Chapter 17 A Treatise on Economics
Nationale Economie came after press in May 1940, just in time to survive the collapse
of its publisher, only to be buried under the avalanche of the war. Many of the copies
Mises sent to friends and colleagues never reached their destinations. Mises took it
with some humour. I suppose the Nazis used them as fuel. The book survived only because
Because its English-language successor, Human Action, drew incomparably more attention from
readers all over the world, but it was in Nationale Ökonomie that Mises first presented
the entire system of thought that he had developed during more than 30 years of intense study.
Human Action, a treatise on economics and Nationale Ökonomie are virtually identical
in general architecture. There are a few substantive differences between the books, but these differences
is pale in comparison to the differences that separate both of them from all similar works.
In the present chapter we will therefore quote Human Action wherever possible. In Human Action
Mises placed a greater emphasis on refuting positivism, whereas in Nationale Economie
he had refuted in particular Spann and Marx. Moreover, in Human Action he added a chapter
on general probability theory, and he expanded the conclusion of Nationale Economie into
to a comprehensive seventh part of human action that dealt with the social and cultural significance
of praxeology. He had planned an American edition early on and had anticipated modifications
of his text to accommodate the particular background of his American readers. The typical
economics textbook was, then as now, just an amalgamation of incompatible bits of theory.
Mises' treatise presented social laws as one coherent whole, and it drew an encompassing
picture of social reality in a step-by-step manner, moving from the most general phenomena
to the most specific. It was social philosophy in the best sense.
Mises understood the importance of a full treatise. A book of smaller scope and size
could not put the various ideas in context. Mises had to educate his readers before he
he could convince them, an essential task in the age of interventionism, in which the
average citizen was constantly exposed to pro-government propaganda. Replying to a reader,
he once said, I try to answer the questions you are asking me in my books. A book is in
fact a letter written to all one's friends, to those the author has already acquired,
as well as to those he hopes to acquire in the future.
But Mises did not have exaggerated confidence in the power of the written word. In a 1957
letter to a friend from Mexico, he expressed his wish to discuss very soon the theoretical
problems that this friend had raised in his previous letter. A personal meeting would
be necessary, because a thorough discussion of those problems can, in writing, only be
done in the form of a book, and the written word can never replace the spoken word.
A System in an Overview In the introduction, virtually identical in
Human Action, Mises set the agenda for the book. The treatise would present the system
of economic science in the light of two central problems that had been neglected in all previous
works in the field, epistemology and value theory. This emphasis demonstrates in turn
the crucial importance of Grundprobleme for the development of nationaleconomie. He then
Mises offered his system in 751 pages, organised into six parts. Now, all his previous discoveries
could appear in their correct context, along with the new elements that he had developed
during his Geneva years.
Part 1 deals with the features of human action that exist under all conceivable conditions
of action. After a first chapter in which he gives an initial characterisation of action,
A fine point to notice, the treatment of epistemology came after the definition of action, because
science and epistemology are themselves instances of action.
Another fine point, in human action Mises adopts the pragmatist definition of truth,
which works in practice, and maintains this definition throughout all later writings.
He then turns to a more detailed analysis of action, chapter 3, in which he argues that
phenomena such as exchange, price, costs, success and failure, and profit and loss are
not given only in the context of a market economy, but are features of human action
in general. They are categories of action. In chapter 3 he also deals with the categories
Studies of Means and Ends and of Preference. Mises did not follow the terminology of the
older Austrian school in speaking of value. Instead, he used the term preference, which
better conveys that the category of action is rooted in human choice. This terminological
decision certainly helped to avoid confusion, especially since Menger, the father of Austrian
value theory, had emphasized that value had nothing to do with human free will. According
According to Menger's principles, economic science studies the relation between man's
needs and the economic goods necessary to satisfy those needs. In Walrass's element,
as well as in the mainstream of the 1930s and 1940s and up until the 1980s, economic
science was essentially about prices and quantities traded on the market. But in national economy,
the true object of the science was understood to be human action, and in particular, choice.
In another noteworthy passage of part 1, Mises presents for the first time the law of diminishing
marginal utility as a praxeological law.
It has nothing to do with the psychological phenomenon of satiation.
Rather, the law concerns the simple fact that larger supplies of a homogeneous good can
serve more ends than smaller supplies.
Yet, these additional ends are by virtue of the very fact that they are additional ends
Less important than those already served with the smaller supply.
Here, Mises departs from all other economists, most notably from Wieser, who had adopted
Gossens' psychological interpretation of the law.
Mises draws a sharp line between praxeology and psychology, and he emphasizes the ramifications
of this in other important passages of the book.
We will take a look at some of these below.
In part two, our author deals with those features of human action that come into play whenever
However an individual interacts with other individuals. Later in the book he analyzes
to particularities of the three fundamental types of social system, the market economy
part 4, socialism part 5, and the hampered market economy part 6. He also restates the
theory of society that he had presented in socialism, but this time in its proper context.
In socialism, an economic and sociological analysis, the theory was presented not in
in the first part, which dealt with fundamentals, but in one of the subsequent parts that dealt
with particular problems of socialist orders. He stresses the Ricardian law of association
and the crucial role of reason in shaping human society.
In part 3 he completes 20 years of intellectual assimilation of his 1920 essay on the impossibility
of economic calculation in socialist commonwealths. In some 35 pages he finally offers a general
Theory of Economic Calculation. What is more, he presents it in its proper place, namely
before turning to the analysis of any concrete system of human cooperation, parts 4 to 6.
Of course, he had anticipated this architectonic necessity in the essays on value theory he
wrote in the late 1920s, but it is one thing to stress the difference between valuation
preference and calculation in a general argument. It is quite another to apply this insight
in Concrete Analysis. Part 4 on the market economy is over 400 pages,
more than half the book. Here Mises restates a good number of the theories he had developed
in previous works, the theory of monopoly prices, the theory of money and credit, his
famous business cycle theory, the theory of wages, and the theory of the harmony of interests
of all market participants. But rather than simply repeating himself, he presents thoroughly
He expands the monopoly theory he first developed in socialism, placing special emphasis on
the discussion of Marxist monopoly theory. He presents the theory of the harmony of interests
in an entirely new formulation and rejects the Anglo-Saxon theories of Keynes and of Robinson
and Chamberlain in perfect competition. In the theory of money he brooks no exception
and to the rule that political modifications of the money supply are unwarranted from an
economic point of view and, finally, he integrates his business cycle theory with interest theory,
a subject he had never addressed before in writing.
Besides interest, the central novelty in his analysis of the market economy was his emphasis
on the role of the entrepreneur.
Mises carefully distinguished between entrepreneurs as those who take successful action in an
in an Uncertain World and Entrepreneurship in the sense of a fundamental economic function,
the bearing of risk under uncertainty. It is this economic function that gives rise
to the specific income component of profit and loss. It was one of the great contributions
of nationale économie to clarify the role of this entrepreneurial function in the workings
of the market economy. Yet Mises felt he could not achieve this without a somewhat roundabout
Exposition. To define entrepreneurship it is necessary to give a proper definition of
profit and loss, but for Mises this was impossible without a clarification of the nature of equilibrium
and its role in economic science. He therefore saw himself forced to start Part IV with a
somewhat basic chapter dealing with the methods necessary for the discursive analysis of the
market economy, with various equilibrium concepts in particular. Only then did he feel that
In Part 5, which deals with socialist societies, Mises does not restate all the main findings
of socialism, rather, he concentrates on the centrepiece of his refutation of the socialist
program, the impossibility of economic calculation, wherever the means of production are collectively
owned.
Thus, Part 5 must be considered an extension of Part 3.
Mises discusses the schemes of socialist calculation developed in the 1930s, most notably in the
Anglo-Saxon world. He refutes the idea of generating prices through an artificial market
and also contests the notion that mathematical economics could overcome the calculation problem,
even theoretically. In part six he delivers a far more comprehensive and detailed discussion
of interventionism than he had in his essays from the mid-1920s. The general line of the
The argument remained the same. Interventionism is counterproductive because it does not
attain the professed ends of its authors.
Nationale Economie featured entirely new and important contributions. Even in those places
where Mises restates his older doctrines, he has revised them, often substantially.
It was therefore highly unusual for Gottfried von Haberler to claim a few years later in
a confidential evaluation for Yale University Press, which considered commissioning a translation
Anti-psychologism Mises' exposition of economic science differed
decisively from all modern authors in that it drew a sharp line between praxeology and
psychology. This has remained a defining feature of the works of his disciples. Mises did not
contest that the psychological background of a person, his worldview, knowledge, conscious
have an immediate impact on his behaviour. Neither did he ignore the important psychological
problems that his friend F.R. Hayek began to stress in those years, in particular that
of knowledge acquisition. Mises's point was that there were also laws of human behaviour
that exist in complete independence of these psychological dispositions. For example, in
In Chapter 4, Mises discusses ends and means, scales of values and scales of needs. He does
not deal with the question of how or why people select ends and means, or how or why they
have certain values and certain needs. He argues that in every human action we do use
means to attain ends, and that needs and values can be ranked. Murray Rothbard later argued
that as a consequence of the mere fact that people rank their choice alternatives, it
It follows that demand curves must slope downward to the right. Mises made no such interference.
He was sceptical about the use of graphical methods in exact analysis. He did accept them
as pedagogical devices. In Chapter 15, The Market, he points out that consumers are sovereign
because their buying decisions steer the market. This is obviously true, irrespective of what
consumers buy or the reason why they make these purchases. Therefore he does not deal
In Chapter 16, Prices, Mises states that the number of market participants determines how
narrow the margins are within which prices are determined. Yet this implies that the
number of market participants has no influence on how prices are formed. Irrespective of
the number of market participants, market prices are always determined by the decisions
of marginal buyers and sellers. Thus, all prices can be explained as a result of the
Praxeology is the science of these laws. It examines the ramifications of the mere fact
that a man makes this or that choice. Considering the relationship between a choice and its
consequences, praxeology examines the suitability of different means to attain particular ends.
In praxeological analysis, the ends are given, not in the sense that human beings cannot
Mises would later discuss the irrelevance of homo economicus for modern economics in
human action. He concluded that the orams concerning commodity prices, wage rates and
interest rates refer to all these phenomena without any regard to devotives causing people
to Buy or to Sell or to Abstain from Buying or Selling.
With respect to the knowledge of market participants, Mises emphasized the fact that the individual
market participants are not equally well informed, yet even if they all had the same information,
they would appraise this information differently. As to equilibrium, he stated again and again
that the market never reaches such a state, that it is a mere mental construct, the only
Only function of which is to analyze profits and losses, that is, the equilibrium construct
is needed to explain a particular component of price spreads. It is not required to explain
prices, wages, interest, commodity prices, as such. Consequently, in Mises's view, equilibrium
is not the right benchmark for the evaluation of the market. To critics of economic science
who complain that the market never produces a perfect balance between different goods
and Services, Mises replies in two steps. First, he points out that this fact of imbalance
does not refute economic doctrine, because economic science explains any state of affairs
as it results from the fact that consumers make certain valuations. Second, he observes
that the relevant benchmark for the market is government intervention, and because government
officials are not supermen, one cannot make the a priori assumption that entrusting them
Capitalism and Liberalism are Rational In Socialism and Liberalism, Mises had argued
that human society was founded on the basis of the higher physical productivity of human
cooperation as compared to individuals acting on their own. This was the crux of the classical
Social Liberal Social Philosophy and the cornerstone of the political programme of laissez-faire,
Manchesterism.
A nationale économie Mises set out to contrast this social philosophy with competing worldviews.
He stressed that economic analysis had given a purely fact-based account of the origin
of human society.
The scientific theory, as developed by the social philosophy of 18th century rationalism
and liberalism and by modern economics, does not resort to any miraculous interference
of Superhuman Powers. Every step by which an individual substitutes concerted action
for isolated action results in an immediate and recognisable improvement in his condition.
The advantages derived from peaceful cooperation and division of labour are universal. They
immediately benefit every generation and not only later descendants. For what the individual
must sacrifice for the sake of society is amply compensated by greater advantages. His
Sacrifice is only apparent and temporary. He forgoes a smaller gain in order to reap a greater one later.
No reasonable being can fail to see this obvious fact.
When social cooperation is intensified by enlarging the field in which there is division of labour,
or when legal protection and the safeguarding of peace are strengthened,
the incentive is the desire of all those concerned to improve their own conditions.
In striving after his own rightly understood interests, the individual works toward an
intensification of social cooperation and peaceful intercourse. Society is a product
of human action, that is, the human urge to remove uneasiness as far as possible. He then
went on to point out the larger cultural and philosophical significance of this discovery.
The historical role of the theory of the division of labour, as elaborated by British political
The Social Economy from Hume to Ricardo consisted in the complete demolition of all metaphysical
doctrines concerning the origin and to the operation of social cooperation. It consummated
the spiritual, moral and intellectual emancipation of mankind inaugurated by the philosophy of
Epicureanism. It substituted an autonomous rational morality for the heteronomous and
intuitionist ethics of older days. Law and legality, the moral code and social institutions
are no longer reserved as unfathomable decrees of heaven, they are of human origin, and the
only yardstick that must be applied to them is that of expediency with regard to human
welfare.
A few years later, Joseph Schumpeter pointed out that the social analysis of the classical
economists had its roots in medieval scholasticism. St. Thomas Aquinas and his followers had pioneered
Methodological Individualism and Utteritarian Justifications of Social Institutions
By contrast, divine law and omnipotent government were Protestant inventions. Thus, the economists
had explained society as a human creation, designed and implemented by cooperating individuals
who satisfy individual needs. In contrast, alternative approaches such as universalism
and collectivism stipulated that society could be defined independently of individual
To the collectivists, society is an entity living its own life, independent of and separate
from the lives of the various individuals acting on its own behalf and aiming at its
own ends, which are different from the ends sought by the individuals. Mises went on to
point out that the conception of society has a natural conclusion, then, of course, an
antagonism between the aims of society and those of its members can emerge. In order
to safeguard the flowering and further development of society, it becomes necessary to master
to the selfishness of the individuals and to compel them to sacrifice their egotistic
designs to the benefit of society. What is needed, therefore, is a definition of the
proper interests of society thus conceived. Mises observed that science was at a loss
to provide such a definition. As a consequence, all these holistic doctrines are bound to
abandon the secular methods of human science and logical reasoning and to shift to theological
Social or Metaphysical Professions of Faith. Mises emphasized the epistemological dimension
of this problem. The essential problem of all varieties of universalistic, collectivistic
and holistic social philosophy is, by what mark do I recognize the true law, the authentic
Apostle of God's Word, and the legitimate authority, for many claim that Providence
has sent them, and each of these prophets preaches another gospel. Equilibrium, profit
and Loss and Entrepreneurship. It was through the writings of Carl Menger and Eugen von
Boehm-Bawerk that Mises had come to understand the market economy as a rational social order
in which all factors of production are geared toward the satisfaction of consumer wants.
Not only the allocation of the production factors, but also the incomes of the owners
of these factors ultimately depended exclusively on their relative contribution to the satisfaction
of Human Wants. All values, all prices, as Frankfurter had put it, depend on the daily
referendum in the market democracy. The market is a democracy where every penny gives a right
of vote. A few pages later he states, So each is measuring the services of all others and
all are valuing each. It is the democracy of valuation. But in none of his predecessors
did Mises find a satisfactory account of the process through which the structure of production
Innovation was brought in line with consumer preferences. His fellow Boehm-Bawerk seminar
member Josef Schumpeter had brilliantly shown how entrepreneurs drive the market. According
to Schumpeter's theory of economic development, entrepreneurs are innovators who constantly
interrupt the smooth operation of an inert economy. Schumpeter had a point. Innovation
does play a central role in the market economy, but how does this fit with the Mengerian picture
of the Market Economy as a Rational Social Order.
Was there a contradiction between the Schumpeterian notion that entrepreneurs reap profits for
innovation and the Mengerian insight that all incomes depend on consumer wishes?
In Nationalökonomie, Mises reconciled Schumpeter with Menger.
From Schumpeter he adopted the idea that entrepreneurs are the motor of the market process, but they
cannot earn a profit for innovation per se, only for innovations that improve the satisfaction
of Consumer Wants.
Entrepreneurs constantly adjust the structure of production to what they expect will be
the future preferences of consumers.
The different entrepreneurs act in effect as advocates for different consumer needs.
Based on their estimates of what they expect to obtain for an imagined product in the future,
they go to the factor markets where they compete with other entrepreneurs, bidding up prices
for the available factors of production, workers and material supplies.
This pricing process determines the incomes of all factors of production and it ensures
that only the most important investment projects, important in terms of future consumer spending,
will be realised. The driving force of entrepreneurship is the profit motive. Profit is the specific
remuneration a person receives for bearing uncertainty. In the market economy, entrepreneurs
act with due caution and responsibility because they are personally liable for any wrong decisions.
Loss is the punishment for unsuccessful entrepreneurship. Profit and loss are together the measure of
entrepreneurship. Are all businessmen entrepreneurs? Are all entrepreneurs businessmen? If not,
how could entrepreneurs be distinguished from regular businessmen and other market participants?
Mises answered these difficult questions by defining entrepreneurship as a social function,
Money as the function of assuming responsibility for the uncertainty of the future. The entrepreneur
in Mises' theory is not a person, but a role played by people, and it is not at all
limited to businessmen. Ultimately anyone can be an entrepreneur to the extent that
he assumes the repercussions of uncertainty. Profits and losses do not only determine the
income of businessmen, but also of wage earners and capitalists. They always come mixed with
with specific factor incomes such as wages and interest.
One of the great problems Mises had to solve in this theory was to give a precise definition
of profit and loss. In particular, he had to distinguish profit and loss from interest.
His solution was that profit and loss were the results of human error. In other words,
profits and losses can only exist in situations of disequilibrium. In contrast, money interest
ultimately springs from time preference and has nothing to do with whether the market
participants make good or bad decisions. Money interests exist both in general equilibrium
and in disequilibrium, whereas profit and loss exist only in the latter case. But then this
line of argument makes it necessary to clarify the precise meaning of general equilibrium
as well as its role in economic analysis. Mises argued that general equilibrium, which
which he called the stationary economy, stationaire wirtschaft, in human action he called it the
evenly rotating economy, is a purely methodological device, it is an imaginary construct, a Duncan
Bild, that has no counterpart in the real world, its only purpose is for the definition
of profit and loss.
Consumer Sovereignty and Interest In national economies Mises finally delved
into Interest Theory, the primary research area of his revered teacher Boehm-Bawerk.
In his classes at the University of Vienna in the 1920s, Mises had frequently dealt with
contemporary interest theories. In those years he had also planned to write a paper on the
subject, but there had always been other projects that seemed more important. In Geneva he was
finally at leisure to fill this gap. He started lecturing on capital and related problems
in the Winter Semester of 1936-1937. By then, Mises must have made his mind up about these
questions.
When Bawerk had initiated the Austrian tradition of defining the phenomenon that was at issue
in interest theory, he argued that the interest rates paid in the context of credit operations
are in fact a secondary aspect of a larger phenomenon. The primary aspect of this phenomenon
was given in certain price differences that could be observed on the market.
The starting point for Boehm-Bawerk's theory was the common observation that successful
business was characterized by a positive spread between the sum total of the prices paid for
its factors of production and the sum total of prices received as proceeds for its products.
Entrepreneurs earned more money by selling their products than they spent on the factors
of production that brought these products into being.
This phenomenon raised the fundamental question of whether the entire spread between selling
proceeds and costs expenditure can be arbitraged away through entrepreneurial competition or
whether at least part of this spread could never be eliminated. In other words, is there
a part of it that contains a pure interest component? And if so, what is its cause?
Boehm-Bawerk's great achievement was to formulate the problem of interest theory as
As a value problem, a question of demonstrated preference between goods, interest results
from human choice and exchange, rather than being caused by some factor outside of human
action. As the result of preference in action, interest reflects a fundamental value inequality,
the choice of a more valuable alternative over a less valuable one. Observable interest
rates manifest an inequality between the value of products and the total value of the corresponding
In Menger's view, interest was the value of a component part of the factors of production,
whereas Boehm-Bawerk saw it as a value differential. But where did such a value differential come
According to Boehm-Bawerk, present goods have in general greater subjective value than future goods of equal quantity and quality.
The American economist Frank Fetter later coined the term time preference to designate this phenomenon.
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.
Boehm-Bawerk emphasized that time preference is only the proximate cause of interest. The
ultimate cause is something even more fundamental. He famously argued that time preference is
itself caused by two psychological dispositions, one, that current needs are usually less well
satisfied than future needs, and two, that human beings tend to underestimate future
needs. He also argued that time preference is caused by the higher physical productivity
of more roundabout methods of production, his famous third cause of time preference.
Mises rejected Boehm-Bawerk's psychological explanation of time preference. Psychology,
Mises argued, could never establish that time preference was an element of the very
nature of human action. In some actions, the psychological forces that Boehm-Bawerk described
were at work and led to a preference of present over future goods of the same kind. But in
In other instances, the very opposite was the case. Boehm-Bawerk himself had admitted
this point, which is why he held that time preference existed only in general, but not
in all cases of human action. Mises also criticised Boehm-Bawerk for having failed to develop
a truly praxeological theory of the period of production.
The Boehm-Bawerkian view of the nature of time preference had two related shortcomings.
First, it was difficult to reconcile with the fact that values and prices are manifested
in human choice. If choice is free, how is it that future values by their very nature,
or at least as a rule, stand in a determinate relationship to present values? Second, and
more importantly, the Boehm-Bawerkian approach was in conflict with the theory of subjective
value. His view of time preference concerns the value differential between homogenous
presents present and future goods, but the very fact that two goods exist at different
points in time automatically makes them heterogeneous goods. Boehm-Bawerk himself admitted this
implicitly when he emphasized that the values of present and future goods is liable to be
different because they are intended for the service of a different set of wants. The second
point is devastating for the old time preference theory, for one cannot even make claims with
with respect to present and future goods of the same quality, without contradicting oneself.
Moreover, as can be seen from Boehm-Bawerk's equivocal description of the time preference
phenomenon, which stresses that only in general are present goods preferred over identical
future goods, he did not assert that time preference was universally positive.
Neither did Erwin Fischer and Frank Fetter think that this was the case. They even argued
that time preference could be negative. In the hands of Mises' predecessors, then,
time preference theory was a mere assertion that a determinate relationship between the
values of future and present goods of the same kind existed. None of its champions proposed
a tenable explanation for the supposed relationship other than the intuitive reference to the
visible facts of the market, that the selling proceeds from products were higher than the
expenditure on the corresponding factors of production. But these are the very facts to
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.
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.
survived the month of February. If the phenomenon we call time preference were not to exist,
people would only consume what is subject to speedy decay. Other things they would always
only save and invest as the outcome of such a behaviour would in their eyes mean a greater
yield than the result of investing them for a shorter period.
Mises had not so much clarified the phenomenon that his predecessors had in mind when they
They used the term time preference, but had instead given a complete restatement of the
theory. When Boehm-Bawerk, Fetter and Fischer used the term time preference, they referred
to an observable value differential between two physically similar goods existing at two
different times. But when Mises used the term, he referred to a counterfactual value differential
between two alternative uses of one and the same good. Time preference concerns the value
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.
Like Boehm-Bawerk, Mises believed that time preference was only the proximate cause of
interest. But rather than seeing the ultimate cause in certain psychological dispositions
of the human being, he followed Frank Fetter and Franz Kuhl in arguing that the ultimate
cause was the necessity of consumption. The fact is that human beings cannot survive if
they do not consume, hence there must be some time preference in human action or the human
and Race would perish. This does not mean that time preference is the only fact to determine
human actions. It means that in order to survive, human beings must at some point prefer shorter
production processes to longer ones, even though the longer ones would be more physically
productive. Mises argued that one would always choose the longest production process if one
could disregard the need for survival through time. It is the need to survive that prompts
The Acting Person also to consider the passage of time and to prefer, at some point, sooner
results to later ones. Consider three alternative fishing processes. The first one leads to
catching one fish at the end of one hour, the second to catching ten fish but only at
the end of one day, and the third to catching one hundred fish, all of them at the end of
a week. Assume we observe a person pursuing the production process leading to a catch
Mises explains the person did not pick the 100-fish alternative because his time preference
was stronger than the additional gain he would have gotten from the longer process. He does
not want to wait a week. The only reason he picked the 10-fish alternative at all, rather
than the 1-fish alternative, is that in this case the attraction of the additional gain
was strong enough to overcome his time preference. Let us highlight the significance of this
This explanation, within the overall theoretical framework of Misesian economics. Consumption
here appears as the root of all economic phenomena. Carl Menger and his disciples had argued that
consumer choices directly determine the prices of consumers' goods and that indirectly they
also determine the prices of producers' goods. Now time preference, too, and with it the
phenomena of capital and interest appear to be rooted in consumption. The great attraction
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.
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.
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.
The Austrian-Misesian theory of the business cycle asserts that intertemporal misallocations result from inflation-induced reductions of the interest rate.
But what was the precise meaning of reduction? Mises did not mean to assert that simple changes
of the interest rate would induce a business cycle. The fact that today's interest is
lower than yesterday's does not by itself mean that a misallocation has occurred. In
his Theory of Money and Credit, Mises had based his analysis on the Mixelian distinction
between the natural rate of interest and the money rate. But this distinction was untenable
in light of Mises' work on economic calculation and on the non-neutrality of money. There
is no such thing as a natural rate of interest, defined as the rate of interest that would
prevail in a barter economy. And even if there were such a natural rate of interest, it would
still be irrelevant for the analysis of a monetary economy. Money is not just a veil
over a barter economy. It affects all economic relations. Prices, incomes, allocation and
social positions in an economy using money are completely different from what they would
be in a society with no common medium of exchange. And so the interest rate in a monetary economy
is necessarily different from what it would have been in the same economy if the market
participants had decided to forgo the benefits of money. Even if one could hypothetically
If we compare natural and money interest rates, which is not the case, it would not follow
that inter-temporal misallocations would ensue whenever the natural rate was higher than
the money rate.
In Nationale Economie, Mises gave a new exposition of his business cycle theory.
He came up with a new benchmark to identify pernicious reductions of the monetary interest
rate.
The relevant benchmark was no longer the Wixellian natural rate that would exist if the economy
were a barter economy.
It was rather the monetary interest rate that would exist in the absence of credit expansion.
Any increase in the supply of credit on the market will reduce the interest rate, but
if the increase comes from printing paper money or banknotes rather than from savings,
then the artificially lower interest rate falsifies the entrepreneurial profit calculus.
In light of the decreased interest rate, a great number of business projects appear to
be profitable and are launched, but the material factors of production necessary for the physical
completion of the greater number of projects do not exist. Credit expansion does not mean
expansion of the real factor endowment of the economy, it merely means expansion of
the money supply through the credit market. It follows that it is physically impossible
to sustain the new structure of production that resulted from the credit expansion. The
boom must eventually end in a bust. Mises stresses that the boom is not a phase
Update of the socialist calculation debate
Mises did not believe that the argument in favour of socialist calculation had made any
progress, but the new pro-socialist arguments provided an opportunity for further elaboration
from his side. He distinguished four types of proposed solutions to the problem he had
The first candidate's solution seeks to perform economic calculation in terms of labor time,
à la Neurat. But this approach cannot work because of the material factors of production
and the heterogeneity of different types of labor. The second candidate parallels the
first in that it seeks to unearth a substitute for money prices as a medium of calculation.
Only here the proposed substitute is not labor time, but utility, as in Mises' theory.
In his rebuttal, Mises points out that human beings cannot measure utility but only rank
it. The utilities of units in different sized supplies are necessarily unequal. Because
of this lack of homogeneity, they cannot serve as units in a calculus of value. According
to the third proposal, socialist communities could create an artificial market by ordering
the plant managers to behave as if they were employed in capitalist firms. The idea was
to combine the benefits of a price system and social control through government-appointed
managers, but without creating bureaucracy and monopoly. Such schemes had become fashionable
during the 1930s, and by the time Nationale Oknui was published, they were achieving the
status of a new orthodoxy that would survive half a century. One of the new theoreticians,
the Polish socialist Oskar Lange, thought some compensation for Mises might be in order,
Lange proposed that a statue of Professor Mises ought to occupy an honourable place
in the great hall of the Central Planning Board of the Socialist State.
No Socialist State was generous enough to follow up on this suggestion, but the University
Rudslal created a statue of Oskar Lange and preserved it into our day, surely, as a monument
to the perennity of his message. Generations of students were taught that socialism was,
in theory at least, a viable economic system. Some authors even went so far as to argue,
statistics in hand, that the Soviet economies of Eastern Europe were superior or about to
become superior to the capitalist economies of the West. See, in particular, the various
The Soviet economy is proof that, contrary to what many sceptics had earlier believed,
the socialist command economy can function and even thrive. This notion evaporated in
1989. In actual practice, market socialism had never played a big role in the Eastern
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.
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.
Incentives, needless to say Lieberman did not address, much less solve, the problems
Mises had pointed out in 1922. Mises himself commented on this newest fad of economic planning
in his observations on the Russian reform movement. The fall of the Berlin Wall opened
everyone's eyes to the stark reality that seventy years of socialism had created nothing
but misery, pollution and slavery. The world learned the hard way, what it could have learned
in 1922 from a readily available book. In socialism, Mises had analysed the idea of
market socialism even before any socialist had thought of it, and he had already identified
its achilles heel, moral hazard. Artificial markets would make managers irresponsible.
Some of the benefits of successful management would still be private – the increased reputation
and Career Advancement of Successful Managers, but all of the costs of mismanagement would
have to be borne by the citizenry at large, as a consequence the managers of the state
would take on excessive risks, they would squander society's capital.
Eighteen years later, in Natsunari Okonomi, Mises did not miss the opportunity to note
the irony that, according to this proposal, the market economy was such a bad thing that
had to be reintroduced through the back door as soon as the new socialist regime is established.
He went on to chastise the champions of artificial markets for narrow-mindedness.
The problem of the allocation of resources is not primarily a managerial problem within each plant,
it is a problem of choosing where to place available capital, which of the existing plants
should be expanded, which ones should be cut back, which new production sites should be established.
These decisions lay in the hands of capitalists, entrepreneurs and speculators, and it was
out of the question to extend the scheme of the artificial market to them.
Restating the analysis of moral hazard along the lines given in socialism, Mises argued
that playing capitalists would be completely irresponsible.
No risk would be too high for the make-believe capitalists, because they themselves would
hardly bear any negative consequences.
Such a system would be neither socialism nor capitalism. It would be no system at all.
It would be chaotic.
He then turned to the fourth scheme, according to which socialist societies should use the
equations of mathematical economics to solve the problem of economic calculation. Here
Mises restates the argument he had presented in his 1938 French language article of the
same title. Those mathematical equations describe a state of affairs that is already
in Equilibrium, but not the concrete steps through which any equilibrium could ever be
reached.
It was an error to suppose that one could calculate the equilibrium state with data
taken from an economy that is not in equilibrium.
It was another error to believe that acting man, for his present-day calculations, needs
to know the evaluations and appraisals that would obtain in the equilibrium state.
He went on to conclude that this fundamental conceptual problem made it superfluous to
The Deal with the Practical Problems of Central Planning that Pareto and Hayek had raised.
A Pure Cash Balance Approach
Natsunari Okunumi and Human Action completed the project Mises had started in 1912 with
his treatise on money. In certain crucial respects, he decisively improved upon his
earlier exposition of monetary theory. The author of Natsunari Okunumi is a better monetary
In his biographical recollections, Mises is somewhat diffident on this point. He merely
says that his work from 1940s had completed the great initial project of integrating marginal
value theory with the theory of money. Some years later he used the harsher term misstatements
to characterise the shortcomings of his early work. To a German correspondent he wrote,
You cannot avoid going astray, Entgleisungen, if you take money out of the total context of market phenomena and deal with it separately.
I have experienced this in my own case. The market process is an indivisible whole.
One cannot subdivide it into pieces. My theory of money has reached maturity only in human action.
The keystone of the mature theory concerns the central importance of the cash balance approach,
which alone would explain money prices in terms of human action, rather than in terms
of mechanistic metaphors such as the velocity of money.
Mises now stressed that the demand for money was truly a demand for cash balances. The value
of the cash balances was not simply borrowed from the value of the goods against which
they could be exchanged, this was the view he championed at least in one crucial passage
in The Theory of Money and Credit. There was an independent source of value in the services
His later theory was already present in the first edition of his Theory of Money and Credit,
but it was presented side by side with other statements taking the opposite point of view.
Mises developed the cash balance approach to the demand for money starting from Menger's
article Geld, Handwerder Buch der Staatswissenschaften. One possible source of Mises' second thoughts
on this question was a short book that Edwin Canaan had published at the end of the First
First World War, Money, its connection with rising and falling prices. In his 1942 lecture
in Mexico City, Mises stressed that the individual demand for money was, in fact, identical with
the individual's cash holdings and referred the audience to page 83 of Canaan's book.
Mises also radicalised his stance on the usefulness of expansions of the money supply. In Theory
of Money and Credit, he held that monetary expansion might be needed to accommodate greater
Growth, at least under plausible circumstances. From 1940 onward he categorically rejected
this notion. All benefits that might result from monetary expansion were now presented
as being strictly ephemeral. They had no systematic positive impact, quite to the contrary.