Economics of the Free Society

It is universally agreed that the division of labor in modern times has been extended and refined to a degree unknown in previous history. Completely self-sufficient economies of the Robinson Crusoe type are practically unknown today. Indeed, it is doubtful whether a wholly exchangeless economy of this kind, ambiguously termed natural economy (ambiguous because the term is also applicable to a moneyless exchange economy), could have existed at any period in history in pure form and on a large scale. The contention that, for instance, the early Middle Ages were characterized by such natural economies has been refuted by contemporary historical investigation. See A. Dopsch, Naturalwirtschaft und Geldwirtschaft in der Weltgeschichte (1930).

Economic historians have attempted to trace through the course of economic history the red thread of a principle labeled “development.” This has produced the so-called theories of economic stages, the earliest of which we owe to Friedrich List in his National System of Political Economy (1841; Eng. trans. by Lloyd, 1885). More scientifically accoutered statements of the same theory appear in Bruno Hildebrand’s Die Nationalökonomie der Gegenwart und Zukunft (1848). Hildebrand distinguished three stages of development: the natural economy, the money economy, and the credit economy. K. Bücher’s Die Entstehung der Volkswirtschaft (tr. under the title of Industrial Evolution by S. Morley Wickett from the 3rd German ed., New York, 1901) distinguishes the stages of (1) the search for food by individuals, (2) the closed household economy (isolated economy without exchange,) (3) the urban economy of the Middle Ages (with its emphasis on production for individual consumers of “custom-made” goods), and (4) the modern market economy (production of goods which are supplied by middlemen to an anonymous circle of buyers). G. Schmoller and many others have enriched the literature devoted to this theme and it remains the object of intensive study by economic historians. As it turns out, the idea that economic history can be reduced to a series of developmental stages was much too arbitrary and required doing more or less violence to the facts. The basic error was to conceive of this “evolution” as progressing in a straight line—an echo of the eighteenth century’s faith in linear progress. Recent researches have shown that the ancient world, and in particular the Roman Empire, reached an astonishing degree of economic development. The ancient world too, it appears, had its capitalism and its world economy. For information on this point, the reader is referred to M. I. Rostovtzeff’s magnificent work Social and Economic History of the Roman Empire (New York, 1926).

A theory which has enjoyed a considerably longer life is the one made popular by Bücher, viz., that from the Middle Ages onward, economic life evolved directly from more primitive to more complex forms, up to the present worldwide division of labor. To this theory are joined more or less romantic and idealized notions of the idyllic characteristics of medieval economic life and medieval economic thought. The writings of Sombart, especially his voluminous work Der Moderne Kapitalismus (three volumes: I, II-1902; III-1928, Berlin), have given currency to these ideas among a wide circle of readers. Here too, recent investigation demonstrates the need for thorough revision of received opinion. We know now that even in the Middle Ages there was an intense degree of economic activity and that it is legitimate to speak of a “world economy of the Middle Ages,” an economy which was not by any means confined to the exchange of luxury-type goods. We have evidence also that the individuals engaged in this economic activity—and this should not surprise—exhibited a pronounced propensity for business enterprise. What is particularly significant is that this highly developed economic system of the Middle Ages crumbled at the beginning of the modern era, to be succeeded by a less differentiated type of economy in the period which saw the rise of mercantilism and of national territorial states. Like the world economy of antiquity, the world economy of the Middle Ages fell in ruins, together with the political system which supported it. It is a story with special relevance to our own age. See F. Rörig, Mittelalterliche Weltwirtschaft, Blüte und Ende einer Weltwirtschaftsperiode (Jena, 1933). In his Die Grundlagen der Nationalökonomie (6th ed., 1950, tr. into English as Foundations of Economics, London, 1950), Walter Eucken offers a fundamental criticism of the evolutionary interpretation of economic history and a convincing analysis of the relations between economic history and economic theory. See also: Ludwig von Mises, Theory and History, An Interpretation of Social and Economic Evolution (New Haven, 1957).

The significance of the marginal utility principle was recognized quite early, for example, by Gossen in 1854. Later, it was further developed and established as the foundation of modern theory by three scholars working simultaneously but independently: the Austrian Carl Menger (1871), the Englishman W. Stanley Jevons (1871), and Leon Walras, a Frenchman who was then teaching in Switzerland (1874). The most important stages in later development of the principle are indicated by the following works: Friedrich von Wieser, Theorie der gesellschaftlichen Wirtschaft (1914; English tr. Theory of Social Economics by A. F. Hinrichs, New York, 1927); E. von Böhm-Bawerk, Positive Theorie des Kapitals (1889; there are several versions in English, the earliest being that of William A. Smart in 1891 and the most recent being that of George D. Huncke and Hans F. Sennholz, Capital and Interest, South Holland, Illinois, 1959); Alfred Marshall, The Principles of Economics (London, 1890); V. Pareto, Cours d’économie politique (Lausanne, 1896/97); M. Pantaleoni, Principii di economia pura (Florence, 1889; English tr. Pure Economics, London, 1898); J. B. Clark, The Distribution of Wealth, (New York, 1899); Philip H. Wicksteed, The Common Sense of Political Economy (London, 1910; newly edited by L. Robbins, 1933); K. Wicksell, Lectures on Political Economy (2 vols.; London, 1934; published originally in Swedish in 1901); G. Cassel, Theoretische Sozialökonomie (1918; English ed. The Theory of Social Economy, 1923); Ludwig von Mises, Nationalökonomie, Theorie des Handelns und Wirtschaftens (Geneva, 1940; an amplified version of this work in English is Mises’ Human Action, New Haven, 1949). These works are truly the pillars upon which reposes all of modern theory. In spite of their differences of perspective and of opinion on many individual matters, they form a unified body of thought which the serious student of economics cannot afford to neglect.

In some quarters, the marginal principle is contemptuously dismissed as a plaisanterie viennoise and nothing more. But it cannot be too strongly emphasized that the whole of present-day economic thought is inconceivable outside the framework of this fundamental concept. Even those economists who expressly deny the usefulness of the marginal utility theory are heavily dependent upon it, nevertheless. An especially typical example of this is supplied in the book cited above by the Swede Gustav Cassel. Cassel, if the truth be known, is largely in debt to Walras and his school, though he never once refers to this source. By putting Walras’ involved theories into intelligible form and by enriching them with his own valuable ideas, Cassel performed a most useful service and contributed greatly to the advancement of economic science, especially in Germany after World War I. But there is no doubt that he is a product of the general tradition of modern economics.

Pantaleoni’s observation (1897) that there are really only two schools of economists, those who understand economics and those who don’t, is worth recalling. If limited to pure theory, the statement is by no means the joking exaggeration it might appear to be. This is evident in the theoretical developments of recent decades. Thus, the three schools which simultaneously discovered the principle of marginal utility (the Austrian school of Menger and Wieser, the Lausanne school of Walras and Pareto, and the Anglo-American school of Jevons, Marshall and Clark) have shown a convergent evolution. The Austrian and Anglo-American movements agree much more than they disagree (especially as a result of the strong emphasis on and persistent investigation of objective cost factors by the Anglo-American school). The Lausanne school, however, is distinguished from the others, firstly, by it emphasis on synthesis rather than analysis. With but brief attention to the motives underlying individual economic behavior, it attempts by means of mathematical formulae to arrive at a method for determining when a state of total economic equilibrium exists. Secondly, the Lausanne theory is more a functional theory (one, that is, which describes mutual dependencies in a state of equilibrium) than a genetic-causal one (which explains how and why the factors work toward a given equilibrium).

The Lausanne school teaches a general and doubtless more comprehensive truth, but this is of little help in solving individual problems. Granted the necessity of dwelling, even at some length, on the more general and more comprehensive truth, the Lausanne theories are too abstract for significant practical application, entirely apart from the forbidding and not altogether necessary mathematical formulae in which the theories are expressed. In spite of the respect which it rightly inspires, the work of the Lausanne school seems somewhat like a mathematical castle in Spain. Its divorcement from reality gives it a patently static character and this is precisely what renders it of little use in solving the most important concrete problems of the economic system, viz., those arising from disturbances of economic equilibrium. On this subject, the reader should consult: Hans Mayer, “Der Erkenntniswert der funktionellen Preistheorien,” in Wirtschaftstheorie de Gegenwart (vol. 2, 1932; in this memorial to Friedrich von Wieser is to be found perhaps the most comprehensive survey of modern economic theory; an excellent supplement is the anthology published under the auspices of the American Economic Association entitled A Survey of Contemporary Economics, ed. H. S. Ellis, Philadelphia, 1948; a critical review of the most recent trends in economic thought is furnished in the essay by Murray N. Rothbard, “Toward a Reconstruction of Utility and Welfare Economics” in the “Festschrift” for Ludwig von Mises On Freedom and Free Enterprise, New York, 1956). It is clear from the foregoing that the differences among the schools are not differences between true and false but differences of presentation and emphasis, and even these have lessened with the passage of time.

Modern marginalist theory must be understood against the background of the so-called classical theory which it overthrew. The fathers of classical theory were Adam Smith (An Inquiry into the Nature and Causes of the Wealth of Nations, 1776), David Ricardo (The Principles of Political Economy and Taxation, 1817), and Thomas Malthus (Essay on the Principle of Population, 1798). Classical theory was further refined by J. B. Say, J. H. von Thünen, Senior, Hermann, J. S. Mill, and others. One of its last representatives was J. E. Cairnes, whose book, Some Leading Principles of Political Economy (London, 1874) still makes enjoyable reading and was published, piquantly enough, in the same year which saw the birth of modern theory.

A fact which, of course, did not escape the classical theorists was that utility is somehow connected with value. Obviously, a thing which is good for nothing can have no value, but does utility determine value? For the classicists, the case of water and diamonds seemed to prove that utility might well be one of the conditions, but not the cause of the value of a good. Because they had not grasped the specific character of utility (marginal utility), they reasoned that so soon as a thing possessed any utility whatsoever, its value (price) was determined by quite other factors. Unfortunately, the classical economists, in spite of their acumen, did not succeed in reducing these value factors to a homogeneous formula. In fact, from their early gropings, three distinctly different theories emerged. They began by distinguishing two kinds of goods: scarce goods, whose quantity could not be increased by production and goods which could be “produced at will.” The value of the first would be determined solely by the degree of their scarcity; the value of the second by their costs of production, thus by something objective. Onto this classification, the classicists grafted a distinction between a normal price (natural price) and a market price which oscillates around the normal. The normal price was supposed to be determined by the costs of production whereas the market price was determined by supply and demand.

The existence of three different explanations of the same phenomenon was unsatisfactory enough. But the classicists, in addition, became ever more entangled in the internal inconsistencies of their concepts the more they sought to get to the bottom of things. Of what do the “costs of production” consist? How can cost factors be reduced to a common denominator? Up to the very end, the classical school struggled vainly to find an answer to these questions. (See A. Amonn, Ricardo als Begründer der theoretischen Nationalökonomie, 1924). It became increasingly clear, too, that a cost-of-production theory was of no help at all in explaining a variety of important phenomena (monopoly price, prices of jointly produced goods, international price formation).

The labored disputes of the classical economists were brought to an end with the simple discovery that their too hasty examination of the utility concept had led them to confuse general with specific utility. From this time on, the objective-technical explanation of value was supplanted by the subjective-economic emphases of modern theory. It is to be noted also that the marginal utility concept makes the labor theory of value, which constitutes the theoretical base of Marxism, wholly untenable. In fact, the purely economic basis of Marxism must be regarded today as merely an intellectual anachronism. Specifically, a suit is not eight times as valuable as a hat because it requires eight times as much labor as a hat to produce. It is because the finished suit will be eight times as valuable as the finished hat that society is willing to employ eight times as much labor for the suit as for the hat (Wicksteed). It is upon this discovery that the remaining parts of Marxist theory (surplus value, capitalist disintegration) have foundered. This certainly does not mean that socialism can be dismissed as mere foolishness, but simply that it cannot be scientifically established upon a Marxist base.

Notwithstanding, it would be an error to believe that classical theory is a collection of sterile fallacies. On the contrary, modern theory itself remains heavily in debt to the spadework of the classical school. There is no difference in the approaches of the classicists and the moderns to the fundamental issues of economics, a fact which, as the “Methodenstreit” (conflict over methods) has demonstrated, flows from the internal logic of things. Moreover, there is no great difference in the conclusions arrived at by the two schools, even though their underlying premises are, in part, quite different (e.g., with respect to the law which causes prices, under competition, to fall towards the costs of production). In several instances, indeed, classical theory anticipated the basic notions of modern theory (e.g., in international trade theory). The acumen which enabled the classical school, in spite of its false foundation and its tortured constructions, to come to useful conclusions deserves admiration. Where modern theory showed the greatest advance over the classical school was in the practical sphere. The stiff classical machinery of “natural laws” has been made so much more flexible that economics has gotten closer to reality, become more capable of adaptation, and more largely human. Purified of the premature economic policy conclusions professed by the classical school (laissez-faire liberalism), modern theory has not only become less partisan politically, but in virtue of that very fact has developed into an indispensable instrument in the solving of current problems of economic policy. Classical theory was philosophical in character while modern theory is primarily instrumental in character.

An extended analysis of the principle of marginal utility will raise difficulties too numerous to be dealt with here. Then too, the process of analysis in this instance is itself subject to the law of diminishing marginal utility, that is, as economic analyses are increasingly refined, they tend to produce less and less interesting results. Much of the criticism of the marginal utility principle is, upon closer inquiry, seen to be aimed at such exaggeratedly long and psychological marking of time at the point of departure. The same impression, indeed, is created by the true, but otherwise not very helpful intellectual architectonics found at the other extreme in the mathematical equilibrium models of the Lausanne school. At all events, these are difficulties which must one day be resolved.

A good survey of the relevant discussion on these matters may be found in the article “Value” in the Encyclopedia of the Social Sciences and in D. H. Robertson, Utility and All That (London, 1952). To bewail such clarification would be just as unintelligent as to let ourselves be irritated by the footnotes in a book. (Though he who believes he can skip the footnotes is quite at liberty to do so). On the other hand, a book should consist of something else besides footnotes. If this point of view were more widely adopted, many a sterile dispute over the principle of marginal utility would be avoided.