Man, Economy, and State with Power and Market

The explanation of the free economic system constitutes a great architectural edifice. Starting from human action and its implications, proceeding to individual value scales and a money economy, we have demonstrated that the quantity of goods produced, the prices of consumers’ goods, the prices of productive factors, the interest rate, profits and losses, all can be explained by the same deductive apparatus. Given a stock of land and labor factors, given existing capital goods inherited from the past, given individual time preferences (and, more broadly, technological knowledge), the capital goods structure and total production is determined. Individual preferences set prices for the various consumers’ goods, and the alternative combinations of various factors in their production set the marginal value-productivity schedules of these factors. Ultimately, the marginal value product accruing to capital goods is resolved into returns to land, labor, and interest for time. The point at which a land or labor factor will settle on its DMVP schedule will be determined by the stock available. Since each factor will operate in an area of diminishing physical and certainly diminishing value returns, any increased stock of the factor, other things being equal, will enter at a lower DMVP point. The intersecting points on the DMVP schedules will yield the prices of the factors, also known as “rents” and “wage rates” (in the case of labor factors). The pure interest rate will be determined by the time-preference schedules of all individuals in the economy. Its chief expression will be not in the loan market, but in the discounts between prices in the various stages of production. Interest on the loan market will be a reflection of this “natural” interest rate. All the prices of each good, as well as the interest rate, will be uniform throughout the entire market. The capital value of every durable good will equal the discounted value of the sum of future rents to be obtained from the good, the discount being the rate of interest.

All this is a picture of the evenly rotating economy—the equilibrium situation toward which the real economy is always tending. If consumer valuations and the supply of resources remained constant, the relevant ERE would be reached. The forces driving toward the ERE are the profit-seeking entrepreneurs, who take the lead in meeting the uncertainties of the real world. By seeking out discrepancies between existing conditions and the equilibrium situation and remedying them, entrepreneurs make profits; those businessmen who unwittingly add to the maladjustments on the market are penalized with losses. Thus, to the extent that producers wish to make money, they drive toward ever more efficient servicing of the desires of the consumers—allocating resources to the most value-productive areas and away from the least value-productive. The (monetary) value productivity of a course of action depends on the extent to which it serves consumer needs.

But consumer valuations and supplies of resources are always changing, so that the ERE goal always changes as well and is never reached. We have analyzed the implications of changing elements in the economy. An increase in the labor supply may lower the DMVP of labor and hence wage rates, or raise them because of the further advantages of the division of labor and a more extended market. Which will occur depends on the optimum population level. Since labor is relatively more scarce than land, and relatively nonspecific, there will always be idle and zero-rent land, while there will never be involuntarily idle or zero-wage labor. An increase or decrease in the supply of “sub-marginal” land will have no effect on production; an increase in supramarginal land will increase production and render hitherto marginal land submarginal.

Lower time preferences will increase capital investment and thereby lengthen the structure of production. Such lengthening of the production structure, increasing the supply of capital goods, is the only way for man to advance from his bare hands and empty acres of land to more and more civilized standards of living. These capital goods are the necessary way stations on the road to higher total production. But they must be maintained and replaced as well as initially produced if people wish to keep their higher standard over any length of time.

To expand production, the important consideration is not so much technological improvement as greater capital investment. At no time has invested capital exhausted the best technological opportunities available. Many firms still use old, unimproved processes and techniques simply because they do not have the capital to invest in new ones. They would know how to improve their plant if capital were available. Thus, while the state of technology is ultimately a very important consideration, at no given time does it play a direct role, since the narrower limit on production is always the supply of capital.

In a progressing economy, given a constant supply of money, increased investment and a longer capital structure bring about lower money prices for factors and still lower prices for consumers’ goods. “Real” factor prices (corrected for changes in the purchasing power of the monetary unit) increase. In net terms, this means that real land rents and real wage rates will increase in the progressing economy. Interest rates will fall as time-preference rates drop and the proportion of gross investment to consumption increases.

If rents are earned by a durable factor, they can be and are “capitalized” on the market, i.e., they have a capital value equivalent to the discounted sum of their expected future rents. Since land is a form of investment on the market just as are shares of a firm, its future rents will be capitalized so that land will tend to earn the same uniform interest rate as any other investment. In a progressing economy, the real capital value of land will increase, although the value will fall in money terms. To the extent that future changes in the value of land can be foreseen, they will be immediately incorporated into its present capital value. Therefore, future owners of land will benefit by future increases in its real capital value only to the extent that previous owners failed to anticipate the increase. To the extent that it was anticipated, the future owners will have paid it in their purchase price.

The course of change in a retrogressing economy will be the opposite. In a stationary economy, total production, the capital structure, real wages per capita, real capital values of land, and the rate of interest will remain the same, while the allocation of factors of production and the relative prices of various products will vary.70

• 70The last few years have seen signs of a revival of “Austrian” production theory—the tradition in which these chapters have been written. In addition to works cited above, see Ludwig M. Lachmann, Capital and Its Structure (London: London School of Economics, 1956) and idem, “Mrs. Robinson on the Accumulation of Capital,” South African Journal of Economics, June, 1958, pp. 87–100. Robert Dorfman’s “Waiting and the Period of Production,” Quarterly Journal of Economics, August, 1959, pp. 351–72, and his “A Graphical Exposition of Böhm-Bawerk’s Interest Theory,” Review of Economic Studies, February, 1959, pp. 153–58, are interesting chiefly as a groping attempt by a leading mathematical economist to return to the Austrian road. For an incisive critique of Dorfman, see Egon Neuberger, “Waiting and the Period of Production: Comment,” Quarterly Journal of Economics, February, 1960, pp. 150–53.