Eugen von Böhm-Bawerk

Böhm-Bawerk gave three reasons why interest rates were positive. First, people's marginal utility of income will fall over time because they expect higher income in the future. Second, for psychological reasons the marginal utility of a good declines with time. For both reasons, which economists now call "positive time-preference," wrote Böhm-Bawerk, people were willing to pay positive interest rates to get access to resources in the present, and insisted on being paid interest to give up such access. Economists have accepted both as valid reasons for positive time-preference.

But Böhm-Bawerk's third reason—the "technical superiority of present over future goods"—was more controversial and harder to understand. Production, he noted, is "round-about," meaning that it takes time. It uses capital, which is produced, to transform nonproduced factors of production—such as land and labor—into output. Roundabout production methods mean that the same amount of input can yield a greater output. Böhm-Bawerk reasoned that the net return to capital was the result of the greater value produced by roundaboutness.

An example helps illustrate the point. As the leader of a primitive fishing village, you are able to send out the townspeople to catch enough fish, with their bare hands, to ensure the village's survival for one day. But if you forgo consumption of fish for one day and use that labor to produce nets, hooks, and lines—capital—each fisherman can catch more fish the following day and the days thereafter. Capital is productive.

Further investment in capital, argued Böhm-Bawerk, increases roundaboutness, i.e., lengthens the production period. On this basis Böhm-Bawerk concluded that the net physical productivity of capital would lead to positive interest rates even if the first two reasons did not hold.

Although his theory of capital is one of the cornerstones of Austrian economics, modern mainstream economists pay no attention to Böhm-Bawerk's analysis of roundaboutness. Instead, they accept Irving Fisher's approach of just assuming that there are investment opportunities that make capital productive. Nevertheless, Böhm-Bawerk's approach helped to pave the way for modern interest theory.

Böhm-Bawerk was also one of the first economists to discuss Karl Marx's views seriously. He argued that interest does not exist due to exploitation of workers. Workers would get the whole of what they helped produce only if production were instantaneous. But because production is roundabout, he wrote, some of the product that Marx attributed to workers must go to finance this roundaboutness, i.e., must go to capital. Böhm-Bawerk noted that interest would have to be paid no matter who owned the capital. Mainstream economists still accept this argument.

Böhm-Bawerk was born in Vienna and studied law at the university there. After teaching at the University of Innsbruck and serving in the civil service, he was appointed minister of finance during the years 1895, 1897, and 1900. He left the ministry in 1904 and taught economics at the University of Vienna until his death in 1914.