The Online Library of Liberty

A project of Liberty Fund, Inc.

• Acknowledgements
• Part One: Introduction
• Walter E. Grinder, In Pursuit of the Subjective Paradigm: Walter E. Grinder
• Austrian Economics In the Present Crisis of Economic Thought
• Part Two: Setting the Stage
• The Significance of the Austrian School of Economics In the History of Ideas
• The Role of Expectations In Economics As a Social Science
• Professor Shackle On the Economic Significance of Time
• The Science of Human Action
• Model Constructions and the Market Economy
• Part Three: the Market Process
• Some Notes On Economic Thought, 1933–1953
• Methodological Individualism and the Market Economy
• Economics As a Social Science1
• Ludwing Von Mises and the Market Process
• Part Four: Problems In Macroeconomic and Capital Theory
• Complementarity and Substitution In the Theory of Capital
• Mrs. Robinson On the Accumulation of Capital
• Sir John Hicks On Capital and Growth: (review Article)
• Sir John Hicks As a Neo-austrian: (review Article)
• A Reconsideration of the Austrian Theory of Industrial Fluctuations
• Part Five: On Economic Policy
• Causes and Consequences of the Inflation of Our Time
• The Market Economy and the Distribution of Wealth
• Cultivated Growth and the Market Economy
• Appendix: Economic Writings of Ludwig M. Lachmann

Model Constructions and the Market Economy

1.

INTRODUCTION

For almost two centuries concepts of the market economy have had a significant place in the development of economic theory. The market, not just as the product of economic history, but as a focus of meaningful action—as the product of, and also as a means of orientation for, economic agents in a society with division of labor—constituted one of the most important themes of classical political economy. It was certainly no accident that in the Methodenstreit the partisans of the historical school accused their opponents, often unjustly, of “Manchesterism.” What they meant was that in classical theory the market and its institutions occupied such a predominant place, and this fact was to them an annoyance.

In recent decades, however, there has been a distinct change. Modern economic theory has become ever more abstract and occupied with the building of pseudo-Platonic models in imitation of the methods of the modern natural sciences. Within this framework, there is little room for a discussion of market processes or of the actions causing them. Even less attention is given to those mental acts from which these economic actions spring. Neoclassical formalism—as I shall designate the predominant trend in economic thinking that has gained such wide acceptance in recent decades—understandably does not find it a congenial task to explain economic phenomena in terms of underlying plans and actions.1 One abstracts from all these and, following the example of the natural sciences, substitutes the functional determination of magnitudes, within a closed system characterized by simultaneous equations, for causal explanation.2

This essay, “Marktwirtschaft und Modellkonstruktionen,” Ordo 17(1966):261–79, was translated from the German by Robert F. Ambacher of Millersville State College and Walter E. Grinder.

As a result of this development in economic theory, the vitality of our thinking about the market economy has been undermined. In this situation, the advocates of the market, faced with new problems, have to fashion their own analytical tools.

First of all, we must concentrate on the fundamental methodological problem facing us. The market is a focus of meaningful action. Market phenomena, quantities of goods and prices, result from the economic plans of market participants, such plans being based on the economic calculations of single individuals and enterprises. Economic plans, thus, are the components of meaningful action. To explain market phenomena therefore means to analyze these phenomena in terms of their meaningful components. If, however, as is done in modern economics, one views all economic phenomena, including market phenomena, as mere parts of a large complex of relationships, that is, the “economic system,” one is limited to the “exact” determination of those quantitative relationships that can be determined at all. This manipulation is possible, of course, only within a closed system and then only when all relationships are fully coherent. This also explains the current preoccupation with conditions of equilibrium. The need to refer all economic phenomena to a central point, the “economic system,” forces one to use such an approach.

Now the determination of economic quantities, as far as this is possible, is obviously a goal of any economic theory and thus of any market theory. But for a method of analysis that is also concerned with the interpretation of the meaning of action, this determination is only the first step. The real task is to explain how relations between quantities derive from mental acts.

The inadequacy of the models constructed by neoclassical formalism, which I shall deal with at length in the next section, stems, then, not from its high degree of abstraction as such, for all theory is abstract; nor from the fact that quantitative relations are determined, for all economic theory must achieve such determination; and most certainly not from the application of mathematics, for mathematics is a proved means of expressing quantitative relationships in all areas of knowledge. Rather, this inadequacy springs from the significance of the elements from which one must abstract: in macroeconomics one abstracts from the human actions and plans that underlie all economic phenomena, while in microeconomics these actions and plans appear all too often as an idealized distortion (“perfect competition”).

Under these conditions the defenders of the market economy are confronted with new tasks. Three of these appear to me to be of particular importance.

First, it must be demonstrated that the stylized images of the market in the neoclassical models have little relevance to actual market processes. When, for example, linear programming theory shows that all rational economic activity implies a price system with prices equal to costs and that all production involving time implies a rate of interest, the similarity of this price system to that of the market economy seems evident. But this similarity only seems evident, and market theory can gain nothing from it. For in this linear price system we are dealing with equilibrium prices that result from a calculus and not from market processes. No account is taken of the central problems of market economics: what occurs in a state of disequilibrium, whether and under what condition equilibrium can be reached at all, how long such a condition would last if once reached, and so on.

No one denies the usefulness of linear programming for solving practical planning problems. But it has nothing to contribute to an understanding of market processes. The reason is that no individual actor in the market actually possesses that total knowledge of the data that linear theory assumes. Market processes and the calculation of optimal allocations are entirely different things. The close proximity of equilibrium and linear theory, which characterizes the neoclassical thought of our time, shows upon close investigation the weakness of the former rather than the fruitfulness of the latter.

Secondly, we must come to terms with the view that the market economy can function only in a stationary state, since only then could orientation to existing market prices warrant the success of economic action. In reality, we are told, the entrepreneur must act on his expectations, which of necessity are uncertain. It is hard to see what could coordinate these expectations. The price system certainly could not do it; and the forward markets of the real world are too little developed and too few in number to offer a solution.3

Without going into these important questions more fully, the following comment is in order:

First, such reliance on forward markets exaggerates the importance of well-coordinated expectations. Even in a world of perfect forward markets the future remains uncertain, and even the best coordinated expectations do not guard against disappointments. Second, the absence of forward markets does not by itself imply an unsatisfied demand for the services of specialized risk takers. In general, the market economy generates the institutions it needs. The lack of an institution may be attributable to the fact that it is not needed.

Finally, the decisive question is whether the market can offer methods for the quick and effective liquidation of malinvestments, even though it cannot prevent thwarted expectations and the failure of plans. For the market economy the revision of plans has no less significance than their original conception.

The third task of market-oriented theory is, in my opinion, the creation of a useful concept of competition. This is a subject that E. H. Chamberlin, J. M. Clark, and a number of others have tackled in the last thirty years. Even those who view the solutions offered with some skepticism should not belittle the accomplishments of these authors; for they have thoroughly investigated actual market processes, an undertaking of no small merit in our age of formalism.

Most important is recognizing that the market is not a state of affairs but a chain of events. It is therefore not possible to view competition as a market condition whose form can be deduced from assumptions about typical schemes of action (market forms). These schemes of action themselves depend on market phenomena from which the actors in the market are continuously taking their orientation. I shall return to this matter in the third section.

2.

IN CRITICISM OF ECONOMIC MODELS

I shall now subject the neoclassical models to a critical examination, above all with regard to the problem of “economic growth.” My reasons are that, on the one hand, theories of growth are really creations of the last twenty years, the neoclassical style of thought being particularly evident in this area, and, on the other hand, the unreal nature of the models often finds here its expression in striking ways.4

A characteristic common to most of these models is the search for, and the almost exclusive preoccupation with, so-called maximum growth paths. Since J. von Neumann's famous work,5 the major task of growth theory has been to show how, under given conditions, the factors of production must be employed in order to attain enduring optimal growth. We are dealing here with a kind of “dynamic welfare economics.” The solution of maximization problems, well known in microeconomics, is viewed here as the task of macroeconomics, although it is never revealed how each market participant gains the relevant partial knowledge he must have if total knowledge of all of market participants is to be equal to the total data possessed by the model builder. To conclude from the similarity of the formal characteristics of maximization problems that what is possible for an individual's personal economy is also possible for the economic system as a whole exactly characterizes the intellectual attitude of neoclassical formalism. At best, only the directors of a planned economy could possess such all-encompassing knowledge of the data—and even this is doubtful. All of this has nothing to do with the market economy.

Central to all activities of the market economy is the individual economic plan. It is one thing to show that all planned action is an attempt at problem solving. It is something quite different to examine “maximum growth paths,” beginning with the assumption that all participants' problems have been successfully solved. Some plans will always fail. What happens in such cases must be of great interest to us. In reality there are no optimal solutions for all participants—except in the minds of welfare economists. Dynamic equilibria, maximum growth paths, and similar concepts are notions of economists with little interest in what matters in the market economy. The logic of choice leads us to the equilibrium of the household and of the firm, and perhaps of the single market, insofar as the market situation is intelligible to its participants. Beyond this point, the logic of choice becomes distorted and loses its meaning.

Every planner and actor must always be aware of a series of viewpoints and changing conditions that are often quantitatively determined and graded and that may be regarded as functions. But that gives us no right to see functions everywhere, or even to limit our investigation to their existence. Concepts that may have significance in the sphere of the individual economy and of the single market often lose it if a “macro” connotation is attributed to them without close investigation of the facts. Working with aggregates whose origins remain unexamined and whose mode of composition is assumed to persist without explanation allows the constructors of economic models to withdraw from the task of tracing market phenomena to the meanings people attribute to their economic actions.

Growth theory has thus become a branch of applied mathematics, in which one is satisfied with the deduction of optimal solutions from given “data,” without having to be concerned with how many economic actors in the real world could possibly understand the meaning of these data. Methods borrowed from the natural sciences are applied without testing their applicability to the objects of the social sciences. The interpretation of complex relationships of meaning is replaced by a mechanical calculus. The market and its phenomena, however, are to be understood only as a focus of meaningful action.

However little the theory of the market economy, aspiring to interpret meaning, has to learn from economic models which lack such aspirations, it cannot afford to ignore it. The reason is simply that these maximum and optimum solutions—regardless of how unrealistic or how abstractly conceived—may be used as standards against which the real market economy can be measured and naturally found wanting. It is hardly an overstatement that most formalists seldom concern themselves with the phenomena of the real market economy except to prove, with great earnestness, that here the high ideal of “Pareto-optimality” has been missed. Unfortunately, we are not informed in what kind of society this could be achieved. The study of models is thus no idle occupation for an adherent to the market economy.

In particular my critique is directed against three features of these schemes: the unflinching use of equilibrium argument, the exclusively macroeconomic form of analysis, and the misunderstanding of the nature of technological progress.

In the individual economy the equilibrium concept obviously makes good sense, for here the actor tries to achieve such a state, even if it is never realized. This concept represents a real point of reference for mental acts. It also makes sense, in the single market, to speak of equilibrium between supply and demand. And where the actors respond very quickly, as, for example, in the stock market, such a condition is achieved every day. Only when we extend the concept to the entire complex of economic relationships do we encounter difficulty. Nevertheless, in a stationary world a general state of equilibrium is at least conceivable, and under certain circumstances it might even be achieved. But in a world of continuous unexpected change, this concept becomes highly questionable.

It is therefore remarkable that all modern growth theories are based on the same conceptual foundation, one that dates from Gustav Cassel's theory of a uniformly progressing economy, “steady state growth.”6 The creators of general equilibrium theory were aware that even in static analysis the conditions of equilibrium do not entail the achievement of a state commensurate with these conditions. They knew that the “road leading to equilibrium” conceals a number of problems.7 They even attempted to circumvent these difficulties through the postulates of “recontract” theory. More than thirty years ago, in a famous essay, Lord Kaldor referred to these problems.8 In recent economic models, however, they have been cast aside.9 This is noteworthy since obviously such problems are bound to cause even greater difficulties in a dynamic economy than in static analysis. Whether even a temporary state of equilibrium will be achieved obviously depends on the velocity of reaction of the various elements in the system; their respective magnitudes, in turn, depend on the expectations of economic agents. Yet formalism avoids confronting these difficult problems by postulating the continued existence of a growth equilibrium, the very origin of which is not explained. The problems of human action in a world of unexpected change are concealed behind a smoke screen of formulae and functions.

Much has already been said about the competition between macroeconomics and microeconomics.10 Here we shall come to grips with this problem in terms of market phenomena.

Obviously, a procedure that neglects to trace market phenomena to plans and fails to divide the complex relationships of these phenomena into their meaningful components is unsatisfactory. Furthermore, under what circumstances can the assumption be justified that changes in aggregates are independent of changes in their constituents? Assuming that the aggregates were composed of homogeneous elements, there would be no distinction between macroanalysis and microanalysis. Such an assumption, however, would obviously contradict reality. On the other hand, the assumption that aggregates follow “stochastic” laws rather than the causal laws of their elements would evidently signify the abdication of economic theory in its traditional sense. Finally, it might be contended that changes in the aggregates are accompanied by changes in the elements of precisely such a nature that regular and uniform growth of the aggregates results. In this case, the burden of proof rests on those who make such a claim.

The dilemma resulting from attempts to separate movements of aggregate quantities from the happenings in the individual markets may be illustrated by an example. The “production function” is a basic concept of modern macroeconomic theory.11 Of these production functions the “Cobb-Douglas-function” is perhaps the best known. How is it possible for such a function to be valid and remain in a world of constant change? It could be so if all firms had the same production functions, but that can hardly be the case (our example of homogeneity.) In a world of heterogeneous individual production functions, constancy of the total function is possible only if the “steady growth” of the whole is accompanied by proportional progress in each sector. Economic growth is in reality, however, almost always accompanied by considerable fluctuation in the relative magnitudes of the individual sectors. This example shows where the improper abstraction of micro processes has led the model builders.

All thought is limited by the forms and modes it employs. Formalism, in opting for the functional mode making possible precise quantitative determinations within a closed system of variables, forgoes the possibility of making meaningful statements about human action. What we call “technical progress,” however, encompasses a diverse complex of interrelationships consisting of many kinds of actions (such as of entrepreneurs and consumers). It is not surprising that formalism, which in its analysis of growth cannot but concern itself with technological progress, can master only those few aspects of the problem that can be compressed into the narrow ducts of its own mode of thought.12

Technological progress, viewed here ex post, is defined as an accomplished fact, as an increase in the productivity of the factors of production, uniform over time. The fact that ex ante it is by no means sure which technological changes will signify “progress” and which not, that this can only be established as the result of the interaction of numerous production and market processes, is simply disregarded. The fact that in a market economy many entrepreneurs continually experiment with new ideas, each in his own way and in another direction, and that final success or failure is determined only by the market lies beyond the model builder's imagination. At the same time, some of the difficulties encountered by them within their own mode of thought can be most instructive.

When technological progress occurs in “embodied form,” that is, when machines built recently are more efficient than those built previously, the capital stock loses the homogeneity upon which the concept of the production function rests. Naturally one then attempts to introduce a new time function that will restore homogeneity. It is hard to see, however, why real productivity changes should conform to this function. The unqualified homogeneity of capital, once questioned, cannot be easily reinstated. Similarly, Kenneth Arrow's concept of “learning by doing” opens to us even broader and more intriguing vistas.13

To the formalist this means, first of all, that technological progress is a function not only of time, but also of the volume of production. No detailed argument is needed to show, however, that no ordinary production index could serve us here as an independent variable. In any case, these occurrences call for a more penetrating interpretation than that compatible with the functional mode of thought.

It is well known that experience in the use of tools and implements will often promote skills that permit their more effective use in the future. Technological progress is thus a concomitant of production as such. Clearly, we are dealing here with mental acts that turn experience into a new awareness, and then into new applications. Certainly, many errors are made in the process. Inequality of men once more becomes apparent in their unequal ability to learn by experience, a process that requires a certain amount of mental alertness. There can be no question of quantitative precision here.

Formalism, again, avoids coming to grips with these difficult problems, inaccessible to its methods. It postulates a functional relationship between aggregate quantities that would, even in the best of cases, prove nothing. The actual conditions of this interesting type of progress lie in the individual abilities of various producers and their influence on others, and not in the quantitative properties of aggregate wholes.

3.

SOME GUIDELINES FOR THE DEVELOPMENT OF A THEORY OF A MARKET ECONOMY

What then should be done to correct these deficiencies in economic models and broaden the conceptual basis of the market economy? To this question I can, within the framework of this essay, give no adequate answer. A few short hints to ideas that might serve as guidelines for a reconstruction of market economic theory, as it has now become necessary, will have to suffice. While a complete outline of market economic theory cannot be presented here, a few hints as to the style of our new edifice and the place of some of its parts in the whole design are in order. In doing so the major deficiencies of today's economic models should be avoided as far as possible.

These models all suffer from the same defect: an exaggerated significance is attributed to equilibrium concepts, and a consistency that does not exist is ascribed to the plans of individuals. To the contrary, room must be left for the unavoidable inconsistency of plans. We must be able to speak not only of unsuccessful plans and malinvestments, but also of the revision of such plans. Essentially, each new plan rests on a revision of an earlier plan.

Functionalism in neoclassical formalism requires a closed system of variables, in which the magnitudes of a number of dependent variables are determined by functional relationships. It is easy to see why such a mode of thought cannot do justice to the market economy, which by its very nature is an “open system.” In the systems of Léon Walras and Vilfredo Pareto, to choose the best known example, equilibrium prices and quantities of goods are determined by the magnitudes of the data. In actual markets, however, no one has such access to the complete constellation of data as would enable them to arrive at the equilibrium quantities and adjust his action to them. At best, one is familiar with the data directly concerning him. For the rest, he depends on conjectures, and for these, again, on inferences from available information. The market as a whole is fed by a broad stream of knowledge, which, although it flows constantly, provides each person with different information. The same information will be interpreted differently by an optimist and a pessimist. The same objective possibility will be used differently by an aggressive and by a restrained actor. In an uncertain world, in which economic agents are dependent on their expectations, a general coherence of plans is almost impossible. The objective existence of “data” that no one knows in their entirely is without significance.

The market economy is thus an “open” system, to which justice can hardly be done by the functionalist mode of thought. It requires, to the contrary, an “open” mode of thought that leaves room for the, at least temporarily, uncoordinated action of economic agents. Such a mode of thought of course does not permit “precisely” determined relations between quantities. It should help us to clarify, however, the manner in which human action is constantly oriented toward events; the interpretations of those events, which themselves change over time, the manner in which ideas are integrated and transformed over time into plans; and the manner in which all action flows from mental acts. In this sense, we may contrast the “genetic-causal” method with the functional one.14 I should like to illustrate this point with two examples.

During the market process the participants orient themselves by each other's actions. Since dissimilar expectations cannot all be accurate, plans based on different expectations cannot all be successful. The market determines success and failure and forces unsuccessful actors to revise their plans. In this way the market process becomes a process of selection of the currently successful. This selection is the necessary result of the original inconsistency of the plans. In a game there cannot be only winners.

Success or failure of a plan is expressed in a capital gain or loss; for every plan requires a capital combination in which the stock of fixed capital is of significance. The successful entrepreneur not only obtains a higher income. His stock of fixed capital will also rise in value, since through the success of his plan it now becomes the source of a quasi-rent income stream. The opposite is true for an unsuccessful plan. The unsuccessful entrepreneur even runs the risk, if he is in debt, of losing control of his capital combination. Even if this does not occur, a capital loss ordinarily restricts the sphere of operation of the entrepreneur.

We may thus regard the stock of fixed capital, which, despite limited economic versatility, forms the backbone of ever plan, as the vessel of the expectations for every plan. The market determines not only the distribution of income but also the distribution of wealth through changes in the value of capital goods.15 It is therefore highly misleading to maintain that the distribution of income in the market depends on the existing distribution of wealth. For the distribution of wealth changes constantly as a result of changes in the value of capital goods that accompany the success or failure of every plan.

The above throws some light on the function of the stock market in the market economy.16 Here, shares of different capital combinations, consisting essentially of fixed capital goods, are continually being evaluated. The stock exchange not only registers success and failure, but also expresses expectations about the prospects of plans already set in motion. The stock exchange may be viewed as the central forward market for future capital yields of indefinite horizon. Buyers and sellers on the exchange express their expectations about the chances of various plans, and thereby also evaluate the underlying capital combinations.

The function of the stock exchange is the same as that of any forward market, namely, to distill from many individual expectations a “market expectation,” finding its expression in the stock price, to which each interested person may orient himself. The equilibrium price of the stock market is determined, not by an “objective” body of information, but by the respective expectations of buyers and sellers. That this price changes from day to day indicates the sensitivity of the price-forming mechanism with regard to expectations, and not the impaired capability of the stock market to function; for the function of the stock exchange, as of any market, is not to guess the future but to reconcile, as much as possible, present actions that extend into an uncertain future.

As a second example I should like to use competition to illustrate the genetic-causal method. It is hardly necessary to show why the “perfect competition” of the textbooks is a thoroughly defective concept and can contribute nothing to our understanding of actual competition.17 Three points may be useful in the search for a better concepts of competition.

In the first place, as indicated previously, competition should be viewed as a chain of events rather than as a state of affairs.18 With competition as with the market as a whole, we are dealing with a process during the course of which the participants orient themselves to each other's actions. The most important point of orientation is here the size of the profits of competitors.

Second, we must discard the assumption, inherited from the classicists, that competitors all start from the “same position,” whereas monopoly involves “privilege.” On the contrary, the value of competition is precisely that buyers have a choice among unequal services. No one doubts that choice and decision are the most important attributes of the economic act. But what sense is there in a choice between equal services and identical goods? Here we see once again that the idea of “pure competition” springs from a mode of thought alien to meaning.

Third, two phases may be discerned in the process of competition, which constantly alternate. On the one hand, there is product differentiation, basically Schumpeter's “new combination,” and, on the other hand, there is the leveling competition of imitators of a successful innovation. Both phases are necessary and complementary elements of the competition process. Without innovation and product differentiation there would be nothing to imitate, and competition could not exist. Without constant competitive pressure from imitators of successful innovations, innovations would remain a permanent source of monopolistic or oligopolistic income.

For economic progress and the functioning of the market economy, the first phase is as necessary as the second. How could aircraft, cars, phonographs, and so on of fifty years ago have been developed to their present forms without constant product differentiation? All progress, especially progress through quality improvements, calls for continual experimentation in different directions. The market passes its final judgment on the technological knowledge gained in this fashion.

Of the second stage of the process, or “competition in the narrower sense,” little of a general nature may be said, other than that, here also, equilibrium concepts hinder rather than promote understanding.

Without price-cost differences no competition can exist in the sense of activity directed toward increasing one's share of the market. On the other hand, competition constantly diminishes these differences. For formalism this means that “ultimately” prices will everywhere be equal to costs. With regard to the actual market economy such a statement is meaningless; for reaching such a final stage simply means that the process of competition consisting of the two phases has come to a standstill. The continual emergence of new combinations with temporary profit possibilities in the first phase alone gives meaning to the leveling process of the second phase.

I have attempted to show why our thinking on the market economy has nothing to learn from contemporary economic theory, as long and insofar as it is dominated by formalism, and why its exponents will in the future have to go their own way. In the first section I briefly indicated those problems that seem especially important in the present situation. In the third section I attempted to outline a method that, in my opinion, promises to do justice to the actual tasks of market economy theory.

In evaluating the prospects of this undertaking, two points must be taken into account. On the one hand, formalism in its triumphal march through the contemporary world has met with resistance. On these islands of resistance we find schools of economic thought with roots in a tradition older than the one borrowed from the natural sciences, a tradition aimed at a meaningful understanding of human action. Although neoclassical formalism may justifiably invoke the analytic methods of its classical ancestors, nevertheless the subjective theory of value and the discovery of the significance of expectations have been achievements of the other tradition. This tradition survives even in this era of formalism. We should take it up again. Besides the work of Eucken and his disciples, there are above all the contributions of the praxeological school, of Mises, Hayek, and Röpke.19 Furthermore, there is rich material in the field of economic history that can be utilized in the development of market economic theory. I refer here to the essays in Capitalism and the Historians20 and the excellent work of Fritz Redlich.21 Finally, it is a historical fact that, even in regard to economic growth, the market form of economic organization has been the most successful. It is a sign of the times that the recipes for rapid growth being peddled everywhere stem from the kitchen of formalism, even though economic history, whose phenomena to be sure have to be interpreted, offers abundant evidence of the true causes of economic progress.

NOTES

PART THREE

THE MARKET PROCESS

[[1]]With a welcome lucidity, Paul A. Samuelson characterized the essence of the cognitive method of formalism: “Implicit in such analyses there are certain recognizable formal uniformities, which are indeed characteristic of all scientific method. It is proposed here to investigate these common features in the hope of demonstrating how it is possible to deduce general principles which can serve to unify large sectors of present day economic theory” (Foundations of Economic Analysis [Cambridge: Harvard University Press, 1947], p. 70).

[[2]]“In every problem of economic theory certain variables (quantities, prices, etc.) are designated as unknowns, in whose determination we are interested. Their values emerge as a solution of a specific set of relationships imposed upon the unknowns by assumption or hypothesis. These functional relationships hold as of a given environment and milieu” (ibid., p. 7).

[[3]]“To my knowledge no formal model of resource allocation through competitive markets has been developed which recognizes ignorance about all decision makers' future actions, preferences, or states of technological information as the main source of uncertainty confronting each individual decision maker, and which at the same time acknowledges the fact that forward markets on which anticipations and intentions could be tested and adjusted do not exist in sufficient variety and with a sufficient span of foresight to make presently developed theory regarding the efficiency of competitive markets applicable. If this judgment is correct, our economic knowledge has not yet been carried to the point where it sheds much light on the core problem of the economic organization of society: the problem of how to face and deal with uncertainty. In particular, the economic profession is not ready to speak with anything approaching scientific authority on the economic aspects of the issue of individual versus collective enterprise which divides mankind in our time. Meanwhile, the best safeguard against overestimation of the range of applicability of economic propositions is a careful spelling out of the premises on which they rest. Precision and rigor in the statement of premises and proofs can be expected to have a sobering effect on our beliefs about the reach of the propositions we have developed” (T. C. Koopmans, Three Essays on the State of Economic Science [New York: McGraw-Hill 1957], pp. 146–47).

[[4]]A detailed survey of the state of growth theory at that time is offered by F. H. Hahn and R. C. O. Matthews, “The Theory of Growth: A Survey,” Economic Journal 74 (December 1964): 779–902.

[[5]]J. von Neumann, Ergebnisse eines mathematischen Kolloquiums, ed. Karl Menger (Vienna, 1935–36).

[[6]]Gustav Cassel, Theoretische Sozialökonomie (Leipzig, 1918), chap. 1, para. 6.

[[7]]In what we might call a semiofficial pronouncement from the headquarters of neoclassical formalism, that, too, is freely admitted today: “Granted that an economy possesses a general equilibrium constellation of prices and outputs, if that constellation is not already in effect are there mechanisms in the economy that will bring it into being? ... Walras recognized this problem also, but was not able to give a satisfactory solution. In fact, the problem remains open to this day. We still do not have a satisfactory specification of the conditions under which the adjustment mechanism of an economy will guide it to its general equilibrium position” (Robert Dorfman, The Price System [Englewood Cliffs, N. J.: Prentice-Hall, 1964], pp. 107–8).

[[8]]Lord Kaldor, “The Determinateness of Static Equilibrium,” in Essays on Value and Distribution (Glencoe, III., Free Press, 1960), originally in Review of Economic Studies 1 (February 1934): 122–36.

[[9]]A notable exception is the incisive study by G. B. Richardson, Information and Investment (London: Oxford University Press, 1960), esp. chaps. 1 and 2.

[[10]]See, for example, Fritz Machlup, Der Wettstreit zwischen Mikround Makro-theorien in der Nationalökonomie (Tübingen: J. C. B. Mohr, 1960).

[[11]]“It is commonly called ‘neo-classical’ but the appropriateness of the description must surely be questioned. There is no ‘production function’ in Jevons or Marshall, Walras or Pareto, Menger or Böhm-Bawerk. There is in Wicksell, but he is careful to confine it to his model of ‘production without capital.’ J. B. Clark can hardly be regarded as a major neoclassical economist. The originators of the ‘production function’ theory of distribution (in the static sense, where I still think that it should be taken fairly seriously) were Wicksteed, Edgeworth, and Pigou” (John Hicks, Capital and Growth [Oxford: Clarendon Press, 1965], p. 293n).

[[12]]On this see especially, F. H. Hahn and R. C. O. Matthews, “Theory of Growth,” pp. 825–52.

[[13]]K.J. Arrow, “The Economic Implications of Learning by Doing,” Review of Economic Studies 29 (June 1962): 155–73.

[[14]]The term “genetic-causal method of inquiry” originated with Sombart (Die drei National-ökonomien [Munich and Leipzig, 1930], p. 121) and was then taken over by Hans Mayer (“Der Erkenntniswert der funktionellen Preistheorien,” in Die Wirtschaftstheorie der Gegenwart [Vienna, 1932], 2:148–51).

[[15]]See, for example L. M. Lachmann, “The Market Economy and the Distribution of Wealth,” in On Freedom and Free Enterprise: Essays in Honor of Ludwig von Mises, ed. Mary Sennholz (New York: D. Van Nostrand, 1956), pp. 175–87.

[[16]]We trust our terminology will not cause a misunderstanding. Functionalism in modern sociology, whose terminology we use when we speak of the “function of the market” has, of course, nothing to do with the functionalism of formalistic economics.

[[17]]F. A. Hayek: “The Meaning of Competition,” in idem, Individualism and Economic Order (London: Routledge & Kegan Paul, 1949).

[[18]]“Competition is by its nature a dynamic process whose essential characteristics are assumed away by the assumptions underlying static analysis” (ibid., p. 94).

[[19]]The word praxeology was first used in Mises's Nationalökonomie, Theorie des Handelns und Wirtschaftens (Geneva, 1940) (translated as Human Action [New Haven: Yale University Press, 1949]). We would like to take this opportunity to refer to the works of two American students of Mises: I. M. Kirzner, The Economic Point of View (New York: D. Van Nostrand, 1960); and M. N. Rothbard, Man, Economy, and State, 2 vols. (New York: D. Van Nostrand, 1962).

[[20]]Capitalism and the Historians, ed. F. A. Hayek (Chicago: University of Chicago Press, 1954).

[[21]]Fritz Redlich, Der Unternehmer (Göttingen, 1964).