Review of Austrian Economics

Knowledge, Judgment, and the Use of Property

Jörg Guido Hülsmann

Two Interpretations of the Causes of the Socialist Disaster

In recent years, the socialist calculation debate of the 1920s and 1930s has attracted anew the interest of thinkers in the Austrian tradition. With the breakdown of the Soviet empire Ludwig von Mises’s claim that socialism as an economic system is impossible has received a somewhat late empirical confirmation. However, modern Austrian economists are far from sharing a common interpretation of the issue.

Some of them think that the impossibility of socialism stems from its inability to communicate dispersed knowledge.1 In their eyes, information about the particular circumstances of time and place can never be centralized. It necessarily exists in dispersed form and yet it can be communicated by the market prices of capitalist societies. Only capitalism is thus capable of solving the knowledge problem.

Other authors consider the knowledge-problem to be secondary.2 They hold that the absence or presence of private property is the salient point. In socialism there can be no calculation because the latter presupposes market prices. Market prices, however, presuppose exchange and, thus, private property.

This division of opinions goes back to Mises and Hayek. Mises considered the emphasis on the knowledge problem to be insufficient because it merely suggested a practical difficulty for the implementation of a socialist regime. What he had in mind was that socialism was, for purely logical reasons, impossible.3 Hayek, on the other hand, focused entirely on the problem of dispersed knowledge.4 He not only developed this point in the context of the socialist calculation debate but it is the foundation of all of his later social philosophy.

Importance of the Dispute

We are not merely discussing the reasons for the failure of socialism, because the dispute concerns both the understanding of what economics is all about and the practical conclusions that can be inferred from our science. The whole issue is of fundamental importance.

According to Mises, economics is a science that consists of a priori propositions about reality. In his eyes these propositions are implied in the conditions of action and are arrived at by an exercise of logic. Whatever is the product of sound discursive reasoning, so the argument goes, must be valid for reality.

This is precisely the point that Hayek wants to oppose. To his understanding, economic theorems are in some way detached from reality. They are mere tautologies. Additional statements about the acquisition of knowledge are necessary to make them relevant for the understanding of our world. Thus, consider the programmatical declaration that he gave in his article on “Economics and Knowledge”:

my main contention will be that the tautologies, of which formal equilibrium analysis in economics essentially consists, can be turned into propositions which tell us anything about causation in the real world only in so far as we are able to fill those formal propositions with definite statements about how knowledge is acquired and communicated. In short, I shall contend that the empirical element in economic theory—the only part which is concerned not merely with implications but with causes and effects and which leads therefore to conclusions which, at any rate in principle, are capable of verification—consists of propositions about the acquisition of knowledge.5

Formal equilibrium analysis in the sense Hayek uses refers to the mathematical approach. However, it is at least doubtful whether one really has to condemn equilibrium analysis altogether in order to refute socialism. This is an issue beyond our present scope. Rather the focus is on a critique of the Hayekian emphasis on knowledge problems and on a reconstruction of the fashionable expressions of market process and knowledge in terms of property and calculation. The Hayekian approach has been elaborated with delicacy by Israel M. Kirzner. Therefore, the present critique will refer mainly to his works.6 The whole knowledge paradigm is a blind alley and its infallibility leads to nihilism of the Shacklean-Lachmannian brand.

The Case Against the Knowledge Paradigm in Economics

Do Prices Communicate Knowledge or Coordinate Actions?

The first thing we have to ask is whether prices do have a communicative function at all. According to Kirzner, there are two quite different communicative functions of prices. He distinguishes between the communicative functions of equilibrium and disequilibrium prices, and places particular emphasis on the latter:

It is one thing to recognize the role of equilibrium prices as economic signals which permit instantaneous coordination of decentralized decisions, based on dispersed bodies of knowledge. It is quite another thing to recognize the role of disequilibrium prices in stimulating entrepreneurial discoveries concerning the availability of dispersed information (whose existence had hitherto escaped relevant attention).7

Let us consider these functions in turn. This first thesis refers to equilibrium prices. It is, indeed, composed of three distinct sub-theses.

First off, prices are claimed to contain economic information in a condensed form.8 This is undoubtedly true if one intends to say that prices give information about exchange ratios of the past. Yet, we have to remark that past prices are the outcome of past conditions. Action, however, is never confronted with past but with future conditions, namely, with all conditions prevailing during its course. Moreover, and this is the crucial point, we should not overlook that prices are always the outcome of an action. Therefore, all information that this action was based upon had to be acquired beforehand. The price itself could not have communicated the knowledge that brought it about. Only in a metaphorical sense could one say that prices reflect or contain information on present conditions. For acting man these conditions of the immediate past are already bygones.

The second sub-thesis says that equilibrium prices permit the communication of dispersed bodies of knowledge.9 These particular circumstances of time and place are never known by anyone in their totality. Yet, through the exchange ratios of the market, they are transmitted in abridged form to all market participants. According to these advocates, socialism suffers because it has no equivalent mechanism. The socialist planning board cannot determine the values of the factors of production because these values are determined by facts of supply and demand that are too widely dispersed.10

Let us observe that the positive part of this reasoning contains no argument at all. It is asserted that prices communicate abridged relevant information. This, however, is only a metaphorical expression. Each exchange ratio is determined by particular circumstances of time and place. Yet, it is not important that this be so but rather—if at all—how precisely this determination operates. As long as there exists no theory about the exact determination of our choices, we can infer nothing from the fact that everything must be determined. It is also mere assertion that no mechanism other than prices could communicate those dispersed facts with the same speed.11 However, if we assume, for the sake of the argument, that this was the case, then the market economy would stumble from one crisis into another. The quickest information for the capitalist-entrepreneurs is in the observation of market prices. Only then would they begin to act. In other words, if information really were so important, there would be no use for anticipating the future, yet it is precisely the latter that permits the market to operate smoothly.

Finally, the advocates of the importance of knowledge problems argue that exchange ratios permit the coordination of decentralized decisions. It is difficult to see how coordination as such could ever be a problem that socialism is incapable of solving. Indeed, in a larger sense all actions are somehow coordinated. Our actions are no less coordinated with the actions of milkmen and movie tycoons than with those of robbers, rapists, and murderers. It is not the problem of murder that the Hayekian knowledge theorists have in mind when they speak of coordination, so an additional criterion is required to distinguish “good” from “bad” coordination. This criterion—and not coordination—would then be the cornerstone of economic analysis.12

Thus, one is led to wonder whether the word “coordination” is but an unfortunate expression that obscures some valuable insights. We should therefore take a closer look at the illustrations given in support of the knowledge-problem approach. Probably most famous is the tin example that Hayek uses to illustrate the claim that “prices can act to coordinate the separate actions of different people in the same way as subjective values help the individual to coordinate the parts of his plan.” Hayek suggests that we:

Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose—and it is significant that it does not matter—which of these two causes had made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the most urgent need has arisen, or in favor of what other needs they ought to husband the supply. If only some of them know directly of the new demand, and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the effect will rapidly spread throughout the whole economic system and influence not only all the uses of tin but also those of its substitutes and the substitutes of these substitutes, the supply of all things made of tin, and their substitutes, and so on; . . . The whole acts as one market, not because any of its members survey the whole field, but because their limited individual fields of vision sufficiently overlap so that through many intermediaries the relevant information is communicated to all.13

There can be no doubt that the effect of the increased scarcity of tin will rapidly spread throughout the whole economic system and influence not only all the uses of tin but also those of its substitutes, etc. This process is, however, not best characterized by a coordinative function of prices.

The fundamental fact of scarcity implies that not every demand for tin can be satisfied. Some people have tin whereas others do not. An increased scarcity of tin implies that some market participants who otherwise could have benefited from tin are now of necessity prevented from using it. If a quantity of tin is sold, then the seller cannot sell it again, regardless of the exchange rate. There is simply no more of this tin left. Whether the seller takes notice of this or not is immaterial. He cannot sell what is no longer in his possession. Moreover, tin does not become scarcer and then this fact can come to be known to someone and lead to adaptations. Rather it is the other way around. The very fact that demand increases means that someone already knows of a more value-productive employment of tin.

It is not prices that coordinate the actions of sellers and buyers of tin; prices are the outcome of (coordinated) action, not its coordinators. It is property, rather than knowledge, that coordinates the separate actions of different people. The terms coordination and communication rather obfuscate than adequately express this fact. This is another example of the dangers linked to the use of metaphors in scientific discourse.

The Attraction Theory of Equilibration

Now, let us return to the second of Kirzner’s theses. How far is it justified to speak of a communicative function of disequilibrium prices? Previously, we have seen that Kirzner believes them to stimulate entrepreneurial discoveries concerning the availability of dispersed information. The important word in this expression is “stimulate.” Does Kirzner intend to say that prices or price spreads are the causes of actions? Indeed, this seems to be the position that he advocates. He says: “opportunities for profit can attract and inspire market actions which turn out to reduce market ignorance and misallocation.”14

It is important to realize that this conception does not coincide with entrepreneurial alertness in the definition used by Kirzner. Entrepreneurial alertness is to be “understood as the capacity independently to size up a situation and more correctly reach an imagined picture of the relevant (as yet indeterminate) future. All of us share in this ability to some extent . . . But some have higher degrees of this ability.”15

Indeed, who would venture to deny that each of us, at least to some extent, manages to size up a situation and correctly reach an imagined picture of the relevant future?16 However, Kirzner’s conception of the communicative function of disequilibrium prices relies on something entirely different from alertness in the above sense. He claims that

it is the prospective gain offered by [future] realities which “switches on” entrepreneurial alertness.17 We know very little about the precise way in which pure profit opportunities attract entrepreneurial attention. But there can be little doubt about the powerful magnetism which such opportunities exert.18

Kirzner has invited us, without supporting argumentation, to share his belief in what could be labelled an attraction or revelation theory. For if action is conscious behavior, what does it mean that price spreads cause action? There must be a sort of mechanism that brings price spreads to the attention of some entrepreneurs. Price spreads must then be conceived of as somehow jumping into an entrepreneur’s consciousness without requiring any prior action on his part. In general terms, Kirzner’s conception implies that we (or some of us) do have information about an object because the object itself puts it somehow in our consciousness. We are passive and the object is active.

Of course, this is not true. The objects in our environment are as they are—whether we know something about them or not. However, without conscious action on our part we will never know anything about them. Or could you even describe the color of the seat you sit upon right now without consciously looking at it once again? Could you even say precisely how many steps one has to climb to get to your hotel room without counting them? There is an infinite number of questions of this kind, and each time the answer is no. It is not the objects that attract our action. We have to act to make them enter into our consciousness.

To be sure, an object must be there to be perceived. Its existence is a necessary condition for its being perceived. Yet a perception is always an action, that is, the manifestation of a choice; and choice is in no known way determined by any object. Thus, without consciously taking notice of the prices that are formed on the market we cannot possibly know about them. As a consequence, we cannot be attracted by prices and price spreads, either.

Price differences in the same market are no exception. Even if there are different prices at the same time and in the same geographical area, entrepreneurs have to consciously look for them. They have to act in order to know where to buy and where to sell.

At each moment there is probably an infinite number of undiscovered price spreads. We would all be much better off if Kirzner was right and these price spreads were revealed to some of our fellows. They could stay at home, sit in their armchairs and reap some pretty profits. Unfortunately, this is not how things happen in our world. It is therefore impossible to conclude with Kirzner that “this very spread between high and low prices suggests to some alert entrepreneurs that arbitrage profits may be won.”19

Kirzner does not claim that every alert entrepreneur will be attracted by profit opportunities. However, this is no solution to the difficulty that his attraction theory faces. In a sense it rather creates additional difficulties. For one still has to explain how an object, by its sole existence, can enter our consciousness. Yet, now, one also has to explain why some persons are more susceptible to price spreads than other persons.

However, even if one ignored these objections and even if one assumed, for the sake of argument, that alert entrepreneurs could somehow know the marginal value product of factors of production, the attraction theory would still be contradictory. For either a factor of production has already been sold on the market or not. If it has been sold at a price below its discounted marginal value product then there is a profit opportunity. Yet, in this case, it would be too late for an alert entrepreneur to intervene, for the very reason that it already has been bought by a competitor. If, by contrast, that factor has not yet been sold to anybody then there is no price spread. As a consequence, no alert entrepreneur can be attracted to purchase this factor. Thus, the attraction theory is invalid even on its own assumptions.

Kirzner would probably deny that his theory leads him close to the grounds of a somewhat crude materialism. He sometimes emphasizes that one “can never say that alertness rendered its possessor sure that he would successfully discover that which he later discovers.”20 However, one should not overlook that his attraction theory is of crucial importance to what he considers to be the central theorem of economics, namely, the theorem that “demonstrates the equilibrative and coordinative tendencies in the market process.”21 This theorem, as Kirzner understands it, rests on the notion of a systematic learning process that is generated throughout subsequent time periods.22 Now such a theorem must of necessity show that discoveries (that is, pertinent judgments) are in some way determined by the objective conditions of action. If discoveries were determined by choice alone, such a demonstration would be impossible, as choice implies that one can err. Hence, Kirzner’s central theorem requires that discoveries be explained by factors other than choice. This is precisely what Kirzner attempts to do with his attraction theory. Indeed, it would be insufficient for his purpose to merely stress the “motivation to see relevant facts as they are.”23 For such a motivation alone would, of course, not assure any success. It is not sufficient to claim that entrepreneurs are alert if one wants to prove the existence of a Kirznerian equilibrating process. One has to show that they succeed and why. Above we have seen that Kirzner can hardly be said to have solved this problem. The reason is, of course, that one cannot think of action apart from choice. Yet, does this mean that it is vain to look for any tendency of the market toward equilibrium? Be that as it may, even if the analysis of equilibrium or equilibration were defective it could hardly be helpful to supplement it or to replace it with another fallacious theory.

The Consequence: Empiricism

By the way, Kirzner seems not to be very convinced of his proof of equilibration, either. Above we have noted that at the bottom of Kirzner’s attraction theory there is nothing but his belief in it. This is no exaggeration. Indeed, Kirzner is very conscious that this is the basis of his theory. Consider the following statements:

It can be shown that our confidence in the market’s ability to learn and to harness the continuous flow of market information to generate the market process depends crucially on our belief in the benign presence of the entrepreneurial element.24

An assertion that the attempted execution of a set of incompatible plans will set in motion a systematic series of plan changes tending toward equilibrium cannot be made on purely logical grounds. Such an assertion must depend on a postulated propensity on the part of market participants to learn the correct lessons from their experience.25

This reliance on mere assertion and on an appeal to share in his belief indicates that Kirzner has abandoned the idea of praxeology, that is, of a logic of the social phenomena. Indeed, his empiricism has constantly grown over the years.26 In his last book he explicitly says:

economic science has always proceeded from the important empirical circumstance of economic order. . . . The market obviously works. That the market works is perhaps the most significant lesson of modern history.27

It is the central tenet of market process theory, under the present variant of it, that despite the complexities thus introduced by continually changing UV’s [underlying variables], the essential character of the market process, as a matter of historical experience, does remain largely intact.28

This is not the way Mises conceived of the market or of the relationship between the historical and the theoretical branches of the social sciences. It is an open question whether market-process analysis of the Kirznerian variant is not essentially a kind of historical investigation. However, we cannot address this topic at this place as our purpose is more limited.

Robbinsian Economizing and Kirznerian Entrepreneurship

From what has been said so far it follows that Kirzner’s whole characterization of entrepreneurial activity as a resourceless discovery29 is unfounded. For if action implies that scarce means are employed in the pursuit of ends, and if one has to act in order to perceive anything whatever, then there can be no such thing as a discovery—or better: a judgment—without the disposition of one’s brains and sensory apparatus. There can be virtually no activity at all without at least some property.30 As a consequence, it would be equally impossible to realize any judgment on the market without becoming a capitalist. Likewise it is inconceivable to be simply a capitalist lending funds to an alert idea man. For doing this, one would at least have to make the discovery that this credit is at the moment the best way to use one’s property.31

We have seen that the root of Kirzner’s errors concerning entrepreneurial discoveries lies in his attempt to determine choice—if only implicitly. Choice is the universal problem with which acting man is confronted. At each moment he has to choose the supposedly most important action that can be executed. This kind of judgment is the cornerstone of economic science. It is well known that Kirzner tends to qualify this. All of his work—virtually all of his articles—starts from a critique of what he calls the “Robbinsian economizer.”32

Kirzner claims that the problems of real life are disfigured if one considers the economic data to be given to the market participants. In Kirzner’s eyes, if a datum is given this means that it is known to some or all market participants.33 As a consequence, he emphasizes that the market participants have to discover the data. If the latter are only incompletely perceived, there can be something like “sheer ignorance” of the present data. It is through the market process that the data become known as they are discovered. Kirzner further argues that what counts is not equilibrium and perfect knowledge but equilibration and discovery. Let us not waste our time, so the argument goes, with the never-never land of the evenly-rotating economy and perfect knowledge. Let us rather focus on our way to acquire knowledge and thus approach equilibrium in a process of equilibration.

One cannot deny that not all data are given to us in the sense that we know them. However, it is a different question whether this was claimed in Lionel Robbins’s The Nature and Significance of Economic Science. And it is also a different question whether, if Robbins did do so, the Kirznerian entrepreneur would be a viable alternative.

An impartial reader of Robbins’s above-mentioned book cannot help but wonder what Kirzner’s critique is based upon. Kirzner rarely gives quotations to support this argument, and it is only in his work The Economic Point of View that he quotes at length from Robbins.34 Yet even in these quotations nothing can be found which could possibly support his claim against Robbins. To avoid any misunderstandings: I do not intend to say that nothing can be found in these quotes that would not be worthwhile criticizing. However, it is obvious that Robbins does not consider the ends of action to be known. Rather, he explicitly states that, for economic theorems to be valid, the concrete means-ends frameworks are irrelevant.35

Perhaps Kirzner’s purpose is not to criticize Robbins but some contemporary microeconomic textbooks featuring a caricature of acting man. Thus, he points out “that the purely allocative decision never does occur, and that in fact it is sheer illusion to imagine that economic science can ever provide the kind of precision suggested in microeconomic textbooks.”36 However, in this case it would be inadequate to charge Robbins with the fallacies of some writers who are (or can be considered to be) inspired by his work. And still the question remains, then, whether the emphasis on discovery and knowledge represents any conceivable advance over the emphasis on choice.

Of course, we do not know everything in our environment in the sense that we have already experienced it. But this is completely irrelevant for the problem of choice. For to choose correctly does not mean that one has experienced all relevant data, but that one acts according to a correct judgment upon these data.37 That data are given does not mean that they are known. It means rather, that our action is confronted with them, be they means or obstacles. Yet they are means and obstacles independently of the question whether we know them or not. It is also irrelevant whether a datum does already exist at the moment of our decision. If it comes into existence only in the future it is no less a datum than any other. For our action, it is then given in the same sense as the presently-existing data are given, too. Entrepreneurial appraisements of the factors of production do not presuppose information about the future. They are judgments based on estimates, that is, judgments about the future.38

Does all this mean that knowledge has no bearing on action whatever? Indeed, one cannot avoid this conclusion by saying that most of our past knowledge can successfully be applied in the future. For the very question is why this is so. The validity of empirical knowledge has been established by experience, and all our experiences are determined by the totality of their conditions. Yet, the conditions of action are not immutable. Rather, they change from day to day. Here lies the problem of the application of past knowledge. We have to judge whether the same conditions will prevail in the future as well. To this task all our empirical knowledge is of no help.

Therefore, there can be no such thing as a “generation of knowledge” through disequilibrium prices. The latter do not “reveal, to alert market participants, how altered decisions on their part . . . may be wiser for the future.”39 No past experience tells us what we should expect for the future to come. Neither can it tell us which actions we should choose.

Each action presupposes an ingredient that is entirely distinct from knowledge and information, namely, a judgment upon the conditions prevailing in the future. Why, then, do we need the Kirznerian entrepreneur at all?40 Even Kirzner himself sometimes describes the Robbinsian economizers as “decision makers [that] are passive price-takers, simply optimizing against the background of assumed data.”41 Thus Robbinsian economizers do not behave as mechanically as Kirzner would have us believe them to be. At least they anticipate the future. They thus cannot be simple price-takers. Kirzner would surely retort that nothing in their behavior assures equilibration. However, as we have seen, nothing in his concept of an entrepreneur can assure this, either. Kirzner’s argument, therefore, boils down to saying that “some assumptions about the future prove to be profitable whereas others do not; therefore the former are ‘entrepreneurial discoveries’ whereas the latter are the ‘data’ assumed by Robbinsian economizers.” True enough, but this kind of wisdom would not require an economist.

Searching for Knowledge of the Future: the Road to Shackleanism

Kirzner’s emphasis on discovery and equilibration is not necessary to give meaning to any sound economic doctrine. As we have already noted, in its attraction-theory version it merely leads to additional problems. Now we have to focus on another area of difficulty that inevitably follows from considering knowledge problems as the cornerstone of economics. For the talk of knowledge and sheer ignorance leads ultimately to what is erroneously called extreme or radical subjectivism (erroneously, because it is rather a spurious subjectivism). If knowledge can only be acquired after perception, then economics (and all other social sciences, too) can only be an empirical, ex post science of human action. Now, strictly speaking, all knowledge that we ever acquire is acquired ex post, i.e., after a perception.42 We always have to advance additional reasons to argue for the more or less universal validity of a perception. Yet, the spurious subjectivists just claim (correctly) that there can be no present experience of future events. From this they infer that there can be no scientific statements about the future, either. For them, the future is kaleidoscopic, veiled and, in principle, unknowable.

Emphasis on discovery and equilibration cannot avoid these conclusions at all. It is vain to think that there is a kind of knowledge-producing mechanism called equilibration. Despite all claims to the contrary, this kind of a mechanism is the very core of Kirzner’s comprehension of the market. One may discuss the question whether it is really a mechanism that is at stake. But it is hardly possible of denying that Kirzner’s theory of equilibration aims at and relies upon statements about the systematic nature of entrepreneurial discoveries. Call this systematic nature of discoveries a mechanism or call it something else—the crucial point is that there must be a constancy that links perceptible events and their perception, that is, their discoveries. Otherwise, one could not speak of a theory at all, for a theory always aims at the establishment of general rules. There cannot be such a rule without constancy.

Of course, neither Kirzner nor anybody else has succeeded in elaborating such a theory. However, we have to address the question of whether it is at least conceivable that such a theory can be constructed. For in this case, Kirzner’s attempts could be considered to be a quite normal failure but not without some merit. Unfortunately this is not the case. The notion of a constant relationship between perceptible objects and their perception, which must be rejected. It is not a viable approach to economics at all. We know nothing about the precise reasons for perceptions.

This criticism has already been noted above. The only way to counter it is to claim that, in the course of time, acting man discovers more and more of the environment of his actions. Once we have discovered an object, we learn each day to deal a little bit better with it. As time goes by, we can better discern what kind of perceptions it does permit under what circumstances.

Even if this is true, let us note three points. First of all, it does not concern the lack of a viable perception theory. The proposition that, once we know something, we know it for all time does not answer the question of how we came to know it. Furthermore, this proposition ignores the fact that the conditions of action do not cease to change. Therefore, the knowledge that we acquired through an ex post evaluation of the past cannot simply be applied again in the future.43 Yet most importantly, it merely refers to objects different from human action. But what about action itself? What about choice and perception? Can choice and its offspring, prices and price spreads, be studied with the same results as the dead matter around us? The answer to this question is no. Not only is it impossible to deduce choice from any other conditions of action, there also can be no theory featuring the causes of choice. Such a theory would have to assume that there was something like constancy in the thought of acting man. In other words, such a theory would have to presuppose that man cannot learn; this, however, is self-defeating.44

To be sure, no entrepreneur can base his judgments on the sole analysis of conditions of action other than choice. He has to analyze choice as well. Yet, this he must do in the way of thymological understanding.45 Thus, he can never arrive at any general conclusions. There is no possibility to say in a general manner under which conditions our discovered knowledge about price spreads will be valid.

The emphasis on knowledge and discovery cannot avoid the pitfalls of spurious subjectivism. However, the latter doctrine is definitely not the position Kirzner advocates. In The Meaning of Market Process, he emphatically refutes the case of spurious subjectivism. He tries to defend what Roger Garrison calls the Austrian middle ground.46 However, on the basis of his own account of economic doctrine, this would be an impossible undertaking. If equilibrium analysis presupposes that all data are known to each market participant, one cannot counter the arguments of the spurious subjectivists. Yet, in his refutation of the latter, Kirzner does not try to show that they have given a wrong account of the allegedly-important problems of knowledge and sheer ignorance. Rather, he makes an excellent case for common sense, and this case he states without recourse to knowledge and ignorance, but with emphasis on action and choice. He says:

The usual, layman’s, perception of human decisions is that some of them are taken wisely, judiciously, successfully. These are the decisions which, in retrospect, one recognizes as having been crucial to the achievement of some desirable outcome. Other decisions, the usual perception has it, turn out to have been unsuccessful; in retrospect, at least, they are seen to have been mistakes. . . . Here we have the nub of our apparent disagreement with the radical subjectivists: is it or is it not meaningful to describe a decision as having been appropriate, in the light of subsequent events, or as having been inappropriate?47

What are these statements other than an implicit acknowledgement of the irrelevance of knowledge problems? In any case, they do not mark a new turn in Kirzner’s thought on these problems. In a revealing passage from his Competition and Entrepreneurship, he made the following remarks:

My discussion of entrepreneurial alertness has deliberately avoided its speculative character. I have of course recognized that in a world of uncertainty every entrepreneurial decision, no matter how much alertness it reflects, must to some extent constitute a gamble. But it has been my purpose to point out that the entrepreneur’s decision—despite its unavoidably speculative character—represents his judgment that an opportunity for profit does exist. All human action is speculative; my emphasis on the element of alertness in action has been intended to point out that, far from being numbed by the inescapable uncertainty of our world, men act upon their judgments of what opportunities have been left unexploited by others.48

This is the common ground of sound economics. However, with regard to Kirzner’s theory of discovery and equilibration we are unconvinced. As will be seen in the next section, Kirzner’s contributions are defective where one would least suspect them to be so, namely, in their account of the market process as it was conceived by Böhm-Bawerk and Mises.

The Case for Property and Calculation

Does Market Process Analysis Rely on Knowledge Problems?

In this section it will be argued that the problems of action that underlie the fashionable expressions of market process and knowledge can be entirely analyzed in terms of property and choice. Let us first take a look at the way in which prices for capital goods are formed on the market. This process has found its first statement in Böhm-Bawerk’s Positive Theory of Capital49; Mises called it the market process.50 The advocates of the alleged importance of knowledge problems claim that the market process is beneficial because it is a device to diffuse and communicate knowledge. However, this is not what a sober analysis reveals.

There are two steps that have to be distinguished in the market process, namely, the formation of prices for consumer goods and the formation of prices for capital goods. The former depends entirely on the individual values of the consumers. The more they appreciate a product the more they will be ready to give in exchange for it. This has direct repercussions on the market for capital goods. The higher the proceeds of a product the more can be successfully given in exchange for its factors of production. Now, what is implied in the fact that each capital good will be exchanged against the highest price its owner can obtain? It means that only the supposedly most-value-productive enterprises can be realized. All other entrepreneurs simply cannot bring the needed capital goods into their possession. They cannot pay prices as high as their competitors.

What role does the knowledge of the market participants play in this analysis? In particular, is any communication or diffusion of knowledge necessary in order to bring the above result? The answer to the latter question clearly is in the negative. The competing entrepreneurs may know nothing at all about other possibilities to employ the factor of production they all want to buy. However, this does not alter in the least the conclusion that, as a consequence of the formation of market prices, only the supposedly most-value-productive enterprises are realized. Out of the available alternatives known to each partner in exchange, none is, at this moment, more beneficial than the exchange itself. This conclusion is a necessary implication of any exchange. Thus, even if every single market participant just knows how to realize his own project and rests ignorant about all other opportunities, the market process still leads to beneficial results.51

The distinguishing feature of the market process does not lay in the communication of knowledge. The formation of prices rather implies a comparison of projects in value terms. This comparison has nothing in common with a dissemination of knowledge. It is through action that the competing projects are compared. Because an entrepreneur pays higher prices for the factors of production, his project must realize higher (discounted) proceeds.

The market process is thus inextricably linked to choice and action. Knowledge and communication, on the other hand, are secondary.52 This is the core of the analytical problems of Kirzner and his followers. To be sure, from each of Kirzner’s articles we learn about another facet of market process. However, what we learn about is a Kirznerian market process the central idea of which is some mystical revelation through prices. This revelation theory has nothing in common with Misesian market-process analysis. It is, therefore, nothing short of ironic when Kirzner regrets “a certain tendency, present in a number of recent expositions of Mises’s work, to de-emphasize (or flatly to deny) the centrality of the idea of the market as a process in the Misesian system.”53 Indeed, nobody has probably done more harm to this idea than Kirzner himself.

It is one thing to note Kirzner’s noble modesty in emphasizing that his own work is but an elaboration of Mises’s writings. It is another question whether this “elaboration” does not, as a matter of fact, amount to negation of the theory. Kirzner claims that, in regard to market process analysis, there is no difference between Mises and Hayek whatever.54 Nothing could be more contrary to truth, though. What Hayek and Kirzner have in mind is a learning process. Ultimately, this is a process leading to perfect knowledge, that is, to equilibrium. In other terms, Kirzner as well as Hayek try to explain why and how we learn about the truth and thus about true prices. They believe that such an explanation can be provided because this “process by which facts are hammered into human consciousness is not wholly ungoverned by the logic of human action; it fits naturally in the tendency for alert acting human beings to notice what is likely to be of service to them.”55 Kirzner’s solution to this problem is that the necessary information is revealed through “wrong” actual prices. Mises, however, was not concerned about this problem at all. To Mises, the analysis of the market process was meant to uncover the implications of human action for the formation of prices on the market:

In supplying the market with those consumers’ goods in the sale of which the highest profits can be earned, they create a tendency toward a fall in their prices. In restricting the output of those consumers’ goods the production of which does not offer chances for reaping profit, they bring about a tendency toward a rise in their prices. All these transformations go on ceaselessly and could stop only if the unrealizable conditions of the evenly rotating economy and of static equilibrium were to be attained.56

Mises makes no attempt to solve the problem that Hayek and Kirzner are eager to solve, namely, why equilibrium is likely to come about. Rather he does not bother about this question at all. In Mises’s eyes equilibrium is a necessary tool of analysis. Yet the validity of economic theorems does not depend at all on the question why and how equilibrium should ever be realized. It is precisely this point that is denied both explicitly (Hayek57) or implicitly (Kirzner) by all would-be market process theorists. Despite all their disdain for mathematical equilibrium theorists they are arguing on the very same grounds. They endlessly repeat the term “market process.” Yet, they strongly believe that the reality of equilibrium has to be proven and explained.

All this is of no relevance for Mises’s market process analysis. From the Misesian perspective there may be equilibrium and disequilibrium prices. One might even follow Kirzner and say that the market process consists in the continual “correction” of disequilibrium prices that occurs in the course of entrepreneurial competition.58 Yet, it is important to see clearly what that means. The correction is in fact an implication of any successful action on the market. The point is that prices are always formed according to the best knowledge available to property owners. Hence, the sole fact that I sell my tomatoes to A and not to B implies that, ex ante at least, this use of my property, and thus the price being established on the market, is better than any other possible use of it (and thus any other price) that could have been realized otherwise. This holds true for disequilibrium and for equilibrium prices. There are no separate explanations for them. All prices are market prices, and as such they have to be explained.

It can hardly be emphasized enough that these different views of the market process have momentous implications. The most important one concerns the very dynamics of market process analysis. The word process means that this kind of analysis is supposed to explain the succession of events in time. This in turn presupposes that one is able to establish a causal link between the events that follow one another. Kirzner’s basic error consists in his attempts to link discoveries (or true judgments) to former events. As no such links can, without inner contradiction, be claimed to be necessary, that is, generally and apodictically valid, Kirzner makes assertions of alleged empirical evidence to make his case at all. Thus, the theorems that he is able to derive must inevitably be empirical. It is for these reasons that Kirzner now considers economics to be based on empirical postulates or empirical facts. On the other hand, the Misesian view on the dynamics of the market process starts from the recognition of the universal fact of scarcity. This alone suffices to arrive at a priori theorems about the succession of real events in time. Some examples are: if I consume more now I shall of necessity be unable to consume as much in the future as I would if I saved more; or: if I overestimate the quantity of means at my disposal I shall nevertheless be led to discover my error sooner or later in the future.

Hence, there doubtlessly is no approach to market-process analysis that is commonly shared by Böhm-Bawerk and Mises on the one hand and by Hayek and Kirzner on the other hand. Most importantly, however, only Mises’s analysis is a viable option to build upon. It does not contain the fallacies of the Hayek—Kirzner approach that have been identified above.

Property and Knowledge

Above we have argued that the advocates of the pre-eminence of knowledge problems in economics cannot adequately deal with the fact that there can be no present experience of future events. However, there is still a more fundamental condition of action. This is the fact that knowledge as such is never scarce. Knowledge problems thus do have a place in economics only insofar as knowledge has to be selected for application. Yet the selection of knowledge depends entirely on the property of the acting person.

At each moment we dispose of a myriad of information, and we often know of many ways to achieve any given end. For example, if my apartment is cold, I could keep my body warm through gymnastics or additional sweaters. I could also burn parts of my furniture or simply turn on the heating and pay higher bills. I could also sit down in my armchair and invent a new technology permitting one to heat my apartment at half of the present cost.

To be sure, the latter alternative is the most elegant one. In any case, as conditions do not cease to change, we constantly have to acquire new knowledge if only to conserve our present standard of living. However, economic science does not have to deal with the factors conditioning the acquisition of knowledge. We may also leave the question open whether economics can deal with them. This is of no importance for the issue at hand. For the moment we are entirely unconcerned with the creation of knowledge, that is, of judgments that prove to be successful in action. We do not bother about the way we reduce our sheer ignorance. Rather we have to consider the principles that govern the selection of the judgments that we actually apply in our actions.

Consider the problem of lighting your cigarette. Do you use a flamethrower, matches, heat your coke-oven until it is red-hot, or wait until the next lightning-flash strikes a piece of wood? Any solution could be most appropriate under certain conditions. Or, consider the myriad of technically-possible ways to get from Harlem to downtown Manhattan. You can take the subway, the express subway, a taxi, your car, rent a bus, rent a helicopter, buy an F-16 and two personal airports, etc. Of course, one would say that the latter alternative is absurd under normal conditions. It is always the conditions of action that we deem reasonable or absurd, not the action as such.

The quantities of means we can dispose of—our property—are always limited. Thus, choice implies that some of our ends must remain unfulfilled. We steadily run the danger of pursuing ends that are less important than the ends that could have been pursued. We have to choose the supposedly most important action, though what we choose is how we use our property. Action means to employ our property in the pursuit of what appears to be the most important ends.

In choosing the most important action we implicitly select some parts of our technological knowledge for application. In other terms, our choices imply a judgment upon the importance of our technological knowledge under the expected conditions of our action. This economic judgment is our only concern. Technological knowledge as such is immaterial for economics. Even if information on particular circumstances of time and place was communicated through prices this would be of secondary importance. Yet, without reference to our property we could not possibly select knowledge in terms of importance. Moreover, once we own property we then know which kind of knowledge could be useful. It is this property that directs our learning toward useful channels.

Property in this sense encompasses the disposition of goods. However, there is a more fundamental sense in which economic knowledge is linked to property, namely, to appropriation. This is because the creation of any good is more fundamental than the disposition of this good. Appropriation is at the core of property itself.59 Thus, the question which kind of technology serves the supposedly most important end under prevailing conditions cannot be answered independently of the property regime. This is of utmost importance.

It is clear that in all property regimes the ultimate end of action is to enjoy the services of consumers’ goods. And in all property regimes consumers’ goods can only originate from human productivity, that is, from original appropriation, from production, and from exchange.

However, in capitalism there is but one way to enjoy the goods of our neighbors. One has to acquire them through exchange on the market, that is, one has to give to its owner some other good that he prefers to the one we desire. Yet this good must of necessity have been produced beforehand. Exchange thus implies mutual production of goods or values. It implies further that only value-productive actions prove to be successful. Therefore, only value-productive knowledge is selected and sought.

Of course there can be error and failure. Our technological judgments can be wrong. We can also discover after our action that we have not sought the most important ends under prevailing conditions. However, all this is irrelevant for the question at stake. Under private property, all of our judgments concern the production of goods. Producing goods is the unique occupation of all members of society. In this endeavor they select the knowledge they want to apply.

The case is different in a system featuring a coercive agency. Here, by definition, a knowledge different from value-productive knowledge is, at least sometimes, more important. (The extent of “sometimes” depends on the range of activities and on the permanence of the coercive agency.) There is, for example, the knowledge of how to reap the fruits of other persons’ labor without provoking their resistance. There is also the knowledge of how to acquire control and ownership of the coercive agency. And there is the knowledge of how to persuade one’s neighbors about the utility of this system, too.60 One can add an infinite number of items to this list. The result, in general terms, remains the same: a violent agency necessarily affects the knowledge structure of the society upon which it is imposed.61

Property, Calculation, and the Structure of Production

Yet, this is not all that private property implies for the selection of knowledge. The greatest benefits accrue to those who participate in the division of labor. Most of our knowledge is valuable only because there is a market. As we have noted above, the market process is essentially a selection procedure. All investment projects are compared in terms of value productivity, and only the most value-productive ones are selected (ex ante) for execution. On the market, the totality of individual knowledge is continually compared in value terms.

The value of the knowledge that the property owners venture to apply is compared through the anticipated exchanges on the market. A calculated profit means that one’s knowledge is valuable under prevailing conditions. A calculated loss means that one’s knowledge is not of value. Its application would take means away from more value-productive enterprises and thus prevent the application of more valuable knowledge.

To be sure, this comparison does not run in terms of freely-floating bits of knowledge that are detached from private property. Rather, each entrepreneur tries to use his property in the most value-productive way that is known to him. Through the pricing process, this value, productivity is compared to the value productivity that can be achieved by the action of other property owners. The entrepreneur makes an estimate of the proceeds that he will realize through his venture. Then, by means of calculation, the entrepreneur knows how much of his property he can give in exchange for a capital good. He cannot give more than the discounted marginal value product that the capital good will earn. And he can appropriate it only if no other entrepreneur knows of a way to realize a higher discounted marginal value product of this capital good. Thus, each single factor of production accrues to him who knows of the supposedly most value-productive way to use it. This knowledge is marginal value knowledge. It is the knowledge about the most value-productive employment of each of the exchanged goods which, at the time of the exchange, is known to their owners.

It might be objected that one could conceive of market participants who had more value-productive ideas than their fellows but who unfortunately lacked the capital to realize their endeavors. There is no use in discussing the probability of such an event. Indeed, the wealth of a man is often indicative of his expertise. Yet, for the sake of the argument, let us assume the above case to be given. The first thing that such persons could do is to try to convince some of their fellows to lend them the funds necessary for their projects. If they do get the capital, then everything is fine for them and the rest of mankind. However, what if they find nobody willing to support them? Would this not be to the great disadvantage of all the other market participants who are now deprived of the most value-productive investment? Those who argue in this way fail to see that one cannot divide the market at will. A person’s property is not only the fund out of which he buys capital goods; it is the fund for his consumption as well. The very fact that our would-be promoter does not obtain the necessary funds means that all other market participants do think other investments to be more value productive. One cannot separate property from the possibility of error; nobody can be free only to succeed. If one fails to use one’s property in a value-productive manner, then one consumes it in one’s errors.62

Let us recall that ex ante calculation does not consist of computation based on past market prices; it is a judgment in quantitative terms that relies on an expectation of future prices. However, and this is the important point, calculation is the source of present market prices as they are continually formed in the market process. Present prices are starting points for our estimates. We regard them as the products of all prevailing conditions of action. Considering the intervening changes of these conditions we form, by way of Verstehen, a judgment upon the prices of the future. Without the basis provided by present money prices, this procedure would be impossible.63 It is indirectly that present prices permit calculation and thus the selection of the most value-productive technology under prevailing conditions. They can have no communicative function because they are only the, if indispensable, starting point for our understanding of the future. If any prices could have a communicative function it would be future prices, but tomorrow’s prices can never be known today.

Moreover, since without private property there could be no successful calculation, marginal value knowledge could not be recognized, either. Property and calculation are clearly prior to the recognition of the knowledge that should be applied.64 This fact illustrates the most important problem of socialist planning, namely, knowing what to do next. Even if it knew the ends that should be attained, it would be incapable of identifying marginal value knowledge. Hence, it would not know which actions were, at each point of time, most value productive in bringing those ends about. Private property is required to recognize these actions; without it, no capital structure can be built.

Conclusion

We now come back to the question of why “socialist planners would be stymied by inability to perform calculations in the narrow arithmetic sense”65 even if they possessed all the information conveyed by genuine market prices.

Only past market prices can be perceived and could thus convey any information at all. However, it is not past but future prices that are of any interest to the market participants. Furthermore, as there exists no general relationship between past and future prices one cannot deduce the latter from the former. Thus, it is not knowledge but entrepreneurial judgment that drives the market process.

Most importantly, all relevant information (in the economic sense) about technology is not the cause but the outcome of action. The market process is not a learning but essentially a selection process. The competition for the factors of production permits only the realization of those technological ideas which, under given circumstances, are supposedly most value productive. This competition, however, relies on calculations. Without them, the marginal value knowledge could not be identified.

Why is it that market prices are superior to the prices that central planners are dealing with? Hayek, Kirzner, and their followers believe that market prices are better because of their junction, namely, that of communicating information. Mises, in contrast, showed that the primary virtue of market prices is attributable to their origin. Genuine market prices originate from voluntary cooperation; they can never be simulated. They can never be grasped by intellectual inquiries because their significance does not relate to truth or knowledge. They can only be brought about by entrepreneurial actions. For only the unhampered use of private property assures a selection that is inspired by value productivity.

Jörg Guido Hülsmann is instructor of economics at the Verwaltungs und Wirtschaftsakademie, Berlin. This paper was first presented at the Mises Institute’s Austrian Scholars Conference in Auburn, Alabama, January 1996. I wish to thank Jeff Tucker for his comments on this paper.

Review of Austrian Economics 10, no. 1 (1997): 23–48

ISSN: 0889–3047

1Historical Statistics of the United States, part 1 (Washington, D.C.: 1975), series D-86 for unemployment rates and series F-32 for gross national product. Throughout this article, the standard data series for unemployment rates are used, with recognition that there has been a challenge to the validity of those data during the Great Depression years. See Michael R. Darby, “Three-and-a-Half Million U.S. Employees Have been Mislaid: Or An Explanation of Unemployment, 1934–1941,” Journal of Political Economy 84, 1976.
2A.C. Pigou, Industrial Fluctuations, 1st ed. (London: Macmillan, 1927), p. 176.
3A.C. Pigou, Theory of Unemployment (London: Macmillan, 1933), p. 252. Pigou makes his arguments in a variety of other places. For example, see his “Real and Money Wage Rates in Relation to Unemployment,” Economic Journal 47, 1937, and “Money Wages in Relation to Unemployment,” Economic Journal 48, 1938.
4It is perhaps something of an exaggeration to ascribe this position entirely to Pigou. A number of other economists espoused similar views. Recognizing that the list is incomplete, we cite a few, beginning with Jacob Viner, Balanced Deflation, Inflation, or more Depression (Minneapolis, Minn.: University of Minnesota Press, 1933), especially pp. 12–13. See also W.H. Beveridge, Causes and Cures of Unemployment (London: Longmans, Green and Co., 1931), p. 25, and Unemployment, A Problem of Industry (London: Longmans, Green and Co., 1930), chapter 16; Wilford I. King, The Causes of Economic Fluctuations (New York: Ronald Press Co., 1938), chapter 8; and Lionel Robbins, The Great Depression (New York: Macmillan, 1934).
5John A. Hobson, The Economics of Unemployment (New York: Macmillan, 1923), p. 84.
6W.T. Foster and W. Catchings, Profits (Boston: Houghton Mifflin, 1925) and Business Without a Buyer (Boston: Houghton Mifflin, 1927); and C.H. Douglas, Credit-Power and Democracy (London: C. Palmer, 1920) and Warning Democracy (London: C.M. Grieve, 1931). A more recent interpretation of the Great Depression with underconsumptionist overtones in John Kenneth Galbraith, The Great Crash, 1929 (Boston: Houghton Mifflin, 1976).
7Murray N. Rothbard, America’s Great Depression (Princeton, N.J.: Van Nostrand, 1963), p. 45.
8Henry Ford, The New York Times, November 22, 1929, p. 2.
9The New York Times, November 22, 1929, p. 1. It is interesting to note that Hoover’s inclinations toward underconsumptionism were recognized and, of course, approved, by trade unionists. Witness a statement by the AFL’s John P. Frey in 1929 relating to a public works scheme of Hoover’s. In effect, Frey argued that the president was in agreement with the AFL’s position that depressions were the result of underconsumption and low wages. See Joseph Dorfman, The Economic Mind in American Civilization (New York: Viking Press, 1959), vol. 4, pp. 349–50. See also Ronald Radosh, “The Development of the Corporate Ideology of American Labor Leaders, 1914–1933” (doctoral dissertation in history, University of Wisconsin, 1967).
10Rothbard, America’s Great Depression, chapter 8. Not to be ignored is the fact that ideas such as those that enamored Hoover were not as unorthodox among professional economists as sometimes claimed. See J. Ronnie Davis, The New Economists and the Old Economists (Ames, Iowa: Iowa State University Press, 1971). Davis presents an interesting array of statements by economists and other academics relating to the issue of the impact of wage reductions on the economy (pp. 94–99).
11John M. Keynes, The General Theory of Employment, Interest and Money (London: Macmillan, 1936).
12Abba P. Lerner, “Mr. Keynes’ ‘General Theory of Employment, Interest and Money,’” International Labor Review 34, 1936. See also W.B. Reddaway, “The General Theory of Employment, Interest and Money,” Economic Record 12, 1936. A systematic description of the thought of this time is contained in Lawrence R. Klein, The Keynesian Revolution (New York: Macmillan, 1947). For a taxonomic description of the various views of the aggregate demand schedule for labor, see Sidney Weintraub, “A Macroeconomic Approach to the Theory of Wages,” American Economic Review 46, 1956.
13Paul M. Sweezy, personal letter to John B. Shelley, dated February 11, 1977, cited in Dana C. Hewins and John B. Shelley, “Sweezy’s Kink: Macro Foundations of a Micro Theory,” Economic Inquiry 17, 1979.
14For a description of the various dimensions of the Keynesian critique of classical economics, see Alvin H. Hansen, A Guide to Keynes (New York: McGraw-Hill, 1953). More recent appraisals and restatements of the total thrust of Keynesianism are Abba P. Lerner, “From ‘The Treatise on Money’ to ‘The General Theory,’” Journal of Economic Literature 12, 1974; and Hyman P. Minsky, John Maynard Keynes (New York: Columbia University Press, 1975).
15Peter Temin, Did Monetary Forces Cause the Great Depression? (New York: Norton, 1976), p. 140. Temin also attempts to demonstrate that the Great Depression was brought on by an autonomous shift in the consumption function. That view has been challenged (successfully, we think) by Thomas Mayer, “Consumption in the Great Depression,” Journal of Political Economy 86, 1978.
16Keynes, The General Theory. In chapter 2, Keynes is very explicit. In reference to the principle that real wages and employment are systematically related, he says, “I am not disputing this vital fact which the classical economists have (rightly) asserted as indefeasible.”
17Ludwig von Mises, The Theory of Money and Credit (New Haven, Conn.: Yale University Press, 1953). Permission granted by Mrs. Margit von Mises. Quotes from 1981 Liberty Classics, Indianapolis, edition.
18Milton Friedman, “The Role of Monetary Policy,” American Economic Review 58, 1968.
19In particular, see Jerome Stein, Monetarist, Keynesian, and New Classical Economics (Cambridge, United Kingdom: B. Blackwell, 1982).
20The key assumptions are constant returns to scale and neutral disembodied technical progress.
21The underlying statistical models are moderately complex. They are described briefly in the statistical appendix. The logic and structure of the models are more fully developed in Lowell Gallaway and Richard Vedder, The “Natural” Rate of Unemployment, staff study, Subcommittee on Monetary and Fiscal Policy, Joint Economic Committee, Congress of the United States (Washington, D.C.: 1982).
22Federal Reserve Bulletin, various issues.
23Historical Statistics, series D-86.
24The productivity-adjusted real wage rate on a quarterly basis is calculated by dividing the manufacturing wage bill by the product of Federal Reserve Board (not the wage bill) and the index of average labor productivity (not total output) should be used. However, converting the wage bill and the index of industrial production to wage rate and productivity measures involves dividing both of them by the same quantity of labor (L). Since L appears in both the numerator and denominator of the expression for the adjusted real wage rate, it cancels out and can be ignored.
25As calculated from Historical Statistics, series D-688.
26Ibid,, series D-683 and D-688.
27Ibid., series D-724 and Paul A. David and Peter Solar, “A Bicentenary Contribution to the History of the Cost of Living in America” in Paul Uselding, ed., Research in Economic History, vol. 2 (Greenwich, Conn.: JAI Press, 1977), pp. 59–60.
28Broadus Mitchell, Depression Decade, vol. 9, The Economic History of the United States (New York: Rinehart, 1947), p. 84; and Arthur Schlesinger, Jr., The Age of Roosevelt: The Crisis of the Old Order, 1919–1933 (Boston: Houghton Mifflin, 1957), p. 249. Interestingly, though, some observers of the period disagree with this assessment. For example, Leo Wolman, Wages in Relation to Economic Recovery (Chicago: 1931) notes, “[I]t is indeed impossible to recall any past depression of similar intensity and duration in which the wages of prosperity were maintained as long as they have been during the depression of 1930–1931.” Similarly, Don Lescohier, “Working Conditions,” vol. 3, History of Labor in the United States, 1896–1932, John R. Commons and Associates, eds. (New York: Macmillan, 1935) states:
29Historic Statistics, series D-802, D-813, D-818, and D-824, respectively.
30Robbins, The Great Depression, p. 224.
31Geoffrey H. Moore, ed., Business Cycle Indicators, vol. 2, Basic Data on Cyclical Indicators (Princeton: Princeton University Press, 1961), p. 129.
32Benjamin M. Anderson, Economics and the Public Welfare (New York: Van Nostrand, 1949), p. 72.
33Historical Statistics, series D-839.
34Anderson, Economics, p. 220.
35Without the productivity adjustment, real wages in manufacturing (in 1923 prices) rose from 58.9 cents an hour in December 1929 to 62.5 cents an hour in December 1930. After that, they continued to rise to 66.3 cents an hour in January 1932. Wilford I. King, Causes of Fluctuations, pp. 182–83. See also Sol Shaviro, “Wages and Payroll in the Depression, 1929–1933” (unpublished M.A. essay, Columbia University, 1947).
36Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton, N.J.: Princeton University Press, 1963).
37U.S. Bureau of the Census, National Income and Product Accounts of the United States, 1929–1976 (Washington, D.C., Department of Commerce, Bureau of Economic Analysis, 1981), p. 308.
38Moore, Business Cycle Indicators, p. 106.
39Harold Barger, Outlay and Income in the United States, 1921–1938 (New York: National Bureau of Economic Research, 1942), appendix B, table 28. A smaller profit decline is reported in a less comprehensive survey conducted by the Federal Reserve Bank of New York. See Irving Fisher, Booms and Depressions: Some First Principles (New York: Adelphi, 1932), p. 98.
40Robbins, The Great Depression, p. 205. The data were originally published in Commercial and Financial Chronicle.
41This is based on the Standard and Poor’s index, which fell 32.9 percent from September to November 1929. The second decline actually began in April 1930. A similar pattern is observed using the Dow-Jones index, which fell 39.7 percent from April to December 1930, compared to 37.0 percent from September to November 1929. The recovery in stock prices after November 1929 was robust; the April 1930 Dow-Jones index was the eleventh highest recorded in history, exceeded only in the first ten months of 1929. See Moore, Cyclical Indicators, pp. 108–9.
42Ben Bernanke, “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression,” American Economic Review, June 1983, p. 261.
43Ibid., p. 262.
44Federal debt declined about $700 million in both 1929 and 1930, but rose more than $600 million in 1931. See Historical Statistics, series Y-493.
45If one uses the consumer price index to measure price changes, real interest rates on bank loans in 1929 averaged about 6 percent, rising to about 7.7 percent in 1930, and to about 13 percent in 1931. This is based solely on current year price changes. A real interest rate model using weighted averages of past price changes would show a smaller rise. Interest rate data are based on Federal Reserve System reports. See Moore, Cyclical Indicators, p. 154.
46Historical Statistics, series F-54.
47Friedman and Schwartz, A Monetary History, table A-1, pp. 712–13.
48Ibid., table B-3, p. 803.
49Ibid. The deposit/currency ratio fell from 11.57 in October 1929, to 4.44 in March 1933, a decline of 7.13 points, with 3.87 points (54 percent) of that decline occurring between October 1930 and October 1931.
50Ibid., pp. 308–13.
51The price would fall to $750 only for a consol, a bond with no maturity. Short-term bonds would sell at a small discount from face value because the owner of the bond would receive the face value at maturity.
52Historic Statistics, series X-581.
53Capital accounts were $10,372 million. Ibid., series X-587.
54Most nominal interest rate series show little change in the early years of the Great Depression, and, indeed, many show some decline. This masks two phenomena, however. First, declining commodity prices during the period led to rising real interest rates over time. Second, most interest rate series report actual transactions, probably ignoring a growing number of customers who were crowded out because of sharply rising risk premiums. It is possible that interest rates demanded of some average potential borrower rose, even though actual interest rates reflected in transactions did not rise.
55Data from U.S. Bureau of Economic Analysis, Fixed Residential Business Capital in the United States, 1929–1973 (Washington, D.C.: Department of Commerce, 1974), reported in Historical Statistics. The exact data series employed is F-484 for producers’ equipment valued at 1958 prices. This series falls from a 1929 level of $74.1 billion to $59.2 billion in 1933. Simon Kuznets, Capital in the American Economy (Princeton, N.J.: Princeton University Press, 1961), table R-5, p. 492, concludes that net capital formation was almost zero in 1931, and decidedly negative in the years 1932–34.
56Use of the consumer price index yields lower-bound measures of the extent of wage disequilibrium. This index fell substantially less than did the wholesale price index during the Great Depression. Consumer prices (Historical Statistics, series E-135) fell 24.3 percent, while wholesale prices (Ibid., series E-23) declined by 30.8 percent.
57The codes in question were the blanket codes introduced pending the development of the specific industry codes. See David A. Shannon, Between the Wars: America, 1919–1941 (Boston: Houghton Mifflin, 1965), pp. 154–55. See also Michael M. Weinstein, “Some Macroeconomic Impacts of the National Industrial Recovery Act, 1933–1935,” chapter 14, pp. 262–81, in Karl Brunner, ed., The Great Depression Revisited (Boston: Kluwer/Nijhoff, 1981) and Recovery and Redistribution under the NIRA (Amsterdam: North-Holland Publication Company, 1980).
58Historical Statistics, series D-802.
59Section 7(a) of the National Industrial Recovery Act was added to allay the fears of labor leaders that industry would act cooperatively against labor. It required that every industry code developed under the act include provisions guaranteeing the right of employees to organize and bargain collectively and that employees could not be required as a condition of employment to either join a company union or refrain from joining a union of their choice.
60After the National Industrial Recovery Act was declared unconstitutional by the Supreme Court, the provisions of section 7(a) were reenacted in a more detailed fashion, including the establishment of an administrative machinery to police the law, in the National Labor Relations Act of 1935.
61Probably the best known study of this question is H. Gregg Lewis, Unionism and Relative Wages in the United States (Chicago: University of Chicago Press, 1963). Also worth noting are John Maher, “Union, Non-Union Wage Differentials,” American Economic Review 46, 1956; and Adrian W. Throop, “The Union-Non-Union Wage Differential and Cost-Push Inflation,” American Economic Review 58, 1968.
62The basic data employed in these calculations are taken from Lowell E. Gallaway, “Trade Unionism, Inflation, and Unemployment” in George Horwich, ed., Monetary Process and Policy: A Symposium (Homewood, Ill.: R.D. Irwin, 1967), pp. 60–66. At first blush, the indication of a significant change in what we call the union/nonunion wage differential appears to conflict with Lewis’s findings in Unionism and Relative Wages, which suggest a stable union/nonunion differential over time. However, we have defined our differential in terms of traditionally organized industries compared to traditionally unorganized ones. Actually, there are substantial numbers of nonunion members in the work force of what we have called the unionized industries. For example, in 1920, when trade union membership peaked at over five million, only about one-fourth of the work force in our unionized industries were union members. See Leo Wolman, Ebb and Flow in Trade Unionism (New York: National Bureau of Economic Research, 1936). They made up about 90 percent of union membership, though. By contrast, on the eve of World War II, when union membership had recovered to over ten million (compared to its 1933 low of less than three million), union workers were approaching accounting for one-half the work force in our unionized industries. In fact, what our wage differential measure attempts to capture is the impact of the changing volume of unionism on the interindustry wage structure and, ultimately, on the average wage rate. Actually, we feel that we may have underestimated the union impact by employing a relative wage differential measure rather than focusing on the absolute differential (in real terms) between the unionized and nonunionized areas. For a theoretical discussion of why the relative wage criterion may not be appropriate, see Gallaway, “Trade Unionism.” If we had used the absolute differential for purposes of this evaluation, the effect of increases in union membership on the interindustry wage structure would have been even more dramatic.
63The detailed statistical analysis is described in the statistical appendix to this article.
64This is done by estimating the impact of growth in union membership on wage levels and then translating the unionization-induced wage shifts into changes in unemployment.
65Total supplements are from Historical Statistics, series D-893. Average annual earnings from ibid., series D-722. See also Albert Rees, New Measures of Wage-Earner Compensation in Manufacturing, 1914–1957, occasional paper 75 (Princeton, N.J.: National Bureau of Economic Research, 1960).