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7. Production: General Pricing of the Factors

4. Land and Capital Goods

The price of the unit service of every factor, then, is equal to its discounted marginal value product. This is true of all factors, whether they be “original” (land and labor) or “produced” (capital goods). However, as we have seen, there is no net income to the owners of capital goods, since their prices contain the prices of the various factors that co-operate in their production. Essentially, then, net income accrues only to owners of land and labor factors and to capitalists for their “time” services. It is still true, however, that the pricing principle—equality to discounted MVP—applies whatever the factor, whether capital good or any other.

Let us revert to the diagram in Figure 41. This time, let us assume for simplicity that we are dealing with one unit of one consumers’ good, which sells for 100 ounces, and that one unit of each particular factor enters into its production. Thus, on Rank 1, 80 refers to one unit of a capital good. Let us consider the first rank first. Capitalistsl purchase one capital good for 80 ounces and (we assume) one labor factor for eight ounces and one land factor for seven ounces. The joint MVP for the three factors is 100. Yet their total price is 95 ounces. The remainder is the discount accruing to the capitalists because of the time element. The sum of the discounted MVPs, then, is 95 ounces, and this is precisely what the owners of three factors received in total. The discounted MVP of the labor factor's service was eight, the DMVP of the land's service was seven, the DMVP of the capital good's service was 80. Thus, each factor obtains its DMVP as its received price. But what happens in the case of the capital good? It has been sold for 80, but it has had to be produced, and this production cost money to pay the income of the various factors. The price of the capital good, then, is reduced to, say, another land factor, paid eight ounces; another labor factor paid 8 ounces, and a capital-goods factor paid 60 ounces. The prices, and therefore the incomes, of all these factors are discounted again to account for the time, and this discount is earned by Capitalists2. The sum of these factor incomes is 76, and once again each factor service earns its DMVP.

Each capital-goods factor must be produced and must continue to be produced in the ERE. Since this is so, we see that the capital-goods factor, though obtaining its DMVP, does not earn it net, for its owner, in turn, must pay money to the factors that produce it. Ultimately, only land, labor, and time factors earn net incomes.

This type of analysis has been severely criticized on the following grounds:

This “Austrian” method of tracing everything back to land and labor (and time!) may be an interesting historical exercise, and we may grant that, if we trace back production and investment far enough, we shall ultimately reach the world of primitive men, who began to produce capital with their bare hands. But of what relevance is this for the modern, complex world around us, a world in which a huge amount of capital already exists and can be worked with? In the modern world there is no production without the aid of capital, and therefore the whole Austrian capital analysis is valueless for the modern economy.

There is no question about the fact that we are not interested in historical analysis, but rather in an economic analysis of the complex economy. In particular, acting man has no interest in the historical origin of his resources; he is acting in the present on behalf of a goal to be achieved in the future.12 Praxeological analysis recognizes this and deals with the individual acting at present to satisfy ends of varying degrees of futurity (from instantaneous to remote).

It is true, too, that the presentation by the master of capital and production theory, Böhm-Bawerk, sowed confusion by giving an historical interpretation to the structure of production. This is particularly true of his concept of the “average period of production,” which attempted to establish an average length of production processes operating at present, but stretching back to the beginning of time. In one of the weakest parts of his theory, Böhm-Bawerk conceded that “The boy who cuts a stick with his knife is, strictly speaking, only continuing the work of the miner who, centuries ago, thrust the first spade into the ground to sink the shaft from which the ore was brought to make the blade.”13 He then tried to salvage the relevance of the production structure by averaging periods of production and maintaining that the effect in the present product of the early centuries’ work is so small (being so remote) as to be negligible.

Mises has succeeded, however, in refining the Austrian production theory so as to eliminate reliance on an almost infinitely high production structure and on the mythical concept of an “average period of production.”

As Mises states:

Acting man does not look at his condition with the eyes of an historian. He is not concerned with how the present situation originated. His only concern is to make the best use of the means available today for the best possible removal of future uneasiness. ... He has at his disposal a definite quantity of material factors of production. He does not ask whether these factors are nature-given or the product of production processes accomplished in the past. It does not matter for him how great a quantity of nature-given, i.e., original material factors of production and labor, was expended in their production and how much time these processes of production have absorbed. He values the available means exclusively from the aspect of the services they can render him in his endeavors to make future conditions more satisfactory. The period of production and the duration of serviceableness are for him categories in planning future action, not concepts of academic retrospection. ... They play a role in so far as the actor has to choose between periods of production of different length. ...

[Böhm-Bawerk] ... was not fully aware of the fact that the period of production is a praxeological category and that the role it plays in action consists entirely in the choices acting man makes between periods of production of different length. The length of time expended in the past for the production of capital goods available today does not count at all.14

But if the past is not taken into account, how can we use the production-structure analysis? How can it apply to an ERE if the structure would have to go back almost endlessly in time? If we base our approach on the present, must we not follow the Knightians in scrapping the production-structure analysis?

A particular point of contention is the dividing line between land and capital goods. The Knightians, in scoffing at the idea of tracing periods of production back through the centuries, scrap the land concept altogether and include land as simply a part of capital goods. This change, of course, completely alters production theory. The Knightians point correctly, for example, to the fact that present-day land has many varieties and amounts of past labor “mixed” with it: canals have been dug, forests cleared, basic improvements have been made in the soil, etc. They assert that practically nothing is pure “land” anymore and therefore that the concept has become an empty one.

As Mises has shown, however, we can revise Böhm-Bawerk's theory and still retain the vital distinction between land and capital goods. We do not have to throw out, as do the Knightians, the land baby with the average-period-of-production bathwater. We can, instead, reformulate the concept of “land.” Up to this point we have simply assumed land to be the original, nature-given factors. Now we must modify this, in keeping with our focus on the present and the future rather than the past. Whether or not a piece of land is “originally” pure land is in fact economically immaterial, so long as whatever alterations have been made are permanent—or rather, so long as these alterations do not have to be reproduced or replaced.15 Land that has been irrigated by canals or altered through the chopping down of forests has become a present, permanent given. Because it is a present given, not worn out in the process of production, and not needing to be replaced, it becomes a land factor under our definition. In the ERE, this factor will continue to give forth its natural powers unstinted and without further investment; it is therefore land in our analysis. Once this occurs, and the permanent are separated from the nonpermanent alterations, we see that the structure of production no longer stretches back infinitely in time, but comes to a close within a relatively brief span of time.16 The capital goods are those which are continually wearing out in the process of production and which labor and land factors must work to replace. When we consider physical wearing out and replacement, then, it becomes evident that it would not take many years for the whole capital-goods structure to collapse, if no work were done on maintenance and replacement, and this is true even in the modern, highly capitalist economy. Of course, the higher the degree of “capitalist” development and the more stages in production, the longer will it take for all the capital goods to wear out.16

The “permanence” with which we are dealing refers, of course, to the physical permanence of the goods, and not to the permanence of their value. The latter depends on the shifting desires of consumers and could never be called permanent. Thus, there might be a land factor uniquely and permanently suitable as a vineyard. It is land and remains so, therefore, indefinitely. If, at some time, the consumers should completely lose their taste for wine, and the land becomes valueless and no longer used, it is still a permanent factor, and therefore is land, although now submarginal. It should be noted that the “permanence” is relevant to present considerations of human action. A piece of land might give forth a permanent marginal (physical) product, without necessity of maintenance, and suddenly a volcano might erupt or a hurricane strike in the area, and the permanence could be destroyed. Such conceivable natural events, however, are not ex ante relevant to human action, and therefore from the point of view of action this land is rightly considered as “permanent,” until the natural changes occur.18,19

The concept of “land” as used throughout this book, then, is entirely different from the popular concept of land. Let us, in this section, distinguish between the two by calling the former economic land and the latter geographic land. The economic concept includes all nature-given sources of value: what is usually known as natural resources, land, water, and air in so far as they are not free goods. On the other hand, a large part of the value of what is generally considered “land”—i.e., that part that has to be maintained with the use of labor—is really a capital good.

That agricultural land is an example of the latter may surprise the reader who is likely to think of it as permanently productive. This is completely wrong; the marginal physical productivity of (geographic) land varies greatly in accordance with the amount of labor that is devoted to maintaining or improving the soil, as against such use or nonuse of the soil as leads to erosion and a lower MPP. The basic soil (and here we are referring to the soil that would remain now if maintenance were suspended, not to the soil as it was in the dim past before cultivation) is the land element, while the final product—which is popularly known as agricultural land—is usually a capital good containing this land element.

And Van Sickle and Rogge say about the soil:

Land, as the top 12 to 18 inches from which grains, vegetables, grasses, and trees draw almost their entire nourishment, is highly destructible. To p soil can be washed or blown away (eroded), or its organic and mineral content can be dissolved and drawn down out of reach of plant life (leached) in a relatively few years, unless great care is exercised in its use. It can also be rebuilt by careful husbandry. Hence it can be said of all soils ... that their maintenance requires saving.20

The indestructibility of land is much more clearly exemplified in what is commonly called “urban land.” For land in urban areas (and this includes suburban land, land for factories, etc.) clearly evinces one of its most fundamentally indestructible features: its physical space—its part of the surface of the earth. For the surface area of the earth is, except in rare cases, eternally fixed, as is the geographic position of each piece of geographic land on the surface. This eternally fixed, permanent, positional aspect of geographic land is called the site aspect of the land, or as Mises aptly puts it, “the land as standing room.” Since it is permanent and nonreproducible, it very clearly comes under the category of economic land. The permanence, once again, refers to its physical spatial aspect; its site values, of course, are always subject to change.21 Midtown Manhattan is on the same site—the same geographical location—now as it was in the 1600's, although the monetary values accruing to it have changed.

Suppose that a piece of currently unused land can be used for various agricultural purposes or for urban purposes. In that case, a choice will be made according to its alternative values as nonreplaceable economic land: between its discounted MVP as a result of the fertility of its basic soil and its discounted MVP as an urban site. And if a decision must be made whether land now used in agriculture and being maintained for that purpose should remain in agriculture or be used as a site for building, the principles of choice are the same. The marginal value return to the agricultural or urban land is broken down by the owner of the land—the “landlord”—into the interest return on the capital maintenance and improvement and the discounted marginal value return to the basic economic land.

“Basic land” (or “ground land”) in this treatise refers to the soil without maintenance, in the case of agriculture, or the pure site without depreciating superstructure, in the case of urban land. The basic land, therefore, whether it be soil or site, earns for its owner an ultimate unit price, or rent, equaling its DMVP. Working on this basic land, labor and investment create a finished capital good. This capital good, like all capital goods, also earns unit rents equal to its DMVP. However, this earning is broken down (and relevantly so in the current market, not as an historical exercise) into basic land rent and interest return on the capital invested (as well, of course, as returns to labor that works on the basic land, i.e., labor's wage or “rent-price,” equaling its DMVP). This capital-good land we have variously termed “geographic land,” “land in the popular sense,” “final land,” “finished land.” When we speak simply of “land,” on the other hand, we shall always be referring to the true economic land—the currently nature-given factor.

  • 12. This was realized by Carl Menger. See F.A. Hayek, “Carl Menger” in Henry W. Spiegel, ed., The Development of Economic Thought (New York: John Wiley, 1952), pp. 530 ff.
  • 13. Böhm-Bawerk, Positive Theory of Capital, p. 88.
  • 14. Mises, Human Action, pp. 477, 485f. Also see Menger, Principles of Economics, pp. 166–67.
  • 15. “Nonreplaceable” as a criterion for land, in contrast to capital goods, is not equivalent to “permanent.” “Permanent” is a subdivision of “non-replaceable.” It is clear that permanent improvements do not have to be replaced. However, depletable natural resources, such as coal, ores, etc., are not permanent, but are also nonreplaceable. The key question is whether a resource has to be produced, in which case it earns only gross rents. If it does not or cannot, it earns net rents as well. Resources that are being depleted obviously cannot be replaced and are therefore land, not capital goods. See the section on depletable resources below.
  • 16. a. b. We may use “permanent” and “nonpermanent” in this section, because resources that are being depleted obviously cannot be included in any evenly rotating equilibrium. For more on depletable resources, see below. With depletable resources left aside, “permanent” becomes identical with “nonreproducible.”
  • 18. Neither is there any relation between the present issue of permanence or nonpermanence and the cosmological question of the permanence of matter and energy. See Mises, Human Action, p. 634.
  • 19. Stigler charges that the various distinctions between land and capital goods based on permanence or origin, such as are discussed herein, are physical rather than economic. These strictures miss the point. No one denies that these homogeneous factors can change greatly in value over time. But whether or not a given factor is original or improved, or permanent or needing to be maintained, is a physical question, and one that is very relevant to economic analysis. Certainly, the Knightian argument that all land is capital goods, because no land is original, is also an argument in the physical realm. Stigler, Production and Distribution Theories, p. 274.
  • 20. John V. Van Sickle and Benjamin A. Rogge, Introduction to Economics (New York: D. Van Nostrand, 1954), p. 141.
  • 21. But while the position is permanent, even the land itself was necessarily altered by man to prepare it for urban use. See chapter 2 above.