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NOTE 6. Time is Money: The Austrian Theory of Capital and Interest

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Chapter 6. Time is Money. The Austrian Theory of Capital and Interest.

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The up-and-coming Austrian school received support from abroad even during the Metodenstreit.

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Leon Walras mentioned already well-known supporters of the new value theory from among the Romance

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countries in the preface to his Théorie de la Monnaie, 1886. In English publications

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as the subjectivist theory of value was gaining increased acceptance as well. The fact alone

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that it had been discovered at almost the same time by three authors, Walras, Menger

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and Jevons, was considered by Boehm-Bawerk to be substantive evidence of its veracity.

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In contrast, Gustav Korn, 1840-1919, an advocate of the historical school, interpreted this

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This brisk publishing activity to mean that the discovery of the marginal utility constituted

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a meagre morsel that would have to be shared by a number of like-minded discoverers. Yet

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within months the derisive phrase meagre morsel was impressively refuted. In 1889 alone, members

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of the Austrian School published a notable number of monographs offering productive suggestions

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for Further Development, Boehm-Bawerk, Positive Theory des Kapitals, Positive Theory of Capital,

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Zuckerkandel, Zur Theorie des Preises on the Theory of Price, Wieser, der Natürliche Wert,

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Natural Value, Schulen zu Schattenhofen, Untersuchungen über Begriff und Wesen der Grundrente, Analyses

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of the Concept and the Essence of the Ground Rent, Sachs, Neuester Fortschritte in der

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The Nationalökonomische Theorie, Recent Advancements in the Theory of Economics, and Kommerzinski,

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Der Wert in der Isolierten Wirtschaft, The Value in the Isolated Economy, Boehm-Bawerk

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achieved the most lasting impact by far. With his positive theory, he not only laid the foundations

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for an Austrian theory of capital and interest, but made a critical contribution to the international

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During a seminar led by Carl Gustav Adolf Knies, 1821-1898, at the University of Heidelberg,

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Boehm-Bawerk, as a scholarship recipient, had already thoroughly considered the relationship

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between the present and the future by posing the question, why is a debtor prepared to

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Pay the creditor interest for a loan on top of paying back the amount of the loan itself.

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He answered this by explaining that future goods have a lower value than present goods,

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and the result is a difference in value between the present and the future, between loan and

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repayment. Payment and return are deemed equivalent when the difference in value has been balanced

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by a quantitative plus, namely interest. Without specifying further, he argued that a self-induced

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creation of capital value would make repayment of such amounts economically feasible for

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a debtor. The publication of Positive Theory was preceded by a wide-ranging, virtually

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complete collection and appraisal of all the established theories of capital and interest.

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Boehm-Bawerk dealt with more than 150 authors and laid out an exemplary history of dogma

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whose structure suggests that he had already put together a complete draft of positive theory.

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Die Geschichte und Kritik der Kapitalzinstheorien, History and Critique of Theories of Interest,

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1884, would give the further development of the Austrian School direction in two ways

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in particular. First, Boehm-Bawerk subjected the socialist labour theories of value by

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by Johann Karl Robertus 1805-1875 and Karl Marx 1818-1883 to a detailed and consistently

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deprecatory criticism, thus laying the foundation for the critique of Marxism in the Austrian

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School's tradition. Second, he dismissed Carl Menger's utility theory, according to

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which capital rent is the remuneration for the hired use of capital. Boehm-Bawerk's objection

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was that Menger considered a good and the disposal over goods to be two separate value

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repositories and would lead to an incorrect double count. This was simply the logical

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outcome of his definition of the term good which differed from Menger's and which Boehm-Bawerk

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had already presented in his revised postdoctoral thesis. This divergence and its consequences

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resulted in the founder of the Austrian schools taking a detached view of its definitive theory

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Theory of Capital and Interest Throughout His Life

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In his Positive Theory, the publication of which was held up for years, Boehm-Bawerk defined

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capital as a group of products destined to serve to its further production or as a group

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of intermediate products.

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Based on this notion of capital, three kinds of capital yield were conceivable – revenue

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from a loan, revenue from renting out a durable good, or revenue from a production process.

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All three types of revenue could ultimately be explained by the subjectivist value theory.

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The starting point had been the observation that in general, present goods were valued

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more highly than future goods of equal kind and number.

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Two reasons can be cited first. The ratio between demand and supply varies at different

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points in time, because personal circumstances and future expectations are constantly changing.

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Second, we systematically underrate our future needs, as well as the means to meet them.

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The causes of this misjudgment are our hazy picture of the future, our weakness of will,

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and our consideration of the brevity and incertitude of life.

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Boehm-Bawerk concluded from all this that we look at the marginal utility of future

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goods diminished, as it were, in perspective, and that thus the aegio on present goods moves

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There is a third reason for the upward pressure on this Arjo premium, however, which does

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not reside in the sphere of the consumer but in that of the producer. According to Boehm-Bawerk,

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it is in the nature of capitalist production that the elementary economic productive forces

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– labour and land use, possibly also in combination with natural forces – are combined

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in such a way that consumer goods are created either directly or indirectly. As a general

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School, such indirect production would also lead to a greater result in output. Thus,

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one could use nothing but one's hands to break stones out of a rock face, or one could

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first extract iron, then use it to make hammer and chisel, and then get to work. An even

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greater and more time-consuming form of indirect production would be to take sulphur and sodium

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nitrate to manufacture gunpowder, fill it into drilled holes and thus blast out the

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Books. An operation like this would increase the result in output many times over. However,

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this rule would only apply for a wisely chosen capitalist process. With increasing diversity

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in production, the additional revenue would then decrease again after a certain point.

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Boehm-Bawerk borrowed the concept of productive diversion and its additional revenue from

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a number of predecessors whose ideas he developed and formulated more stringently. Later it

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It would turn out that John Ray, 1796-1872, a Scotsman who had emigrated to Canada and

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fallen into oblivion, had already preempted the positive theory on key points in 1834.

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Interest according to Boehm-Bawerk thus had psychological and productive technical causes.

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It also exists independently of the prevailing economic and social system. A difference in

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Human value would exist between present and future goods even in a socialist state. The

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interest principle can therefore in no way be conceived as exploitation because it is

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not a historico-legal category but an economic category which springs from elementary economic

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causes. Boehm-Bawerk, who considered the basic principles of his theory of capital and interest

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to be unusually simple and natural. Had to supplement and expand his work considerably

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in order to combine the subjectivist value theory with his capital theory. He thus made

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a clear distinction between the reasons for the origin of interest and those which were

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responsible for this specific interest rate. Furthermore, as he had combined heterogeneous

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intermediate products and their variously long indirect production paths under the term

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The Theory of Money and Credit

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Production Costs. These and other additions meant that the basically elegant theoretical

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structure appeared more and more contrived and overburdened. Nevertheless, Boehm-Bawerk's

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positive theory had an enormous impact internationally. It was translated into English as early as

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1891, and into French soon afterward. In 1892, Swedish economist Knut Wichsel, 1851-1926,

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saw to its mathematical reformulation.

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By the turn of the century, Boehm-Bawerk was counted among the world's most famous and

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talked about economists.

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A second edition was published in 1900, and it contained a heftily expanded criticism

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of Marx.

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A third was published in 1913.

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Both editions included excursuses in which responses were given to objections that had

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been raised.

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Finally, Friedrich von Mises arranged for a fourth publication in 1921, a complete edition

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in three volumes that was to be published under the title Kapital und Kapitalzins, Capital

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and Interest. Menger, whose notion of capital fundamentally differed from Boehm-Bawerk's,

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took up an extremely critical stance. In small circles he even went so far as to call Boehm-Bawerk's

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Theory, one of the greatest errors ever committed. There has been much speculation as to what

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might have led to Menger's stern rejection. It could hardly have been Boehm-Bawerk's

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insufficiently consistent subjectivism, as even Menger's definitions of value theory

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contained some residual objectivism. A distinctive dividing line, however, were their differing

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methodological approaches. Menger took Boehm-Bawerk to task for the obvious artificiality of

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Of some of his theories, Boehm-Bawerk did indeed demonstrate an almost unconcerned pragmatic

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eclectic attitude when it came to methodological questions. Characteristic of this attitude

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was his rejection of the use of mathematics in economics. This was not for fundamental

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epistemological reasons, as was the case with Menger, but because he, along with most of

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his faculty colleagues, utterly lacked the necessary mathematical skills. Furthermore,

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The theory seems in some respects to point in the direction of modern macroeconomics.

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Unlike other key works of the Austrians, it contains an unmistakable tendency to create

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highly abstract aggregates, and demonstrates a hearty propensity to quantify, albeit in

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the modest guise of simple forms of calculation.

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Boehm-Bawerk's theory was also met with reservation or even rejection by the successive

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of Generations of the Austrian School, the 28-year-old Josef R. Schumpeter, 1883-1953,

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developed his own dynamic theory of interest, which must have appeared to Boehm-Bawerk as

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a defamation of middle-class economic morality and a heralding of inflationist daredevil

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policies. Boehm-Bawerk rejected it with rare forcefulness. Schumpeter's response was accordingly

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In the context of Boehm-Bawerk's seminars, Ludwig von Mises, 1881-1973, also made the criticism that his theory of capital and interest had proceeded on the assumption of a neutrality of money. According to Mises, Boehm-Bawerk moved far beyond his published theories by the end of his life.

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It was finally Emil Sachs who in Der Kapitalzins, 1916, Interest on Capital, presented the first

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comprehensive critique of Boehm-Bawerk and compiled all of the arguments that future authors would

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raise against him. Boehm-Bawerk's theory of capital and interest was a chain of thought

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too elaborately spun out and owing to its unevenness unable to withstand a tensile test.

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Above all Sachs believed he could prove that each of the three reasons for a value difference

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The difference between present and future goods was questionable. The durable goods, fixed capital, as such, could not yield any interest, but the term average roundabout production process,

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durchschnittlicher Produktionsumweg, was too indeterminate, and that the positive theory did not account for compound interest.

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Thus, der Kapitalzins documented just another step in the drifting apart of the Austrian School at the height of its international eminence.

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external events, such as Menger's permanent withdrawal from university activity, Boehm-Bawerk's death in 1914, and the outbreak of the war, however, scarcely allowed this internal split to come to the surface.

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In the last analysis, no economist of note agreed with Boehm-Bawerk on every point, but for decades his work continued to have an unusually inspiring and fruitful impact.

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Act.

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Among the representatives of the Austrian School, Boehm-Bawerk was always revered as

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one of the greats.

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The generation of academics who came after the First World War felt compelled to qualify

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his work and make manifold changes or other shifts in emphasis, but this did little or

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no harm to the remarkable fascination with which Boehm-Bawerk's theory of capital and

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interest is treated to this very day.

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This undiminished appeal might be due to the fact that Boehm-Bawerk's monumental theory

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reveals a glimpse of the hidden logic or the grammar of economic phenomena.