Liberty Matters

Frank Fetter and the Historically Specific Meaning of Capital

The work of Frank Fetter is important for a number of reasons, and Matthew McCaffrey (2019a, 2019b) has done an excellent job in showing why Fetter's work has roots in both the Austrian school and the original institutional economics. This important combination of influences makes Fetter's work both distinctive and invaluable. McCaffrey has also made a major contribution by bringing extensive archival research on Fetter to the table. Fetter's insights can be incorporated with great benefit by Austrian and institutional economists. In this comment I supplement McCaffrey's research by stressing that Fetter's critique of standard capital concepts in mainstream economics is of vital importance. Austrian economists – as well as others – should consider taking Fetter's insights on board.
In brief, Fetter (1927, 1930) rejected the concept of capital that most economists had adopted since Adam Smith. He urged a return to the original, monetary-accounting meaning, which is still in use in businesses today. This meaning had emerged by the 13th century with the rise of commerce and finance in Italy. Fernand Braudel(1982, 232-33) pointed out that the word capitale was in use in Italy in 1211 and is found from 1283 "in the sense of the capital assets of a trading firm." The word gradually came to mean the "money capital of a firm or of a merchant," and it spread through Western Europe. This monetary-accounting meaning of capital became firmly established in the rising market and financial systems throughout Europe. This meaning is still prevalent in business and accounting circles today.
But economists and sociologists have radically changed their usage of the term. Adam Smith (1776) started the process. Edwin Cannan (1921, 480) noted Smith's "very serious departure from the conception of capital which had hitherto prevailed: Instead of making the capital a sum of money which is to be invested, or which has been invested in certain things, Smith makes it the things themselves. Instead of being a sum of money expended on the acquisition of stock, it is part of the stock itself." Smith was largely responsible for a decisive shift away from a monetary-accounting view toward a notion of capital as physical things.
This physicalist view of capital pervades contemporary mainstream, heterodox, and Austrian economics. Taking a cue from Smith, economists developed the concept of human capital. (Fisher 1897, Becker 1964) Sociologists have widened its meaning still further to include anything that has durability and utility – including the concept of "social capital." (Bourdieu 1986, Coleman 1990) Capital has become a general and historical concept referring to any durable asset or form of wealth.
Critics of this shift away from the monetary-accounting view of capital are a small minority of economists, but they include major names such as John A. Hobson, Werner Sombart, Max Weber, Alfred Mitchell Innes, Frank Fetter, and Joseph A. Schumpeter. (Hodgson 2014, 2015a) Among them, Fetter (1927, 156) strongly attacked the physical view of capital:
Capital is essentially an individual acquisitive, financial, investment ownership concept. It is not coextensive with wealth as physical objects, but rather with legal rights as claims to uses and incomes. It is or should be a concept relating unequivocally to private property and to the existing price system.
Accordingly, for Fetter (1930, 190), capital is a historically specific phenomenon:
Capital is defined as a conception of individual riches having real meaning only within the price system and the market where it originated, and developing with the spread of the financial calculus in business practice.
Further archival scholarship may reveal more on the inspirations for Fetter's stance in favor of a monetary view of capital. One possible inspiration is Schumpeter (1954, 323), who wrote:
What a mass of confused, futile, and downright silly controversies it would have saved us, if economists had had the sense to stick to those monetary and accounting meanings of the term instead of trying to "deepen" them!
The historical specificity of the capital concept is also evident in writing in the German historical school. For example, Werner Sombart (1902, vol. 2, 129) recognized that capital is a phenomenon found in specific historical epochs and defined it as "the sum of exchange value which serves as the working basis of a capitalist enterprise."
Max Weber's position resembles that of Sombart. In his Economy and Society, Weber (1968, vol. 1, 91) wrote that "'Capital' is the money value of the means of profit-making available to the enterprise at the balancing of the books." For Weber, "capital" was expressed in monetary units in an era of rational accounting based on monetary measurement.
By contrast, Austrian school theorists such as Eugen von Böhm-Bawerk (1890, 6) saw capital in physical terms, as a "complex of goods that originate in a previous process of production, and are destined, not for immediate consumption, but to serve as means of acquiring further goods." There is no mention of money here. The focus is on physical goods that are used to produce more goods. Friedrich Hayek (1941) made another major contribution to capital theory. His view of capital was also one of physical factors of production. Much of Hayek's Pure Theory of Capital uses the abstraction of an economy without money. Consequently, Austrian capital theory is dominated by conceptions of capital as physical stuff.
The big exception, however, is Carl Menger. After publishing his influential work on the principles of economics in 1871, Menger modified his position on several things, including his view of capital. (Menger 1871, 1888; Braun 2012, 2017) Menger eventually gave much greater recognition to the historical specificity of capitalist institutions, and he rooted concepts such as capital in historically specific institutions rather than defining it in ahistorical terms.
Menger (1888, 6) argued that economists should not disregard everyday business meanings of terms such as capital: "a mistake that cannot be disapproved of enough when a science … denotes completely new concepts by words that, in common parlance, already describe a fundamentally different category of phenomena – a category that is also important for the respective discipline – correctly and properly." (Trans. Braun 2015, 83) Several other prominent economists and philosophers have similarly warned of this danger in making alien definitions of standard concepts. Because science is a social process, due respect should be made to everyday meanings. (Hodgson 2019a) 
Menger (1888, 40) made his own position clear: "The realistic notion of capital comprises all assets of a business, of whichever technical nature they may be, in so far as their monetary value is the object of our economic calculations, i.e., when they calculatorily constitute sums of money for us that are dedicated to the acquisition of income." (Trans. Braun 2015 90) Consequently, Menger ended up with a historically specific and monetary-accounting view of capital in contrast to the physicalist view of the majority of economists.
Eduard Braun (2015) showed that Menger's mature view of capital mildly influenced others in the Austrian school, including Mises. But the outcome was that Mises contradicted himself to a degree while retaining a dominant ahistorical and highly generalist stance. By contrast Schumpeter (1954, 899) fully endorsed Menger's change in position.
As Braun (2015, 2017) pointed out, the view of capital as money-value advanced for investment and production dovetails completely with Austrian arguments concerning the importance and meaningful economic calculation through the price mechanism. (Hayek 1935) Hence capital is both the expression and an instrument for the creation of money-values in the historically specific type of economic system known as capitalism. (Hodgson 2014, 2015a) This monetary-accounting view of capital augments the Austrian emphasis on meaningful calculation of prices through interactions between agents in a market economy.
For most economists outside the Austrian school, an ahistorical and physicalist view of capital and the failure to appreciate the nature and importance of the socialist-calculation debate are linked. (Hodgson 2019b, 2019c) The physicalist view of production masks the importance of monetary calculation and its role in decision-making and individual incentivization. The Austrian position on this would be further enhanced by fully acknowledging and rehabilitating Menger's mature view of capital alongside Fetter's similar insights in this area.
Fetter's advice that we should drop the post-Smithian distortion of the capital concept and instead understand capital as an historically specific category, rooted in the financial institutions of modern market economies, is well worth following. McCaffrey is to be commended for reminding us of Fetter's importance.