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Cultivated Growth and the Market Economy - Ludwig M. Lachmann, Capital, Expectations, and the Market Process 
Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy, ed. with an Introduction by Walter E. Grinder (Kansas City: Sheed Andrews and McMeel, 1977).
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Cultivated Growth and the Market Economy
In looking around for a suitable subject for this address I have been struck, once again, by the limited range of topics available to an academic economist on occasions such as this. In this age in which, the narrower the range of one's speciality the higher the reputation one is able to enjoy, there are few fields in which his knowledge can permit him to speak with competence and with the confidence that he has anything worthwhile to say. Moreover, where his own field of interests lies on a level of abstraction to which he cannot very well expect a “captive” audience to follow him willingly, and not merely for the sake of politeness, this field, too, is barred to him.
Last year I endeavoured to solve the problem by inviting my audience to follow me in an exploration of the deeper causes of the inflation of our time, which we found partly in certain characteristics of the economic institutions of modern society, and largely in the climate of opinion within which these institutions have to function. Alas, such themes, in which the topical impinges upon the abstract, and which permit the academic economist to display the practical relevance of supposedly esoteric issues, are rare.
Yet I have come to think that there is one kind of contribution such an academic economist might make that may be of wider interest, viz.: to clarify the terms in which controversial opinions on an economic issue are expressed. For we often find cases in which controversy on an economic issue is due not so much to different observations of facts, nor to differences in value judgements (in which latter case the economist as such can have nothing to say), but to the fact that different economists relate the facts observed and the practical issues in hand to different conceptual frameworks. In such cases we say that they “do not speak the same language” or “misunderstand each other's terms” because these belong to different conceptual structures. Here it is possible to feel that the economist whose chief interests lie in the field of theory may perhaps render a service by helping to make it clear where and how the conceptual frameworks of the contestants differ from each other, and by thus contributing towards the elucidation of the issues at stake.
Presidential address delivered at the Thirty-sixth Annual General Meeting of the Economic Society of South Africa held in Pretoria on 16th August 1963. Reprinted from South African Journal of Economics 31 (September 1963).
In what follows I shall endeavour to make a contribution of this nature with regard to the controversy on non-coercive Planning or Economic Budgeting in the course of which some of my fellow-economists have of late expressed their views on the compatibility of certain forms of PLANNING with the principles and modus operandi of a Market Economy.
I have to make it clear at the outset that I shall not plead for or against this or that type of Planning. My task will be to find out whether or not a certain type of Planning would be possible within the framework of a Market Economy. Whether or not it is, or will be, possible in practice, and if so, whether it should be adopted in the present situation in this country, are entirely different questions on which I do not feel competent to pronounce. For, let me add that I lack all practical knowledge of the subject. My knowledge of it, such as it is, is all derived from reading books and articles on various forms of Planning in different countries and at different times. It is truly academic—in the worst of possible senses. But it may be just for this reason that I think I have been able to detect, in the controversy mentioned, certain differences in shades of meaning, in approach and conceptual structure, and in particular in what is implicitly taken for granted, that may seem of no interest to the man of action absorbed in his task, but are of interest to those concerned with the clarification of controversial issues.
In turning now to this task of elucidation I shall first deal with the fundamental concepts involved. Later on I shall have something to say about certain economic problems likely to be encountered by a policy of cultivating growth by concerted action.
What are the essential characteristics of the new Planning? In the first place, it has nothing whatever to do with the kind of Central Planning typical of the countries under the domination of Communism. Private enterprise is safeguarded and all Planning is private planning by entrepreneurs. Nor is it akin to the form of Planning we found, e.g., in Nazi Germany before 1939 (what Walter Euken called Zentralverwaltungswirtschaft) which so largely employed compulsion over what were otherwise still private producers. The new Planning uses no compulsion, it leaves the entrepreneurs the free choice of their resources—but it tries to persuade them to plan and act otherwise than they would have done, had they drawn up their respective plans in isolation from each other.
The essence of Economic Budgeting, this new non-coercive type of Planning, as I understand it, is, then, the continuous exchange of information among entrepreneurs about each other's intentions, which will enable every entrepreneur, in making his plan, to know what every one else plans to do. Also, since certain projections of expected future trends in the economic system are being shown to them, it is hoped and expected that they will take them into account. In other words, we find here a method, not of engineering growth by decree, but of cultivating it by creating the conditions, at least so far as entrepreneurial knowledge goes, which may give rise to it. The analogy of the gardener, as distinct from the engineer, naturally suggests itself.
How far all this is really feasible, or would produce results notably different from what would happen without such concerting of plans, only experience can show. I would hesitate to draw too far-reaching conclusions from the French example. In the first place, the economic theorist must show some caution in interpreting economic history. We never know how much of what happened was due to the special circumstances of time and place, and how much to underlying economic forces. Secondly, French planning methods themselves have changed in seventeen years.
In any case, we are here concerned not with feasibility but with conditions and implications. When we ask how far such Planning is compatible with the existence of a Market Economy, we are really asking: Are the conditions which make the existence of a Market Economy possible such that better knowledge obtained by exchange of information is likely to cause faster growth?
What we have to deal with, then, is an endeavour to coordinate the plans of entrepreneurs, investment plans as well as plans about the use of existing resources, ex ante. It is true that in a Market Economy the market process would in any case produce co-ordination, but it would do so only ex post. Economic Budgeting means that the participants, entrepreneurs and economic planners, acting in concert, determine the collective environment within which each private planner carries out his own plan. The fact that he knows, or at least hopes to, what plans the others—be they customers or suppliers, or even potential rivals—will follow, offers him points of orientation which should reduce his uncertainty and, in favourable circumstances, enable him to make more definite plans. Individual plans are thus being attuned to each other. Each entrepreneur is able to carry out his plans with a greater assurance than he could do otherwise.
We must now take a closer look at the social and political background of the scheme. The modern State in its Western version, which promotes such schemes for faster economic growth, is what has come to be known as a Welfare State: it has taken over the responsibility for satisfying more and more needs. Already it has made itself responsible for Full Employment. It may be said that taking on the responsibility for growth is merely a further step along the same road. But it is a step which must be regarded with great misgivings, in general and not merely on economic grounds.
In the first place, we have to ask ourselves: Where and when is this process to end? Secondly, it means that more and more economic phenomena will become political issues—with all that this means in the age of the mass electorate! It is difficult to contemplate with equanimity a situation in which, whether a government can stay in power, will depend on its ability to persuade the electorate that the rate of growth of the national economy could not possibly have been higher, and in which the opposition will have to address itself to refuting this claim. Already it is possible to sense a certain note of hysteria in some discussions, even academic, on growth. Can we economists relish the prospect of an era in which the range of political jugglery with economic concepts is thus greatly extended, until one day perhaps the question whether a country's “actual growth” was what was “warranted,” not to mention its “natural rate,” becomes a favourite topic for comment in the columns of the daily press? Perhaps the pages adjacent to the sports columns would provide an appropriate place for such a feature.1
Let us remember two facts. First, “Economics is the study of mutual interference: any ‘abnormal’ movement cannot long continue without sooner or later bringing into play corrective movements.”2 Secondly, all policy consists in the simultaneous pursuit of a number of objectives, the relative significance of each of which has to be continuously weighed against that of the others. “Growth” cannot be pursued in isolation from other economic objectives.
We now have to confront our main question, viz. whether Economic Budgeting of the kind described above is compatible with the principles and modus operandi of the Market Economy.
A Market Economy is an economy in which all want-satisfying activities are carried out by individuals. Units of production are organised by individual entrepreneurs (who usually act in groups). The very essence of the Market Economy consists in the continuous Market Process, the never-ending course of entrepreneurial action set in train by price-cost differences, actual or expected. In exploiting these profitable opportunities entrepreneurs adjust supply to demand thus reducing existing disequilibria. If their activity is unhampered, and if no new changes supervened, their action should in the end wipe out the very price-cost differences which originally motivated it. Of course this never happens. In the real world equilibrium does not exist.
We therefore have to distinguish sharply between this “ideal type” of a Market Economy and what is often now called the neoclassical model, as it has emerged from the work of Walras, Pareto and Cassel. This model denotes a closed system in which equilibrium prices and equilibrium quantities produced and exchanged are all mutually determined. The Market Economy, on the contrary, is an open system. Its prices and quantities are not equilibrium prices and quantities; hence they are not determinate. They very possibility of making profits stems from the absence of equilibrium. The Market Economy essentially rests on a mechanism of adjustment, but of adjustment to ever-changing circumstances. To put one's trust in the Market Economy is not to assert a faith in the final attainment of equilibrium, nor even in the efficacy of the equilibrating forces, which might be hampered or deflected before attaining their goal. It is to assert a faith in the beneficial results of the continuous Market Process the modus operandi of which I have tried to sketch.
There is another important difference between the neo-classical equilibrium system and the Market Economy which lies behind the dichotomy “closed system—open system.” This difference concerns the kind of knowledge assumed. In the former case we have to assume that all those who participate in market action leading towards equilibrium actually know the equilibrium position before it is reached. Otherwise it is hard to see how it can be attained. But it has been pointed out that equilibrium theory, for all its sophistication and ostensible precision, fails to explain where entrepreneurs derive such knowledge from.3 Equilibrium theory has to assume a state of knowledge shared by all participants as a datum the origin of which is left in the dark.
In the Market Economy, on the other hand, we can assume no such state of knowledge. Each entrepreneur, at each moment, has to make the most profitable use of the resources at his disposal, including his knowledge. Naturally he will do his best to improve the latter. Entrepreneurial action is a good example of “learning by doing.” But there is here no such thing as a common state of knowledge shared by all which we could regard as a datum. On the contrary, it is knowledge superior to that of others which brings success. A common state of knowledge may emerge, perhaps, in the end, as the net result of these diverse actions. It would then last only until circumstances change again.
From the fact that in a Market Economy everybody is engaged in the exploitation of profitable opportunities inherent in price-cost differences, actual or expected, it does not follow that all such opportunities in existence at any moment will actually be exploited. There may well be “gaps” due to that incomplete knowledge which is a feature of reality, as distinct from the neo-classical model. Some profitable opportunities will be neglected. We cannot even say that these will be the least profitable. It all depends on the distribution of knowledge among entrepreneurs, and this is a matter about which we can say nothing in general.
In the light of these circumstances, the conclusion that a scheme for the exchange of information and subsequent action based upon it is incompatible with the principles and modus operandi of the Market Economy does not appear to be warranted. The Market Economy is an open system. We cannot say what concrete action an entrepreneur confronted with a given situation will actually take. It depends on his interpretation of it. Hence, we are unable to say that Economic Budgeting will deflect the course of his action from what it would be otherwise, since we simply do not know what that might have been. A closed system, like the Walrasian, would permit us to say that. But it has no counterpart in reality, as equilibrium is merely a figment of the imagination of the model-builders.
Similar reasoning applies to the question of the effect on entrepreneurial knowledge. Economic Budgeting certainly will change the distribution of knowledge among entrepreneurs in the direction of greater similarity. But, as we saw, no assumption about the mode of distribution of this knowledge is included among the fundamental postulates of the Market Economy. In it changes in knowledge happen every day. The Market Economy is neutral with respect to the knowledge required of its actors. Again, it would be different in a general equilibrium model in which a certain state of knowledge has to be assumed. But for the reasons given no such model can serve as a standard of comparison for anything that happens in the real world.
We now have to address ourselves to the question, in what way Economic Budgeting by the co-ordination of entrepreneurial plans can lead to a higher rate of growth than would otherwise exist. In general, our answer has to be, by widening knowledge about the possible use of resources and its consequences. But what specific results might be achieved in this way? What are the plants we are thus enabled to cultivate in our garden?
There are in general, so far as I can see, three methods of promoting faster growth:
Every capital good exists in a specific form which limits the range of its possible uses: it has limited versatility. Each capital good therefore depends for its efficient use on the support of other capital goods complementary to it. Malinvestment may arise in many ways through faulty expectations, but failure of complementary capital goods to become available is one of them.
The market process tends to produce a coherent complementarity pattern throughout the economic system ex post, but it does its work by compelling the scrapping of those capital goods which do not fit into this pattern, or at least their removal to other spheres of production where a pigeon-hole can be found for them, usually with a concomitant capital loss. The market process tends to eliminate the results of malinvestment but cannot prevent its occurrence.
The question now before us is, whether it is possible by coordinating investment plans of many entrepreneurs ex ante to prevent such a waste of resources. If we succeed in this we can make a given amount of investment yield more output; we obtain a higher rate of growth per unit of investment input. To illustrate this possibility let me give you two well-known examples of malinvestment which might be prevented by coordination of plans.
There is, firstly, the case, often mentioned by critics of the Market Economy,4 where, owing to the market structure, an increase in demand for the product leads to excess capacity. Let us assume that the demand for a certain product rises by m. If the marginal capital output ratio in the industry is 3, an investment of 3 m in the industry is required. But if the industry consists of ten firms each of which hopes to attract the additional demand entirely to itself, 30m will actually be invested with the result we can all imagine. It is possible to see the primary function of Economic Budgeting in the prevention of this kind of excess capacity.
There is, secondly, the case where capital investment in an industry cannot be profitably used for lack of complementary capital resources at other stages of production. This may result either from weakness of what has come to be known as the infra structure or from what we shall have to call “weakness of the super structure.” The latter happens where, e.g., the possibilities opened up by a new capital good are not exploited by the consumption goods industries, or where lack of an adequate sales organization hampers the sale of a new consumption good. Even in such cases we need not doubt that the market process will ultimately lead to the growth of such complementary resources, in infra structure and super structure, as will be required. The question before us is whether by co-ordination of plans and concerted action such a result can be brought about earlier, or without the temporary waste of resources.
I see the chief importance of growth point planning in the possibility of anticipating the effects of growth in some industries on the composition of output and the capital structure of others. And I see the significance of input-output tables in that they enable us, I will not say to “forecast,” but to form an idea about the changes in the composition of the flow of circulating capital between earlier and later stages of production which a given change in output is likely to entail. It is to be hoped that in assessing the effects of output changes on capital requirements it will become possible to extend this type of analysis to fixed capital which does not enter the input-output streams.
So far I have spoken of the prevention of excess capacity. But there are also interesting problems resulting from the existence of excess capacity the occurrence of which could not be prevented. It may be the result of malinvestment of the past, or of sudden changes in demand or in technique of production. Of the numerous problems we meet here I shall confine myself to two.
Lastly, I come to the question, whether the practice of Economic Budgeting is at all compatible with the principles of competition. Does not competition require the competitors to act in ignorance of one another's intentions, with their minds directed solely to market prices, actual or expected? Will these business men, exchanging information, learning about one another's plans, agreeing among one another to avoid excess capacity, not end up by constituting a super-cartel—with the benevolent connivance of the planners?
This is a serious and difficult question. It is a question I dare not shirk since I did promise to devote myself to the clarification of concepts in this controversial issue. At the same time it is a question which has been raised in the controversy. It might even be said that it is the central question.
Now the main difficulty in answering it can be stated briefly. At bottom it is the same difficulty we encountered before. The only concept of competition we could use as our criterion exists only within the framework of an equilibrium model. It is the well-known notion of pure or perfect competition. But in the real world it does not exist. The Market Economy, on the other hand, certainly requires competitive markets. But in spite of valiant attempts to work out a concept of “workable competition” to serve as a criterion for a Market Economy, we have not succeeded (yet?) in finding one that would be suitable. We are unable to say how competitive a Market Economy has to be.
Moreover, in reality it would be quite impossible for all markets within a Market Economy to be equally competitive. Hence, whatever our criterion is to be, some might fall within it, others not. How, then, do we determine the permissible scope of the Market Economy? What range of dispersion of market conditions do we have to use as our criterion, and how is this range to defined? This is of some importance for our problem since Economic Budgeting, as we saw, concerns not merely relationships between producers for the same market but also between suppliers and customers at different stages of production. In practice we often find that the problems arising in such inter-industrial relations are solved by means of vertical integration, e.g., coal-iron-steel, or by similar devices. It seems that they are hardly compatible with the competitive character of a Market Economy. But in the absence of a clearly defined criterion of such competition as is required by the principles of the Market Economy, how are we to judge them? The same applies to Economic Budgeting.
But I do not think we should rest content with the negative conclusion that the case against the compatibility between Economic Budgeting and the Market Economy cannot be proved as long as we do not know how much competition the latter requires. I think we should go a step further.
I said earlier on that in a Market Economy there is no such thing as a common state of knowledge, but that everybody acts on his own individual knowledge. But is it not one of the purposes of Economic Budgeting, perhaps the most important, to produce just such a common state of knowledge? It seems to me that here we have to consider the social function of competition.
In a Market Economy, everybody, producer and consumer, is continuously engaged in acquiring new knowledge, testing and diffusing it. The very fact, e.g., that successful innovations will be imitated, illustrates this. The Market Economy as it were, sends out its agents in various directions on reconnaissance duties. What they bring back is then tested, in workshop and marketplace, and the consumer ultimately decides what he likes best. Technical progress requires experiments in various directions, and this entails product differentiation.
But this is not the only way in which new knowledge can be acquired, tested and diffused. Sometimes this task is delegated to a special agency, say a research institute, which then puts the new knowledge at the disposal of all by direct communication.
It now seems to me that the knowledge to be diffused by means of Economic Budgeting may be such as to lend itself to this second method of diffusion. Or, to put this distinction in another way: Competition is an excellent method of reducing our ignorance in those cases in which division of labour will be most useful. But there are other cases in which the best results will be obtained by close cooperation of specialists in a narrow field and the subsequent direct communication of their results to those who can make use of them. The knowledge conveyed by input-output tables, for instance, appears to be of this second kind. In other words, in those cases where we can obtain knowledge otherwise than through the market process, competition is not a necessary requirement either.
We need not doubt that, in the absence of a scheme such as the one under discussion, wherever the exchange of information is of mutual profit to entrepreneurs, the Market Economy would still evolve institutions which serve this end. European economic history in the age of free enterprise offers many examples of this. I find this view perfectly compatible with a belief that a public agency, guided by competent economists, could do it more expeditiously and perhaps more thoroughly. I should not care to say, however, which way fewer mistakes are likely to be made.
Earlier on I promised you not to plead for or against this or that type of Planning, but to confine myself to the elucidation of conceptual differences. In so doing I drew attention, in particular, to what appear to me to be important differences between the “ideal type” of the Market Economy and the neo-classical equilibrium model. In this regard we found that different assumptions about distribution of knowledge among entrepreneurs and its diffusion between them called for special notice.
I believe it to be no accident that thus, in probing a practical problem of economic organization, we have found ourselves at last confronted with a problem concerning knowledge. This fact in my view should serve us as a warning against a narrowly materialistic interpretation of the subject of our discipline.
“Economics is not about goods and services; it is about human choice and action,” Ludwig von Mises has said. To which I would add, if you will permit me such an obiter dictum as a concluding remark, that the knowledge we gain from economic study is not knowledge about things but knowledge about knowledge. This is the strongest reason I can think of why the study of our discipline must not be pursued as though it were a natural science.
Economic Writings of Ludwig M. Lachmann
Books and Monographs
Economics as a Social Science: Inaugural Lecture. Johannesburg: University of the Witwatersrand, 1950.
Capital and Its Structure. London: London School of Economics and Political Science, 1956. Reprint edition. Kansas City: Sheed Andrews & McMeel, forthcoming.
The Legacy of Max Weber. Berkeley, California: Glendessary Press, 1971.
Macro-economic Thinking and the Market Economy: An Essay on the Neglect of the Micro-Fundations and Its Consequences. London. Institute of Economic Affairs, 1973.
“Commodity Stocks and Equilibrium.” Review of Economic Statistics 3(June 1936):230–34.
“Uncertainty and Liquidity Preference.” Economica 4(August 1937):295–308.
“Investment and Costs of Production.” American Economic Review 28(September 1938):469–81.
“Commodity Stocks in the Trade Cycle.” Jointly with F. Snapper. Economica 5(November 1938):435–54.
“On Crisis and Adjustment.” Review of Economics and Statistics 21(May 1939):62–68.
“A Reconsideration of the Austrian Theory of Industrial Fluctuations.” Economica 7(May 1940):179–96.
“On the Measurement of Capital.” Economica 8(November 1941):361–77.
“The Role of Expectations in Economics as a Social Science.” Economica 14(February 1943):108–19.
“Finance Capitalism?” Economica 11(May 1944):64–73.
“Notes on the Proposals for International Currency Stabilization.” Review of Economics and Statistics 26(November 1944):184–91.
“A Note on the Elasticity of Expectations.” Economica 12(November 1945):248–53.
“Complementarity and Substitution in the Theory of Capital.” Economica 14(May 1947):108–19.
“Investment Repercussions.” Quarterly Journal of Economics 62(November 1948):698–713. “Reply.” Quarterly Journal Economics 63(August 1949):432–34.
“Joseph A. Schumpeter, 1883–1950.” South African Journal of Economics 18(June 1950):215–18.
“Economics as a Social Science.” South African Journal of Economics 18(September 1950):233–41.
“The Science of Human Action.” Economica 18(November 1951):412–27.
“Some Notes on Economic Thought, 1933–1953.” South African Journal of Economics 22(March 1954):22–31.
“The Velocity of Circulation as a Predictor.” South African Journal of Economics 24(March 1956):17–24.
“The Market Economy and the Distribution of Wealth.” In On Freedom and Free Enterprise: Essays in Honor of Ludwig von Mises, edited by Mary Sennholz. New York. D. Van Nostrand, 1956.
“Mrs. Robinson on the Accumulation of Capital.” South African Journal of Economics 26(June 1958):87–100.
“Professor Shackle on the Economic Significance of Time.” Metroeconomica 11(September 1959):64–73.
“Cost Inflation and Economic Institutions.” South African Journal of Economics 30(September 1962):177–89.
“Cultivated Growth and the Market Economy.” South African Journal of Economics 31(September 1963):165–74.
“Sir John Hicks on Capital and Growth.” South African Journal of Economics 34(June 1966):113–23.
“The Significance of the Austrian School of Economics in the History of Ideas.” Translation of “Die geistesgeschichtliche Bedeutung der österreichischen Schule in der Volks-wirtschaftslehre.” Zeitschrift für Nationalökonomie 26(January 1966):152–67.
“Model Constructions and the Market Economy.” Translation of “Marktwirtschaft und Modellkonstruktionen.” Ordo 17(1966):261–79.
“Causes and Consequences of the Inflation of Our Time.” South African Journal of Economics 35(December 1967):281–91.
“Methodological Individualism and the Market Economy.” In Roads to Freedom: Essays in Honour of Friedrich A. von Hayek, edited by Erich Streissler et al. London: Routledge & Kegan Paul, 1969.
“The Rational for Development Programming and the Market Economy.” South African Journal of Economics 39(December 1971):319–32.
“Ludwig von Mises and the Market Process.” In Toward Liberty: Essays in Honour of Ludwig von Mises, edited by Friedrich A. Hayek. 2 vols. Menlo Park, Calif.: Institute for Humane Studies, 1971.
“Sir John Hicks as a Neo-Austrian.” South African Journal of Economics 41(September 1973):195–207.
“From Mises to Shackle: An Essay.” Journal of Economic Literature 14(March 1976):54–62.
“On the Central Concept of Austrian Economics: Market Process.” “On Austrian Capital Theory.” “Toward a Critique of Macroeconomics.” “Austrian Economics in the Age of the Neo-Ricardian Counterrevolution.” In The Foundations of Modern Austrian Economics, edited by Edwin G. Dolan. Kansas City: Sheed Andrews & McMeel, 1976.
[]The effect of the current obsession with growth on the quality of economic theorizing has been no less disastrous. “In tackling the problems of economic growth, economists in the last decade or so appear to have adopted the custom of discarding their habitual apparel and instead donning that of the planner or technocrat. Indeed the recent cataract of journal articles and books on this obsessive subject have set a deplorable standard in economic writing. It would seem that the ability to manipulate a second order difference equation—plus, perhaps some passing reference to holy works—is the only qualification required of the writer. At any rate, it is often the only one displayed.” E.J. Mishan, Economica 29 (February 1962):88.
[]See previous footnote.
[]G. B. Richardson, Information and Investment (London: Oxford University Press, 1960), Chapter I.
[]See, e.g., Joan Robinson, Economic Philosophy (London: C. A. Watts & Co., 1962), p. 136.