The Market and the Distribution of Wealth
Everywhere today in the free world we find the opponents of the market economy at a loss for plausible arguments. Of late the "case for central planning" has shed much of its erstwhile luster. We have had too much experience of it. The facts of the last 40 years are too eloquent.
Who can now doubt that, as Professor Mises pointed out 30 years ago, every intervention by a political authority entails a further intervention to prevent the inevitable economic repercussions of the first step from taking place? Who will deny that a command economy requires an atmosphere of inflation to operate at all, and who today does not know the baneful effects of "controlled inflation?" Even though some economists have now invented the eulogistic term "secular inflation" in order to describe the permanent inflation we all know so well, it is unlikely that anyone is deceived. It did not really require the recent German example to demonstrate to us that a market economy will create order out of "administratively controlled" chaos even in the most unfavorable circumstances. A form of economic organization based on voluntary cooperation and the universal exchange of knowledge is necessarily superior to any hierarchical structure, even if in the latter a rational test for the qualifications of those who give the word of command could exist. Those who are able to learn from reason and experience knew it before, and those who are not are unlikely to learn it even now.
Confronted with this situation the opponents of the market economy have shifted their ground; they now oppose it on "social" rather than economic grounds. They accuse it of being unjust rather than inefficient. They now dwell on the "distorting effects" of the ownership of wealth and contend that "the plebiscite of the market is swayed by plural voting." They show that the distribution of wealth affects production and income distribution since the owners of wealth not merely receive an "unfair share" of the social income, but will also influence the composition of the social product: luxuries are too many and necessities too few. Moreover, since these owners do most of the saving they also determine the rate of capital accumulation and thus of economic progress.
Some of these opponents would not altogether deny that there is a sense in which the distribution of wealth is the cumulative result of the play of economic forces, but would hold that this cumulation operates in such a fashion as to make the present a slave of the past, a bygone an arbitrary factor in the present. Today's income distribution is shaped by today's distribution of wealth, and even though today's wealth was partly accumulated yesterday, it was accumulated by processes reflecting the influence of the distribution of wealth on the day before yesterday. In the main this argument of the opponents of the market economy is based on the institution of inheritance to which, even in a progressive society, we are told, a majority of the owners owe their wealth.
This argument appears to be widely accepted today, even by many who are genuinely in favor of economic freedom. Such people have come to believe that a "redistribution of wealth," for instance through death duties, would have socially desirable, but no unfavorable economic results. On the contrary, since such measures would help to free the present from the "dead hand" of the past they would also help to adjust present incomes to present needs. The distribution of wealth is a datum of the market, and by changing data we can change results without interfering with the market mechanism! It follows that only when accompanied by a policy designed continually to redistribute existing wealth, would the market process have "socially tolerable" results.
This view, as we said, is today held by many, even by some economists who understand the superiority of the market economy over the command economy and the frustrations of interventionism, but dislike what they regard as the social consequences of the market economy. They are prepared to accept the market economy only where its operation is accompanied by such a policy of redistribution.
The present paper is devoted to a criticism of the basis of this view.
In the first place, the whole argument rests logically on verbal confusion arising from the ambiguous meaning of the term "datum." In common usage as well as in most sciences, for instance in statistics, the word "datum" means something that is, at a moment of time, "given" to us as observers of the scene. In this sense it is, of course, a truism that the mode of the distribution of wealth is a datum at any given moment of time, simply in the trivial sense that it happens to exist and no other mode does. But in the equilibrium theories which, for better or worse, have come to mean so much for present-day economic thought and have so largely shaped its content, the word "datum" has acquired a second and very different meaning: here a datum means a necessary condition of equilibrium, an independent variable, and "the data" collectively mean the total sum of necessary and sufficient conditions from which, once we know them all, we without further ado can deduce equilibrium price and quantity. In this second sense the distribution of wealth would thus, together with the other data, be a determinant, though not the only determinant, of the prices and quantities of the various services and products bought and sold.
It will, however, be our main task in the paper to show that the distribution of wealth is not a "datum" in this second sense. Far from being an "independent variable" of the market process, it is, on the contrary, continuously subject to modification by the market forces. Needless to say, this is not to deny that at any moment it is among the forces which shape the path of the market process in the immediate future, but it is to deny that the mode of distribution as such can have any permanent influence. Though wealth is always distributed in some definite way, the mode of this distribution is ever changing.
Only if the mode of distribution remained the same in period after period, while individual pieces of wealth were being transferred by inheritance, could such a constant mode be said to be a permanent economic force. In reality this is not so. The distribution of wealth is being shaped by the forces of the market as an object, not an agent, and whatever its mode may be today will soon have become an irrelevant bygone.
The distribution of wealth, therefore, has no place among the data of equilibrium. What is, however, of great economic and social interest is not the mode of distribution of wealth at a moment of time, but its mode of change over time. Such change, we shall see, finds its true place among the events that happen on that problematical "path" which may, but rarely in reality does, lead to equilibrium. It is a typically "dynamic" phenomenon. It is a curious fact that at a time when so much is heard of the need for the pursuit and promotion of dynamic studies it should arouse so little interest.
Ownership is a legal concept which refers to concrete material objects. Wealth is an economic concept which refers to scarce resources. All valuable resources are — or reflect, or embody — material objects, but not all material objects are resources: Derelict houses and heaps of scrap are obvious examples, as are any objects which their owners would gladly give away if they could find somebody willing to remove them. Moreover, what is a resource today may cease to be one tomorrow, while what is a valueless object today may become valuable tomorrow. The resource status of material objects is therefore always problematical and depends to some extent on foresight. An object constitutes wealth only if it is a source of an income stream. The value of the object to the owner, actual or potential, reflects at any moment its expected income-yielding capacity. This, in its turn, will depend on the uses to which the object can be turned. The mere ownership of objects, therefore, does not necessarily confer wealth; it is their successful use which confers it. Not ownership but use of resources is the source of income and wealth. An ice-cream factory in New York may mean wealth to its owner; the same ice-cream factory in Greenland would scarcely be a resource.
In a world of unexpected change the maintenance of wealth is always problematical; and in the long run it may be said to be impossible. In order to be able to maintain a given amount of wealth which could be transferred by inheritance from one generation to the next, a family would have to own such resources as will yield a permanent net income stream, i.e., a stream of surplus of output value over the cost of factor services complementary to the resources owned. It seems that this would be possible only either in a stationary world — a world in which today is as yesterday and tomorrow like today, and in which thus, day after day, and year after year, the same income will accrue to the same owners or their heirs — or if all resource owners had perfect foresight. Since both cases are remote from reality we can safely ignore them. What, then, in reality happens to wealth in a world of unexpected change?
All wealth consists of capital assets which, in one way or another, embody or at least ultimately reflect the material resources of production, the sources of valuable output. All output is produced by human labor with the help of combinations of such resources. For this purpose resources have to be used in certain combinations; complementarity is of the essence of resource use. The modes of this complementarity are in no way "given" to the entrepreneurs who make, initiate, and carry out production plans. There is in reality no such thing as A production function. On the contrary, the task of the entrepreneur consists precisely in finding, in a world of perpetual change, which combination of resources will yield, in the conditions of today, a maximum surplus of output over input value, and in guessing which will do so in the probable conditions of tomorrow, when output values, cost of complementary input, and technology all will have changed.
If all capital resources were infinitely versatile, the entrepreneurial problem would consist in no more than following the changes of external conditions by turning combinations of resources to a succession of uses made profitable by these changes. As it is, resources have, as a rule, a limited range of versatility, each is specific to a number of uses. Hence, the need for adjustment to change will often entail the need for a change in the composition of the resource group, for "capital regrouping." But each change in the mode of complementarity will affect the value of the component resources by giving rise to capital gains and losses. Entrepreneurs will make higher bids for the services of those resources for which they have found more profitable uses, and lower bids for those which have to be turned to less profitable uses. In the limiting case where no (present or potential future) use can be found for a resource which has so far formed part of a profitable combination, this resource will lose its resource character altogether. But even in less drastic cases capital gains and losses made on durable assets are an inevitable concomitant of a world of unexpected change.
The market process is thus seen to be a leveling process. In a market economy a process of redistribution of wealth is taking place all the time before which those outwardly similar processes which modern politicians are in the habit of instituting, pale into comparative insignificance, if for no other reason than that the market gives wealth to those who can hold it, while politicians give it to their constituents who, as a rule, cannot.
This process of redistribution of wealth is not prompted by a concatenation of hazards. Those who participate in it are not playing a game of chance, but a game of skill. This process, like all real dynamic processes, reflects the transmission of knowledge from mind to mind. It is possible only because some people have knowledge that others have not yet acquired, because knowledge of change and its implications spread gradually and unevenly throughout society.
In this process he is successful who understands earlier than anyone else that a certain resource which today can be produced, when it is new, or bought, when it is an existing resource, at a certain price A, will tomorrow form part of a productive combination as a result of which it will be worth A'. Such capital gains or losses, prompted by the chance of, or need for, turning resources from one use to another, superior or inferior to the first, form the economic substance of what wealth means in a changing world, and are the chief vehicle of the process of redistribution.
In this process it is most unlikely that the same man will continue to be right in his guesses about possible new uses for existing or potential resources time after time, unless he is really superior. And in the latter case his heirs are unlikely to show similar success — unless they are superior, too. In a world of unexpected change capital losses are ultimately as inevitable as are capital gains. Competition between capital owners and the specific nature of durable resources, even though it be "multiple specificity," entail that gains are followed by losses as losses are followed by gains.
These economic facts have certain social consequences. As the critics of the market economy nowadays prefer to take their stand on "social" grounds, it may be not inappropriate here to elucidate the true social results of the market process. We have already spoken of it as a leveling process. More aptly, we may now describe these results as an instance of what Pareto called "the circulation of elites." Wealth is unlikely to stay for long in the same hands. It passes from hand to hand as unforeseen change confers value now on this, now on that specific resource, engendering capital gains and losses. The owners of wealth, we might say with Schumpeter, are like the guests at a hotel or the passengers in a train: They are always there but are never for long the same people.
It may be objected that our argument applies in any case only to a small segment of society and that the circulation of elites does not eliminate social injustice. There may be such circulation among wealth owners, but what about the rest of society? What chance have those without wealth of even participating, let alone winning, in the game? This objection, however, would ignore the part played by managers and entrepreneurs in the market process, a part to which we shall soon have to return.
In a market economy, we have seen, all wealth is of a problematical nature. The more durable assets are and the more specific, the more restricted the range of uses to which they may be turned, the more clearly the problem becomes visible. But in a society with little fixed capital in which most accumulated wealth took the form of stocks of commodities, mainly agricultural and perishable, carried for periods of various lengths, a society in which durable consumer goods, except perhaps for houses and furniture, hardly existed, the problem was not so clearly visible. Such was, by and large, the society in which the classical economists were living and from which they naturally borrowed many traits. In the conditions of their time, therefore, the classical economists were justified, up to a point, in regarding all capital as virtually homogeneous and perfectly versatile, contrasting it with land, the only specific and irreproducible resource. But in our time there is little or no justification for such dichotomy. The more fixed capital there is, and the more durable it is, the greater the probability that such capital resources will, before they wear out, have to be used for purposes other than those for which they were originally designed. This means practically that in a modern market economy there can be no such thing as a source of permanent income. Durability and limited versatility make it impossible.
It may be asked whether in presenting our argument we have not confused the capital owner with the entrepreneur, ascribing to the former functions which properly belong to the latter. Is not the decision about the use of existing resources as well as the decision which specifies the concrete form of new capital resources, viz. the investment decision, a typical entrepreneurial task? Is it not for the entrepreneur to regroup and redeploy combinations of capital goods? Are we not claiming for capital owners the economic functions of the entrepreneur?
We are not primarily concerned with claiming functions for anybody. We are concerned with the effects of unexpected change on asset values and on the distribution of wealth. The effects of such change will fall upon the owners of wealth irrespective of where the change originates. If the distinction between capitalist and entrepreneur could always easily be made, it might be claimed that the continuous redistribution of wealth is the result of entrepreneurial action, a process in which capital owners play a merely passive part. But that the process really occurs, that wealth is being redistributed by the market, cannot be doubted, nor that the process is prompted by the transmission of knowledge from one center of entrepreneurial action to another. Where capital owners and entrepreneurs can be clearly distinguished, it is true that the owners of wealth take no active part in the process themselves, but passively have to accept its results.
Yet there are many cases in which such a clear-cut distinction cannot be made. In the modern world wealth typically takes the form of securities. The owner of wealth is typically a shareholder. Is the shareholder an entrepreneur? Professor Knight asserts that he is, but a succession of authors from Walter Rathenau to Mr. Burnham have denied him that status. The answer depends, of course, on our definition of the entrepreneur. If we define him as an uncertainty bearer, it is clear that the shareholder is an entrepreneur. But in recent years there seems to be a growing tendency to define the entrepreneur as the planner and decision maker. If so, directors and managers are entrepreneurs, but shareholders, it seems, are not.
Yet we have to be careful in drawing our conclusions. One of the most important tasks of the entrepreneur is to specify the concrete form of capital resources, to say what buildings are to be erected, what stocks to be kept, etc. If we are clearly to distinguish between capitalist and entrepreneur we must assume that a "pure" entrepreneur, with no wealth of his own, borrows capital in money form, i.e., in a nonspecific form, from "pure" capital owners.
But do the directors and managers at the top of the organizational ladder really make all the specifying decisions? Are not many such decisions made "lower down" by works managers, supervisors, etc.? Is it really at all possible to indicate "the entrepreneur" in a world in which managerial functions are so widely spread?
On the other hand, the decision of a capital owner to buy new shares in company A rather than in company B is also a specifying decision. In fact this is the primary decision on which all the managerial decisions within the firm ultimately depend, since without capital there would be nothing for them to specify. We have to realize, it seems, that the specifying decisions of shareholders, directors, managers, etc., are in the end all mutually dependent upon each other, are but links in a chain. All are specifying decisions distinguished only by the degree of concreteness which increases as we are moving down the organizational ladder. Buying shares in company A is a decision which gives capital a form less concrete than does the decision of the workshop manager as to which tools are to be made, but it is a specifying decision all the same, and one which provides the material basis for the workshop manager's action. In this sense we may say that the capital owner makes the "highest" specifying decision.
The distinction between capital owner and entrepreneur is thus not always easily made. To this extent, then, the contrast between the active entrepreneurs, forming and redeploying combinations of capital resources, and the passive asset owners, who have to accept the verdict of the market forces on the success of "their" entrepreneurs, is much overdrawn. Shareholders, after all, are not quite defenseless in these matters. If they cannot persuade their directors to refrain from a certain step, there is one thing they can do: they can sell!
But what about bondholders? Shareholders may make capital gains and losses; their wealth is visibly affected by market forces. But bondholders seem to be in an altogether different position. Are they not owners of wealth who can claim immunity from the market forces we have described, and thus from the process of redistribution?
In the first place, of course, the difference is merely a matter of degree. Cases are not unknown in which, owing to failure of plans, inefficiency of management, or to external circumstances which had not been foreseen, bondholders had to take over an enterprise and thus became involuntary shareholders. It is true, however, that most bondholders are wealth owners who stand, as it were, at one remove from the scene we have endeavored to describe, from the source of changes which are bound to affect most asset values, though it is not true of all of them. Most of the repercussions radiating from this source will have been, as it were, intercepted by others before they reach the bondholders. The higher the "gear" of a company's capital, the thinner the protective layer of the equity, the more repercussions will reach the bondholders, and the more strongly they will be affected. It is thus quite wrong to cite the case of the bondholder in order to show that there are wealth owners exempt from the operation of the market forces we have described. Wealth owners as a class can never be so exempt, though some may be relatively more affected than others.
Furthermore, there are two cases of economic forces engendering capital gains and losses from which, in the nature of these cases, the bondholder cannot protect himself, however thick the protective armor of the equity may happen to be: the rate of interest and inflation. A rise in long-term rates of interest will depress bond values where equity holders may still hope to recoup themselves by higher profits, while a fall will have the opposite effect. Inflation transfers wealth from creditors to debtors, whereas deflation has the opposite effect. In both cases we have, of course, instances of that redistribution of wealth with which we have become acquainted. We may say that with a constant long-term rate of interest and with no change in the value of money, the susceptibility of bondholders' wealth to unexpected change will depend on their relative position as against equity holders, their "economic distance" from the center of disturbances; while interest changes and changes in the value of money will modify that relative position.
The holders of government bonds, of course, are exempt from many of the repercussions of unexpected change, but by no means from all of them. To be sure, they do not need the protective armor of the equity to shield them against the market forces which modify prices and costs. But interest changes and inflation are as much of a threat to them as to other bondholders. In the world of permanent inflation in which we are now living, to regard wealth in the form of government securities as not liable to erosion by the forces of change would be ludicrous. But in any case the existence of a government debt is not a result of the operation of market forces. It is the result of the operation of politicians eager to save their constituents from the task of having to pay taxes they would otherwise have had to pay.
The main fact we have stressed in this paper, the redistribution of wealth caused by the forces of the market in a world of unexpected change, is a fact of common observation. Why, then, is it constantly being ignored? We could understand why the politicians choose to ignore it: after all, the large majority of their constituents are unlikely to be directly affected by it, and, as is amply shown in the case of inflation, would scarcely be able to understand it if they were. But why should economists choose to ignore it? That the mode of the distribution of wealth is a result of the operation of economic forces is the kind of proposition which, one would think, appeal to them. Why, then, do so many economists continue to regard the distribution of wealth as a "datum" in the second sense mentioned above? We submit that the reason has to be sought in an excessive preoccupation with equilibrium problems.
We saw before that the successive modes of the distribution of wealth belong to the world of disequilibrium. Capital gains and losses arise in the main because durable resources have to be used in ways for which they were not planned, and because some men understand better and earlier than other men what the changing needs and resources of a world in motion imply. Equilibrium means consistency of plans, but the redistribution of wealth by the market is typically a result of inconsistent action. To those trained to think in equilibrium terms it is perhaps only natural that such processes as we have described should appear to be not quite "respectable." For them the "real" economic forces are those which tend to establish and maintain equilibrium. Forces only operating in disequilibrium are thus regarded as not really very interesting and are therefore all too often ignored. There may be two reasons for such neglect. No doubt a belief that a tendency towards equilibrium does exist in reality and that, in any conceivable situation, the forces tending towards equilibrium will always be stronger than the forces of resistance, plays a part in it.
But an equally strong reason, we may suspect, is the inability of economists preoccupied with equilibria to cope at all with the forces of disequilibrium. All theory has to make use of coherent models. If one has only one such model at one's disposal a good many phenomena that do not seem to fit into one's scheme are likely to remain unaccounted for. The neglect of the process of redistribution is thus not merely of far-reaching practical importance in political economy since it prevents us from understanding certain features of the world in which we are living. It is also of crucial methodological significance to the central area of economic thought.
We are not saying, of course, that the modern economist, so learned in the grammar of equilibrium, so ignorant of the facts of the market, is unable or unready to cope with economic change; that would be absurd. We are saying that he is well-equipped only to deal with types of change that happen to conform to a fairly rigid pattern. In most of the literature currently in fashion change is conceived as a transition from one equilibrium to another, i.e., in terms of comparative statics. There are even some economists who, having thoroughly misunderstood Cassel's idea of a "uniformly progressive economy," cannot conceive of economic progress in any other way! Such smooth transition from one equilibrium (long run or short run) to another virtually bars not only discussion of the process in which we are interested here, but of all true economic processes. For such smooth transition will only take place where the new equilibrium position is already generally known and anticipated before it is reached. Where this is not so, a process of trial and error (Walras's "tâtonnements") will start which in the end may or may not lead to a new equilibrium position. But even where it does, the new equilibrium finally reached will not be that which would have been reached immediately had everybody anticipated it at the beginning, since it will be the cumulative result of the events which took place on the "path" leading to it. Among these events changes in the distribution of wealth occupy a prominent place.
Professor Lindahl has recently shown to what extent Keynes's analytical model is vitiated by his apparent determination to squeeze a variety of economic forces into the Procrustean bed of short-period equilibrium analysis. Keynes, while he wished to describe the modus operandi of a number of dynamic forces, cast his model in the mold of a system of simultaneous equations, though the various forces studied by him clearly belonged to periods of different length. The lesson to be learned here is that once we allow ourselves to ignore fundamental facts about the market, such as differential knowledge, some people understanding the meaning of an event before others, and in general, the temporal pattern of events, we shall be tempted to express "immediate" effects in short-period equilibrium terms. And all too soon we shall also allow ourselves to forget that what is of real economic interest are not the equilibria, even if they exist, which is in any case doubtful, but what happens between them. "An auxiliary makeshift employed by the logical economists as a limiting notion" can produce rather disastrous results when it is misemployed.
The preoccupation with equilibrium ultimately stems from a confusion between subject and object, between the mind of the observer and the minds of the actors observed. There can, of course, be no systematic science without a coherent frame of reference, but we can hardly expect to find such coherence as our frame of reference requires ready-made for us in the situations we observe. It is, on the contrary, our task to produce it by analytical effort. There are, in the social sciences, many situations which are interesting to us precisely because the human actions in them are inconsistent with each other, and in which coherence, if at all, is ultimately produced by the interplay of mind on mind. The present paper is devoted to the study of one such situation. We have endeavored to show that a social phenomenon of some importance can be understood if presented in terms of a process reflecting the interplay of mind on mind, but not otherwise. The model builders, econometric and otherwise, naturally have to avoid such themes.
It is very much to be hoped that economists in the future will show themselves less inclined than they have been in the past to look for ready-made, but spurious, coherence, and that they will take a greater interest in the variety of ways in which the human mind in action produces coherence out of an initially incoherent situation.
 The argument presented in what follows owes a good deal to ideas first set forth by Professor Mises in Das festangelegte Kapital. See Grundprobleme der Nationaloekonomie, pp. 201–14.
 Vom Aktienwesen, 1917.
 This definition has, of course, certain social implications. Those who accept it can hardly continue to regard entrepreneurs as a class access to which is impossible for those with no wealth of their own. Whatever degree of the "imperfection of the capital market" we choose to assume will not give us this result.
 For a most effective criticism of this kind of model building see, Joan Robinson "The Model of an Expanding Economy," Economic Journal, March 1952.
 Erik Lindahl, "On Keynes' Economic System," Economic Record, May and November 1954.
 Ludwig von Mises, Human Action, Yale University Press, New Haven, Conn., p. 352.