WEBVTT NOTE 17. A Treatise on Economics 1 00:00:00.000 --> 00:00:05.100 Chapter 17 A Treatise on Economics 2 00:00:05.100 --> 00:00:10.560 Nationale Economie came after press in May 1940, just in time to survive the collapse 3 00:00:10.560 --> 00:00:16.420 of its publisher, only to be buried under the avalanche of the war. Many of the copies 4 00:00:16.420 --> 00:00:21.120 Mises sent to friends and colleagues never reached their destinations. Mises took it 5 00:00:21.120 --> 00:00:26.820 with some humour. I suppose the Nazis used them as fuel. The book survived only because 6 00:00:26.820 --> 00:00:31.860 Because its English-language successor, Human Action, drew incomparably more attention from 7 00:00:31.860 --> 00:00:37.300 readers all over the world, but it was in Nationale Ökonomie that Mises first presented 8 00:00:37.300 --> 00:00:43.560 the entire system of thought that he had developed during more than 30 years of intense study. 9 00:00:43.560 --> 00:00:48.460 Human Action, a treatise on economics and Nationale Ökonomie are virtually identical 10 00:00:48.460 --> 00:00:54.820 in general architecture. There are a few substantive differences between the books, but these differences 11 00:00:54.820 --> 00:01:00.560 is pale in comparison to the differences that separate both of them from all similar works. 12 00:01:00.560 --> 00:01:06.380 In the present chapter we will therefore quote Human Action wherever possible. In Human Action 13 00:01:06.380 --> 00:01:10.980 Mises placed a greater emphasis on refuting positivism, whereas in Nationale Economie 14 00:01:10.980 --> 00:01:16.900 he had refuted in particular Spann and Marx. Moreover, in Human Action he added a chapter 15 00:01:16.900 --> 00:01:23.520 on general probability theory, and he expanded the conclusion of Nationale Economie into 16 00:01:23.520 --> 00:01:29.940 to a comprehensive seventh part of human action that dealt with the social and cultural significance 17 00:01:29.940 --> 00:01:36.440 of praxeology. He had planned an American edition early on and had anticipated modifications 18 00:01:36.440 --> 00:01:41.840 of his text to accommodate the particular background of his American readers. The typical 19 00:01:41.840 --> 00:01:49.080 economics textbook was, then as now, just an amalgamation of incompatible bits of theory. 20 00:01:49.080 --> 00:01:54.840 Mises' treatise presented social laws as one coherent whole, and it drew an encompassing 21 00:01:54.840 --> 00:02:00.400 picture of social reality in a step-by-step manner, moving from the most general phenomena 22 00:02:00.400 --> 00:02:06.440 to the most specific. It was social philosophy in the best sense. 23 00:02:06.440 --> 00:02:11.000 Mises understood the importance of a full treatise. A book of smaller scope and size 24 00:02:11.000 --> 00:02:16.140 could not put the various ideas in context. Mises had to educate his readers before he 25 00:02:16.140 --> 00:02:20.960 he could convince them, an essential task in the age of interventionism, in which the 26 00:02:20.960 --> 00:02:27.140 average citizen was constantly exposed to pro-government propaganda. Replying to a reader, 27 00:02:27.140 --> 00:02:32.240 he once said, I try to answer the questions you are asking me in my books. A book is in 28 00:02:32.240 --> 00:02:37.640 fact a letter written to all one's friends, to those the author has already acquired, 29 00:02:37.640 --> 00:02:41.180 as well as to those he hopes to acquire in the future. 30 00:02:41.180 --> 00:02:47.060 But Mises did not have exaggerated confidence in the power of the written word. In a 1957 31 00:02:47.060 --> 00:02:51.660 letter to a friend from Mexico, he expressed his wish to discuss very soon the theoretical 32 00:02:51.660 --> 00:02:56.820 problems that this friend had raised in his previous letter. A personal meeting would 33 00:02:56.820 --> 00:03:01.460 be necessary, because a thorough discussion of those problems can, in writing, only be 34 00:03:01.460 --> 00:03:07.620 done in the form of a book, and the written word can never replace the spoken word. 35 00:03:07.620 --> 00:03:11.780 A System in an Overview In the introduction, virtually identical in 36 00:03:11.780 --> 00:03:16.700 Human Action, Mises set the agenda for the book. The treatise would present the system 37 00:03:16.700 --> 00:03:21.340 of economic science in the light of two central problems that had been neglected in all previous 38 00:03:21.340 --> 00:03:27.140 works in the field, epistemology and value theory. This emphasis demonstrates in turn 39 00:03:27.140 --> 00:03:32.860 the crucial importance of Grundprobleme for the development of nationaleconomie. He then 40 00:03:32.860 --> 00:03:40.220 Mises offered his system in 751 pages, organised into six parts. Now, all his previous discoveries 41 00:03:40.220 --> 00:03:44.740 could appear in their correct context, along with the new elements that he had developed 42 00:03:44.740 --> 00:03:46.980 during his Geneva years. 43 00:03:46.980 --> 00:03:52.060 Part 1 deals with the features of human action that exist under all conceivable conditions 44 00:03:52.060 --> 00:03:57.860 of action. After a first chapter in which he gives an initial characterisation of action, 45 00:03:57.860 --> 00:04:13.780 A fine point to notice, the treatment of epistemology came after the definition of action, because 46 00:04:13.780 --> 00:04:19.100 science and epistemology are themselves instances of action. 47 00:04:19.100 --> 00:04:24.140 Another fine point, in human action Mises adopts the pragmatist definition of truth, 48 00:04:24.140 --> 00:04:30.420 which works in practice, and maintains this definition throughout all later writings. 49 00:04:30.420 --> 00:04:35.380 He then turns to a more detailed analysis of action, chapter 3, in which he argues that 50 00:04:35.380 --> 00:04:41.180 phenomena such as exchange, price, costs, success and failure, and profit and loss are 51 00:04:41.180 --> 00:04:45.860 not given only in the context of a market economy, but are features of human action 52 00:04:45.860 --> 00:04:51.420 in general. They are categories of action. In chapter 3 he also deals with the categories 53 00:04:51.420 --> 00:04:56.780 Studies of Means and Ends and of Preference. Mises did not follow the terminology of the 54 00:04:56.780 --> 00:05:03.440 older Austrian school in speaking of value. Instead, he used the term preference, which 55 00:05:03.440 --> 00:05:08.860 better conveys that the category of action is rooted in human choice. This terminological 56 00:05:08.860 --> 00:05:14.100 decision certainly helped to avoid confusion, especially since Menger, the father of Austrian 57 00:05:14.100 --> 00:05:20.100 value theory, had emphasized that value had nothing to do with human free will. According 58 00:05:20.100 --> 00:05:25.060 According to Menger's principles, economic science studies the relation between man's 59 00:05:25.060 --> 00:05:31.100 needs and the economic goods necessary to satisfy those needs. In Walrass's element, 60 00:05:31.100 --> 00:05:37.240 as well as in the mainstream of the 1930s and 1940s and up until the 1980s, economic 61 00:05:37.240 --> 00:05:43.420 science was essentially about prices and quantities traded on the market. But in national economy, 62 00:05:43.420 --> 00:05:49.760 the true object of the science was understood to be human action, and in particular, choice. 63 00:05:49.760 --> 00:05:54.840 In another noteworthy passage of part 1, Mises presents for the first time the law of diminishing 64 00:05:54.840 --> 00:05:58.960 marginal utility as a praxeological law. 65 00:05:58.960 --> 00:06:02.440 It has nothing to do with the psychological phenomenon of satiation. 66 00:06:02.440 --> 00:06:08.520 Rather, the law concerns the simple fact that larger supplies of a homogeneous good can 67 00:06:08.520 --> 00:06:11.400 serve more ends than smaller supplies. 68 00:06:11.400 --> 00:06:16.280 Yet, these additional ends are by virtue of the very fact that they are additional ends 69 00:06:16.280 --> 00:06:19.720 Less important than those already served with the smaller supply. 70 00:06:19.720 --> 00:06:25.520 Here, Mises departs from all other economists, most notably from Wieser, who had adopted 71 00:06:25.520 --> 00:06:28.640 Gossens' psychological interpretation of the law. 72 00:06:28.640 --> 00:06:35.140 Mises draws a sharp line between praxeology and psychology, and he emphasizes the ramifications 73 00:06:35.140 --> 00:06:38.120 of this in other important passages of the book. 74 00:06:38.120 --> 00:06:41.000 We will take a look at some of these below. 75 00:06:41.000 --> 00:06:45.640 In part two, our author deals with those features of human action that come into play whenever 76 00:06:45.640 --> 00:06:50.340 However an individual interacts with other individuals. Later in the book he analyzes 77 00:06:50.340 --> 00:06:54.800 to particularities of the three fundamental types of social system, the market economy 78 00:06:54.800 --> 00:07:02.280 part 4, socialism part 5, and the hampered market economy part 6. He also restates the 79 00:07:02.280 --> 00:07:08.160 theory of society that he had presented in socialism, but this time in its proper context. 80 00:07:08.160 --> 00:07:13.960 In socialism, an economic and sociological analysis, the theory was presented not in 81 00:07:13.960 --> 00:07:18.840 in the first part, which dealt with fundamentals, but in one of the subsequent parts that dealt 82 00:07:18.840 --> 00:07:24.720 with particular problems of socialist orders. He stresses the Ricardian law of association 83 00:07:24.720 --> 00:07:29.340 and the crucial role of reason in shaping human society. 84 00:07:29.340 --> 00:07:35.640 In part 3 he completes 20 years of intellectual assimilation of his 1920 essay on the impossibility 85 00:07:35.640 --> 00:07:42.320 of economic calculation in socialist commonwealths. In some 35 pages he finally offers a general 86 00:07:42.320 --> 00:07:48.120 Theory of Economic Calculation. What is more, he presents it in its proper place, namely 87 00:07:48.120 --> 00:07:55.120 before turning to the analysis of any concrete system of human cooperation, parts 4 to 6. 88 00:07:55.120 --> 00:08:00.240 Of course, he had anticipated this architectonic necessity in the essays on value theory he 89 00:08:00.240 --> 00:08:05.720 wrote in the late 1920s, but it is one thing to stress the difference between valuation 90 00:08:05.720 --> 00:08:11.520 preference and calculation in a general argument. It is quite another to apply this insight 91 00:08:11.520 --> 00:08:17.540 in Concrete Analysis. Part 4 on the market economy is over 400 pages, 92 00:08:17.540 --> 00:08:22.580 more than half the book. Here Mises restates a good number of the theories he had developed 93 00:08:22.580 --> 00:08:27.740 in previous works, the theory of monopoly prices, the theory of money and credit, his 94 00:08:27.740 --> 00:08:32.900 famous business cycle theory, the theory of wages, and the theory of the harmony of interests 95 00:08:32.900 --> 00:08:39.180 of all market participants. But rather than simply repeating himself, he presents thoroughly 96 00:08:39.180 --> 00:08:47.660 He expands the monopoly theory he first developed in socialism, placing special emphasis on 97 00:08:47.660 --> 00:08:53.140 the discussion of Marxist monopoly theory. He presents the theory of the harmony of interests 98 00:08:53.140 --> 00:08:59.300 in an entirely new formulation and rejects the Anglo-Saxon theories of Keynes and of Robinson 99 00:08:59.300 --> 00:09:04.800 and Chamberlain in perfect competition. In the theory of money he brooks no exception 100 00:09:04.800 --> 00:09:09.360 and to the rule that political modifications of the money supply are unwarranted from an 101 00:09:09.360 --> 00:09:15.160 economic point of view and, finally, he integrates his business cycle theory with interest theory, 102 00:09:15.160 --> 00:09:18.520 a subject he had never addressed before in writing. 103 00:09:18.520 --> 00:09:23.640 Besides interest, the central novelty in his analysis of the market economy was his emphasis 104 00:09:23.640 --> 00:09:25.920 on the role of the entrepreneur. 105 00:09:25.920 --> 00:09:30.360 Mises carefully distinguished between entrepreneurs as those who take successful action in an 106 00:09:30.360 --> 00:09:36.320 in an Uncertain World and Entrepreneurship in the sense of a fundamental economic function, 107 00:09:36.320 --> 00:09:41.560 the bearing of risk under uncertainty. It is this economic function that gives rise 108 00:09:41.560 --> 00:09:46.520 to the specific income component of profit and loss. It was one of the great contributions 109 00:09:46.520 --> 00:09:51.440 of nationale économie to clarify the role of this entrepreneurial function in the workings 110 00:09:51.440 --> 00:09:56.920 of the market economy. Yet Mises felt he could not achieve this without a somewhat roundabout 111 00:09:56.920 --> 00:10:01.880 Exposition. To define entrepreneurship it is necessary to give a proper definition of 112 00:10:01.880 --> 00:10:08.760 profit and loss, but for Mises this was impossible without a clarification of the nature of equilibrium 113 00:10:08.760 --> 00:10:14.240 and its role in economic science. He therefore saw himself forced to start Part IV with a 114 00:10:14.240 --> 00:10:19.280 somewhat basic chapter dealing with the methods necessary for the discursive analysis of the 115 00:10:19.280 --> 00:10:24.720 market economy, with various equilibrium concepts in particular. Only then did he feel that 116 00:10:24.720 --> 00:10:36.400 In Part 5, which deals with socialist societies, Mises does not restate all the main findings 117 00:10:36.400 --> 00:10:41.440 of socialism, rather, he concentrates on the centrepiece of his refutation of the socialist 118 00:10:41.440 --> 00:10:47.240 program, the impossibility of economic calculation, wherever the means of production are collectively 119 00:10:47.240 --> 00:10:48.240 owned. 120 00:10:48.240 --> 00:10:52.800 Thus, Part 5 must be considered an extension of Part 3. 121 00:10:52.800 --> 00:10:58.040 Mises discusses the schemes of socialist calculation developed in the 1930s, most notably in the 122 00:10:58.040 --> 00:11:03.720 Anglo-Saxon world. He refutes the idea of generating prices through an artificial market 123 00:11:03.720 --> 00:11:09.640 and also contests the notion that mathematical economics could overcome the calculation problem, 124 00:11:09.640 --> 00:11:15.800 even theoretically. In part six he delivers a far more comprehensive and detailed discussion 125 00:11:15.800 --> 00:11:21.300 of interventionism than he had in his essays from the mid-1920s. The general line of the 126 00:11:21.300 --> 00:11:26.260 The argument remained the same. Interventionism is counterproductive because it does not 127 00:11:26.260 --> 00:11:29.460 attain the professed ends of its authors. 128 00:11:29.460 --> 00:11:34.820 Nationale Economie featured entirely new and important contributions. Even in those places 129 00:11:34.820 --> 00:11:40.780 where Mises restates his older doctrines, he has revised them, often substantially. 130 00:11:40.780 --> 00:11:45.220 It was therefore highly unusual for Gottfried von Haberler to claim a few years later in 131 00:11:45.220 --> 00:11:50.500 a confidential evaluation for Yale University Press, which considered commissioning a translation 132 00:11:50.500 --> 00:12:00.460 Anti-psychologism Mises' exposition of economic science differed 133 00:12:00.460 --> 00:12:06.220 decisively from all modern authors in that it drew a sharp line between praxeology and 134 00:12:06.220 --> 00:12:12.820 psychology. This has remained a defining feature of the works of his disciples. Mises did not 135 00:12:12.820 --> 00:12:17.780 contest that the psychological background of a person, his worldview, knowledge, conscious 136 00:12:17.780 --> 00:12:26.520 have an immediate impact on his behaviour. Neither did he ignore the important psychological 137 00:12:26.520 --> 00:12:31.020 problems that his friend F.R. Hayek began to stress in those years, in particular that 138 00:12:31.020 --> 00:12:36.180 of knowledge acquisition. Mises's point was that there were also laws of human behaviour 139 00:12:36.180 --> 00:12:41.980 that exist in complete independence of these psychological dispositions. For example, in 140 00:12:41.980 --> 00:12:48.540 In Chapter 4, Mises discusses ends and means, scales of values and scales of needs. He does 141 00:12:48.540 --> 00:12:53.940 not deal with the question of how or why people select ends and means, or how or why they 142 00:12:53.940 --> 00:12:59.620 have certain values and certain needs. He argues that in every human action we do use 143 00:12:59.620 --> 00:13:07.200 means to attain ends, and that needs and values can be ranked. Murray Rothbard later argued 144 00:13:07.200 --> 00:13:11.780 that as a consequence of the mere fact that people rank their choice alternatives, it 145 00:13:11.780 --> 00:13:17.760 It follows that demand curves must slope downward to the right. Mises made no such interference. 146 00:13:17.760 --> 00:13:23.020 He was sceptical about the use of graphical methods in exact analysis. He did accept them 147 00:13:23.020 --> 00:13:28.820 as pedagogical devices. In Chapter 15, The Market, he points out that consumers are sovereign 148 00:13:28.820 --> 00:13:35.020 because their buying decisions steer the market. This is obviously true, irrespective of what 149 00:13:35.020 --> 00:13:39.900 consumers buy or the reason why they make these purchases. Therefore he does not deal 150 00:13:39.900 --> 00:13:46.220 In Chapter 16, Prices, Mises states that the number of market participants determines how 151 00:13:46.220 --> 00:13:51.660 narrow the margins are within which prices are determined. Yet this implies that the 152 00:13:51.660 --> 00:13:56.500 number of market participants has no influence on how prices are formed. Irrespective of 153 00:13:56.500 --> 00:14:00.980 the number of market participants, market prices are always determined by the decisions 154 00:14:00.980 --> 00:14:06.260 of marginal buyers and sellers. Thus, all prices can be explained as a result of the 155 00:14:06.260 --> 00:14:16.980 Praxeology is the science of these laws. It examines the ramifications of the mere fact 156 00:14:16.980 --> 00:14:22.780 that a man makes this or that choice. Considering the relationship between a choice and its 157 00:14:22.780 --> 00:14:29.260 consequences, praxeology examines the suitability of different means to attain particular ends. 158 00:14:29.260 --> 00:14:34.980 In praxeological analysis, the ends are given, not in the sense that human beings cannot 159 00:14:34.980 --> 00:14:50.180 Mises would later discuss the irrelevance of homo economicus for modern economics in 160 00:14:50.180 --> 00:14:56.360 human action. He concluded that the orams concerning commodity prices, wage rates and 161 00:14:56.360 --> 00:15:01.920 interest rates refer to all these phenomena without any regard to devotives causing people 162 00:15:01.920 --> 00:15:06.200 to Buy or to Sell or to Abstain from Buying or Selling. 163 00:15:06.200 --> 00:15:11.200 With respect to the knowledge of market participants, Mises emphasized the fact that the individual 164 00:15:11.200 --> 00:15:18.240 market participants are not equally well informed, yet even if they all had the same information, 165 00:15:18.240 --> 00:15:23.560 they would appraise this information differently. As to equilibrium, he stated again and again 166 00:15:23.560 --> 00:15:28.540 that the market never reaches such a state, that it is a mere mental construct, the only 167 00:15:28.540 --> 00:15:33.900 Only function of which is to analyze profits and losses, that is, the equilibrium construct 168 00:15:33.900 --> 00:15:39.940 is needed to explain a particular component of price spreads. It is not required to explain 169 00:15:39.940 --> 00:15:46.740 prices, wages, interest, commodity prices, as such. Consequently, in Mises's view, equilibrium 170 00:15:46.740 --> 00:15:52.980 is not the right benchmark for the evaluation of the market. To critics of economic science 171 00:15:52.980 --> 00:15:57.460 who complain that the market never produces a perfect balance between different goods 172 00:15:57.460 --> 00:16:03.500 and Services, Mises replies in two steps. First, he points out that this fact of imbalance 173 00:16:03.500 --> 00:16:08.740 does not refute economic doctrine, because economic science explains any state of affairs 174 00:16:08.740 --> 00:16:14.340 as it results from the fact that consumers make certain valuations. Second, he observes 175 00:16:14.340 --> 00:16:18.820 that the relevant benchmark for the market is government intervention, and because government 176 00:16:18.820 --> 00:16:24.060 officials are not supermen, one cannot make the a priori assumption that entrusting them 177 00:16:24.060 --> 00:16:40.060 Capitalism and Liberalism are Rational In Socialism and Liberalism, Mises had argued 178 00:16:40.060 --> 00:16:44.460 that human society was founded on the basis of the higher physical productivity of human 179 00:16:44.460 --> 00:16:49.720 cooperation as compared to individuals acting on their own. This was the crux of the classical 180 00:16:49.720 --> 00:16:54.960 Social Liberal Social Philosophy and the cornerstone of the political programme of laissez-faire, 181 00:16:54.960 --> 00:16:55.960 Manchesterism. 182 00:16:55.960 --> 00:17:01.920 A nationale économie Mises set out to contrast this social philosophy with competing worldviews. 183 00:17:01.920 --> 00:17:06.320 He stressed that economic analysis had given a purely fact-based account of the origin 184 00:17:06.320 --> 00:17:08.360 of human society. 185 00:17:08.360 --> 00:17:13.080 The scientific theory, as developed by the social philosophy of 18th century rationalism 186 00:17:13.080 --> 00:17:18.100 and liberalism and by modern economics, does not resort to any miraculous interference 187 00:17:18.100 --> 00:17:23.660 of Superhuman Powers. Every step by which an individual substitutes concerted action 188 00:17:23.660 --> 00:17:30.160 for isolated action results in an immediate and recognisable improvement in his condition. 189 00:17:30.160 --> 00:17:34.920 The advantages derived from peaceful cooperation and division of labour are universal. They 190 00:17:34.920 --> 00:17:40.940 immediately benefit every generation and not only later descendants. For what the individual 191 00:17:40.940 --> 00:17:47.020 must sacrifice for the sake of society is amply compensated by greater advantages. His 192 00:17:47.020 --> 00:17:53.820 Sacrifice is only apparent and temporary. He forgoes a smaller gain in order to reap a greater one later. 193 00:17:53.820 --> 00:17:57.420 No reasonable being can fail to see this obvious fact. 194 00:17:57.420 --> 00:18:02.320 When social cooperation is intensified by enlarging the field in which there is division of labour, 195 00:18:02.320 --> 00:18:06.620 or when legal protection and the safeguarding of peace are strengthened, 196 00:18:06.620 --> 00:18:12.020 the incentive is the desire of all those concerned to improve their own conditions. 197 00:18:12.020 --> 00:18:16.580 In striving after his own rightly understood interests, the individual works toward an 198 00:18:16.580 --> 00:18:22.100 intensification of social cooperation and peaceful intercourse. Society is a product 199 00:18:22.100 --> 00:18:28.700 of human action, that is, the human urge to remove uneasiness as far as possible. He then 200 00:18:28.700 --> 00:18:34.640 went on to point out the larger cultural and philosophical significance of this discovery. 201 00:18:34.640 --> 00:18:39.220 The historical role of the theory of the division of labour, as elaborated by British political 202 00:18:39.220 --> 00:18:44.380 The Social Economy from Hume to Ricardo consisted in the complete demolition of all metaphysical 203 00:18:44.380 --> 00:18:50.000 doctrines concerning the origin and to the operation of social cooperation. It consummated 204 00:18:50.000 --> 00:18:55.560 the spiritual, moral and intellectual emancipation of mankind inaugurated by the philosophy of 205 00:18:55.560 --> 00:19:01.940 Epicureanism. It substituted an autonomous rational morality for the heteronomous and 206 00:19:01.940 --> 00:19:08.620 intuitionist ethics of older days. Law and legality, the moral code and social institutions 207 00:19:08.620 --> 00:19:14.840 are no longer reserved as unfathomable decrees of heaven, they are of human origin, and the 208 00:19:14.840 --> 00:19:20.140 only yardstick that must be applied to them is that of expediency with regard to human 209 00:19:20.140 --> 00:19:21.140 welfare. 210 00:19:21.140 --> 00:19:26.240 A few years later, Joseph Schumpeter pointed out that the social analysis of the classical 211 00:19:26.240 --> 00:19:33.060 economists had its roots in medieval scholasticism. St. Thomas Aquinas and his followers had pioneered 212 00:19:33.060 --> 00:19:38.620 Methodological Individualism and Utteritarian Justifications of Social Institutions 213 00:19:38.620 --> 00:19:45.340 By contrast, divine law and omnipotent government were Protestant inventions. Thus, the economists 214 00:19:45.340 --> 00:19:51.260 had explained society as a human creation, designed and implemented by cooperating individuals 215 00:19:51.260 --> 00:19:57.580 who satisfy individual needs. In contrast, alternative approaches such as universalism 216 00:19:57.580 --> 00:20:03.020 and collectivism stipulated that society could be defined independently of individual 217 00:20:03.020 --> 00:20:08.700 To the collectivists, society is an entity living its own life, independent of and separate 218 00:20:08.700 --> 00:20:13.100 from the lives of the various individuals acting on its own behalf and aiming at its 219 00:20:13.100 --> 00:20:17.920 own ends, which are different from the ends sought by the individuals. Mises went on to 220 00:20:17.920 --> 00:20:23.100 point out that the conception of society has a natural conclusion, then, of course, an 221 00:20:23.100 --> 00:20:27.340 antagonism between the aims of society and those of its members can emerge. In order 222 00:20:27.340 --> 00:20:32.680 to safeguard the flowering and further development of society, it becomes necessary to master 223 00:20:32.680 --> 00:20:37.400 to the selfishness of the individuals and to compel them to sacrifice their egotistic 224 00:20:37.400 --> 00:20:42.920 designs to the benefit of society. What is needed, therefore, is a definition of the 225 00:20:42.920 --> 00:20:48.760 proper interests of society thus conceived. Mises observed that science was at a loss 226 00:20:48.760 --> 00:20:53.940 to provide such a definition. As a consequence, all these holistic doctrines are bound to 227 00:20:53.940 --> 00:20:59.280 abandon the secular methods of human science and logical reasoning and to shift to theological 228 00:20:59.280 --> 00:21:04.880 Social or Metaphysical Professions of Faith. Mises emphasized the epistemological dimension 229 00:21:04.880 --> 00:21:10.800 of this problem. The essential problem of all varieties of universalistic, collectivistic 230 00:21:10.800 --> 00:21:17.080 and holistic social philosophy is, by what mark do I recognize the true law, the authentic 231 00:21:17.080 --> 00:21:22.480 Apostle of God's Word, and the legitimate authority, for many claim that Providence 232 00:21:22.480 --> 00:21:28.920 has sent them, and each of these prophets preaches another gospel. Equilibrium, profit 233 00:21:28.920 --> 00:21:34.320 and Loss and Entrepreneurship. It was through the writings of Carl Menger and Eugen von 234 00:21:34.320 --> 00:21:39.720 Boehm-Bawerk that Mises had come to understand the market economy as a rational social order 235 00:21:39.720 --> 00:21:45.040 in which all factors of production are geared toward the satisfaction of consumer wants. 236 00:21:45.040 --> 00:21:48.940 Not only the allocation of the production factors, but also the incomes of the owners 237 00:21:48.940 --> 00:21:54.540 of these factors ultimately depended exclusively on their relative contribution to the satisfaction 238 00:21:54.540 --> 00:22:00.380 of Human Wants. All values, all prices, as Frankfurter had put it, depend on the daily 239 00:22:00.380 --> 00:22:05.420 referendum in the market democracy. The market is a democracy where every penny gives a right 240 00:22:05.420 --> 00:22:11.380 of vote. A few pages later he states, So each is measuring the services of all others and 241 00:22:11.380 --> 00:22:17.540 all are valuing each. It is the democracy of valuation. But in none of his predecessors 242 00:22:17.540 --> 00:22:21.860 did Mises find a satisfactory account of the process through which the structure of production 243 00:22:21.860 --> 00:22:26.660 Innovation was brought in line with consumer preferences. His fellow Boehm-Bawerk seminar 244 00:22:26.660 --> 00:22:32.100 member Josef Schumpeter had brilliantly shown how entrepreneurs drive the market. According 245 00:22:32.100 --> 00:22:36.980 to Schumpeter's theory of economic development, entrepreneurs are innovators who constantly 246 00:22:36.980 --> 00:22:43.340 interrupt the smooth operation of an inert economy. Schumpeter had a point. Innovation 247 00:22:43.340 --> 00:22:48.500 does play a central role in the market economy, but how does this fit with the Mengerian picture 248 00:22:48.500 --> 00:22:52.300 of the Market Economy as a Rational Social Order. 249 00:22:52.300 --> 00:22:56.980 Was there a contradiction between the Schumpeterian notion that entrepreneurs reap profits for 250 00:22:56.980 --> 00:23:03.020 innovation and the Mengerian insight that all incomes depend on consumer wishes? 251 00:23:03.020 --> 00:23:06.900 In Nationalökonomie, Mises reconciled Schumpeter with Menger. 252 00:23:06.900 --> 00:23:11.740 From Schumpeter he adopted the idea that entrepreneurs are the motor of the market process, but they 253 00:23:11.740 --> 00:23:17.100 cannot earn a profit for innovation per se, only for innovations that improve the satisfaction 254 00:23:17.100 --> 00:23:19.580 of Consumer Wants. 255 00:23:19.580 --> 00:23:23.420 Entrepreneurs constantly adjust the structure of production to what they expect will be 256 00:23:23.420 --> 00:23:25.860 the future preferences of consumers. 257 00:23:25.860 --> 00:23:30.340 The different entrepreneurs act in effect as advocates for different consumer needs. 258 00:23:30.340 --> 00:23:34.820 Based on their estimates of what they expect to obtain for an imagined product in the future, 259 00:23:34.820 --> 00:23:39.360 they go to the factor markets where they compete with other entrepreneurs, bidding up prices 260 00:23:39.360 --> 00:23:43.540 for the available factors of production, workers and material supplies. 261 00:23:43.540 --> 00:23:48.780 This pricing process determines the incomes of all factors of production and it ensures 262 00:23:48.780 --> 00:23:54.180 that only the most important investment projects, important in terms of future consumer spending, 263 00:23:54.180 --> 00:24:00.380 will be realised. The driving force of entrepreneurship is the profit motive. Profit is the specific 264 00:24:00.380 --> 00:24:06.380 remuneration a person receives for bearing uncertainty. In the market economy, entrepreneurs 265 00:24:06.380 --> 00:24:12.700 act with due caution and responsibility because they are personally liable for any wrong decisions. 266 00:24:12.700 --> 00:24:18.900 Loss is the punishment for unsuccessful entrepreneurship. Profit and loss are together the measure of 267 00:24:18.900 --> 00:24:26.220 entrepreneurship. Are all businessmen entrepreneurs? Are all entrepreneurs businessmen? If not, 268 00:24:26.220 --> 00:24:32.580 how could entrepreneurs be distinguished from regular businessmen and other market participants? 269 00:24:32.580 --> 00:24:38.580 Mises answered these difficult questions by defining entrepreneurship as a social function, 270 00:24:38.580 --> 00:24:45.240 Money as the function of assuming responsibility for the uncertainty of the future. The entrepreneur 271 00:24:45.240 --> 00:24:50.640 in Mises' theory is not a person, but a role played by people, and it is not at all 272 00:24:50.640 --> 00:24:56.200 limited to businessmen. Ultimately anyone can be an entrepreneur to the extent that 273 00:24:56.200 --> 00:25:02.760 he assumes the repercussions of uncertainty. Profits and losses do not only determine the 274 00:25:02.760 --> 00:25:08.520 income of businessmen, but also of wage earners and capitalists. They always come mixed with 275 00:25:08.520 --> 00:25:13.280 with specific factor incomes such as wages and interest. 276 00:25:13.280 --> 00:25:17.960 One of the great problems Mises had to solve in this theory was to give a precise definition 277 00:25:17.960 --> 00:25:23.880 of profit and loss. In particular, he had to distinguish profit and loss from interest. 278 00:25:23.880 --> 00:25:29.360 His solution was that profit and loss were the results of human error. In other words, 279 00:25:29.360 --> 00:25:35.980 profits and losses can only exist in situations of disequilibrium. In contrast, money interest 280 00:25:35.980 --> 00:25:40.300 ultimately springs from time preference and has nothing to do with whether the market 281 00:25:40.300 --> 00:25:46.020 participants make good or bad decisions. Money interests exist both in general equilibrium 282 00:25:46.020 --> 00:25:51.860 and in disequilibrium, whereas profit and loss exist only in the latter case. But then this 283 00:25:51.860 --> 00:25:57.100 line of argument makes it necessary to clarify the precise meaning of general equilibrium 284 00:25:57.100 --> 00:26:03.340 as well as its role in economic analysis. Mises argued that general equilibrium, which 285 00:26:03.340 --> 00:26:09.500 which he called the stationary economy, stationaire wirtschaft, in human action he called it the 286 00:26:09.500 --> 00:26:16.820 evenly rotating economy, is a purely methodological device, it is an imaginary construct, a Duncan 287 00:26:16.820 --> 00:26:22.260 Bild, that has no counterpart in the real world, its only purpose is for the definition 288 00:26:22.260 --> 00:26:25.820 of profit and loss. 289 00:26:25.820 --> 00:26:30.540 Consumer Sovereignty and Interest In national economies Mises finally delved 290 00:26:30.540 --> 00:26:37.300 into Interest Theory, the primary research area of his revered teacher Boehm-Bawerk. 291 00:26:37.300 --> 00:26:42.320 In his classes at the University of Vienna in the 1920s, Mises had frequently dealt with 292 00:26:42.320 --> 00:26:48.180 contemporary interest theories. In those years he had also planned to write a paper on the 293 00:26:48.180 --> 00:26:54.020 subject, but there had always been other projects that seemed more important. In Geneva he was 294 00:26:54.020 --> 00:26:59.300 finally at leisure to fill this gap. He started lecturing on capital and related problems 295 00:26:59.300 --> 00:27:05.460 in the Winter Semester of 1936-1937. By then, Mises must have made his mind up about these 296 00:27:05.460 --> 00:27:06.460 questions. 297 00:27:06.460 --> 00:27:12.140 When Bawerk had initiated the Austrian tradition of defining the phenomenon that was at issue 298 00:27:12.140 --> 00:27:18.420 in interest theory, he argued that the interest rates paid in the context of credit operations 299 00:27:18.420 --> 00:27:24.860 are in fact a secondary aspect of a larger phenomenon. The primary aspect of this phenomenon 300 00:27:24.860 --> 00:27:29.620 was given in certain price differences that could be observed on the market. 301 00:27:29.620 --> 00:27:33.620 The starting point for Boehm-Bawerk's theory was the common observation that successful 302 00:27:33.620 --> 00:27:39.020 business was characterized by a positive spread between the sum total of the prices paid for 303 00:27:39.020 --> 00:27:45.740 its factors of production and the sum total of prices received as proceeds for its products. 304 00:27:45.740 --> 00:27:49.400 Entrepreneurs earned more money by selling their products than they spent on the factors 305 00:27:49.400 --> 00:27:53.180 of production that brought these products into being. 306 00:27:53.180 --> 00:27:57.220 This phenomenon raised the fundamental question of whether the entire spread between selling 307 00:27:57.220 --> 00:28:03.260 proceeds and costs expenditure can be arbitraged away through entrepreneurial competition or 308 00:28:03.260 --> 00:28:07.860 whether at least part of this spread could never be eliminated. In other words, is there 309 00:28:07.860 --> 00:28:14.220 a part of it that contains a pure interest component? And if so, what is its cause? 310 00:28:14.220 --> 00:28:18.180 Boehm-Bawerk's great achievement was to formulate the problem of interest theory as 311 00:28:18.180 --> 00:28:24.100 As a value problem, a question of demonstrated preference between goods, interest results 312 00:28:24.100 --> 00:28:29.780 from human choice and exchange, rather than being caused by some factor outside of human 313 00:28:29.780 --> 00:28:36.720 action. As the result of preference in action, interest reflects a fundamental value inequality, 314 00:28:36.720 --> 00:28:41.700 the choice of a more valuable alternative over a less valuable one. Observable interest 315 00:28:41.700 --> 00:28:46.840 rates manifest an inequality between the value of products and the total value of the corresponding 316 00:28:46.840 --> 00:29:09.760 In Menger's view, interest was the value of a component part of the factors of production, 317 00:29:09.760 --> 00:29:15.400 whereas Boehm-Bawerk saw it as a value differential. But where did such a value differential come 318 00:29:15.400 --> 00:29:24.400 According to Boehm-Bawerk, present goods have in general greater subjective value than future goods of equal quantity and quality. 319 00:29:24.400 --> 00:29:30.400 The American economist Frank Fetter later coined the term time preference to designate this phenomenon. 320 00:29:30.400 --> 00:29:43.400 It is because of a time preference for present goods over future goods that factors of production, which will yield products in the future, are less valuable than the corresponding quantity of otherwise equal products existing here and now. 321 00:29:43.400 --> 00:29:49.280 Boehm-Bawerk emphasized that time preference is only the proximate cause of interest. The 322 00:29:49.280 --> 00:29:55.400 ultimate cause is something even more fundamental. He famously argued that time preference is 323 00:29:55.400 --> 00:30:00.900 itself caused by two psychological dispositions, one, that current needs are usually less well 324 00:30:00.900 --> 00:30:06.480 satisfied than future needs, and two, that human beings tend to underestimate future 325 00:30:06.480 --> 00:30:11.940 needs. He also argued that time preference is caused by the higher physical productivity 326 00:30:11.940 --> 00:30:18.260 of more roundabout methods of production, his famous third cause of time preference. 327 00:30:18.260 --> 00:30:22.980 Mises rejected Boehm-Bawerk's psychological explanation of time preference. Psychology, 328 00:30:22.980 --> 00:30:27.580 Mises argued, could never establish that time preference was an element of the very 329 00:30:27.580 --> 00:30:33.220 nature of human action. In some actions, the psychological forces that Boehm-Bawerk described 330 00:30:33.220 --> 00:30:39.100 were at work and led to a preference of present over future goods of the same kind. But in 331 00:30:39.100 --> 00:30:43.860 In other instances, the very opposite was the case. Boehm-Bawerk himself had admitted 332 00:30:43.860 --> 00:30:49.200 this point, which is why he held that time preference existed only in general, but not 333 00:30:49.200 --> 00:30:55.220 in all cases of human action. Mises also criticised Boehm-Bawerk for having failed to develop 334 00:30:55.220 --> 00:31:00.300 a truly praxeological theory of the period of production. 335 00:31:00.300 --> 00:31:05.060 The Boehm-Bawerkian view of the nature of time preference had two related shortcomings. 336 00:31:05.060 --> 00:31:10.320 First, it was difficult to reconcile with the fact that values and prices are manifested 337 00:31:10.320 --> 00:31:17.340 in human choice. If choice is free, how is it that future values by their very nature, 338 00:31:17.340 --> 00:31:23.360 or at least as a rule, stand in a determinate relationship to present values? Second, and 339 00:31:23.360 --> 00:31:27.960 more importantly, the Boehm-Bawerkian approach was in conflict with the theory of subjective 340 00:31:27.960 --> 00:31:32.920 value. His view of time preference concerns the value differential between homogenous 341 00:31:32.920 --> 00:31:37.720 presents present and future goods, but the very fact that two goods exist at different 342 00:31:37.720 --> 00:31:43.120 points in time automatically makes them heterogeneous goods. Boehm-Bawerk himself admitted this 343 00:31:43.120 --> 00:31:48.880 implicitly when he emphasized that the values of present and future goods is liable to be 344 00:31:48.880 --> 00:31:54.560 different because they are intended for the service of a different set of wants. The second 345 00:31:54.560 --> 00:31:59.480 point is devastating for the old time preference theory, for one cannot even make claims with 346 00:31:59.480 --> 00:32:04.440 with respect to present and future goods of the same quality, without contradicting oneself. 347 00:32:04.440 --> 00:32:09.260 Moreover, as can be seen from Boehm-Bawerk's equivocal description of the time preference 348 00:32:09.260 --> 00:32:14.420 phenomenon, which stresses that only in general are present goods preferred over identical 349 00:32:14.420 --> 00:32:20.360 future goods, he did not assert that time preference was universally positive. 350 00:32:20.360 --> 00:32:25.040 Neither did Erwin Fischer and Frank Fetter think that this was the case. They even argued 351 00:32:25.040 --> 00:32:29.920 that time preference could be negative. In the hands of Mises' predecessors, then, 352 00:32:29.920 --> 00:32:34.640 time preference theory was a mere assertion that a determinate relationship between the 353 00:32:34.640 --> 00:32:39.600 values of future and present goods of the same kind existed. None of its champions proposed 354 00:32:39.600 --> 00:32:44.760 a tenable explanation for the supposed relationship other than the intuitive reference to the 355 00:32:44.760 --> 00:32:49.320 visible facts of the market, that the selling proceeds from products were higher than the 356 00:32:49.320 --> 00:32:53.720 expenditure on the corresponding factors of production. But these are the very facts to 357 00:32:53.720 --> 00:33:13.720 How did Mises solve these problems? He asserted on a priori grounds that time preference is, at all times and places, positive. Human action, by its very nature, involves a preference for sooner rather than later fulfilment of one's needs. 358 00:33:13.720 --> 00:33:30.720 Time Preference is not the result of the psychological dispositions of man, but of the temporal nature of action. Years later, Mises nicely summarized this point in private correspondence. 359 00:33:43.720 --> 00:33:49.960 survived the month of February. If the phenomenon we call time preference were not to exist, 360 00:33:49.960 --> 00:33:55.260 people would only consume what is subject to speedy decay. Other things they would always 361 00:33:55.260 --> 00:34:00.260 only save and invest as the outcome of such a behaviour would in their eyes mean a greater 362 00:34:00.260 --> 00:34:04.380 yield than the result of investing them for a shorter period. 363 00:34:04.380 --> 00:34:08.860 Mises had not so much clarified the phenomenon that his predecessors had in mind when they 364 00:34:08.860 --> 00:34:13.340 They used the term time preference, but had instead given a complete restatement of the 365 00:34:13.340 --> 00:34:19.620 theory. When Boehm-Bawerk, Fetter and Fischer used the term time preference, they referred 366 00:34:19.620 --> 00:34:24.620 to an observable value differential between two physically similar goods existing at two 367 00:34:24.620 --> 00:34:30.940 different times. But when Mises used the term, he referred to a counterfactual value differential 368 00:34:30.940 --> 00:34:37.100 between two alternative uses of one and the same good. Time preference concerns the value 369 00:34:37.100 --> 00:35:01.100 When I use a good now rather than later, I demonstrate that I prefer to use the good now rather than later, and this in turn necessarily means that the value of its present use is higher for me than the value of the use I might have made of it in the future. 370 00:35:01.100 --> 00:35:06.900 Like Boehm-Bawerk, Mises believed that time preference was only the proximate cause of 371 00:35:06.900 --> 00:35:11.700 interest. But rather than seeing the ultimate cause in certain psychological dispositions 372 00:35:11.700 --> 00:35:16.620 of the human being, he followed Frank Fetter and Franz Kuhl in arguing that the ultimate 373 00:35:16.620 --> 00:35:22.300 cause was the necessity of consumption. The fact is that human beings cannot survive if 374 00:35:22.300 --> 00:35:27.700 they do not consume, hence there must be some time preference in human action or the human 375 00:35:27.700 --> 00:35:32.380 and Race would perish. This does not mean that time preference is the only fact to determine 376 00:35:32.380 --> 00:35:38.020 human actions. It means that in order to survive, human beings must at some point prefer shorter 377 00:35:38.020 --> 00:35:41.940 production processes to longer ones, even though the longer ones would be more physically 378 00:35:41.940 --> 00:35:47.620 productive. Mises argued that one would always choose the longest production process if one 379 00:35:47.620 --> 00:35:52.900 could disregard the need for survival through time. It is the need to survive that prompts 380 00:35:52.900 --> 00:35:58.300 The Acting Person also to consider the passage of time and to prefer, at some point, sooner 381 00:35:58.300 --> 00:36:03.840 results to later ones. Consider three alternative fishing processes. The first one leads to 382 00:36:03.840 --> 00:36:09.300 catching one fish at the end of one hour, the second to catching ten fish but only at 383 00:36:09.300 --> 00:36:14.580 the end of one day, and the third to catching one hundred fish, all of them at the end of 384 00:36:14.580 --> 00:36:19.260 a week. Assume we observe a person pursuing the production process leading to a catch 385 00:36:19.260 --> 00:36:27.720 Mises explains the person did not pick the 100-fish alternative because his time preference 386 00:36:27.720 --> 00:36:32.360 was stronger than the additional gain he would have gotten from the longer process. He does 387 00:36:32.360 --> 00:36:37.520 not want to wait a week. The only reason he picked the 10-fish alternative at all, rather 388 00:36:37.520 --> 00:36:41.560 than the 1-fish alternative, is that in this case the attraction of the additional gain 389 00:36:41.560 --> 00:36:46.820 was strong enough to overcome his time preference. Let us highlight the significance of this 390 00:36:46.820 --> 00:36:52.880 This explanation, within the overall theoretical framework of Misesian economics. Consumption 391 00:36:52.880 --> 00:36:58.860 here appears as the root of all economic phenomena. Carl Menger and his disciples had argued that 392 00:36:58.860 --> 00:37:04.420 consumer choices directly determine the prices of consumers' goods and that indirectly they 393 00:37:04.420 --> 00:37:09.900 also determine the prices of producers' goods. Now time preference, too, and with it the 394 00:37:09.900 --> 00:37:15.180 phenomena of capital and interest appear to be rooted in consumption. The great attraction 395 00:37:15.180 --> 00:37:28.180 The conclusion of this explanation, at least from Mises' point of view, was that it did not stress any psychological dispositions of man, but relied on the fundamental fact that there can be no human action without consumption. 396 00:37:28.180 --> 00:37:43.180 The consumption theory of time preference thus seamlessly integrates the theory of capital and interest into the general theory of prices. In the field of interest, as in the broader market process, the consumer is sovereign. 397 00:37:43.180 --> 00:37:55.180 Business cycle theory restated. In light of his theory of interest, Mises now clarified the relationship between interest and changes in the quantity of money. 398 00:37:55.180 --> 00:38:05.180 The Austrian-Misesian theory of the business cycle asserts that intertemporal misallocations result from inflation-induced reductions of the interest rate. 399 00:38:05.180 --> 00:38:10.980 But what was the precise meaning of reduction? Mises did not mean to assert that simple changes 400 00:38:10.980 --> 00:38:15.120 of the interest rate would induce a business cycle. The fact that today's interest is 401 00:38:15.120 --> 00:38:20.340 lower than yesterday's does not by itself mean that a misallocation has occurred. In 402 00:38:20.340 --> 00:38:25.900 his Theory of Money and Credit, Mises had based his analysis on the Mixelian distinction 403 00:38:25.900 --> 00:38:31.800 between the natural rate of interest and the money rate. But this distinction was untenable 404 00:38:31.800 --> 00:38:38.220 in light of Mises' work on economic calculation and on the non-neutrality of money. There 405 00:38:38.220 --> 00:38:43.280 is no such thing as a natural rate of interest, defined as the rate of interest that would 406 00:38:43.280 --> 00:38:48.920 prevail in a barter economy. And even if there were such a natural rate of interest, it would 407 00:38:48.920 --> 00:38:55.080 still be irrelevant for the analysis of a monetary economy. Money is not just a veil 408 00:38:55.080 --> 00:39:01.780 over a barter economy. It affects all economic relations. Prices, incomes, allocation and 409 00:39:01.780 --> 00:39:06.440 social positions in an economy using money are completely different from what they would 410 00:39:06.440 --> 00:39:12.140 be in a society with no common medium of exchange. And so the interest rate in a monetary economy 411 00:39:12.140 --> 00:39:17.000 is necessarily different from what it would have been in the same economy if the market 412 00:39:17.000 --> 00:39:22.280 participants had decided to forgo the benefits of money. Even if one could hypothetically 413 00:39:22.280 --> 00:39:27.480 If we compare natural and money interest rates, which is not the case, it would not follow 414 00:39:27.480 --> 00:39:32.280 that inter-temporal misallocations would ensue whenever the natural rate was higher than 415 00:39:32.280 --> 00:39:33.960 the money rate. 416 00:39:33.960 --> 00:39:38.880 In Nationale Economie, Mises gave a new exposition of his business cycle theory. 417 00:39:38.880 --> 00:39:43.920 He came up with a new benchmark to identify pernicious reductions of the monetary interest 418 00:39:43.920 --> 00:39:44.920 rate. 419 00:39:44.920 --> 00:39:50.440 The relevant benchmark was no longer the Wixellian natural rate that would exist if the economy 420 00:39:50.440 --> 00:39:52.040 were a barter economy. 421 00:39:52.040 --> 00:39:58.040 It was rather the monetary interest rate that would exist in the absence of credit expansion. 422 00:39:58.040 --> 00:40:02.360 Any increase in the supply of credit on the market will reduce the interest rate, but 423 00:40:02.360 --> 00:40:07.600 if the increase comes from printing paper money or banknotes rather than from savings, 424 00:40:07.600 --> 00:40:13.120 then the artificially lower interest rate falsifies the entrepreneurial profit calculus. 425 00:40:13.120 --> 00:40:16.360 In light of the decreased interest rate, a great number of business projects appear to 426 00:40:16.360 --> 00:40:21.320 be profitable and are launched, but the material factors of production necessary for the physical 427 00:40:21.320 --> 00:40:26.840 completion of the greater number of projects do not exist. Credit expansion does not mean 428 00:40:26.840 --> 00:40:31.640 expansion of the real factor endowment of the economy, it merely means expansion of 429 00:40:31.640 --> 00:40:36.840 the money supply through the credit market. It follows that it is physically impossible 430 00:40:36.840 --> 00:40:42.160 to sustain the new structure of production that resulted from the credit expansion. The 431 00:40:42.160 --> 00:40:47.720 boom must eventually end in a bust. Mises stresses that the boom is not a phase 432 00:40:47.720 --> 00:40:59.800 Update of the socialist calculation debate 433 00:40:59.800 --> 00:41:05.040 Mises did not believe that the argument in favour of socialist calculation had made any 434 00:41:05.040 --> 00:41:10.840 progress, but the new pro-socialist arguments provided an opportunity for further elaboration 435 00:41:10.840 --> 00:41:15.840 from his side. He distinguished four types of proposed solutions to the problem he had 436 00:41:15.840 --> 00:41:22.480 The first candidate's solution seeks to perform economic calculation in terms of labor time, 437 00:41:22.480 --> 00:41:27.740 à la Neurat. But this approach cannot work because of the material factors of production 438 00:41:27.740 --> 00:41:32.380 and the heterogeneity of different types of labor. The second candidate parallels the 439 00:41:32.380 --> 00:41:38.380 first in that it seeks to unearth a substitute for money prices as a medium of calculation. 440 00:41:38.380 --> 00:41:44.300 Only here the proposed substitute is not labor time, but utility, as in Mises' theory. 441 00:41:44.300 --> 00:41:49.700 In his rebuttal, Mises points out that human beings cannot measure utility but only rank 442 00:41:49.700 --> 00:41:54.920 it. The utilities of units in different sized supplies are necessarily unequal. Because 443 00:41:54.920 --> 00:42:00.280 of this lack of homogeneity, they cannot serve as units in a calculus of value. According 444 00:42:00.280 --> 00:42:05.380 to the third proposal, socialist communities could create an artificial market by ordering 445 00:42:05.380 --> 00:42:10.500 the plant managers to behave as if they were employed in capitalist firms. The idea was 446 00:42:10.500 --> 00:42:15.660 to combine the benefits of a price system and social control through government-appointed 447 00:42:15.660 --> 00:42:20.840 managers, but without creating bureaucracy and monopoly. Such schemes had become fashionable 448 00:42:20.840 --> 00:42:26.460 during the 1930s, and by the time Nationale Oknui was published, they were achieving the 449 00:42:26.460 --> 00:42:32.100 status of a new orthodoxy that would survive half a century. One of the new theoreticians, 450 00:42:32.100 --> 00:42:37.100 the Polish socialist Oskar Lange, thought some compensation for Mises might be in order, 451 00:42:37.100 --> 00:42:53.660 Lange proposed that a statue of Professor Mises ought to occupy an honourable place 452 00:42:53.660 --> 00:42:58.660 in the great hall of the Central Planning Board of the Socialist State. 453 00:42:58.660 --> 00:43:03.500 No Socialist State was generous enough to follow up on this suggestion, but the University 454 00:43:03.500 --> 00:43:10.180 Rudslal created a statue of Oskar Lange and preserved it into our day, surely, as a monument 455 00:43:10.180 --> 00:43:14.740 to the perennity of his message. Generations of students were taught that socialism was, 456 00:43:14.740 --> 00:43:19.780 in theory at least, a viable economic system. Some authors even went so far as to argue, 457 00:43:19.780 --> 00:43:24.580 statistics in hand, that the Soviet economies of Eastern Europe were superior or about to 458 00:43:24.580 --> 00:43:30.420 become superior to the capitalist economies of the West. See, in particular, the various 459 00:43:30.420 --> 00:43:46.980 The Soviet economy is proof that, contrary to what many sceptics had earlier believed, 460 00:43:46.980 --> 00:43:52.260 the socialist command economy can function and even thrive. This notion evaporated in 461 00:43:52.260 --> 00:43:57.780 1989. In actual practice, market socialism had never played a big role in the Eastern 462 00:43:57.780 --> 00:44:07.780 Some intellectuals were allowed to discuss the calculation problem and the market socialist solution, but in practice there was central planning, not any form of competitive pricing. 463 00:44:07.780 --> 00:44:18.780 Significantly, in the early 1960s, the Soviet professor, Yevsey G. Lieberman, received worldwide attention with his proposals to steer production with the help of price incentives. 464 00:44:18.780 --> 00:44:23.580 Incentives, needless to say Lieberman did not address, much less solve, the problems 465 00:44:23.580 --> 00:44:30.000 Mises had pointed out in 1922. Mises himself commented on this newest fad of economic planning 466 00:44:30.000 --> 00:44:35.520 in his observations on the Russian reform movement. The fall of the Berlin Wall opened 467 00:44:35.520 --> 00:44:41.000 everyone's eyes to the stark reality that seventy years of socialism had created nothing 468 00:44:41.000 --> 00:44:47.420 but misery, pollution and slavery. The world learned the hard way, what it could have learned 469 00:44:47.420 --> 00:44:53.420 in 1922 from a readily available book. In socialism, Mises had analysed the idea of 470 00:44:53.420 --> 00:44:58.980 market socialism even before any socialist had thought of it, and he had already identified 471 00:44:58.980 --> 00:45:06.740 its achilles heel, moral hazard. Artificial markets would make managers irresponsible. 472 00:45:06.740 --> 00:45:12.140 Some of the benefits of successful management would still be private – the increased reputation 473 00:45:12.140 --> 00:45:18.260 and Career Advancement of Successful Managers, but all of the costs of mismanagement would 474 00:45:18.260 --> 00:45:24.140 have to be borne by the citizenry at large, as a consequence the managers of the state 475 00:45:24.140 --> 00:45:28.920 would take on excessive risks, they would squander society's capital. 476 00:45:28.920 --> 00:45:33.980 Eighteen years later, in Natsunari Okonomi, Mises did not miss the opportunity to note 477 00:45:33.980 --> 00:45:38.860 the irony that, according to this proposal, the market economy was such a bad thing that 478 00:45:38.860 --> 00:45:43.820 had to be reintroduced through the back door as soon as the new socialist regime is established. 479 00:45:43.820 --> 00:45:48.460 He went on to chastise the champions of artificial markets for narrow-mindedness. 480 00:45:49.100 --> 00:45:54.700 The problem of the allocation of resources is not primarily a managerial problem within each plant, 481 00:45:54.700 --> 00:46:00.220 it is a problem of choosing where to place available capital, which of the existing plants 482 00:46:00.220 --> 00:46:06.060 should be expanded, which ones should be cut back, which new production sites should be established. 483 00:46:06.060 --> 00:46:12.620 These decisions lay in the hands of capitalists, entrepreneurs and speculators, and it was 484 00:46:12.620 --> 00:46:17.060 out of the question to extend the scheme of the artificial market to them. 485 00:46:17.060 --> 00:46:22.340 Restating the analysis of moral hazard along the lines given in socialism, Mises argued 486 00:46:22.340 --> 00:46:25.780 that playing capitalists would be completely irresponsible. 487 00:46:25.780 --> 00:46:30.340 No risk would be too high for the make-believe capitalists, because they themselves would 488 00:46:30.340 --> 00:46:33.660 hardly bear any negative consequences. 489 00:46:33.660 --> 00:46:39.300 Such a system would be neither socialism nor capitalism. It would be no system at all. 490 00:46:39.300 --> 00:46:41.860 It would be chaotic. 491 00:46:41.860 --> 00:46:46.940 He then turned to the fourth scheme, according to which socialist societies should use the 492 00:46:46.940 --> 00:46:52.180 equations of mathematical economics to solve the problem of economic calculation. Here 493 00:46:52.180 --> 00:46:57.340 Mises restates the argument he had presented in his 1938 French language article of the 494 00:46:57.340 --> 00:47:02.580 same title. Those mathematical equations describe a state of affairs that is already 495 00:47:02.580 --> 00:47:07.280 in Equilibrium, but not the concrete steps through which any equilibrium could ever be 496 00:47:07.280 --> 00:47:09.020 reached. 497 00:47:09.020 --> 00:47:13.380 It was an error to suppose that one could calculate the equilibrium state with data 498 00:47:13.380 --> 00:47:16.460 taken from an economy that is not in equilibrium. 499 00:47:16.460 --> 00:47:21.100 It was another error to believe that acting man, for his present-day calculations, needs 500 00:47:21.100 --> 00:47:26.620 to know the evaluations and appraisals that would obtain in the equilibrium state. 501 00:47:26.620 --> 00:47:30.540 He went on to conclude that this fundamental conceptual problem made it superfluous to 502 00:47:30.540 --> 00:47:36.220 The Deal with the Practical Problems of Central Planning that Pareto and Hayek had raised. 503 00:47:36.220 --> 00:47:39.420 A Pure Cash Balance Approach 504 00:47:39.420 --> 00:47:44.940 Natsunari Okunumi and Human Action completed the project Mises had started in 1912 with 505 00:47:44.940 --> 00:47:50.380 his treatise on money. In certain crucial respects, he decisively improved upon his 506 00:47:50.380 --> 00:47:55.920 earlier exposition of monetary theory. The author of Natsunari Okunumi is a better monetary 507 00:47:55.920 --> 00:48:04.480 In his biographical recollections, Mises is somewhat diffident on this point. He merely 508 00:48:04.480 --> 00:48:10.040 says that his work from 1940s had completed the great initial project of integrating marginal 509 00:48:10.040 --> 00:48:14.880 value theory with the theory of money. Some years later he used the harsher term misstatements 510 00:48:14.880 --> 00:48:20.480 to characterise the shortcomings of his early work. To a German correspondent he wrote, 511 00:48:20.480 --> 00:48:29.480 You cannot avoid going astray, Entgleisungen, if you take money out of the total context of market phenomena and deal with it separately. 512 00:48:29.480 --> 00:48:35.480 I have experienced this in my own case. The market process is an indivisible whole. 513 00:48:35.480 --> 00:48:41.480 One cannot subdivide it into pieces. My theory of money has reached maturity only in human action. 514 00:48:41.480 --> 00:48:47.480 The keystone of the mature theory concerns the central importance of the cash balance approach, 515 00:48:47.480 --> 00:48:52.000 which alone would explain money prices in terms of human action, rather than in terms 516 00:48:52.000 --> 00:48:56.320 of mechanistic metaphors such as the velocity of money. 517 00:48:56.320 --> 00:49:01.420 Mises now stressed that the demand for money was truly a demand for cash balances. The value 518 00:49:01.420 --> 00:49:05.640 of the cash balances was not simply borrowed from the value of the goods against which 519 00:49:05.640 --> 00:49:10.040 they could be exchanged, this was the view he championed at least in one crucial passage 520 00:49:10.040 --> 00:49:14.560 in The Theory of Money and Credit. There was an independent source of value in the services 521 00:49:14.560 --> 00:49:24.040 His later theory was already present in the first edition of his Theory of Money and Credit, 522 00:49:24.040 --> 00:49:29.440 but it was presented side by side with other statements taking the opposite point of view. 523 00:49:29.440 --> 00:49:33.360 Mises developed the cash balance approach to the demand for money starting from Menger's 524 00:49:33.360 --> 00:49:39.440 article Geld, Handwerder Buch der Staatswissenschaften. One possible source of Mises' second thoughts 525 00:49:39.440 --> 00:49:43.680 on this question was a short book that Edwin Canaan had published at the end of the First 526 00:49:43.680 --> 00:49:48.700 First World War, Money, its connection with rising and falling prices. In his 1942 lecture 527 00:49:48.700 --> 00:49:54.000 in Mexico City, Mises stressed that the individual demand for money was, in fact, identical with 528 00:49:54.000 --> 00:50:00.520 the individual's cash holdings and referred the audience to page 83 of Canaan's book. 529 00:50:00.520 --> 00:50:06.360 Mises also radicalised his stance on the usefulness of expansions of the money supply. In Theory 530 00:50:06.360 --> 00:50:11.400 of Money and Credit, he held that monetary expansion might be needed to accommodate greater 531 00:50:11.400 --> 00:50:18.600 Growth, at least under plausible circumstances. From 1940 onward he categorically rejected 532 00:50:18.600 --> 00:50:23.600 this notion. All benefits that might result from monetary expansion were now presented 533 00:50:23.600 --> 00:50:30.280 as being strictly ephemeral. They had no systematic positive impact, quite to the contrary.