The Economics of Ludwig von Mises: Toward a Critical Reappraisal
I am confronted here with an impossible task: to discuss four interesting and complex papers in no more than twenty minutes. The task is even more formidable when one considers that the link connecting these papers is not the unity of a single subject or a single theme, but rather the evaluation of the life's work of a man who, during the course of his lifetime, considered virtually every aspect of the science of economics. In a century in which reputations are built on short articles written on highly specialized parts of subfields in economics, Ludwig von Mises produced a comprehensive treatise on the whole science of human action, of which economics was the most developed part. Hence we have heard today four papers dealing with the contributions of Mises to our knowledge of economic action, each on a topic that occupies many volumes of economic literature. Although the topics are themselves very different—monetary theory, capital theory, economic calculation, and finally political philosophy—I shall try in the course of my comments to find some common themes that mark the thought of Ludwig von Mises.
First we turn to Professor Moss' paper on Mises' monetary theory. This is a suitable place to begin, since Mises' earliest and best known work was done in this field, although the value of his contributions has not always been appreciated. Professor Moss has done an excellent job of beginning to overcome this lack of appreciation. The Moss paper is by far the most ambitious and most successful of the four papers, because Moss has gone beyond mere exposition of Mises' thought to critical evaluation and assessment of its relevance to contemporary economic theory. Too often it has been the practice of Austrians to emphasize their differences with received doctrine at the cost of ignoring the similarities. This was true of Carl Menger (although undoubtedly for very good reasons), it was true of Mises, and it is true of present-day Austrians. Mises especially was prone to stress the differences, often in a polemical and sometimes superficial manner, which, to say the least, frequently led to a lack of appreciation for the real subtlety of his arguments. To illustrate my point, I am reminded of something that happened this summer. Milton Friedman (a vocal and confirmed non-Austrian who nevertheless shares most of their policy conclusions) was invited to speak on Austrian economics to a group that had gathered for a week-long conference in Vermont. Professor Friedman proceeded to unendear himself to the gathering by proclaiming that, as far as he was concerned, there was no such thing as Austrian economics, only good economics and bad economics. To which most of the disgruntled audience felt compelled to reply, yes, but Austrian economics is good economics, and you just don't know about it. Hence, we appreciate Professor Moss' attempt to explain Mises in the terminology of modern economic theory, and we find as a result that the relationship between Mises' work and accepted mainstream economics is more often one of complementarity than of substitutability.
I take for my theme in discussing the Moss paper, Mises' emphasis on adjustment processes in the marketplace. Mises throughout his work was interested in how markets adjust to changing data, how information is transmitted, and how expectations are formed. This preoccupation is especially evident (and especially complementary to accepted doctrine) in two points discussed by Moss. The first is the treatment of Mises' theory of how optimal cash balances are arrived at and how they are related to price levels. According to Moss, the problem Mises was trying to solve was the following: the optimum level of individuals' cash balances depends upon the price level, but the price level depends in part on the level of cash balances people choose to hold. How, then, can people arrive at their optimum cash balance without knowing the price level, which can only be determined after people decide how much cash to hold? Moss referred to this as the famous "circularity problem" that troubled early twentieth-century economic theory. Moss credited Patinkin with showing that the problem is eliminated once we realize that the optimum level of cash balances can be determined by the intersection of the supply curve for money and the demand curve derived by a hypothetical comparison of various price levels and the resulting level of cash balances desired, yet he congratulated Mises for developing a "bold empirical hypothesis" about how expectations are formed. Here is, I think, a perfect example of the importance of Mises' approach to economics as a supplement to neoclassical theory. Mises could not divorce the problem of the acquisition of knowledge and the formation of expectations from the problem of how equilibrium states are reached. While Patinkin was interested in defining an equilibrium condition, Mises was much more interested in explaining how human actions lead toward that equilibrium. In that light, Mises' hypothesis—that individuals determine their cash balances on the basis of yesterday's prices, which in turn affect today's prices, until expectations about prices and the actual price level converge to an equilibrium price is where the supply and demand curves intersect; justs from one equilibrium to another. Individual economic actors only know when the system is out of equilibrium, when reality does not meet their expectations (yet their expectations will have some influence on the reality that occurs), and it is this lack of realization of their plans that conveys the knowledge to them that they must revise their plans. It is this process that Mises was describing. We all tell our undergraduates that it is not enough to say that equilibrium price is where the supply and demand curves intersect; one must explain how that equilibrium is achieved and how the market adjusts to new equilibria. If we recognize that Patinkin told us what the equilibrium conditions are, it is Mises who was trying to explain how we get there.
This emphasis on processes of adjustment in the marketplace is also evident in what Moss called the "proportionality theorem." Here Mises' insistence on the importance of examining how inflation takes place adds far more to our understanding of the role of money in the economy that the simple statement that an increase in the quantity of money will cause the price level to rise. Mises, so to speak, filled in the gap between an increase in M and an increase in P and showed that not only the change in the quantity of money but also the route by which it enters the system are important in determining the ultimate course of inflation. In this analysis Mises went far beyond the "quantity theorists" upon whose theories he built. We might note that the analysis of the process of inflation was first attempted by Richard Cantillon in the eighteenth century, who was also attempting to ascertain who the gainers are and who the losers are from inflation. We can thank Mises for reviving and expanding an important analysis, which unfortunately was shunted aside in the nineteenth century.
Mises' concern with disequilibrium processes, with how expectations are formulated and how information is transmitted, all arose from his insistence on viewing economics exclusively as a science of individual action. While methodological individualism was not born in Mises' writings, it certainly was nurtured there with a dedication duplicated by few other economists. This methodological individualism is, I believe, the key to understanding Mises' view of capital and interest.
Professor Kirzner chose to explore one of the most difficult aspects of Misesian economics or any kind of economics for that matter. The theory of capital is perhaps the most controversial and least understood part of economic science; rarely in the literature does one find two economists who agree on what capital is and how it is measured, let alone how it functions in an economic system. We agree that we are better off with more of it than with less of it, but we are not exactly sure why. Into this area of confusion, Mises brought, if not total illumination, at least a consistency that is frequently lacking in the mainstream literature.
Professor Kirzner did an admirable job of clarifying some of the more difficult aspects of Mises' theory of capital by contrasting Mises' views with those of Böhm-Bawerk (whom most of us generally take to be the quintessential Austrian capital theorist) and Frank Knight, the leader of the opposing camp. We come to realize that, because of Mises' concern with the individual as the only acting entity, the entire concept of capital is relevant only to individual decision making, an attitude that is evident in Mises' distinction between capital and capital goods. Capital goods are unfinished consumer goods, which are arranged from higher order to lower order depending upon how close they are to the finished product. Because they are a heterogeneous grouping of unfinished goods, only the entrepreneur is able to decide what is and what is not a capital good, and that decision depends upon his plans for their future use (a can of beans on a grocer's shelf is only a capital good if the grocer plans to sell it rather than to eat it himself). Capital, on the other hand, is purely an accounting concept and is equal to the market value of all assets minus the market value of liabilities of a business organization. It is useful only as a means of calculating the profitability of an enterprise and of aiding the entrepreneur in his decision making. There is no meaning to a concept of an aggregate capital stock since one cannot aggregate a collection of heterogeneous entities. Also there is no meaning to the idea of an aggregate fund of capital since the market value of the existing group of unfinished goods is subject to continual change as the unfolding of entrepreneurial plans reveals unanticipated conflicts that nullify the expectations of some and exceed the expectations of others. Hence, the attempt to arrive at a calculation of the value of the capital stock of some political entity (say, the United States of America) yields only a meaningless number that says nothing about the level of income to be expected in the future, because it says nothing about the decision-making process of the owners and users of the capital.
It is perhaps astonishing to a neoclassical economist that Mises denied what is taken to be the mainstay of capital theory: the productivity of capital. Since capital goods are nothing but unfinished consumer goods, one cannot conceive of them as being productive in the way labor is productive. The factors of production to Mises are labor, land, and time. It takes human effort, material resources, and the passing of time to yield output. (If one may engage in a philosophical comment, this view of the primacy of human productive activity shows every bit as much of a respect for the "dignity of labor" as that one usually associated with Marxists, but for Mises all labor was important, including entrepreneurial labor.) Because Mises denied the productivity of capital, he also denied any role for capital productivity in the formation of the interest rate, which was instead the result of pure time preference. It is here that I wish Professor Kirzner had been a little more expansive. He stated that "the phenomenon of interest arises only because, as a result of time preference, factors reflect only the discounted values of their services." I think what Professor Kirzner meant here is that only time preference gives rise to a rate of interest in the sense that factors of production reflect only their discounted marginal value products. If capital goods were productive of future output, however, would not people still be willing to pay a premium to borrow money to invest in capital in the hope of receiving a greater return in the future whether or not they valued goods higher in the present than in the future? Perhaps the confusion here is mine rather than Professor Kirzner's, and I only wish he had dealt with this controversial problem at greater length.
Mises' theory of capital provides a good transition to the next paper on our program, Professor Rothbard's on Mises and the controversy over economic calculation under socialism, because the heart of the Misesian challenge was his contention that it would be impossible to calculate efficiently under socialism without capital markets to determine input prices. Rothbard's paper was also well placed in the program because the controversy about which he wrote summarizes Mises' view of the functioning of a market economy. To paraphrase Professor Rothbard, the controversy was much more than one over socialism versus capitalism as we know it, rather it was a controversy over the efficacy of political versus economic action. It is ironic that this is the one area discussed in the session where Mises was given glowing recognition for his achievement while it is generally believed that he lost the debate. I am reminded of Buchanan's statement that the degree to which one accepts the alleged defeat of Mises is the degree to which one is confused as to what the debate was about. Though I think that Professor Rothbard perhaps gave Mises too much credit for working out the details of the Austrian answer to the controversy about economic calculation, when in fact it was Hayek who chose to respond to some of the more difficult problems (Mises' so-called final refutation in Human Action is mostly polemic and glosses over the real problems), I admit that it was Mises, nevertheless, who indicated in what direction the answer to the Socialists lay.
The importance of the debate can, I believe, be underscored by a remark Hayek once made to the effect that because of Mises the Socialists were forced to change their claim that socialism was superior to capitalism to a defense of the possibility of socialism at all. Furthermore, to every challenge Mises and Hayek hurled at the Socialist scheme, the response was to find some means of duplicating the market. To Mises, this alone was evidence of his triumph over the Socialists, since he considered every admission of the need for markets to be one more step away from pure socialism. To Mises, the final proposals of Lange were no longer socialism at all but state capitalism, where the Planning Board assumed the entrepreneurial function and performed in a manner far inferior to the decentralization of this function, which is characteristic of the free market.
What I believe to be the most interesting results of the controversy, however, were the further developments of economic theory to which it gave rise. For example, Rothbard noted the further developments in the theory of cost as a subjective phenomenon dependent solely on the forgone utility of the choser, that took place at the London School of Economics during the thirties, forties, and fifties. This work grew out of an examination of the idea of using the rule of marginal cost pricing to direct the behavior of Socialist managers. Hayek, Coase, and Thirlby all questioned the usefulness of such a rule if one accepts the idea that the evaluation of cost is not merely a mechanical adding up of expenditures but depends upon the ability of the manager to assess the value of forgone opportunities with which he is confronted. Furthermore, when the manager's judgments are to be monitored, not by the profits or losses he earns in the market place, but by a Planning Board who must agree with his evaluation of costs, the manager's behavior is bound to differ substantially from that of the market entrepreneur.
This raises a most fundamental question involved in the Socialist controversy: what is the role of private ownership in economic activity? Mises and Hayek both believed that the essence of entrepreneurial activity was risk-taking in one's attempt to anticipate the market. If the users of capital were to be shielded even partially from the consequences of their risky actions (either good or bad), their actions would be far different from those of people who were risking their own fortunes regardless of the behavioral rules issued by the Planning Board. Hence central planning could never duplicate the outcomes of a functioning market economy.
Finally, we come to a consideration of Professor Baumgarth's paper, a fitting conclusion to our survey of the economic contributions of Ludwig von Mises, since Mises defended his politics of liberalism on economic grounds. I will address my comments to one particular aspect of Baumgarth's paper: the source of Mises' defense of liberalism.
Liberalism as a philosophy implies individual freedom. In the seventeenth century, when the philosophy was being developed in England, freedom was considered to be a value desirable for its own sake. It was a natural condition of human beings. (This positing of a natural condition was an attempt to find a "scientific" way of determining what political society should be. By starting with man in a state of nature one could then discover what role government should play in civil society.) It was a moral value that, as a bonus, also happened to lead to the well-being of society. The moral, or, as it was viewed at the time, the scientific, argument was primary, and the utilitarian argument was brought in as additional fire power. This was the way John Locke developed the philosophy of liberalism and the way it was understood until sometime in the nineteenth century. By the time of John Stuart Mill, however, the argument became reversed, and freedom was espoused, not because it was a good in itself, but because it led to "the greatest good for the greatest number." Obviously, if it could have been shown that the greatest good for the greatest number (assuming, of course, there is some way to define and recognize such a thing when one is confronted with it) was best achieved through restriction of individual liberty and control of man's economic activities, the case for freedom would be nullified. (This is, in fact, precisely what happened in the United States, where liberalism means exactly the opposite of what it meant in nineteenth-century England: here liberals are in favor of restriction of economic freedoms, which they perceive to be contrary to the greatest good for the greatest number.)
Mises, unfortunately, attempted to refute the collectivists and authoritarians by accepting the terms of their argument and arguing for the superior ability of the free market to provide for the economic well-being of the populace. We see this in the economic-calculation argument, where he took his demonstration of the superior efficiency of the market as a complete refutation of socialism as a political system. Such an attempt to defend freedom is dangerous on two counts. First, it is open to empirical refutation. For instance, Mises' attack on slavery was based on the contention that slavery is inefficient: yet the recent work of Fogel and Engerman suggests that, on the contrary, it is a highly efficient system if one does not count the loss of utility to the slaves. How then does one argue for freedom in this case? Secondly, the defense of freedom on utilitarian grounds is dangerous for a more important reason. Even given that the market is much more efficient at providing for the well-being of individuals in a material sense, this is not the final refutation of a political system, because there may be nonmaterial items in individual utility functions. For example, what about those individuals whose utility functions include the desire to control and regulate, whose skills are greatest in bureaucratic paper shuffling and carrying favor with higher-ups in the bureaucracy? Such people would not fare well in a completely free market (or at least they will do better in an environment that rewards such activity more highly than the market does), and their well-being will be greatly enhanced in a system predicated on control. Since no interpersonal comparisons of utility are permitted, which system will provide then for the maximum social welfare?
What this leads us to, I believe, is the conclusion that the justification for any political system, whether it be complete authoritarianism, anarchism, or something in between, must be based on more than just economic efficiency: it must include a moral justification, and this moral justification must be based on a system of ethics that can be shared by all rational human beings. Mises despaired that such a rational ethics might never be developed, but without it there cannot be a conclusive defense of freedom.
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