Home

Liberty Fund, Inc. is a private, educational foundation established to encourage the study of the ideal of a society of free and responsible individuals.

Copyright information:

The copyright to this edition, in both print and electronic forms, is held by Liberty Fund, Inc.

Fair use statement:

This material is put online to further the educational goals of Liberty Fund, Inc. Unless otherwise stated in the Copyright Information section above, this material may be used freely for educational and academic purposes. It may not be used in any way for profit.

Some Observations on the Underconsumption Bogey and on the Purchasing Power Argument

In speaking of underconsumption, people mean to describe a state of affairs in which a part of the goods produced cannot be consumed because the people who could consume them are by their poverty prevented from buying them. These goods remain unsold or can be swapped only at prices not covering the cost of production. Hence various disarrangements and disturbances arise, the total complex of which is called economic depression.

Now it happens again and again that entrepreneurs err in anticipating the future state of the market. Instead of producing those goods for which the demand of the consumers is most intense, they produce less urgently needed goods or things which cannot be sold at all. These inefficient entrepreneurs suffer losses while their more efficient competitors who anticipated the wishes of the consumers earn profits. The losses of the former group of entrepreneurs are not caused by a general abstention from buying on the part of the public; they are due to the fact that the public prefers to buy other goods.

If it were true, as the underconsumption myth implies, that the workers are too poor to buy the products because the entrepreneurs and the capitalists unfairly appropriate to themselves what by rights should go to the wage earners, the state of affairs would not be altered. The “exploiters” are not supposed to exploit from sheer wantonness. They want, it is insinuated, to increase at the expense of the “exploited” either their own consumption or their own investments. They do not withdraw their booty from the universe. They spend it either in buying luxuries for their own household or in buying producers’ goods for the expansion of their enterprises. Of course, their demand is directed toward goods other than those the wage earners would have bought if the profits had been confiscated and distributed among them. Entrepreneurial errors with regard to the state of the market of various classes of commodities as created by such “exploitation” are in no way different from any other entrepreneurial shortcomings. Entrepreneurial errors result in losses for the inefficient entrepreneurs which are counterbalanced by the profits of the efficient entrepreneurs. They make business bad for some groups of industries and good for other groups. They do not bring about a general depression of trade.

The underconsumption myth is baseless self-contradictory balderdash. Its reasoning crumbles away as soon as one begins to examine it. It is untenable even if one, for the sake of argument, accepts the “exploitation” doctrine as correct.

The purchasing power argument runs in a slightly different manner. It contends that a rise in wage rates is a prerequisite of the expansion of production. If wage rates do not rise, there is no use for business to increase the quantity and to improve the quality of the goods produced. For the additional products would find no buyers or only such buyers as restrict their purchases of other goods. What is needed first for the realization of economic progress is to make wage rates rise continually. Government or labor union pressure and compulsion aiming at the enforcement of higher wage rates are the main vehicles of progress.

As has been demonstrated above the emergence of an excess in the total sum of entrepreneurial profits over the total sum of entrepreneurial losses is inseparably bound up with the fact that a portion of the benefits derived from the increase in the quantity of capital goods available and from the improvement of technological procedures goes to the nonentrepreneurial groups. The rise in the prices of complementary factors of production, first among them wage rates, is neither a concession which the entrepreneurs willy-nilly must make to the rest of the people nor a clever device of the entrepreneurs in order to make profits. It is an unavoidable and necessary phenomenon in the chain of successive events which the endeavors of the entrepreneurs to make profits by adjusting the supply of the consumers’ goods to the new state of affairs are bound to bring about. The same process which results in an excess of entrepreneurial profits over losses causes first—i.e., before such an excess appears—the emergence of a tendency toward a rise in wage rates and in the prices of many material factors of production. And it is again the same process that would in the further course of events make this excess of profits over losses disappear, provided that no further changes, increasing the amount of capital goods available, were to occur. The excess of profits over losses is not a consequence of the rise in the prices of the factors of production. The two phenomena—the rise in the prices of the factors of production and the excess of profits over losses—are both steps in the process of adjustment of production to the increase in the quantity of capital goods and to the technological changes which the entrepreneurial actions actuate. Only to the extent that the other strata of the population are enriched by this adjustment can an excess of profits over losses temporarily come into being.

The basic error of the purchasing power argument consists in misconstruing this causal relation. It turns things upside down when considering the rise in wage rates as the force bringing about economic improvement.

We will discuss at a later stage of this book the consequences of the attempts of the governments and of organized labor violence to enforce wage rates higher than those determined by a nonhampered market.24 Here we must only add one more explanatory remark.

When speaking of profits and losses, prices and wage rates, what we have in mind is always real profits and losses, real prices and real wage rates. It is the arbitrary interchange of money terms and real terms that has led many people astray. This problem too will be dealt with exhaustively in later chapters. Let us incidentally only mention the fact that a rise in real wage rates is compatible with a drop in nominal wage rates.

10

Promoters, Managers, Technicians, and Bureaucrats

The entrepreneur hires the technicians, i.e., people who have the ability and the skill to perform definite kinds and quantities of work. The class of technicians includes the great inventors, the champions in the field of applied science, the constructors and designers as well as the performers of the most simple tasks. The entrepreneur joins their ranks as far as he himself takes part in the technical execution of his entrepreneurial plans. The technician contributes his own toil and trouble; but it is the entrepreneur qua entrepreneur who directs his labor toward definite goals. And the entrepreneur himself acts as a mandatary, as it were, of the consumers.

The entrepreneurs are not omnipresent. They cannot themselves attend to the manifold tasks which are incumbent upon them. Adjustment of production to the best possible supplying of the consumers with the goods they are asking for most urgently does not merely consist in determining the general plan for the utilization of resources. There is, of course, no doubt that this is the main function of the promoter and speculator. But besides the great adjustments, many small adjustments are necessary too. Each of them may seem trifling and of little bearing upon the total result. But the cumulative effect of shortcomings in many of these minor matters can be such as to frustrate entirely the success of a correct solution of the great problems. At any rate, it is certain that every failure to handle the smaller problems results in a squandering of scarce factors of production and consequently in impairing the best possible satisfaction of the consumers.

It is important to conceive in what respects the problem we have in mind differs from the technological tasks of the technicians. The execution of every project upon which the entrepreneur has embarked in making his decision with regard to the general plan of action requires a multiplicity of minute decisions. Each of these decisions must be effected in such a way as to prefer that solution of the problem which—without interfering with the designs of the general plan for the whole project—is the most economical one. It must avoid superfluous costs in the same way as does the general plan. The technician from his purely technological point of view either may not see any difference in the alternatives offered by various methods for the solution of such a detail or may give preference to one of these methods on account of its greater output in physical quantities. But the entrepreneur is actuated by the profit motive. This enjoins upon him the urge to prefer the most economical solution, i.e., that solution which avoids employing factors of production whose employment would impair the satisfaction of the more intensely felt wants of the consumers. He will prefer among the various methods, with regard to which the technicians are neutral, the one the application of which requires the smallest cost. He may reject the technicians’ suggestion to choose a more costly method securing a greater physical output if his calculation shows that the increase in output would not outweigh the increase in cost required. Not only in the great decisions and plans but no less in the daily decisions of small problems as they turn up in the current conduct of affairs, the entrepreneur must perform his task of adjusting production to the demand of the consumers as reflected in the prices of the market.

Economic calculation as practiced in the market economy, and especially the system of double-entry bookkeeping, make it possible to relieve the entrepreneur of involvement in too much detail. He can devote himself to his great tasks without being entangled in a multitude of trifles beyond any mortal man’s range of sight. He can appoint assistants to whose solicitude he entrusts the care of subordinate entrepreneurial duties. And these assistants in their turn can be aided according to the same principle by assistants appointed for a smaller sphere of duties. In this way a whole managerial hierarchy can be built up.

A manager is a junior partner of the entrepreneur, as it were, no matter what the contractual and financial terms of his employment are. The only relevant thing is that his own financial interests force him to attend to the best of his abilities to the entrepreneurial functions which are assigned to him within a limited and precisely determined sphere of action.

It is the system of double-entry bookkeeping that makes the functioning of the managerial system possible. Thanks to it, the entrepreneur is in a position to separate the calculation of each part of his total enterprise in such a way that he can determine the role it plays within his whole enterprise. Thus he can look at each section as if it were a separate entity and can appraise it according to the share it contributes to the success of the total enterprise. Within this system of business calculation each section of a firm represents an integral entity, a hypothetical independent business, as it were. It is assumed that this section “owns” a definite part of the whole capital employed in the enterprise, that it buys from other sections and sells to them, that it has its own expenses and its own revenues, that its dealings result either in a profit or in a loss which is imputed to its own conduct of affairs as distinguished from the result of the other sections. Thus the entrepreneur can assign to each section’s management a great deal of independence. The only directive he gives to a man whom he entrusts with the management of a circumscribed job is to make as much profit as possible. An examination of the accounts shows how successful or unsuccessful the managers were in executing this directive. Every manager and submanager is responsible for the working of his section or subsection. It is to his credit if the accounts show a profit, and it is to his disadvantage if they show a loss. His own interests impel him toward the utmost care and exertion in the conduct of his section’s affairs. If he incurs losses, he will be replaced by a man whom the entrepreneur expects to be more successful, or the whole section will be discontinued. At any rate, the manager will lose his job. If he succeeds in making profits, his income will be increased, or at least he will not be in danger of losing it. Whether or not a manager is entitled to a share in the profit imputed to his section is not important with regard to the personal interest he takes in the results of his section’s dealings. His welfare is at any rate closely connected with that of his section. His task is not like that of the technician, to perform a definite piece of work according to a definite precept. It is to adjust—within the limited scope left to his discretion—the operation of his section to the state of the market. Of course, just as an entrepreneur may combine in his person entrepreneurial functions and those of a technician, such a union of various functions can also occur with a manager.

The managerial function is always subservient to the entrepreneurial function. It can relieve the entrepreneur of a part of his minor duties; it can never evolve into a substitute for entrepreneurship. The fallacy to the contrary is due to the error confusing the category of entrepreneurship as it is defined in the imaginary construction of functional distribution with conditions in a living and operating market economy. The function of the entrepreneur cannot be separated from the direction of the employment of factors of production for the accomplishment of definite tasks. The entrepreneur controls the factors of production; it is this control that brings him either entrepreneurial profit or loss.

It is possible to reward the manager by paying for his services in proportion to the contribution of his section to the profit earned by the entrepreneur. But this is of no avail. As has been pointed out, the manager is under any circumstances interested in the success of that part of the business which is entrusted to his care. But the manager cannot be made answerable for the losses incurred. These losses are suffered by the owners of the capital employed. They cannot be shifted to the manager.

Society can freely leave the care for the best possible employment of capital goods to their owners. In embarking upon definite projects these owners expose their own property, wealth, and social position. They are even more interested in the success of their entrepreneurial activities than is society as a whole. For society as a whole the squandering of capital invested in a definite project means only the loss of a small part of its total funds; for the owner it means much more, for the most part the loss of his total fortune. But if a manager is given a completely free hand, things are different. He speculates in risking other people’s money. He sees the prospects of an uncertain enterprise from another angle than that of the man who is answerable for the losses. It is precisely when he is rewarded by a share of the profits that he becomes foolhardy because he does not share in the losses too.

The illusion that management is the totality of entrepreneurial activities and that management is a perfect substitute for entrepreneurship is the outgrowth of a misinterpretation of the conditions of the corporations, the typical form of present-day business. It is asserted that the corporation is operated by the salaried managers, while the shareholders are merely passive spectators. All the powers are concentrated in the hands of hired employees. The shareholders are idle and useless; they harvest what the managers have sown.

This doctrine disregards entirely the role that the capital and money market, the stock and bond exchange, which a pertinent idiom simply calls the “market,” plays in the direction of corporate business. The dealings of this market are branded by popular anticapitalistic bias as a hazardous game, as mere gambling. In fact, the changes in the prices of common and preferred stock and of corporate bonds are the means applied by the capitalists for the supreme control of the flow of capital. The price structure as determined by the speculations on the capital and money markets and on the big commodity exchanges not only decides how much capital is available for the conduct of each corporation’s business; it creates a state of affairs to which the managers must adjust their operations in detail.

The general direction of a corporation’s conduct of business is exercised by the stockholders and their elected mandataries, the directors. The directors appoint and discharge the managers. In smaller companies and sometimes even in bigger ones the offices of the directors and the managers are often combined in the same persons. A successful corporation is ultimately never controlled by hired managers. The emergence of an omnipotent managerial class is not a phenomenon of the unhampered market economy. It was, on the contrary, an outgrowth of the interventionist policies consciously aiming at an elimination of the influence of the shareholders and at their virtual expropriation. In Germany, Italy, and Austria it was a preliminary step on the way toward the substitution of government control of business for free enterprise, as has been the case in Great Britain with regard to the Bank of England and the railroads. Similar tendencies are prevalent in the American public utilities. The marvelous achievements of corporate business were not a result of the activities of a salaried managerial oligarchy; they were accomplished by people who were connected with the corporation by means of the ownership of a considerable part or of the greater part of its stock and whom part of the public scorned as promoters and profiteers.

The entrepreneur determines alone, without any managerial interference, in what lines of business to employ capital and how much capital to employ. He determines the expansion and contraction of the size of the total business and its main sections. He determines the enterprise’s financial structure. These are the essential decisions which are instrumental in the conduct of business. They always fall upon the entrepreneur, in corporations as well as in other types of a firm’s legal structure. Any assistance given to the entrepreneur in this regard is of ancillary character only; he takes information about the past state of affairs from experts in the fields of law, statistics, and technology; but the final decision implying a judgment about the future state of the market rests with him alone. The execution of the details of his projects may then be entrusted to managers.

The social functions of the managerial elite are no less indispensable for the operation of the market economy than are the functions of the elite of inventors, technologists, engineers, designers, scientists, and experimenters. In the ranks of the managers many of the most eminent men serve the cause of economic progress. Successful managers are remunerated by high salaries and often by a share in the enterprise’s gross profits. Many of them in the course of their careers become themselves capitalists and entrepreneurs. Nonetheless, the managerial function is different from the entrepreneurial function.

It is a serious mistake to identify entrepreneurship with management as in the popular antithesis of “management” and “labor.” This confusion is, of course, intentional. It is designed to obscure the fact that the functions of entrepreneurship are entirely different from those of the managers attending to the minor details of the conduct of business. The structure of business, the allocation of capital to the various branches of production and firms, the size and the line of operation of each plant and shop are considered as given facts and it is implied that no further changes will be effected with regard to them. The only task is to go on in the old routine. In such a stationary world, of course, there is no need for innovators and promoters; the total amount of profits is counterbalanced by the total amount of losses. To explode the fallacies of this doctrine it is enough to compare the structure of American business in 1960 with that of 1940.

But even in a stationary world it would be nonsensical to give “labor,” as a popular slogan demands, a share in management. The realization of such a postulate would result in syndicalism.25

There is furthermore a readiness to confuse the manager with a bureaucrat. Bureaucratic management, as distinguished from profit management, is the method applied in the conduct of administrative affairs, the result of which has no cash value on the market. The successful performance of the duties entrusted to the care of a police department is of the greatest importance for the preservation of social cooperation and benefits each member of society. But it has no price on the market, it cannot be bought or sold; it can therefore not be confronted with the expenses incurred in the endeavors to secure it. It results in gains, but these gains are not reflected in profits liable to expression in terms of money. The methods of economic calculation, and especially those of double-entry bookkeeping, are not applicable to them. Success or failure of a police department’s activities cannot be ascertained according to the arithmetical procedures of profit-seeking business. No accountant can establish whether or not a police department or one of its subdivisions has succeeded.

The amount of money to be expended in every branch of profitseeking business is determined by the behavior of the consumers. If the automobile industry were to treble the capital employed, it would certainly improve the services it renders to the public. There would be more cars available. But this expansion of the industry would withhold capital from other branches of production in which it could fill more urgent wants of the consumers. This fact would render the expansion of the automobile industry unprofitable and increase profits in other branches of business. In their endeavors to strive after the highest profit obtainable, entrepreneurs are forced to allocate to each branch of business only as much capital as can be employed in it without impairing the satisfaction of more urgent wants of the consumers. Thus the entrepreneurial activities are automatically, as it were, directed by the consumers’ wishes as they are reflected in the price structure of consumers’ goods.

No such limitation is enjoined upon the allocation of funds for the performance of the tasks incumbent upon government activities. There is no doubt that the services rendered by the police department of the City of New York could be considerably improved by trebling the budgetary allocation. But the question is whether or not this improvement would be considerable enough to justify either the restriction of the services rendered by other departments—e.g., those of the department of sanitation—or the restriction of the private consumption of the taxpayers. This question cannot be answered by the accounts of the police department. These accounts provide information only about the expenses incurred. They cannot provide any information about the results obtained, as these results cannot be expressed in money equivalents. The citizens must directly determine the amount of services they want to get and are ready to pay for. They discharge this task by electing councilmen and officeholders who are prepared to comply with their intentions.

Thus the mayor and the chiefs of the city’s various departments are restricted by the budget. They are not free to act upon what they themselves consider the most beneficial solution of the various problems the citizenry has to face. They are bound to spend the funds allocated for the purposes the budget has assigned them. They must not use them for other tasks. Auditing in the field of public administration is entirely different from that in the field of profit-seeking business. Its goal is to establish whether or not the funds allocated have been expended in strict compliance with the provisions of the budget.

In profit-seeking business the discretion of the managers and submanagers is restricted by considerations of profit and loss. The profit motive is the only directive needed to make them subservient to the wishes of the consumers. There is no need to restrict their discretion by minute instructions and rules. If they are efficient, such meddling with details would at best be superfluous, if not pernicious in tying their hands. If they are inefficient, it would not render their activities more successful. It would only provide them with a lame excuse that the failure was caused by inappropriate rules. The only instruction required is self-understood and does not need to be especially mentioned: Seek profit.

Things are different in public administration, in the conduct of government affairs. In this field the discretion of the officeholders and their subaltern aids is not restricted by considerations of profit and loss. If their supreme boss—no matter whether he is the sovereign people or a sovereign despot—were to leave them a free hand, he would renounce his own supremacy in their favor. These officers would become irresponsible agents, and their power would supersede that of the people or the despot. They would do what pleased them, not what their bosses wanted them to do. To prevent this outcome and to make them subservient to the will of their bosses, it is necessary to give them detailed instructions regulating their conduct of affairs in every respect. Then it becomes their duty to handle all affairs in strict compliance with these rules and regulations. Their freedom to adjust their acts to what seems to them the most appropriate solution of a concrete problem is limited by these norms. They are bureaucrats, i.e., men who in every instance must observe a set of inflexible regulations.

Bureaucratic conduct of affairs is conduct bound to comply with detailed rules and regulations fixed by the authority of a superior body. It is the only alternative to profit management. Profit management is inapplicable in the pursuit of affairs which have no cash value on the market and in the non-profit conduct of affairs which could also be operated on a profit basis. The former is the case of the administration of the social apparatus of coercion and compulsion; the latter is the case in the conduct of an institution on a non-profit basis, e.g., a school, a hospital, or a postal system. Whenever the operation of a system is not directed by the profit motive, it must be directed by bureaucratic rules.

Bureaucratic conduct of affairs is, as such, not an evil. It is the only appropriate method of handling governmental affairs, i.e., the social apparatus of compulsion and coercion. As government is necessary, bureaucratism is—in this field—no less necessary. Where economic calculation is unfeasible, bureaucratic methods are indispensable. A socialist government must apply them to all affairs.

No business, whatever its size or specific task, can ever become bureaucratic so long as it is entirely and solely operated on a profit basis. But as soon as it abandons profit seeking and substitutes for it what is called the service principle—i.e., the rendering of services without regard as to whether or not the prices to be obtained for them cover the expenses—it must substitute bureaucratic methods for those of entrepreneurial management.26

11

The Selective Process

The selective process of the market is actuated by the composite effort of all members of the market economy. Driven by the urge to remove his own uneasiness as much as possible, each individual is intent, on the one hand, upon attaining that position in which he can contribute most to the best satisfaction of everyone else and, on the other hand, upon taking best advantage of the services offered by everyone else. This means that he tries to sell on the dearest market and to buy on the cheapest market. The resultant of these endeavors is not only the price structure but no less the social structure, the assignment of definite tasks to the various individuals. The market makes people rich or poor, determines who shall run the big plants and who shall scrub the floors, fixes how many people shall work in the copper mines and how many in the symphony orchestras. None of these decisions is made once and for all; they are revocable every day. The selective process never stops. It goes on adjusting the social apparatus of production to the changes in demand and supply. It reviews again and again its previous decisions and forces everybody to submit to a new examination of his case. There is no security and no such thing as a right to preserve any position acquired in the past. Nobody is exempt from the law of the market, the consumers’ sovereignty.

Ownership of the means of production is not a privilege, but a social liability. Capitalists and landowners are compelled to employ their property for the best possible satisfaction of the consumers. If they are slow and inept in the performance of their duties, they are penalized by losses. If they do not learn the lesson and do not reform their conduct of affairs, they lose their wealth. No investment is safe forever. He who does not use his property in serving the consumers in the most efficient way is doomed to failure. There is no room left for people who would like to enjoy their fortunes in idleness and thoughtlessness. The proprietor must aim to invest his funds in such a way that principal and yield are at least not impaired.

In the ages of caste privileges and trade barriers there were revenues not dependent on the market. Princes and lords lived at the expense of the humble slaves and serfs who owed them tithes, statute labor, and tributes. Ownership of land could only be acquired either by conquest or by largesse on the part of a conqueror. It could be forfeited only by recantation on the part of the donor or by conquest on the part of another conqueror. Even later, when the lords and their liegemen began to sell their surpluses on the market, they could not be ousted by the competition of more efficient people. Competition was free only within very narrow limits. The acquisition of manorial estates was reserved to the nobility, that of urban real property to the citizens of the township, that of farm land to the peasants. Competition in the arts and crafts was restricted by the guilds. The consumers were not in a position to satisfy their wants in the cheapest way, as price control made underbidding impossible to the sellers. The buyers were at the mercy of their purveyors. If the privileged producers refused to resort to the employment of the most adequate raw materials and of the most efficient methods of processing, the consumers were forced to endure the consequences of such stubbornness and conservatism.

The landowner who lives in perfect self-sufficiency from the fruits of his own farming is independent of the market. But the modern farmer who buys equipment, fertilizers, seed, labor, and other factors of production and sells agricultural products is subject to the law of the market. His income depends on the consumers and he must adjust his operations to their wishes.

The selective function of the market works also with regard to labor. The worker is attracted by that kind of work in which he can expect to earn most. As is the case with material factors of production, the factor labor too is allocated to those employments in which it best serves the consumers. There prevails the tendency not to waste any quantity of labor for the satisfaction of less urgent demand if more urgent demand is still unsatisfied. Like all other strata of society, the worker is subject to the supremacy of the consumers. If he disobeys, he is penalized by a cut in earnings.

The selection of the market does not establish social orders, castes, or classes in the Marxian sense. Nor do the entrepreneurs and promoters form an integrated social class. Each individual is free to become a promoter if he relies upon his own ability to anticipate future market conditions better than his fellow citizens and if his attempts to act at his own peril and on his own responsibility are approved by the consumers. One enters the ranks of the promoters by spontaneously pushing forward and thus submitting to the trial to which the market subjects, without respect for persons, everybody who wants to become a promoter or to remain in this eminent position. Everybody has the opportunity to take his chance. A newcomer does not need to wait for an invitation or encouragement from anyone. He must leap forward on his own account and must himself know how to provide the means needed.

It has been contended again and again that under the conditions of “late” or “mature” capitalism it is no longer possible for penniless people to climb the ladder to wealth and entrepreneurial position. No attempt has ever been made to prove this thesis. Since it was first advanced, the composition of the entrepreneurial and capitalist groups has changed considerably. A great part of the former entrepreneurs and their heirs have been eliminated and other people, newcomers, have taken their places. It is, of course, true that in the last years institutions have been purposely developed which, if not abolished very soon, will make the functioning of the market in every regard impossible.

The point of view from which the consumers choose the captains of industry and business is exclusively their qualification to adjust production to the needs of the consumers. They do not bother about other features and merits. They want a shoe manufacturer to fabricate good and cheap shoes. They are not intent upon entrusting the conduct of the shoe trade to handsome amiable boys, to people of good drawing-room manners, of artistic gifts, of scholarly habits, or of any other virtues or talents. A proficient businessman may often be deficient in many accomplishments which contribute to the success of a man in other spheres of life.

It is quite common nowadays to deprecate the capitalists and entrepreneurs. A man is prone to sneer at those who are more prosperous than himself. These people, he contends, are richer only because they are less scrupulous than he. If he were not restrained by due consideration for the laws of morality and decency, he would be no less successful than they are. Thus men glory in the aureole of self-complacency and Pharisaic self-righteousness.

Now it is true that under the conditions brought about by interventionism many people can acquire wealth by graft and bribery. In many countries interventionism has so undermined the supremacy of the market that it is more advantageous for a businessman to rely upon the aid of those in political office than upon the best satisfaction of the needs of the consumers. But it is not this that the popular critics of other people’s wealth have in mind. They contend that the methods by which wealth is acquired in a pure market society are objectionable from the ethical point of view.

Against such statements it is necessary to emphasize that, so far as the operation of the market is not sabotaged by the interference of governments and other factors of coercion, success in business is the proof of services rendered to the consumers. The poor man need not be inferior to the prosperous businessman in other regards; he may sometimes be outstanding in scientific, literary, and artistic achievements or in civic leadership. But in the social system of production he is inferior. The creative genius may be right in his disdain for commercial success; it may be true that he would have been prosperous in business if he had not preferred other things. But the clerks and workers who boast of their moral superiority deceive themselves and find consolation in this self-deception. They do not admit that they have been tried and found wanting by their fellow citizens, the consumers.

It is often asserted that the poor man’s failure in the competition of the market is caused by his lack of education. Equality of opportunity, it is said, could be provided only by making education at every level accessible to all. There prevails today the tendency to reduce all differences among various peoples to their education and to deny the existence of inborn inequalities in intellect, will power, and character. It is not generally realized that education can never be more than indoctrination with theories and ideas already developed. Education, whatever benefits it may confer, is transmission of traditional doctrines and valuations; it is by necessity conservative. It produces imitation and routine, not improvement and progress. Innovators and creative geniuses cannot be reared in schools. They are precisely the men who defy what the school has taught them.

In order to succeed in business a man does not need a degree from a school of business administration. These schools train the subalterns for routine jobs. They certainly do not train entrepreneurs. An entrepreneur cannot be trained. A man becomes an entrepreneur in seizing an opportunity and filling the gap. No special education is required for such a display of keen judgment, foresight, and energy. The most successful businessmen were often uneducated when measured by the scholastic standards of the teaching profession. But they were equal to their social function of adjusting production to the most urgent demand. Because of these merits the consumers chose them for business leadership.

12

The Individual and the Market

It is customary to speak metaphorically of the automatic and anonymous forces actuating the “mechanism” of the market. In employing such metaphors people are ready to disregard the fact that the only factors directing the market and the determination of prices are purposive acts of men. There is no automatism; there are only men consciously and deliberately aiming at ends chosen. There are no mysterious mechanical forces; there is only the human will to remove uneasiness. There is no anonymity; there are you and I and Bill and Joe and all the rest. And each of us is both a producer and a consumer.

The market is a social body; it is the foremost social body. The market phenomena are social phenomena. They are the resultant of each individual’s active contribution. But they are different from each such contribution. They appear to the individual as something given which he himself cannot alter. He does not always see that he himself is a part, although a small part, of the complex of elements determining each momentary state of the market. Because he fails to realize this fact, he feels himself free, in criticizing the market phenomena, to condemn with regard to his fellow men a mode of conduct which he considers as quite right with regard to himself. He blames the market for its callousness and disregard of persons and asks for social control of the market in order to “humanize” it. He asks on the one hand for measures to protect the consumer against the producers. But on the other hand he insists even more passionately upon the necessity of protecting himself as a producer against the consumers. The outcome of these contradictory demands is the modern methods of government interference whose most outstanding examples were the Sozialpolitik of imperial Germany and the American New Deal.

It is an old fallacy that it is a legitimate task of civil government to protect the less efficient producer against the competition of the more efficient. One asks for a “producers’ policy” as distinct from a “consumers’ policy.” While flamboyantly repeating the truism that the only aim of production is to provide ample supplies for consumption, people emphasize with no less eloquence that the “industrious” producer should be protected against the “idle” consumer.

However, producers and consumers are identical. Production and consumption are different stages in acting. Catallactics embodies these differences in speaking of producers and consumers. But in reality they are the same people. It is, of course, possible to protect a less efficient producer against the competition of more efficient fellows. Such a privilege conveys to the privileged the benefits which the unhampered market provides only to those who succeed in best filling the wants of the consumers. But it necessarily impairs the satisfaction of the consumers. If only one producer or a small group is privileged, the beneficiaries enjoy an advantage at the expense of the rest of the people. But if all producers are privileged to the same extent, everybody loses in his capacity as consumer as much as he gains in his capacity as a producer. Moreover, all are injured because the supply of products drops if the most efficient men are prevented from employing their skill in that field in which they could render the best services to the consumers.

If a consumer believes that it is expedient or right to pay a higher price for domestic cereals than for cereals imported from abroad, or for manufactures processed in plants operated by small business or employing unionized workers than for those of another provenance, he is free to do so. He would only have to satisfy himself that the commodity offered for sale meets the conditions upon which he makes the allowance of a higher price depend. Laws which forbid counterfeiting of labels of origin and trademarks would succeed in attaining the ends aimed at by tariffs, labor legislation, and privileges granted to small business. But it is beyond doubt that the consumers are not prepared to act in this way. The fact that a commodity is marked as imported does not impair its salability if it is better or cheaper, or both. As a rule the buyers want to buy as cheaply as possible without regard for the origin of the article or some particular characteristics of the producers.

The psychological root of the producers’ policy as practiced today in all parts of the world is to be seen in spurious economic doctrines. These doctrines flatly deny that the privileges granted to less efficient producers burden the consumer. Their advocates contend that such measures are prejudicial only to those against whom they discriminate. When pressed further, they are forced to admit that the consumers are damaged too, they maintain that the losses of the consumers are more than compensated by an increase in their money income which the measures in question are bound to bring about.

Thus in the predominantly industrial countries of Europe the protectionists were first eager to declare that the tariff on agricultural products hurts exclusively the interests of the farmers of the predominantly agricultural countries and of the grain dealers. It is certain that these exporting interests are damaged too. But it is no less certain that the consumers of the country that adopts the tariff policy are losing with them. They must pay higher prices for their food. Of course, the protectionist retorts, that this is not a burden. For, he argues, the additional amount that the domestic consumer pays increases the farmers’ income and their purchasing power; they will spend the whole surplus in buying more of the products manufactured by the nonagricultural strata of the population. This paralogism can easily be exploded by referring to the well-known anecdote of the man who asks an innkeeper for a gift of ten dollars; it will not cost him anything because the beggar promises to spend the whole amount in his inn. But for all that, the protectionist fallacy got hold of public opinion, and this alone explains the popularity of the measures inspired by it. Many people simply do not realize that the only effect of protection is to divert production from those places in which it could produce more per unit of capital and labor expended to places in which it produces less. It makes people poorer, not more prosperous.

The ultimate foundation of modern protectionism and of the striving for economic autarky of each country is to be found in this mistaken belief that they are the best means to make every citizen, or at least the immense majority of them, richer. The term riches means in this connection an increase in the individual’s real income and an improvement in his standard of living. It is true that the policy of national economic insulation is a necessary corollary of the endeavors to interfere with domestic business, and that it is an outcome of warlike tendencies as well as one of the factors producing these tendencies. But the fact remains that it would never have been possible to sell the idea of protection to the voters if one had not been able to convince them that protection not only does not impair their standard of living but raises it considerably.

It is important to emphasize this fact because it utterly explodes a myth propagated by many popular books. According to these myths, contemporary man is no longer motivated by the desire to improve his material well-being and to raise his standard of living. The assertions of the economists to the contrary are mistaken. Modern man gives priority to “noneconomic” or “irrational” things and is ready to forego material betterment whenever its attainment stands in the way of those “ideal” concerns. It is a serious blunder, common mostly with economists and businessmen, to interpret the events of our time from an “economic” point of view and to criticize current ideologies with regard to the alleged economic fallacies implied. People long for other things more than for a good life.

It is hardly possible to misconstrue the history of our age more crassly. Our contemporaries are driven by a fanatical zeal to get more amenities and by an unrestrained appetite to enjoy life. A characteristic social phenomenon of our day is the pressure group, an alliance of people eager to promote their own material well-being by the employment of all means, legal or illegal, peaceful or violent. For the pressure group nothing matters but the increase of its members’ real income. It is not concerned with any other aspects of life. It does not bother whether or not the realization of its program hurts the vital interests of other men, of their own nation or country, and of the whole of mankind. But, of course, every pressure group is anxious to justify its demands as beneficial to the general public welfare and to stigmatize its critics as abject scoundrels, idiots, and traitors. In the pursuit of its plans it displays a quasi-religious ardor.

Without exception all political parties promise their supporters a higher real income. There is no difference in this respect between nationalists and internationalists and between the supporters of a market economy and the advocates of either socialism or interventionism. If a party asks its supporters to make sacrifices for its cause, it always explains these sacrifices as the necessary temporary means for the attainment of the ultimate goal, the improvement of the material well-being of its members. Each party considers it as an insidious plot against its prestige and its survival if somebody ventures to question the capacity of its projects to make the group members more prosperous. Each party regards with a deadly hatred the economists embarking upon such a critique.

All varieties of the producers’ policy are advocated on the ground of their alleged ability to raise the party members’ standard of living. Protectionism and economic self-sufficiency, labor union pressure and compulsion, labor legislation, minimum wage rates, public spending, credit expansion, subsidies, and other makeshifts are always recommended by their advocates as the most suitable or the only means to increase the real income of the people for whose votes they canvass. Every contemporary statesman or politician invariably tells his voters: My program will make you as affluent as conditions may permit, while my adversaries’ program will bring you want and misery.

It is true that some secluded intellectuals in their esoteric circles talk differently. They proclaim the priority of what they call eternal absolute values and feign in their declamations—not in their personal conduct—a disdain of things secular and transitory. But the public ignores such utterances. The main goal of present-day political action is to secure for the respective pressure group memberships the highest material well-being. The only way for a leader to succeed is to instill in people the conviction that his program best serves the attainment of this goal.

What is wrong with the producers’ policies is their faulty economics.

If one is prepared to indulge in the fashionable tendency to explain human things by resorting to the terminology of psychopathology, one might be tempted to say that modern man in contrasting a producers’ policy with a consumers’ policy has fallen victim to a kind of schizophrenia. He fails to realize that he is an undivided and indivisible person, i.e., an individual, and as such no less a consumer than a producer. The unity of his consciousness is split into two parts; his mind is inwardly divided against himself. But it matters little whether or not we adopt this mode of describing the fact that the economic doctrine resulting in these policies is faulty. We are not concerned with the pathological source from which an error may stem, but with the error as such and with its logical roots. The unmasking of the error by means of ratiocination is the primary fact. If a statement were not exposed as logically erroneous, psychopathology would not be in a position to qualify the state of mind from which it stems as pathological. If a man imagines himself to be the king of Siam, the first thing which the psychiatrist has to establish is whether or not he really is what he believes himself to be. Only if this question is answered in the negative can the man be considered insane.

It is true that most of our contemporaries are committed to a fallacious interpretation of the producer-consumer nexus. In buying they behave as if they were connected with the market only as buyers, and vice versa in selling. As buyers they advocate stern measures to protect them against the sellers, and as sellers they advocate no less harsh measures against the buyers. But this antisocial conduct which shakes the very foundations of social cooperation is not an outgrowth of a pathological state of mind. It is the outcome of a narrow-mindedness which fails to conceive the operation of the market economy and to anticipate the ultimate effects of one’s own actions.

It is permissible to contend that the immense majority of our contemporaries are mentally and intellectually not adjusted to life in the market society, although they themselves and their fathers have unwittingly created this society by their actions. But this maladjustment consists in nothing else than in the failure to recognize erroneous doctrines as such.

13

Business Propaganda

The consumer is not omniscient. He does not know where he can obtain at the cheapest price what he is looking for. Very often he does not even know what kind of commodity or service is suitable to remove most efficaciously the particular uneasiness he wants to remove. At best he is familiar with the market conditions of the immediate past and arranges his plans on the basis of this information. To convey to him information about the actual state of the market is the task of business propaganda.

Business propaganda must be obtrusive and blatant. It is its aim to attract the attention of slow people, to rouse latent wishes, to entice men to substitute innovation for inert clinging to traditional routine. In order to succeed, advertising must be adjusted to the mentality of the people courted. It must suit their tastes and speak their idiom. Advertising is shrill, noisy, coarse, puffing, because the public does not react to dignified allusions. It is the bad taste of the public that forces the advertisers to display bad taste in their publicity campaigns. The art of advertising has evolved into a branch of applied psychology, a sister discipline of pedagogy.

Like all things designed to suit the taste of the masses, advertising is repellent to people of delicate feeling. This abhorrence influences the appraisal of business propaganda. Advertising and all other methods of business propaganda are condemned as one of the most outrageous outgrowths of unlimited competition. It should be forbidden. The consumers should be instructed by impartial experts; the public schools, the “nonpartisan” press, and cooperatives should perform this task.

The restriction of the right of businessmen to advertise their products would restrict the freedom of the consumers to spend their income according to their own wants and desires. It would make it impossible for them to learn as much as they can and want about the state of the market and the conditions which they may consider as relevant in choosing what to buy and what not to buy. They would no longer be in a position to decide on the basis of the opinion which they themselves have formed about the seller’s appraisal of his products; they would be forced to act on the recommendation of other people. It is not unlikely that these mentors would save them some mistakes. But the individual consumers would be under the tutelage of guardians. If advertising is not restricted, the consumers are by and large in the position of a jury which learns about the case by hearing the witnesses and examining directly all other means of evidence. If advertising is restricted, they are in the position of a jury to whom an officer reports about the result of his own examination of evidence.

It is a widespread fallacy that skillful advertising can talk the consumers into buying everything that the advertiser wants them to buy. The consumer is, according to this legend, simply defenseless against “high-pressure” advertising. If this were true, success or failure in business would depend on the mode of advertising only. However, nobody believes that any kind of advertising would have succeeded in making the candlemakers hold the field against the electric bulb, the horsedrivers against the motorcars, the goose quill against the steel pen and later against the fountain pen. But whoever admits this implies that the quality of the commodity advertised is instrumental in bringing about the success of an advertising campaign. Then there is no reason to maintain that advertising is a method of cheating the gullible public.

It is certainly possible for an advertiser to induce a man to try an article which he would not have bought if he had known its qualities beforehand. But as long as advertising is free to all competing firms, the article which is better from the point of view of the consumers’ appetites will finally outstrip the less appropriate article, whatever methods of advertising may be applied. The tricks and artifices of advertising are available to the seller of the better product no less than to the seller of the poorer product. But only the former enjoys the advantage derived from the better quality of his product.

The effects of advertising of commodities are determined by the fact that as a rule the buyer is in a position to form a correct opinion about the usefulness of an article bought. The housewife who has tried a particular brand of soap or canned food learns from experience whether it is good for her to buy and consume that product in the future too. Therefore advertising pays the advertiser only if the examination of the first sample bought does not result in the consumer’s refusal to buy more of it. It is agreed among businessmen that it does not pay to advertise products other than good ones.

Entirely different are conditions in those fields in which experience cannot teach us anything. The statements of religious, metaphysical, and political propaganda can be neither verified nor falsified by experience. With regard to the life beyond and the absolute, any experience is denied to men living in this world. In political matters experience is always the experience of complex phenomena which is open to different interpretations; the only yardstick which can be applied to political doctrines is aprioristic reasoning. Thus political propaganda and business propaganda are essentially different things, although they often resort to the same technical methods.

There are many evils for which contemporary technology and therapeutics have no remedy. There are incurable diseases and there are irreparable personal defects. It is a sad fact that some people try to exploit their fellow men’s plight by offering them patent medicines. Such quackeries do not make old people young and ugly girls pretty. They only raise hopes. It would not impair the operation of the market if the authorities were to prevent such advertising, the truth of which cannot be evidenced by the methods of the experimental natural sciences. But whoever is ready to grant to the government this power would be inconsistent if he objected to the demand to submit the statements of churches and sects to the same examination. Freedom is indivisible. As soon as one starts to restrict it, one enters upon a decline on which it is difficult to stop. If one assigns to the government the task of making truth prevail in the advertising of perfumes and toothpaste, one cannot contest it the right to look after truth in the more important matters of religion, philosophy, and social ideology.

The idea that business propaganda can force the consumers to submit to the will of the advertisers is spurious. Advertising can never succeed in supplanting better or cheaper goods by poorer goods.

The costs incurred by advertising are, from the point of view of the advertiser, a part of the total bill of production costs. A businessman expends money for advertising if and as far as he expects that the increase in sales resulting will increase the total net proceeds. In this regard there is no difference between the costs of advertising and all other costs of production. An attempt has been made to distinguish between production costs and sales costs. An increase in production costs, it has been said, increases supply, while an increase in sales costs (advertising costs included) increases demand.27 This is a mistake. All costs of production are expended with the intention of increasing demand. If the manufacturer of candy employs a better raw material, he aims at an increase in demand in the same way as he does in making the wrappings more attractive and his stores more inviting and in spending more for advertisements. In increasing production costs per unit of the product the idea is always to increase demand. If a businessman wants to increase supply, he must increase the total cost of production, which often results in lowering production costs per unit.

14

The “Volkswirtschaft”

The market economy as such does not respect political frontiers. Its field is the world.

The term Volkswirtschaft was long applied by the German champions of government omnipotence. Only much later did the British and the French begin to speak of the “British economy” and “l’économie francaise” as distinct from the economies of other nations. But neither the English nor the French language produced an equivalent of the term Volkswirtschaft. With the modern trend toward national planning and national autarky, the doctrine involved in this German word became popular everywhere. Nonetheless, only the German language is able to express in one word all the ideas implied.

The Volkswirtschaft is a sovereign nation’s total complex of economic activities directed and controlled by the government. It is socialism realized within the political frontiers of each nation. In employing this term people are fully aware of the fact that real conditions differ from the state of affairs which they deem the only adequate and desirable state. But they judge everything that happens in the market economy from the point of view of their ideal. They assume that there is an irreconcilable conflict between the interests of the Volkswirtschaft and those of the selfish individuals eager to seek profit. They do not hesitate to assign priority to the interests of the Volkswirtschaft over those of the individuals. The righteous citizen should always place the volkswirtschaftliche interests above his own selfish interests. He should act of his own accord as if he were an officer of the government executing its orders. Gemeinnutz geht vor Eigennutz (the welfare of the nation takes precedence over the selfishness of the individuals) was the fundamental principle of Nazi economic management. But as people are too dull and too vicious to comply with this rule, it is the task of government to enforce it. The German princes of the seventeenth and eighteenth century, foremost among them the Hohenzollern Electors of Brandenburg and Kings of Prussia, were fully equal to this task. In the nineteenth century, even in Germany the liberal ideologies imported from the West superseded the well-tried and natural policies of nationalism and socialism. However, Bismarck’s and his successors’ Sozialpolitik and finally Nazism restored them.

The interests of a Volkswirtschaft are seen as implacably opposed not only to those of the individuals, but no less to those of the Volkswirtschaft of any foreign nation. The most desirable state of a Volkswirtschaft is complete economic self-sufficiency. A nation which depends on any imports from abroad lacks economic independence; its sovereignty is only a sham. Therefore a nation which cannot produce at home all that it needs is bound to conquer all the territories required. To be really sovereign and independent a nation must have Lebensraum, i.e., a territory so large and rich in natural resources that it can live in autarky at a standard no lower than that of any other nation.

Thus the idea of the Volkswirtschaft is the most radical denial of all the principles of the market economy. It was this idea that guided, more or less, the economic policies of all nations in the last decades. It was the pursuit of this idea that brought about the terrific wars of our century and may kindle still more pernicious wars in the future.

From the early beginnings of human history the two opposite principles of the market economy and of the Volkswirtschaft fought each other. Government, i.e., a social apparatus of coercion and compulsion, is a necessary requisite of peaceful cooperation. The market economy cannot do without a police power safeguarding its smooth functioning by the threat or the application of violence against peace-breakers. But the indispensable administrators and their armed satellites are always tempted to use their arms for the establishment of their own totalitarian rule. For ambitious kings and generalissimos the very existence of a sphere of the individuals’ lives not subject to regimentation is a challenge. Princes, governors, and generals are never spontaneously liberal. They become liberal only when forced to by the citizens.

The problems raised by the plans of the socialists and the interventionists will be dealt with in later parts of this book. Here we have only to answer the question of whether or not any of the essential features of the Volkswirtschaft are compatible with the market economy. For the champions of the idea of the Volkswirtschaft do not consider their scheme merely as a pattern for the establishment of a future social order. They declare emphatically that even under the system of the market economy, which, of course, in their eyes is a debased and vicious product of policies contrary to human nature, the Volkswirtschaften of the various nations are integrated units whose interests are irreconcilably opposed to those of all other nations’ Volkswirtschaften. As they see it, what separates one Volkswirtschaft from all the others is not, as the economists would have us believe, merely political institutions. It is not the trade and migration barriers established by government interference with business and the differences in legislation and in the protection granted to the individuals by the courts and tribunals that bring about the distinction between domestic trade and foreign trade. This diversity, they say, is, on the contrary, the necessary outcome of the very nature of things, of an inextricable factor; it cannot be removed by any ideology and produces its effects whether the laws and the administrators and judges are prepared to take notice of it or not. Thus in their eyes the Volkswirtschaft appears as a nature-given reality, while the world-embracing ecumenic society of men, the world economy (Weltwirtschaft), is only an imaginary phantom of a spurious doctrine, a plan devised for the destruction of civilization.

The truth is that individuals in their acting, in their capacity as producers and consumers, as sellers and buyers, do not make any distinction as between the domestic market and the foreign market. They make a distinction as between local trade and trading with more distant places as far as the costs of transportation play a role. If government interference, such as tariffs, renders international transactions more expensive, they take this fact into account in the same way in which they pay regard to shipping costs. A tariff on caviar has no effect other than would a rise in the cost of transportation. A rigid prohibition of the importation of caviar produces a state of affairs no different from that which would prevail if caviar could not stand shipping without an essential deterioration in its quality.

There has never been in the history of the West such a thing as regional or national autarky. There was, as we may admit, a period in which the division of labor did not go beyond the members of a family household. There was autarky of families and tribes which did not practice interpersonal exchange. But as soon as interpersonal exchange emerged, it crossed the boundaries of the political communities. Barter between the inhabitants of regions more remote from one another, between the members of various tribes, villages, and political communities preceded the practice of barter between neighbors. What people wanted first to acquire by barter and trade were things they could not produce themselves out of their own resources. Salt, other minerals and metals, the deposits of which are unequally distributed over the earth’s surface, cereals which one could not grow on the domestic soil, and artifacts which only the inhabitants of some regions were able to manufacture were the first objects of trade. Trade started as foreign trade. Only later did domestic exchange develop between neighbors. The first holes that opened the closed household economy to interpersonal exchange were made by the products of distant regions. No consumer cared on his own account whether the salt and the metals he bought were of “domestic” or of “foreign” provenance. If it had been otherwise, the governments would not have had any reason to interfere by means of tariffs and other barriers to foreign trade.

But even if a government succeeds in making the barriers separating its domestic market from foreign markets insurmountable and thus establishes perfect national autarky, it does not create a Volkswirtschaft. A market economy which is perfectly autarkic remains for all that a market economy; it forms a closed and isolated catallactic system. The fact that its citizens miss the advantages which they could derive from the international division of labor is simply a datum of their economic conditions. Only if such an isolated country goes outright socialist, does it convert its market economy into a Volkswirtschaft.

Fascinated by the propaganda of Neo-Mercantilism, people apply idioms which are in contrast to the principles they take as guides in their acting and to all the characteristics of the social order in which they are living. Long ago the British began to call plants and farms located in Great Britain, and even those located in the Dominions, in the East Indies, and in the colonies, “ours.” But if a man did not just want to make a show of his patriotic zeal and to impress other people, he was not prepared to pay a higher price for the products of his “own” plants than for those of the “foreign” plants. Even if he had behaved in this way, the designation of the plants located within the political boundaries of his nation as “ours” would not be adequate. In what sense could a Londoner, before the nationalization, call coal mines located in England which he did not own “our” mines and those of the Ruhr “foreign” mines? Whether he bought “British” coal or “German” coal, he always had to pay the full market price. It is not “America” that buys champagne from “France.” It is always an individual American who buys it from an individual Frenchman.

As far as there is still some room left for the actions of individuals, as far as there is private ownership and exchange of goods and services between individuals, there is no Volkswirtschaft. Only if full government control is substituted for the choices of individuals does the Volkswirtschaft emerge as a real entity.

CHAPTER 16

Prices

1

The Pricing Process

In an occasional act of barter in which men who ordinarily do not resort to trading with other people exchange goods ordinarily not negotiated, the ratio of exchange is determined only within broad margins. Catallactics, the theory of exchange ratios and prices, cannot determine at what point within these margins the concrete ratio will be established. All that it can assert with regard to such exchanges is that they can be effected only if each party values what he receives more highly than what he gives away.

The recurrence of individual acts of exchange generates the market step by step with the evolution of the division of labor within a society based on private property. As it becomes a rule to produce for other people’s consumption, the members of society must sell and buy. The multiplication of the acts of exchange and the increase in the number of people offering or asking for the same commodities narrow the margins between the valuations of the parties. Indirect exchange and its perfection through the use of money divide the transactions into two different parts: sale and purchase. What in the eyes of one party is a sale, is for the other party a purchase. The divisibility of money, unlimited for all practical purposes, makes it possible to determine the exchange ratios with nicety. The exchange ratios are now as a rule money prices. They are determined between extremely narrow margins: the valuations on the one hand of the marginal buyer and those of the marginal offerer who abstains from selling, and the valuations on the other hand of the marginal seller and those of the marginal potential buyer who abstains from buying.

The concatenation of the market is an outcome of the activities of entrepreneurs, promoters, speculators, and dealers in futures and in arbitrage. It has been asserted that catallactics is based on the assumption—contrary to reality—that all parties are provided with perfect knowledge concerning the market data and are therefore in a position to take best advantage of the most favorable opportunities for buying and selling. It is true that some economists really believed that such an assumption is implied in the theory of prices. These authors not only failed to realize in what respects a world peopled with men perfectly equal in knowledge and foresight would differ from the real world which all economists wanted to interpret in developing their theories; they also erred in being unaware of the fact that they themselves did not resort to such an assumption in their own treatment of prices.

In an economic system in which every actor is in a position to recognize correctly the market situation with the same degree of insight, the adjustment of prices to every change in the data would be achieved at one stroke. It is impossible to imagine such uniformity in the correct cognition and appraisal of changes in data except by the intercession of superhuman agencies. We would have to assume that every man is approached by an angel informing him of the change in data which has occurred and advising him how to adjust his own conduct in the most adequate way to this change. Certainly the market that catallactics deals with is filled with people who are to different degrees aware of the changes in data and who, even if they have the same information, appraise it differently. The operation of the market reflects the fact that changes in the data are first perceived only by a few people and that different men draw different conclusions in appraising their effects. The more enterprising and brighter individuals take the lead, others follow later. The shrewder individuals appreciate conditions more correctly than the less intelligent and therefore succeed better in their actions. Economists must never disregard in their reasoning the fact that the innate and acquired inequality of men differentiates their adjustment to the conditions of their environment.

The driving force of the market process is provided neither by the consumers nor by the owners of the means of production—land, capital goods, and labor—but by the promoting and speculating entrepreneurs. These are people intent upon profiting by taking advantage of differences in prices. Quicker of apprehension and farther-sighted than other men, they look around for sources of profit. They buy where and when they deem prices too low, and they sell where and when they deem prices too high. They approach the owners of the factors of production, and their competition sends the prices of these factors up to the limit corresponding to their anticipation of the future prices of the products. They approach the consumers, and their competition forces prices of consumers’ goods down to the point at which the whole supply can be sold. Profit-seeking speculation is the driving force of the market as it is the driving force of production.

On the market agitation never stops. The imaginary construction of an evenly rotating economy has no counterpart in reality. There can never emerge a state of affairs in which the sum of the prices of the complementary factors of production, due allowance being made for time preference, equals the prices of the products and no further changes are to be expected. There are always profits to be earned by somebody. The speculators are always enticed by the expectation of profit.

The imaginary construction of the evenly rotating economy is a mental tool for comprehension of entrepreneurial profit and loss. It is, to be sure, not a design for comprehension of the pricing process. The final prices corresponding to this imaginary conception are by no means identical with the market prices. The activities of the entrepreneurs or of any other actors on the economic scene are not guided by consideration of any such things as equilibrium prices and the evenly rotating economy. The entrepreneurs take into account anticipated future prices, not final prices or equilibrium prices. They discover discrepancies between the height of the prices of the complementary factors of production and the anticipated future prices of the products, and they are intent upon taking advantage of such discrepancies. These endeavors of the entrepreneurs would finally result in the emergence of the evenly rotating economy if no further changes in the data were to appear.

The operation of the entrepreneurs brings about a tendency toward an equalization of prices for the same goods in all subdivisions of the market, due allowance being made for the cost of transportation and the time absorbed by it. Differences in prices which are not merely transitory and bound to be wiped out by entrepreneurial action are always the outcome of particular obstacles obstructing the inherent tendency toward equalization. Some check prevents profit-seeking business from interfering. An observer not sufficiently familiar with actual commercial conditions is often at a loss to recognize the institutional barrier hindering such equalization. But the merchants concerned always know what makes it impossible for them to take advantage of such differences.

Statisticians treat this problem too lightly. When they have discovered differences in the wholesale price of a commodity between two cities or countries, not entirely accounted for by the cost of transportation, tariffs, and excise duties, they acquiesce in asserting that the purchasing power of money and the “level” of prices are different.1 On the basis of such statements people draft programs to remove these differences by monetary measures. However, the root cause of these differences cannot lie in monetary conditions. If prices in both countries are quoted in terms of the same kind of money, it is necessary to answer the question as to what prevents businessmen from embarking upon dealings which are bound to make price differences disappear. Things are essentially the same if the prices are expressed in terms of different kinds of money. For the mutual exchange ratio between various kinds of money tends toward a point at which there is no further margin left to profitable exploitation of differences in commodity prices. Whenever differences in commodity prices between various places persist, it is a task for economic history and descriptive economics to establish what institutional barriers hinder the execution of transactions which must result in the equalization of prices.

All the prices we know are past prices. They are facts of economic history. In speaking of present prices we imply that the prices of the immediate future will not differ from those of the immediate past. However, all that is asserted with regard to future prices is merely an outcome of the understanding of future events.

The experience of economic history never tells us more than that at a definite date and definite place two parties A and B traded a definite quantity of the commodity a against a definite number of units of the money p. In speaking of such acts of buying and selling at the market price of a, we are guided by a theoretical insight, deduced from an aprioristic starting point. This is the insight that, in the absence of particular factors making for price differences, the prices paid at the same time and the same place for equal quantities of the same commodity tend toward equalization, viz., a final price. But the actual market prices never reach this final state. The various market prices about which we can get information were determined under different conditions. It is impermissible to confuse averages computed from them with the final prices.

Only with regard to fungible commodities negotiated on organized stock or commodity exchanges is it permissible, in comparing prices, to assume that they refer to the same quality. Apart from such prices negotiated in exchanges and from prices of commodities the homogeneity of which can be precisely established by technological analysis, it is a serious blunder to disregard differences in the quality of the commodity in question. Even in the wholesale trade of raw textiles the diversity of the articles plays the main role. A comparison of prices of consumers’ goods is mainly misleading on account of the difference in quality. The quantity traded in one transaction too is relevant in the determination of the price paid per unit. Shares of a corporation sold in one large lot bring a different price than those sold in several small lots.

It is necessary to emphasize these facts again and again because it is customary nowadays to play off the statistical elaboration of price data against the theory of prices. However, the statistics of prices is altogether questionable. Its foundations are precarious because circumstances for the most part do not permit the comparison of the various data, their linking together in series, and the computation of averages. Full of zeal to embark upon mathematical operations, the statisticians yield to the temptation of disregarding the incomparability of the data available. The information that a certain firm sold at a definite date a definite type of shoes for six dollars a pair relates a fact of economic history. A study of the behavior of shoe prices from 1923 to 1939 is conjectural, however sophisticated the methods applied may be.

Catallactics shows that entrepreneurial activities tend toward an abolition of price differences not caused by the costs of transportation and trade barriers. No experience has ever contradicted this theorem. The results obtained by an arbitrary identification of unequal things are irrelevant.

2

Valuation and Appraisement

The ultimate source of the determination of prices is the value judgments of the consumers. Prices are the outcome of the valuation preferring a to b. They are social phenomena as they are brought about by the interplay of the valuations of all individuals participating in the operation of the market. Each individual, in buying or not buying and in selling or not selling, contributes his share to the formation of the market prices. But the larger the market is, the smaller is the weight of each individual’s contribution. Thus the structure of market prices appears to the individual as a datum to which he must adjust his own conduct.

The valuations which result in determination of definite prices are different. Each party attaches a higher value to the good he receives than to that he gives away. The exchange ratio, the price, is not the product of an equality of valuation, but, on the contrary, the product of a discrepancy in valuation.

Appraisement must be clearly distinguished from valuation. Appraisement in no way depends upon the subjective valuation of the man who appraises. He is not intent upon establishing the subjective use-value of the good concerned, but upon anticipating the prices which the market will determine. Valuation is a value judgment expressive of a difference in value. Appraisement is the anticipation of an expected fact. It aims at establishing what prices will be paid on the market for a particular commodity or what amount of money will be required for the purchase of a definite commodity.

Valuation and appraisement are, however, closely connected. The valuations of an autarkic husbandman directly compare the weight he attaches to different means for the removal of uneasiness. The valuations of a man buying and selling on the market must not disregard the structure of market prices; they depend upon appraisement. In order to know the meaning of a price one must know the purchasing power of the amount of money concerned. It is necessary by and large to be familiar with the prices of those goods which one would like to acquire and to form on the ground of such knowledge an opinion about their future prices. If an individual speaks of the costs incurred by the purchase of some goods already acquired or to be incurred by the purchase of goods he plans to acquire, he expresses these costs in terms of money. But this amount of money represents in his eyes the degree of satisfaction he could obtain by employing it for the acquisition of other goods. The valuation makes a detour, it goes via the appraisement of the structure of market prices; but it always aims finally at the comparison of alternative modes for the removal of felt uneasiness.

It is ultimately always the subjective value judgments of individuals that determine the formation of prices. Catallactics in conceiving the pricing process necessarily reverts to the fundamental category of action, the preference given to a over b. In view of popular errors it is expedient to emphasize that catallactics deals with the real prices as they are paid in definite transactions and not with imaginary prices. The concept of final prices is merely a mental tool for the grasp of a particular problem, the emergence of entrepreneurial profit and loss. The concept of a “just” or “fair” price is devoid of any scientific meaning; it is a disguise for wishes, a striving for a state of affairs different from reality. Market prices are entirely determined by the value judgments of men as they really act.

If one says that prices tend toward a point at which total demand is equal to total supply, one resorts to another mode of expressing the same concatenation of phenomena. Demand and supply are the outcome of the conduct of those buying and selling. If, other things being equal, supply increases, prices must drop. At the previous price all those ready to pay this price could buy the quantity they wanted to buy. If the supply increases, they must buy larger quantities or other people who did not buy before must become interested in buying. This can only be attained at a lower price.

It is possible to visualize this interaction by drawing two curves, the demand curve and the supply curve, whose intersection shows the price. It is no less possible to express it in mathematical symbols. But it is necessary to comprehend that such pictorial or mathematical modes of representation do not affect the essence of our interpretation and that they do not add a whit to our insight. Furthermore it is important to realize that we do not have any knowledge or experience concerning the shape of such curves. Always, what we know is only market prices—that is, not the curves but only a point which we interpret as the intersection of two hypothetical curves. The drawing of such curves may prove expedient in visualizing the problems for undergraduates. For the real tasks of catallactics they are mere byplay.

3

The Prices of the Goods of Higher Orders

The market process is coherent and indivisible. It is an indissoluble intertwinement of actions and reactions, of moves and countermoves. But the insufficiency of our mental abilities enjoins upon us the necessity of dividing it into parts and analyzing each of these parts separately. In resorting to such artificial cleavages we must never forget that the seemingly autonomous existence of these parts is an imaginary makeshift of our minds. They are only parts, that is, they cannot even be thought of as existing outside the structure of which they are parts.

The prices of the goods of higher orders are ultimately determined by the prices of the goods of the first or lowest order, that is, the consumers’ goods. As a consequence of this dependence they are ultimately determined by the subjective valuations of all members of the market society. It is, however, important to realize that we are faced with a connection of prices, not with a connection of valuations. The prices of the complementary factors of production are conditioned by the prices of the consumers’ goods. The factors of production are appraised with regard to the prices of the products, and from this appraisement their prices emerge. Not the valuations but the appraisements are transferred from the goods of the first order to those of higher orders. The prices of the consumers’ goods engender the actions resulting in the determination of the prices of the factors of production. These prices are primarily connected only with the prices of the consumers’ goods. With the valuations of the individuals they are only indirectly connected, viz., through the intermediary of the prices of the consumers’ goods, the products of their joint employment.

The tasks incumbent upon the theory of the prices of factors of production are to be solved by the same methods which are employed for treatment of the prices of consumers’ goods. We conceive the operation of the market of consumers’ goods in a twofold way. We think on the one hand of a state of affairs which leads to acts of exchange; the situation is such that the uneasiness of various individuals can be removed to some extent because various people value the same goods in a different way. On the other hand we think of a situation in which no further acts of exchange can happen because no actor expects any further improvement of his satisfaction by further acts of exchange. We proceed in the same way in comprehending the formation of the prices of factors of production. The operation of this market is actuated and kept in motion by the exertion of the promoting entrepreneurs, eager to profit from differences in the market prices of the factors of production and the expected prices of the products. The operation of this market would stop if a situation were ever to emerge in which the sum of the prices of the complementary factors of production—but for interest—equaled the prices of the products and nobody believed that further price changes were to be expected. Thus we have described the process adequately and completely by pointing out, positively, what actuates it and, negatively, what would suspend its motion. The main importance is to be attached to the positive description. The negative description resulting in the imaginary constructions of the final price and the evenly rotating economy is merely auxiliary. For the task is not the treatment of imaginary concepts, which never appear in life and action, but the treatment of the market prices at which the goods of higher orders are really bought and sold.

This method we owe to Gossen, Carl Menger, and Böhm-Bawerk. Its main merit is that it implies the cognition that we are faced with a phenomenon of price determination inextricably linked with the market process. It distinguishes between two things: (a) the direct valuation of the factors of production which attaches the value of the product to the total complex of the complementary factors of production, and (b) the prices of the single factors of production which are formed on the market as the resultant of the concurring actions of competing highest bidders. Valuation as it can be practiced by an isolated actor (Robinson Crusoe or a socialist board of production management) can never result in a determination of such a thing as quotas of value. Valuation can only arrange goods in scales of preference. It can never attach to a good something that could be called a quantity or magnitude of value. It would be absurd to speak of a sum of valuations or values. It is permissible to declare that, due allowance being made for time preference, the value attached to a product is equal to the value of the total complex of complementary factors of production. But it would be nonsensical to assert that the value attached to a product is equal to the “sum” of the values attached to the various complementary factors of production. One cannot add up values or valuations. One can add up prices expressed in terms of money, but not scales of preference. One cannot divide values or single out quotas of them. A value judgment never consists in anything other than preferring a to b.

The process of value imputation does not result in derivation of the value of the single productive agents from the value of their joint product. It does not bring about results which could serve as elements of economic calculation. It is only the market that, in establishing prices for each factor of production, creates the conditions required for economic calculation. Economic calculation always deals with prices, never with values.

The market determines prices of factors of production in the same way in which it determines prices of consumers’ goods. The market process is an interaction of men deliberately striving after the best possible removal of dissatisfaction. It is impossible to think away or to eliminate from the market process the men actuating its operation. One cannot deal with the market of consumers’ goods and disregard the actions of the consumers. One cannot deal with the market of the goods of higher orders while disregarding the actions of the entrepreneurs and the fact that the use of money is essential in their transactions. There is nothing automatic or mechanical in the operation of the market. The entrepreneurs, eager to earn profits, appear as bidders at an auction, as it were, in which the owners of the factors of production put up for sale land, capital goods, and labor. The entrepreneurs are eager to outdo one another by bidding higher prices than their rivals. Their offers are limited on the one hand by their anticipation of future prices of the products and on the other hand by the necessity to snatch the factors of production away from the hands of other entrepreneurs competing with them.

The entrepreneur is the agency that prevents the persistence of a state of production unsuitable to fill the most urgent wants of the consumers in the cheapest way. All people are anxious for the best possible satisfaction of their wants and are in this sense striving after the highest profit they can reap. The mentality of the promoters, speculators, and entrepreneurs is not different from that of their fellow men. They are merely superior to the masses in mental power and energy. They are the leaders on the way toward material progress. They are the first to understand that there is a discrepancy between what is done and what could be done. They guess what the consumers would like to have and are intent upon providing them with these things. In the pursuit of such plans they bid higher prices for some factors of production and lower the prices of other factors of production by restricting their demand for them. 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.

In drafting their plans the entrepreneurs look first at the prices of the immediate past which are mistakenly called present prices. Of course, the entrepreneurs never make these prices enter into their calculations without paying regard to anticipated changes. The prices of the immediate past are for them only the starting point of deliberations leading to forecasts of future prices. The prices of the past do not influence the determination of future prices. It is, on the contrary, the anticipation of future prices of the products that determines the state of prices of the complementary factors of production. The determination of prices has, as far as the mutual exchange ratios between various commodities are concerned,2 no direct causal relation whatever with the prices of the past. The allocation of the nonconvertible factors of production among the various branches of production3 and the amount of capital goods available for future production are historical magnitudes; in this regard the past is instrumental in shaping the course of future production and in affecting the prices of the future. But directly the prices of the factors of production are determined exclusively by the anticipation of future prices of the products. The fact that yesterday people valued and appraised commodities in a different way is irrelevant. The consumers do not care about the investments made with regard to past market conditions and do not bother about the vested interests of entrepreneurs, capitalists, landowners, and workers, who may be hurt by changes in the structure of prices. Such sentiments play no role in the formation of prices. (It is precisely the fact that the market does not respect vested interests that makes the people concerned ask for government interference.) The prices of the past are for the entrepreneur, the shaper of future production, merely a mental tool. The entrepreneurs do not construct afresh every day a radically new structure of prices or allocate anew the factors of production to the various branches of industry. They merely transform what the past has transmitted in better adapting it to the altered conditions. How much of the previous conditions they preserve and how much they change depends on the extent to which the data have changed.

The economic process is a continuous interplay of production and consumption. Today’s activities are linked with those of the past through the technological knowledge at hand, the amount and the quality of the capital goods available, and the distribution of the ownership of these goods among various individuals. They are linked with the future through the very essence of human action; action is always directed toward the improvement of future conditions. In order to see his way in the unknown and uncertain future man has within his reach only two aids: experience of past events and his faculty of understanding. Knowledge about past prices is a part of this experience and at the same time the starting point of understanding the future.

If the memory of all prices of the past were to fade away, the pricing process would become more troublesome, but not impossible as far as the mutual exchange ratios between various commodities are concerned. It would be harder for the entrepreneurs to adjust production to the demand of the public, but it could be done nonetheless. It would be necessary for them to assemble anew all the data they need as the basis of their operations. They would not avoid mistakes which they now evade on account of experience at their disposal. Price fluctuations would be more violent at the beginning, factors of production would be wasted, want-satisfaction would be impaired. But finally, having paid dearly, people would again have acquired the experience needed for a smooth working of the market process.

The essential fact is that it is the competition of profit-seeking entrepreneurs that does not tolerate the preservation of false prices of the factors of production. The activities of the entrepreneurs are the element that would bring about the unrealizable state of the evenly rotating economy if no further changes were to occur. In the world-embracing public sale called the market they are the bidders for the factors of production. In bidding, they are the mandataries of the consumers, as it were. Each entrepreneur represents a different aspect of the consumers’ wants, either a different commodity or another way of producing the same commodity. The competition among the entrepreneurs is ultimately a competition among the various possibilities open to men to remove their uneasiness as far as possible by the acquisition of consumers’ goods. The decisions of the consumers to buy one commodity and to postpone buying another determine the prices of factors of production required for manufacturing these commodities. The competition among the entrepreneurs reflects the prices of consumers’ goods in the formation of the prices of the factors of production. It reflects in the external world the conflict which the inexorable scarcity of the factors of production brings about in the soul of each individual. It makes effective the subsumed decisions of the consumers as to what purpose the nonspecific factors should be used for and to what extent the specific factors of production should be used.

The pricing process is a social process. It is consummated by an interaction of all members of the society. All collaborate and cooperate, each in the particular role he has chosen for himself in the framework of the division of labor. Competing in cooperation and cooperating in competition all people are instrumental in bringing about the result, viz., the price structure of the market, the allocation of the factors of production to the various lines of want-satisfaction, and the determination of the share of each individual. These three events are not three different matters. They are only different aspects of one indivisible phenomenon which our analytical scrutiny separates into three parts. In the market process they are accomplished uno actu [(Latin) by a single action]. Only people prepossessed by socialist leanings who cannot free themselves from longing glances at socialist methods speak of three different processes in dealing with the market phenomena: the determination of prices, the direction of productive efforts, and distribution.

[24. ]Cf. below, pp. 769–79.

[25. ]Cf. below, pp. 812–20.

[26. ]For a detailed treatment of the problems involved, cf. Mises, Bureaucracy (New Haven, 1944). [Bureaucracy has since been reprinted by Arlington House (New Rochelle, N.Y., 1969) and the Libertarian Press (Grove City, Pa., 1983).]

[27. ]Cf. Chamberlin, The Theory of Monopolistic Competition (Cambridge, Mass., 1935), pp. 123 ff.

[1. ]Sometimes the difference in price as established by price statistics is apparent only. The price quotations may refer to various qualities of the article concerned. Or they may, complying with the local usages of commerce, mean different things. They may, for instance, include or not include packing charges; they may refer to cash payment or to payment at a later date; and so on.

[2. ]It is different with regard to the mutual exchange ratios between money and the vendible commodities and services. Cf. below, pp. 410–11.

[3. ]The problem of the nonconvertible capital goods is dealt with below, pp. 503–9.

Home

The Forum

Econlib

The Library

Other Sites

The Library

Return to Title Page for Human Action: A Treatise on Economics, vol. 2 (LF ed.)

The Online Library of Liberty

A project of Liberty Fund, Inc.

Search this Title:

Also in the Library:

Some Observations on the Underconsumption Bogey and on the Purchasing Power Argument - Ludwig von Mises, Human Action: A Treatise on Economics, vol. 2 (LF ed.) [1996]

Edition used:

Part of: Human Action: A Treatise on Economics, in 4 vols. (LF ed.)

About Liberty Fund: