An Essay on the Nature and Significance of Economic Science

CHAPTER III

THE RELATIVITY OF ECONOMIC “QUANTITIES”

1. That aspect of behaviour which is the subject-matter of Economics is, as we have seen, conditioned by the scarcity of given means for the attainment of given ends. It is clear, therefore, that the quality of scarcity in goods is not an “absolute” quality. Scarcity does not mean mere infrequency of occurrence. It means limitation in relation to demand. Good eggs are scarce because, having regard to the demand for them, there are not enough to go round. But bad eggs, of which, let us hope, there are far fewer in existence, are not scarce at all in our sense. They are redundant. This conception of scarcity has implications both for theory and for practice which it is the object of this chapter to elucidate.

2. It follows from what has just been said that the conception of an economic good is necessarily purely formal.1 There is no quality in things taken out of their relation to men which can make them economic goods. There is no quality in services taken out of relation to the end served which makes them economic. Whether a particular thing or a particular service is an economic good depends entirely on its relation to valuations.

Thus wealth2 is not wealth because of its substantial qualities. It is wealth because it is scarce. We cannot define wealth in physical terms as we can define food in terms of vitamin content or calorific value. It is an essentially relative concept. For the community of ascetics discussed in the last chapter there may be so many goods of certain kinds in relation to the demand for them that they are free goods—not wealth at all in the strict sense. In similar circumstances, the community of sybarites might be “poor”. That is to say, for them, the self-same goods might be economic goods.

So, too, when we think of productive power in the economic sense, we do not mean something absolute—something capable of physical computation. We mean power to satisfy given demands. If the given demands change, then productive power in this sense changes also.

A very vivid example of what this means is to be found in Mr. Winston Churchill’s account of the situation confronting the Ministry of Munitions at 11 a.m. on November 11th, 1918—the moment of the signing of the Armistice. After years of effort, the nation had acquired a machine for turning out the materials of war in unprecedented quantities. Enormous programmes of production were in every stage of completion. Suddenly the whole position is changed. The “demand” collapses. The needs of war are at an end. What was to be done? Mr. Churchill relates how, in the interests of a smooth change-over, instructions were issued that material more than 60 per cent. advanced was to be finished. “Thus for many weeks after the war was over we continued to disgorge upon the gaping world masses of artillery and military materials of every kind.”3 “It was waste”, he adds, “but perhaps it was a prudent waste.” Whether this last contention is correct or not is irrelevant to the point under discussion. What is relevant is that what at 10.55 a.m. that morning was wealth and productive power, at 11.5 had become “not-wealth,” an embarrassment. a source of social waste. The substance had not changed. The guns were the same. The potentialities of the machines were the same. From the point of view of the technician, everything was exactly the same. But from the point of view of the economist, everything was different. Guns, explosives, lathes, retorts, all had suffered a sea change. The ends had changed. The scarcity of means was different.4

3. The proposition which we have just been discussing, concerning what may be described as the relativity of “economic quantities”, has an important bearing on many problems of Applied Economics—so important, indeed, that it is worth while, here and now, interrupting the course of our main argument in order to examine them rather more fully. There can be no better illustration of the way in which the propositions of pure theory facilitate comprehension of the meaning of concrete issues.

A conspicuous instance of a type of problem which can only be satisfactorily solved with the aid of the distinctions we have been developing, is to be found in contemporary discussions of the alleged economies of mass production. At the present day the lay mind is dominated by the spectacular achievements of mass production. Mass production has become a sort of cure-all, an open sesame. The goggled eyes of the world turn westward to Ford the deliverer. He who has gaped longest at the conveyors at Detroit is hailed as the most competent economist.

Now, naturally, no economist in his senses would wish to deny the importance for modern civilisation of the potentialities of modern manufacturing technique. The technical changes which bring to the door, even of the comparatively poor man, the motor-car, the gramophone, the wireless apparatus, are truly momentous changes. But, in judging their significance in regard to a given set of ends, it is very important to bear in mind this distinction between the mere multiplication of material objects and the satisfaction of demand, which the definitions of this chapter elucidate. To use a convenient jargon, it is important to bear in mind the distinction between technical and value productivity. The mass production of particular things irrespective of demand for them, however technically efficient, is not necessarily “economical”. As we have seen already, there is a fundamental difference between technical and economic problems.5 We may take it as obvious that, within certain limits (which, of course, change with changing conditions of technique), specialisation of men and machinery is conducive to technical efficiency. But the extent to which such specialisation is “economical” depends essentially upon the extent of the market—that is to say, upon demand.6 For a blacksmith producing for a small and isolated community to specialise solely on the production of a certain type of horse-shoe, in order to secure the economies of mass production, would be folly. After he has made a limited number of shoes of one size, it is clearly better for him to turn his attention to producing shoes of other sizes, additional units of which will be more urgently demanded than additional units of the size of which he has already manufactured a large quantity.

So, too, in the world at large at any particular moment, there are definite limits to the extent to which the mass production of any one type of commodity to the exclusion of other types is in conformity with the demands of consumers. If it is carried beyond these limits, not only is there waste, in the sense that productive power is used to produce goods of less value than could be produced otherwise, but there is also definite financial loss for the productive enterprise concerned. It is one of the paradoxes of the history of modern thought that, at a time when the disproportionate development of particular lines of production has wrought more chaos in the economic system than at any earlier period in history, there should arise the naïve belief that a general resort to mass production, whenever and wherever it is technically possible, regardless of the conditions of demand, will see us out of our difficulties. It is the nemesis of the worship of the machine, the paralysis of the intellect of a world of technicians.

This confusion between technical potentiality and economic value, which, borrowing a phrase of Professor Whitehead’s, we may call the “fallacy of misplaced concreteness”,7 also underlies certain notions at present unduly prevalent with regard to the value of fixed capital. It is sometimes thought that the fact that large sums of money have been sunk in certain forms of fixed capital renders it undesirable, if consumer’s demand changes, or if technical invention renders it possible to satisfy a given consumer’s demand in other more profitable ways, that the capital should fall into disuse. If the satisfaction of demand is assumed as the criterion of economic organisation, this belief is completely fallacious. If I purchase a railway ticket from London to Glasgow, and half-way on my journey I receive a telegram informing me that my appointment must take place in Manchester, it is not rational conduct for me to continue my journey northwards, just because I have “sunk capital” in the ticket which I am unable to recover. It is true that the ticket is still as “technically efficient” in procuring me the right to go to Glasgow. But my objective has now changed. The power to continue my journey northward is no longer valuable to me. To continue nevertheless would be irrational. In Economics, as Jevons remarked, bygones are forever bygones.

Exactly similar considerations apply when we are considering the present status of machinery for whose products demand has ceased, or which has ceased to be as profitable, taking everything into account, as other kinds of machinery. Although the machinery may be technically as efficient as it was before these changes, yet its economic status is different.8 No doubt, if the change in demand or in cost conditions which led to its supersession had been foreseen, the disposition of resources would have been different. In that sense it is not meaningless to speak of a waste due to ignorance—although there are difficulties here. But once the change has taken place, what has happened before is totally irrelevant—it is waste to take it into further consideration. The problem is one of adjustment to the situation that is given. When every legitimate criticism of the subjective theory of value has been taken into account, it still remains the unshakable achievement of this theory that it focuses attention on this fact, as important in applied Economics as in the purest of pure theory.

As a last example of the importance for applied Economics of the propositions we have been considering, we may examine certain misconceptions with regard to the economic effects of inflation. It is a well-known fact that during periods of inflation there is often for a time extreme activity in the constructional industries. Under the stimulus of the artificially low interest rates, overhauling of capital equipment on the most extensive scale is often undertaken. New factories are built. Old factories are reequipped. To the lay mind, there is something extraordinarily fascinating about this spectacular activity; and when the effects of inflation are being discussed, it is not infrequently regarded as a virtue that it should be instrumental in bringing this about. How often does one hear it said of the German inflation that, while it was painful enough while it lasted, it did at least provide German industry with a new capital equipment. Indeed, no less an authority than Professor F. B. Graham has given the weight of his authority to this view.9

But, plausible as all this may seem, it is founded on the same crude materialist conception as the other fallacies we have been discussing. For the efficiency of any industrial system does not consist in the presence of large quantities of up-to-date capital equipment, irrespective of the demand for its products or the price of the factors of production which are needed for the profitable exploitation of such equipment. It consists in the degree of adaptation to meet demand of the organisation of all resources. Now it can be shown10 that, during times of inflation, the artificially low rates of interest tend to encourage expansion of certain kinds of capitalistic production in such measure that, when the stimulus is exhausted, it is no longer possible to work them as profitable undertakings. At the same time, liquid resources are dissipated and exhausted. When the slump comes, the system is left high and dry with an incubus of fixed capital too costly to be worked at a profit, and a relative shortage of “liquid capital” which causes interest rates to be stringent and oppressive. The beautiful machinery which so impressed the newspaper correspondents is still there, but the wheels are empty of profit. The material is there. But it has lost its economic significance. Considerations of this sort might have been thought to be very remote from reality at the time of the German inflation or at the time of stabilisation. After years of chronic “capital shortage” in that unhappy country, they begin to appear less paradoxical.11

4. It is time to return to more abstract considerations. We have next to consider the bearing of our definitions upon the meaning of Economic Statistics.

Economic Statistics employ two kinds of units of reckoning—physical units and value units. Reckoning is by “weight and tale” or by valuation—so many tons of coal, so many pounds sterling worth of coal. From the point of view of economic analysis, what meaning is to be attached to these computations?

So far as physical reckonings are concerned, what has been said already is sufficient. There is no need further to labour the proposition that, although, as records of fact, physical computations may be unimpeachable and, in certain connections, useful, yet from the point of view of the economist they have no significance apart from relative valuations. No doubt, assuming a certain empirical permanence of relative valuations, many physical series have direct significance for applied Economics. But from the logical point of view this is an accident. The significance of the series always depends upon the background of relative valuation.

So far as reckonings in terms of value are concerned, there are other subtler difficulties which we must now proceed to unravel.

According to modern price theory, the prices of different commodities and factors of production are expressions of relative scarcity, or, in other words, marginal valuations.12 Given an initial distribution of resources, each individual entering the market may be conceived to have a scale of relative valuations; and the interplay of the market serves to bring these individual scales and the market scale as expressed in relative prices into harmony with one another.13 Prices, therefore, express in money a grading of the various goods and services coming on the market. Any given price, therefore, has significance only in relation to the other prices prevailing at that time. Taken by itself it means nothing. It is only as the expression in money terms of a certain order of preference that it means anything at all. As Samuel Bailey pointed out over a hundred years ago, “As we cannot speak of the distance of any object without implying some other object between which and the former this relation exists, so we cannot speak of the value of a commodity, but in reference to another commodity compared with it. A thing cannot be valuable in itself without reference to another thing, any more than a thing can be distant in itself without reference to another thing.”14

It follows from this that the term which, for the sake of continuity and to raise certain definite associations, we have used hitherto in this chapter, the term “economic quantity” is really very misleading. A price, it is true, expresses the quantity of money which it is necessary to give in exchange for a given commodity. But its significance is the relationship between this quantity of money and other similar quantities. And the valuations which the price system expresses are not quantities at all. They are arrangements in a certain order. To assume that the scale of relative prices measures any quantity at all save quantities of money is quite unnecessary. Value is a relation, not a measurement.15

But, if this is so, it follows that the addition of prices or individual incomes to form social aggregates is an operation with a very limited meaning. As quantities of money expended, particular prices and particular incomes are capable of addition, and the total arrived at has a definite monetary significance. But as expressions of an order of preference, a relative scale, they are incapable of addition. Their aggregate has no meaning. They are only significant in relation to each other. Estimates of the social income may have a quite definite meaning for monetary theory. But beyond this they have only conventional significance.

It is important to realise exactly both the weight and the limitations of this conclusion. It does mean that a comprehensive aggregate of prices means nothing but a stream of money payments. Both the concept of world money income and the national money income have strict significance only for monetary theory—the one in relation to the general theory of indirect exchange, the other to the Ricardian theory of the distribution of the precious metals. But, of course, this does not exclude a conventional significance. If we like to assume that preferences and distribution do not change rapidly within short periods, and that certain price changes may be regarded as particularly significant for the majority of economic subjects, then no doubt we may assign to the movements of these aggregates a certain arbitrary meaning which is not without its uses. And this is all that is claimed for such estimates by the best statisticians. All that is intended here is to emphasise the essentially arbitrary nature of the assumptions necessary. They do not have an exact counterpart in fact, and they do not follow from the main categories of pure theory.

We can see the bearing of all this if we consider for a moment the use which may be made of such aggregates in examining the probable effects of drastic changes in distribution. From time to time computations are made of the total money income accruing within a given area, and, from these totals, attempts are made to estimate the effects of large changes in an equalitarian direction. The best known of such attempts are the estimates of Professor Bowley and Sir Josiah Stamp.16

Now, in so far as such estimates are confined to ascertaining the initial amount of spending power available for redistribution, they are valuable and important. And, of course, this is all that has ever been contended by the distinguished statisticians who put them forward. But beyond this it is futile to attach any precise significance to them. For, by the very fact of redistribution, relative valuations would necessarily alter. The whole “set” of the productive machine would be different. The stream of goods and services would have a different composition. Indeed, if we think a little further into the problem, we can see that an estimate of this sort must very grossly overestimate the amount of productive power that would be released by such changes. For a substantial proportion of the high incomes of the rich are due to the existence of other rich persons. Lawyers, doctors, the proprietors of rare sites, etc., enjoy high incomes because there exist people with high incomes who value their services highly. Redistribute money incomes, and, although the technical efficiency of the factors concerned would be the same, their place on the relative scale would be entirely different. With a constant volume of money and a constant velocity of circulation, it is almost certain that the main initial result would be a rise in the prices of articles of working-class consumption. This conclusion, which is obvious enough from the census of occupations, tends actually to be concealed by computations in money—pessimistic as these computations are often supposed to be. If we compute the proportion of the population now producing real income for the rich who could be turned to producing real income for the poor, it is easy to see that the increase available would be negligible. If we attempt greater precision by means of money computations, we are likely to exaggerate. And the greater the degree of initial inequality, the greater the degree of exaggeration.17

5. It is a further consequence of the conception of value as an expression of an order of preference that comparisons of prices have no precise significance, unless exchange is possible between the commodities whose prices are being compared.

It follows, therefore, that to compare the prices of a particular commodity at different periods of time in the past, is an operation which, by itself, does not necessarily afford results which have further meaning. The fact that bread last year was 8d. and bread this year is 6d. does not necessarily imply that the relative scarcity of bread this year is less than the relative scarcity of bread last year. The significant comparison is not the comparison between 8d. last year and 6d. this year, but the comparison between 8d. and other prices last year and the comparison between 6d. and other prices this year. For it is these relationships which are significant for conduct. It is these relationships alone which imply a unitary system of valuations.18

At one time it used to be thought that these difficulties could be overcome by correcting individual prices for variations in the “value of money”. And it may be admitted that, if the relations between each commodity and all the others save the one under consideration remained the same, and only the supply of money and the demand or supply of this particular commodity altered, such corrections would be sufficient. If, that is to say, the original price relationships were

(1) Pa=Pb=Pc=Pd=Pe

and in the next period they were

(2) Pa=1/2 Pb=1/2 Pc=1/2 Pd=1/2 Pe

then matters would be simple, and the comparison would have some meaning. But such a relationship is not possible save as a result of a series of compensatory accidents. This is not merely because demand or the conditions of production of other commodities may change. It is because almost any conceivable change, either real or monetary, must bring about different changes in the relation of a particular good to each other commodity. That is to say, save in the case of a compensatory accident, any change will lead not to a new set of relationships of the order of equation (2), but rather to a set of relationships of the order

(3) Pa=1/2 Pb=1/4 Pc=3/4 Pd=Pe

It has long been recognised that this must be the case with real changes. If the demand for a changes, it is most improbable that the demand for b, c, d, e . . . will change in such a way that the change in relation between a and b will be equivalent to the change in relation to b and c . . . and so on. With changes in technique, factors of production which are released from the production of a will not be likely to be distributed between b, c, d in such proportions as to preserve Pb:Pc::Pc:Pd . . . But, as may be demonstrated by very elementary reasoning,19 the same is true of “monetary” changes. It is almost impossible to conceive a “monetary” change which does not affect relative prices differently. But, if this is so, the idea of precise “correction” of price changes over time is illusory.20 Samuel Bailey’s conclusion remains: “When we say that an article in a former age was of a certain value, we mean that it exchanged for a certain quantity of some other commodity. But this is an inapplicable expression in speaking of only one commodity at two different periods.”21 It is important to realise the exact significance of this proposition. It does not deny the possibility of intertemporal price relationships. Quite clearly, at any moment, anticipations of what prices will be at a future period inevitably influence present valuations and price relationships.22 It is possible to exchange goods now for goods in the future, and we can conceive an equilibrium direction of price change through time. This is true and important. But while there is and must be a connection between present prices and anticipations of future prices, there is no necessary connection or significant value relationship between present prices and past prices. The conception of an equilibrium relationship through time is a hypothetical relationship. It is realised only in so far as anticipations are proved to have been justified. Through history, the data change, and though at every moment there may be tendencies towards an equilibrium, yet from moment to moment it is not the same equilibrium towards which there is movement. There is a fundamental asymmetry in price relationships through time. The future—the apparent future, that is to say—affects the present, but the past is irrelevant. The effects of the past are now simply part of the data. So far as the act of valuation is concerned, bygones are forever bygones.

Here, again, as in the case of our considerations regarding aggregates, there is no intention of denying the practical utility and significance of comparisons of certain prices over time, or of the value of “corrections” of these prices by suitably devised index numbers. It is not open to serious question that for certain questions of applied Economics on the one hand, and interpretation of history on the other, the index number technique is of great practical utility. Given a willingness to make arbitrary assumptions with regard to the significance of certain price sums, it is not denied that conclusions which are important for practice may be reached. All that it is desired to emphasise is that such conclusions do not follow from the categories of pure theory, and that they must necessarily involve a conventional element depending either upon the assumption of a certain empirical constancy of data23 or upon arbitrary judgments of value with regard to the relative importance of particular prices and particular economic subjects.

6. The interpretation of economic statistics is not the only department of economic studies to be affected by this conception of our subject-matter. The arrangement and elaboration of the central body of theoretical analysis is also considerably modified. This is an interesting example of the utility of this kind of investigation. Starting from the intention to state more precisely the subject of our generalisations, we reach a point of view which enables us, not only to pick out what is essential and what is accidental in those generalisations, but also to restate them in such a way as to give their essential bearing much greater force. Let us see how this happens.

The traditional approach to Economics, at any rate among English-speaking economists, has been by way of an enquiry into the causes determining the production and distribution of wealth.24 Economics has been divided into two main divisions, the theory of production and the theory of distribution, and the task of these theories has been to explain the causes determining the size of the “total product” and the causes determining the proportions in which it is distributed between different factors of production and different persons. There have been minor differences of content under these two headings. There has always been a great deal of trouble about the position of the theory of value. But, speaking broadly, up to quite a recent date, this has been the main “cut” into the body of the subject.

Now, no doubt, there is a strong prima facie case for this procedure. As Professor Cannan urges,25 the questions in which we are interested from the point of view of social policy are—or at any rate appear to be—questions relating to production and distribution. If we are contemplating the imposition of a tax or the granting of a subsidy, the questions we tend to ask (whether we understand what we mean or not) are: What will be the effects of this measure on production? What will be its effects on distribution? It is not unnatural, therefore, that, in the past, economists have tended to arrange their generalisations in the form of answers to these two questions.26

Yet, if we bear in mind what has been said already with regard to the nature of our subject-matter and the relativity of the “quantities” it contemplates, it should be fairly clear that from this point of view the traditional division has serious deficiencies.

It should not be necessary at this stage to dwell upon the inappropriateness of the various technical elements which almost inevitably intrude into a system arranged on this principle. We have all felt, with Professor Schumpeter, a sense almost of shame at the incredible banalities of much of the so-called theory of production—the tedious discussions of the various forms of peasant proprietorship, factory organisation, industrial psychology, technical education, etc., which are apt to occur in even the best treatises on general theory arranged on this plan.27

But there is a more fundamental objection to this procedure; it necessarily precludes precision. Scientific generalisations, if they are to pretend to the status of laws, must be capable of being stated exactly. That does not mean, as we shall see in a later chapter, that they must be capable of quantitative exactitude. We do not need to give numerical values to the law of demand to be in a position to use it for deducing important consequences. But we do need to state it in such a way as to make it relate to formal relations which are capable of being conceived exactly.28

Now, as we have seen already, the idea of changes in the total volume of production has no precise content. We may, if we please, attach certain conventional values to certain indices and say that we define a change in production as a change in this index; for certain purposes this may be advisable. But there is no analytical justification for this procedure. It does not follow from our conception of an economic good. The kind of empirical generalisation which may be made concerning what causes will affect production in this sense, can never achieve the status of a law. For a law must relate to definite conceptions and relationships; and a change in the aggregate of production is not a definite conception.

As a matter of fact, nothing which can really be called a “law” of production in this sense has ever been elaborated.29 Whenever the generalisations of economists have assumed the form of laws, they have related not to vague notions such as the total product, but to perfectly definite concepts such as price, supply, demand, and so on. The Ricardian System which, in this respect, provides the archetype of all subsequent systems, is essentially a discussion of the tendencies to equilibrium of clear-cut quantities and relationships. It is no accident that wherever its discussions have related to separate types of economic goods and ratios of exchange between economic goods, there the generalisations of Economics have assumed the form of scientific laws.30

For this reason, in recent years economists have tended more and more to abandon the traditional arrangement. We no longer enquire concerning the causes determining variations of production and distribution. We enquire rather concerning the conditions of equilibrium of various economic “quantities”,31 given certain initial data, and we enquire concerning the effects of variations of these data. Instead of dividing our central body of analysis into a theory of production and a theory of distribution, we have a theory of equilibrium, a theory of comparative statics and a theory of dynamic change. Instead of regarding the economic system as a gigantic machine for turning out an aggregate product and proceeding to enquire what causes make this product greater or less, and in what proportions this product is divided, we regard it as a series of interdependent but conceptually discrete relationships between men and economic goods; and we ask under what conditions these relationships are constant and what are the effects of changes in either the ends or the means between which they mediate and how such changes may be expected to take place through time.32

As we have seen already, this tendency, although in its completest form very modern indeed, has its origin very early in the literature of scientific Economics. Quesnay’s Tableau Economique was essentially an attempt to apply what is now called equilibrium analysis. And, although Adam Smith’s great work professed to deal with the causes of the wealth of nations, and did in fact make many remarks on the general question of the conditions of opulence which are of great importance in any history of applied Economics, yet, from the point of view of the history of theoretical Economics, the central achievement of his book was his demonstration of the mode in which the division of labour tended to be kept in equilibrium by the mechanism of relative prices—a demonstration which, as Allyn Young has shown,33 is in harmony with the most refined apparatus of the modern School of Lausanne. The theory of value and distribution was really the central core of the analysis of the Classics, try as they might to conceal their objects under other names. And the traditional theory relating to the effects of taxes and bounties was always couched in terms thoroughly consistent with the procedure of modern comparative statics. Thus, though the appearance of modern theory may be new, its substance is continuous with what was most essential in the old. The modern arrangement simply makes explicit the methodological foundations of the earlier theories and generalises the procedure.34

At first sight it might be thought that these innovations ran the risk of over-austerity; that they involved dispensing with a mass of theory which is genuinely illuminating. Such a belief would be founded on an absence of knowledge of the potentialities of the new procedure. It may safely be asserted that there is nothing which fits into the old framework, which cannot be more satisfactorily exhibited in the new. The only difference is that, at every step in the new arrangement, we know exactly the limitations and implications of our knowledge. If we step outside the sphere of pure analysis and adopt any of the conventional assumptions of applied Economics, we know just where we are. We are never in danger of asserting as an implication of our fundamental premises something which is smuggled in on the way by means of a conventional assumption.

We may take as an example of the advantages of this procedure the modern treatment of organisation of production. The old treatment of this subject was very unsatisfactory: A few trite generalisations about the advantages of the division of labour copied from Adam Smith, and illustrated perhaps by a few examples from Babbage; then extensive discursions on industrial “forms” and the “entrepreneur” with a series of thoroughly unscientific and question-begging remarks on national characteristics—the whole wound up, perhaps, with a chapter on localisation. There is no need to dwell on the dreariness and mediocrity of all this. But it is perhaps just as well to state definitely its considerable positive deficiencies. It suggests that from the point of view of the economist “organisation” is a matter of internal industrial (or agricultural) arrangement—if not internal to the firm, at any rate internal to “the” industry—although, as might be expected, “the” industry is seldom satisfactorily defined. At the same time it tends to leave out completely the governing factor of all productive organisation—the relationship of prices and costs. That comes in a different division which deals with “value”. As a result, as almost any teacher who has taken over students reared on the old textbooks will realise, it was quite possible for a man to have an extensive knowledge of value theory and its copious refinements and to be able to prattle away at great length about the rate of interest and its possible “causes”, without ever having realised the fundamental part played by prices, costs, and interest rates in the organisation of production.

In the modern treatment this is impossible. In the modern treatment, discussion of “production” is an integral part of the theory of equilibrium. It is shown how factors of production are distributed between the production of different goods by the mechanism of prices and costs, how given certain fundamental data, interest rates and price margins determine the distribution of factors between production for the present and production for the future.35 The doctrine of division of labour, heretofore so disagreeably technological, becomes an integral feature of a theory of moving equilibrium through time. Even the question of “internal” organisation and administration now becomes related to an outside network of relative prices and costs; and since this is how things work in practice, what is at first sight the greater remoteness of pure theory in fact brings us much nearer to reality.

• 1“Economic Science in Recent Discussion”, American Economic Review, vol. xxiv., pp. 225–238.
• 2Unsettled Questions of Political Economy, p. 120.
• 3“Nicht die ‘sachlichen’ Zusammenhänge der ‘Dinge’ sondern die gedanklichen Zusammenhänge der Probleme liegen den Arbeitsgebieten der Wissenschaften zugrunde” (Max Weber, Die Objectivität sozialwissenschaftlicher und sozialpolitischer Erkenntnis, Gesammelte Aufsätze zur Wissenschaftslehre, p. 166).
• 4See Cannan, Review of Economic Theory, pp. 1–35, and Schumpeter, Epochen der Methoden- und Dogmengeschichte, pp. 21–38.
• 5See Chapter II., Section 5, especially the footnote on p. 42, for further elaboration of this point.
• 6Wealth, 1st edition, p. 17.
• 7Principles, 8th edition, p. 1.
• 8Cours d’Economie Politique, p. 6.
• 9Essentials of Economic Theory, p. 6. See also Philosophy of Wealth, ch. i. In this chapter the difficulties discussed below are explicitly recognised, but, surprisingly enough, instead of this leading to a rejection of the definition, it leads only to a somewhat surprising attempt to change the significance of the word “material”.
• 10But see Chapter II. below for an examination of the validity of this interpretation.
• 11In this connection it is perhaps worth while clearing up a confusion which not infrequently occurs in discussions of terminology. It is often urged that scientific definitions of words used both in ordinary language and in scientific analysis should not depart from the usages of everyday speech. No doubt this is a counsel of perfection, but in principle the main contention may be accepted. Great confusion is certainly created when a word which is used in one sense in business practice is used in another sense in the analysis of such practice. One has only to think of the difficulties which have been created by such departures in regard to the meaning of the term capital. But it is one thing to follow everyday usage when appropriating a term. It is another thing to contend that everyday speech is the final court of appeal when defining a science. For in this case the significant implication of the word is the subject-matter of the generalisations of the science. And it is only by reference to these that the definition can finally be established. Any other procedure would be intolerable.
• 12Cannan, An Economist’s Protest, p. 49.
• 13Wealth of Nations (Cannan’s ed.), p. 315.
• 14Theories of Production and Distribution, pp. 18–31; Review of Economic Theory, pp. 49–51.
• 15It is even arguable that the reaction has gone too far. Whatever its demerits, the Smithian classification had a significance for capital theory which in recent times has not always been clearly recognised. See Taussig, Wages and Capital, pp. 132–151.
• 16The Nature of Capital and Income, ch. vii.
• 17This is the title of ch. ii. of Wealth (1st edition).
• 18There are other quarrels which we might pick with this particular definition. From the philosophical point of view, the term “material welfare” is a very odd construction. “The material causes of welfare” might be admitted. But “material welfare” seems to involve a division of states of mind which are essentially unitary. For the purposes of this chapter, however, it has seemed better to ignore these deficiencies and to concentrate on the main question, namely, whether the definition can in any way describe the contents of which it is intended to serve as a label.
• 19It is perhaps worth emphasising the significance of this qualification. The application of technically similar means to the achievement of qualitatively similar ends at different times constitute alternative uses of these means. Unless this is clearly realised, one of the most important types of economic action is overlooked.
• 20This may seem an unnecessary refinement, and in the first edition of this essay I left it out for that reason. But the condition that there exists a hierarchy of ends is so important in the theory of value that it seems better to state it explicitly even at this stage. See Chapter IV., Section 2.
• 21Cp. Schönfeld, Grenznutzen und Wirtschaftsrechnung, p. 1; Hans Mayer, Untersuchungen zu dem Grundgesetze der wirtschaftlichen Wertrechnung (Zeitschrift für Volkswirtschaft und Sozialpolitik, Bd. 2, p. 123).
• 22It should be clear that there is no disharmony between the conception of end here employed, the terminus of particular lines of conduct in acts of final consumption, and the conception involved when it is said that there is but one end of activity—the maximising of satisfaction, “utility”, or what not. Our “ends” are to be regarded as proximate to the achievement of this ultimate end. If the means are scarce they cannot all be achieved, and according to the scarcity of means and their relative importance the achievement of some ends has to be relinquished.
• 23Cp. Menger, Grundsätze der Volkswirtschaftslehre, lte Aufl., pp. 51–70; Mises, Die Gemeinwirtschaft, pp. 98 seq.; Fetter, Economic Principles, ch. i.; Strigl, Die ökonomischen Kategorien und die Organisation der Wirtschaft, passim; Mayer, op. cit.
• 24On the distinction between analytical and classificatory definitions, see Irving Fisher, Senses of Capital (Economic Journal, vol. vii., p. 213). It is interesting to observe that the change in the conception of Economics implied by our definition is similar to the change in the conception of capital implied in Professor Fisher’s definition. Adam Smith defined capital as a kind of wealth. Professor Fisher would have us regard it as an aspect of wealth.
• 25See his Objekt und Grundbegriffe der theoretischen Nationalökonomie, 2 Aufl. The criticisms of Schumpeter and Strigl on pp. 110–125 and pp. 165–156 are particularly important from this point of view. With the very greatest respect for Professor Amonn’s exhaustive analysis, I cannot resist the impression that he is inclined rather to magnify the degree of his divergence from the attitude of these two authors.
• 26See Mises, Die Gemeinwirtschaft, pp. 94–138. In his Economic Planning in Soviet Russia, Professor Boris Brutzkus has well shown the way in which this difficulty has been exemplified in the various phases of the Russian experiment.
• 27See Strigl, op. cit., pp. 23–28.
• 28Professor Cassel’s dismissal of Crusoe Economics (Fundamental Thoughts, p. 27) seems unfortunate since it is only when contemplating the conditions of isolated man that the importance of the condition that the scarce means must have alternative uses if there is to be economic activity, which was emphasised above, leaps clearly to the eye. In a social economy of any kind, the mere multiplicity of economic subjects leads one to overlook the possibility of the existence of scarce goods with no alternative uses.
• 29The objections outlined above to the definition suggested by Professor Amonn should be sufficient to indicate the nature of the objections to those definitions which run in terms of phenomena from the standpoint of price (Davenport), susceptibility to the “measuring rod of money” (Pigou), or the “science of exchange” (Landry, etc.). Professor Schumpeter, in his Wesen und Hauptinhalt der theoretischen Nationalökonomie, has attempted with never to be forgotten subtlety to vindicate the latter definition by demonstrating that it is possible to conceive all the fundamental aspects of behaviour germane to Economic Science as having the form of exchange. That this is correct and that it embodies a truth fundamental to the proper understanding of equilibrium theory may be readily admitted. But it is one thing to generalise the notion of exchange as a construction. It is another to use it in this sense as a criterion. That it can function in this way is not disputed. But that it throws the maximum light on the ultimate nature of our subject-matter is surely open to question.
• 30Wealth (1st edition), ch. i.
• 31On the various types of equilibrium contemplated, see Knight, Risk, Uncertainty and Profit, p. 143, note; Wicksell, Lectures on Political Economy, vol. i; and Robbins, On a Certain Ambiguity in the Conception of Stationary Equilibrium (Economic Journal, vol. xl., pp. 194–214).
• 32See Pareto, Manuel d’Economie Politique, p. 147; also my article on Production in the Encyclopædia of the Social Sciences. In the first edition of this essay I subsumed the theory of comparative statics and the theory of dynamic change under the single heading, “Theory of Variations.” I now think it it better to make explicit the two types of variation theory. For further elucidations see below, Chapter IV., Section 7.
• 33Op cit., pp. 540–542.
• 34The beginning of the change dates from the coming of the subjective theory of value. So long as the theory of value was expounded in terms of costs, it was possible to regard the subject-matter of Economics as something social and collective, and to discuss price relationships simply as market phenomena. With the realisation that these market phenomena were, in fact, dependent on the interplay of individual choice, and that the very social phenomena in terms of which they were explained—costs—were in the last analysis the reflex of individual choice—the valuation of alternative opportunities (Wieser, Davenport)—this approach becomes less and less convenient. The work of the mathematical economists in this respect only sets out particularly boldly a procedure which is really common to all modern theory.
• 35The best discussions are to be found in Wicksell, Lectures on Political Economy, vol. i., pp. 100–206; Hans Mayer, Produktion in the Handwörterbuch der Staatswissenschaften.