determining the “functional distribution” of the
factors. “Personal
distribution”—how much money each person
receives from the productive system—is determined,
in turn, by the functions that he or his property performs in that
system. There is no separation between production and distribution, and
it is completely erroneous for writers to treat the productive
system as if producers dump their product onto some stockpile, to be
later “distributed” in some way to the
people in the society. “Distribution” is only the
other side of the coin of production on the market.
Many people criticize the free market as follows: Yes, we agree that
production and prices will be allocated on the free market in a way
best fitted to serve the needs of the consumers. But this law is
necessarily based on a given initial distribution of income
among the consumers; some consumers begin with only a little money,
others with a great deal. The market system of production can
be commended only if the original distribution of income meets
with our approval.
This initial distribution of income (or rather of money assets) did not
originate in thin air, however. It, too, was the necessary consequence
of a market allocation of prices and production. It was the consequence
of serving the needs of previous consumers. It was not an arbitrarily
given distribution, but one that itself emerged from satisfying
consumer needs. It too was inextricably bound up with production.
As we saw in chapter 2, a person’s presently owned property
could have been ultimately obtained in only one of the
following ways: through personal production, voluntary
exchange for a personal product, the finding and first using of
unappropriated land, or theft from a producer. On a free market, only
the first three can obtain, so that any
“distribution” served by producers was in itself
the result of free production and exchange.
Suppose, however, that at some preceding time the bulk of the wealthy
consumers had acquired their property through theft and not through
serving other consumers on the free market. Does this not instill a
“built-in bias” into the market economy, since
future producers must satisfy demands ensuing from unjust
incomes?
The answer is that after the initial period, the effect of unjust
incomes becomes less and less important. For in order to keep and
increase their ill-gotten gains, the former robbers, now that a free
economy is established, have to invest and recoup their funds so as to
serve consumers correctly. If they are not fit for this task, and their
exploits in predation have certainly not trained them for it, then
entrepreneurial losses will diminish their assets and shift them to
more able producers.
6.
A Summary of the Market
The explanation of the free economic system constitutes a great
architectural edifice. Starting from human action and its implications,
proceeding to individual value scales and a money economy, we have
demonstrated that the quantity of goods produced, the prices
of consumers’ goods, the prices of productive factors, the
interest rate, profits and losses, all can be explained by the same
deductive apparatus. Given a stock of land and labor factors,
given existing capital goods inherited from the past, given individual
time preferences (and, more broadly, technological knowledge),
the capital goods structure and total production is determined.
Individual preferences set prices for the various consumers’
goods, and the alternative combinations of various factors in their
production set the marginal value-productivity schedules of these
factors. Ultimately, the marginal value product accruing to capital
goods is resolved into returns to land, labor, and interest for time.
The point at which a land or labor factor will settle on its DMVP
schedule will be determined by the stock available. Since each factor
will operate in an area of diminishing physical and certainly
diminishing value returns, any increased stock of the factor,
other things being equal, will enter at a lower DMVP point. The
intersecting points on the DMVP schedules will yield the prices of the
factors, also known as “rents” and “wage
rates” (in the case of labor factors). The pure interest rate
will be determined by the time-preference schedules of all individuals
in the economy. Its chief expression will be not in the loan market,
but in the discounts between prices in the various stages of
production. Interest on the loan market will be a reflection of this
“natural” interest rate. All the prices of each
good, as well as the interest rate, will be uniform throughout the
entire market. The capital value of every durable good will equal the
discounted value of the sum of future rents to be obtained
from the good, the discount being the rate of interest.
All this is a picture of the evenly rotating economy—the
equilibrium situation toward which the real economy is always
tending. If consumer valuations and the supply of resources
remained constant, the relevant ERE would be reached. The forces
driving toward the ERE are the profit-seeking entrepreneurs,
who take the lead in meeting the uncertainties of the real world. By
seeking out discrepancies between existing conditions and the
equilibrium situation and remedying them, entrepreneurs make profits;
those businessmen who unwittingly add to the maladjustments on
the market are penalized with losses. Thus, to the extent that
producers wish to make money, they drive toward ever more efficient
servicing of the desires of the consumers—allocating
resources to the most value-productive areas and away from the least
value-productive. The (monetary) value productivity of a course of
action depends on the extent to which it serves consumer needs.
But consumer valuations and supplies of resources are always changing,
so that the ERE goal always changes as well and is never reached. We
have analyzed the implications of changing elements in the economy. An
increase in the labor supply may lower the DMVP of labor and hence wage
rates, or raise them because of the further advantages of the division
of labor and a more extended market. Which will occur depends on the
optimum population level. Since labor is relatively more
scarce than land, and relatively nonspecific, there will always be idle
and zero-rent land, while there will never be involuntarily idle or
zero-wage labor. An increase or decrease in the supply of
“submarginal” land will have no effect on
production; an increase in supramarginal land will
increase production and render hitherto marginal land submarginal.
Lower time preferences will increase capital investment and thereby
lengthen the structure of production. Such lengthening of the
production structure, increasing the supply of capital goods, is the
only way for man to advance from his bare hands and empty acres of land
to more and more civilized standards of living. These capital goods are
the necessary way stations on the road to higher total production. But
they must be maintained and replaced as well as initially
produced if people wish to keep their higher standard over any length
of time.
To expand production, the important consideration is not so much
technological improvement as greater capital investment. At no time has
invested capital exhausted the best technological opportunities
available. Many firms still use old, unimproved processes and
techniques simply because they do not have the capital to invest in new
ones. They would know how to improve their plant if capital were
available. Thus, while the state of technology is ultimately a very
important consideration, at no given time does it play a direct
role, since the narrower limit on production is
always the supply of capital.
In a progressing economy, given a constant supply of money, increased
investment and a longer capital structure bring about lower money
prices for factors and still lower prices for
consumers’ goods. “Real” factor
prices (corrected for changes in the purchasing power of the monetary
unit) increase. In net terms, this means that real land rents and real
wage rates will increase in the progressing economy. Interest rates
will fall as time-preference rates drop and the proportion of
gross investment to consumption increases.
If rents are earned by a durable factor, they can be and are
“capitalized” on the market, i.e., they have a
capital value equivalent to the discounted sum of their
expected future rents. Since land is a form of investment on the market
just as are shares of a firm, its future rents will be capitalized so
that land will tend to earn the same uniform interest rate as any other
investment. In a progressing economy, the real capital value of land
will increase, although the value will fall in money terms. To
the extent that future changes in the value of land can be
foreseen, they will be immediately incorporated into its present
capital value. Therefore, future owners of land will benefit by future
increases in its real capital value only to the extent that
previous owners failed to anticipate the increase. To the
extent that it was anticipated, the future owners will have paid it in
their purchase price.
The course of change in a retrogressing economy will be the opposite.
In a stationary economy, total production, the
capital structure, real wages per capita, real capital values of land,
and the rate of interest will remain the same, while the allocation of
factors of production and the relative prices of various
products will vary.
See Gottfried
von Haberler, The Theory of International Trade
(London: William Hodge, 1936), pp. 3–8.
See Mises, Human
Action:
The
fact that the production of raw materials and foodstuffs cannot be
centralized and forces people to disperse over the various parts of the
earth’s surface enjoins also upon the processing industries a
certain degree of decentralization. It makes it necessary to
consider the problems of transportation as a particular factor of
production costs. The costs of transportation must be weighed against
the economies to be expected from more thoroughgoing specialization.
(pp. 341–42)
See Mises, Human
Action, pp. 622–24.
For the weighty implications of
this “Misesian” analysis for the theory of
“international trade,” cf. not only
Mises’ Theory of Money and Credit, but
also the excellent, though neglected, Chi-Yuen Wu, An
Outline of International Price Theories (London:
George Routledge & Sons, 1939), pp. 115, 233–35, and passim.
This error lies at the root of
attacks on the “basing-point system” of pricing in
some industries. The critics assume that uniform pricing
of a good means uniform pricing at the various mills,
whereas it really implies uniform “delivered
prices” of the various firms at any given consumer
center. On the basing-point question, see also the analysis
in United States Steel Corporation T.N.E.C. Papers
(New York: United States Steel Corporation, 1940), II, pp.
102–35.
For purposes of simplification, we
have omitted the consumers in Rochester, Detroit, and elsewhere, but
the same law applies to them. For consumers in Rochester and Detroit,
in equilibrium:
P(Cr) in Rochester = P(Cd)
in Rochester, and
P(Cr) in Detroit
= P(C
d)
in Detroit, etc.
For a critique of some aspects of
this separation in the “new welfare economics,” see
B.R. Rairikar, “Welfare Economics and Welfare
Criteria,” Indian Journal of Economics,
July, 1953, pp. 1–15.
The last few years have seen signs
of a revival of “Austrian” production
theory—the tradition in which these chapters have been
written. In addition to works cited above, see
Ludwig M. Lachmann, Capital and Its Structure
(London: London School of Economics, 1956) and idem,
“Mrs. Robinson on the Accumulation of Capital,” South
African Journal of Economics, June, 1958, pp.
87–100. Robert Dorfman’s “Waiting and the
Period of Production,” Quarterly Journal of
Economics, August, 1959, pp. 351–72, and his
“A Graphical Exposition of Böhm-Bawerk’s
Interest Theory,” Review of Economic Studies,
February, 1959, pp. 153–58, are interesting chiefly as a
groping attempt by a leading mathematical economist to return
to the Austrian road. For an incisive critique of Dorfman, see
Egon Neuberger, “Waiting and the Period of Production:
Comment,” Quarterly Journal of Economics,
February, 1960, pp. 150–53.
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