The Austrian Economists
Eugen Bohm-Bawerk
[From: Annals of the American Academy of
Political and Social Science, Vol.1, 1891 - Part 1 of 2]
The Editors of this magazine have requested from my pen an account of
the work of that group of economists which is popularly called the
Austrian School. Since I am myself a member of the group, possibly I
shall prove to be no impartial expositor. I will, nevertheless, comply
with the request as well as I can, and I will attempt to describe what
we Austrians are actually doing and seeking to do.
The province of the Austrian economists is theory in the strict sense
of the word. They are of the opinion that the theoretical part of
political economy needs to be thoroughly transformed. The most
important and most famous doctrines of the classical economists are
either no longer tenable at all, or are tenable only after essential
alterations and additions. In the conviction of the inadequacy of the
classical political economy, the Austrian economists and the adherents
of the historical school agree. But in regard to the final cause of
the inadequacy, there is a fundamental difference of opinion which has
led to a lively contention over methods.
The historical school believes the ultimate source of the errors of
the classical economy to be the false method by which it was pursued.
It was almost entirely abstract-deductive, and, in their opinion,
political economy should be only, or at least chiefly, inductive. In
order to accomplish the necessary reform of the science, we must
change the method of investigation; we must abandon abstraction and
set ourselves to collecting empirical material-devote ourselves to
history and statistics.
The Austrians, on the contrary, are of the opinion that the errors of
the classical economists were only, so to speak, the ordinary diseases
of the childhood of the science. Political economy is even yet one of
the youngest sciences, and it was still younger in the time of the
classical economy, which, in spite of its name "classical,"
given, as the event proved, too soon, was only an incipient, embryonic
science. It has never happened in any other case that the whole of a
science was discovered, at the first attempt, even by the greatest
genius; and so it is not surprising that the whole of political
economy was not discovered, even by the classical school. Their
greatest fault was that they were forerunners; our greatest advantage
is that we come after. We who are richer by the fruits of a century's
research than were our predecessors, need not work by different
methods, but simply work better than they. The historical school are
certainly right in holding that our theories should be supported by as
abundant empirical material as possible; but they are wrong in giving
to the work of collection an abnormal preference, and in wishing
either entirely to dispense with, or at least to push into the
background, the use of abstract generalization. Without such
generalization there can be no science at all.
Numerous works of the Austrian economists are devoted to this strife
over methods.(1*) among them the Untersuchungen uber die Methode der
Sozialwissenschaften, by C. Menger, stands first in deep and
exhaustive treatment of the problems involved. It should be noticed in
this connection that the "exact," or, as I prefer to call
it, the "isolating" method recommended by Menger, together
with the "empirico-realistic" method, is by no means purely
speculative or unempirical, but, on the contrary, seeks and always
finds its foundation in experience. But although the strife of
methods, perhaps more than anything else, has drawn attention to the
Austrian economists, I prefer to regard it as an unimportant episode
of their activity. The matter of importance to them was, and is, the
reform of positive theory. It is only because they found themselves
disturbed in their peaceful and fruitful labors by the attacks of the
historical school, that they, like the farmer on the frontier who
holds the plow with one hand and the sword with the other, have been
constrained, almost against their will, to spend part of their time
and strength in defensive polemics and in the solution of the problems
of method forced upon them.
What, now, are the peculiar features which the Austrian school
presents in the domain of positive theory?
Their researches take their direction from the theory of value, the
corner-stone being the well-known theory of final utility. This theory
can be condensed into three unusually simple propositions. The value
of goods is measured by the importance of the want whose satisfaction
is dependent upon the possession of the goods. Which satisfaction is
the dependent one can be determined very simply and infallibly by
considering which want would be unsatisfied if the goods whose value
is to be determined were not in possession. And again, it is evident
that the dependent satisfaction is not that satisfaction for the
purpose of which the goods are actually used, but it is the least
important of all the satisfactions which the total possessions of the
individual can procure. Why? Because, according to very simple and
unquestionably established prudential considerations of practical
life, we are always careful to shift to the least sensitive point an
injury to well-being which comes through loss of property. If we lose
property that has been devoted to the satisfaction of a more important
want, we do not sacrifice the satisfaction of this want, but simply
withdraw other property which had been devoted to a less important
satisfaction and put it in place of that which was lost. The loss thus
falls upon the lesser utility, or -- since we naturally give up the
least important of all our satisfactions -- upon the "final
utility."
Suppose a peasant have three sacks of corn: the first, a, for his
support; the second, b, for seed; the third, c, for fattening poultry.
Suppose sack a be destroyed by fire. Will the peasant on that account
starve? Certainly not. Or will he leave his field unsown? Certainly
not. He will simply shift the loss to the least sensitive point. He
will bake his bread from sack c, and consequently fatten no poultry.
What is, therefore, really dependent upon the burning or not burning
of sack a is only the use of the least important unit which may be
substituted for it, or, as we call it, the final utility.
As is well known, the fundamental principle of this theory of the
Austrian school is shared by certain other economists. A German
economist, Gossen, had enunciated it in a book of his which appeared
in 1854, but at that time it attracted not the slightest
attention.(2*) Somewhat later the same principle was almost
simultaneously discovered in three different countries, by three
economists who knew nothing of one another and nothing of Gossen -- by
the Englishman W.S. Jevons,(3*) by C. Menger, the founder of the
Austrian school,(4*) and by the Swiss Walras.(5*) Professor J.B.
Clark, too, an American investigator, came very near the same
idea.(6*) But the direction in which I believe the Austrians have
outstripped their rivals, is the use they have made of the fundamental
idea in the subsequent construction of economic theory. The idea of
final utility is to the expert the open sesame, as it were, by which
he unlocks the most complicated phenomena of economic life and solves
the hardest problems of the science. In this art of explication lies,
as it seems to me, the peculiar strength and the characteristic
significance of the Austrian school.
And here everything turns upon one point: we need only take the
trouble to discern the universal validity of the law of final utility
throughout the manifold complications in which it is involved in the
highly developed and varied economy of modern nations. This will cost
us at the outset some trouble, but the effort will be well rewarded.
For in the process we shall come upon all the important theoretical
questions in their order, and, what is the chief point, we shall
approach them from the side from which they appear in their most
natural form, and from which we can most easily find a solution for
them. I will attempt to make this plain for a few of the most
important cases, at least so far as it is possible to do so without
entering into details of theory.
The law of final utility rests, as we have seen, upon a peculiar
substitution of goods, due to sound prudential considerations. Those
goods which can most easily be dispensed with must always - stand
ready to fill the breach which may at any time be made at a more
important point. In the case of our peasant with the sacks of corn,
the cause and the consequence of the substitution are very easy to
understand. But in highly developed economic relations, important
complications take place, since the substitution of goods will extend
in various directions beyond the supply of goods of the same species.
The first complication is that due to exchange. If the only winter
coat I possess be stolen, I shall certainly not go shivering and
endanger my health, but I shall simply buy another winter coat with
twenty dollars which I should otherwise have spent for something else.
Of course, then, I can buy only twenty dollars' worth less of other
goods, and, of course, I shall make the retrenchment in goods which I
think I can most easily dispense with; i.e., whose utility, as in the
foregoing example, is the least; in a word, I shall dispense with the
final utility. The real thing, therefore, which is dependent upon
whether or not I lose my winter coat is the satisfactions that are
most easily dispensed with, the satisfactions which, in the given
condition of my property and income I could have procured with twenty
dollars more; and it is upon those other satisfactions. which may be
very different in nature, that, through the workings of substitution
by exchange, the loss, and with it the final utility dependent on it,
is shifted.(7*)
If we carefully follow out this complication we shall come upon one
of the most important of theoretical problems: viz., upon the relation
between the market price of given goods, and the subjective estimate
which individuals set upon those goods according to their very various
wants and inclinations on the one hand and their property and income
on the other. I will merely remark in passing that the complete
solution of this problem requires very subtle investigation, which was
first undertaken by the Austrian economists, and I will proceed to
show the results which they have obtained. According to their
conclusions, the price or "objective value" of goods is a
sort of resultant of the different subjective estimates of the goods
which the buyers and sellers make in accordance with the law of final
utility; and, indeed, the price coincides very nearly with the
estimate of the "last buyer." It is well known that Jevons
and Walras arrived at a similar law of price. Their statement,
however, has considerable deficiencies, which were first supplied by
the Austrians. It was the latter who first found the right way of
escape from the circulus vitiosus in which the older theory of price
as dependent upon supply and demand was involved. Since it was
undeniable that, on the one hand, the price which can be asked in the
market is influenced by the estimate which the buyer sets upon the
goods, but, on the other hand, it is just as undeniable that in many
cases the buyer's estimate is influenced by the state of the market
(as, for instance, the final utility of my winter coat is materially
less when I can replace it in the market for ten dollars than when it
costs me twenty dollars); the theorists who found a more exact
psychological explanation necessary for the law of supply and demand
in general,(8*) have usually allowed themselves to be beguiled into
reasoning in a circle. They more or less openly explained the price by
the estimate of the individual, and, vice versa, the estimate of the
individual by the price. Of course, such a solution is not one upon
which a science that wishes to deserve the name of a science can rest.
An attempt to get to the bottom of the matter was first made by the
Austrian economists by means of the subtle investigation of which I
have spoken above.(9*)
A second interesting and difficult complication of the substitution
of goods is due to production: viz., given a sufficient time, the
goods whose substitution is under consideration could be replaced by
production. As in the former case the goods were replaced by the use
of money, so in this case they can be replaced directly by the
conversion of materials of production. But, of course, there will be
less of these materials of production left for other purposes, and
just as surely as before the necessary diminution of production will
be shifted to that class of goods which can be most easily dispensed
with, which is considered least valuable.
Take Wieser's example:(10*) If a nation finds weapons necessary to
the defence of its honor or its existence, it will produce them from
the same iron which would otherwise have been used for other
necessary, but more or less dispensable utensils. What, therefore,
happens to the people through the necessity of procuring weapons is
that they can have only somewhat less of the most dispensable utensils
which they would have made of the iron; in other words, the loss falls
upon the least utility, or the final utility, which could have been
derived from the materials of production necessary to the manufacture
of the weapons.
From this point, again, the way leads to one of the most important
theoretical principles, which under a certain form has long been
familiar. This principle is that the value of those goods which can be
reproduced at will without hindrance shows a tendency to coincide with
the cost of production. This principle comes to light as a special
case of the law of final utility, occurring under given actual
conditions. The "cost of production" is nothing else than
the sum of all the materials of production by means of which the goods
or a substitute for the same can be reproduced. Since, then, as above
pointed out, the value of the goods is determined by the final utility
of their substitute, it follows that so far as that substitution can
be made ad libitum, the value of the product must coincide with the
final utility and value of the materials of production, or, as is
usually said, with the cost of production.
As to the final cause of this coincidence the Austrians have a theory
quite different from the older one. The older theory explained the
relation between cost and value to be such that the cost was the cause
and final cause, while the value of the product was the effect; it
supposed the scientific problem of explaining the value of goods to be
satisfactorily solved when it had appealed to cost as the "ultimate
regulator of value." The Austrians, on the contrary, believe that
herein only half, and by far the easier half, of the explanation is to
be found. The cost is identical with the value of the materials of
production necessary to the manufacture of the goods. Cost rises when
and because the materials of production (fuel, machinery, rent, labor)
rise; it falls when and because the value of the materials declines.
Hence, it is evident that the value of materials of production must
first be explained. And the interesting point is that when the
explanation is carefully carried out it leads us to see that the value
of the completed product is the cause. For without doubt we place a
high estimate upon materials of production only when and because they
are capable of furnishing valuable products. The relation of cause and
effect is, therefore, exactly the reverse of what the older theory
stated. The older theory explained the value of the product as the
effect, and the cost-that is, the value of the materials of production
-- as the cause, and thought no further explanation necessary. The
Austrian economists found: 1st, that the value of the materials of
production needs, first of all, to be explained; and, 2d, that after
this explanation is made, and after the net of complicated relations
is untangled, the value of the materials of production is seen in the
end to be the effect, and the value of the product the cause.
I know very well that this thesis will seem strange to many readers
at the first glance. I cannot here attempt to demonstrate it or even
to guard it against certain misapprehensions to which it is liable. I
will call attention to only one circumstance. In the case of certain
materials of production, whose true causal connection was for special
reasons easy to see, the old theory recognized the principle; as, for
instance, in regard to the value of the use of land, which is
expressed in rent, Adam Smith observed that the price of the products
of the soil is not high or low because rent is high or low; but, vice
versa, rent is high or low according as the price of the product is
high or low. Or again, no one supposes that copper is dear because the
stock of the mining companies is high; but obviously the value of the
mines and the stock is high when and because copper is dear. Now, just
as well might the water of one river flow up hill while that of the
river beside it flows down, as that in the case of different sorts of
materials of production the causal connections should run in opposite
directions. The law is one and the same for all materials of
production. The difference is only that in case of certain materials
the true relation of cause and effect is very easy to see, while in
others, owing to manifold obscuring complications, it is very hard to
see. The establishment of the law for those cases also, when deceptive
appearances had led to the opposite explanation, is one of the most
important contributions of the Austrian, school.
Perhaps it is the most important of all. Every political economist
knows what a vast part cost of production plays in the theory of
political economy-in the theory of production no less than in that of
value and price, and in this no less than in that of distribution,
rent, wages, profit on capital, international trade, etc. It is safe
to say that there is not one important phenomenon of economic life for
the explanation of which we are not compelled either directly or
indirectly to appeal to cost of production. And here rises the
question which having once been thrown into the world is no more to be
put out of it: What place does this much appealed - to cost properly
hold in the system of phenomena and their explanation? Does it play
the part of a centre about which as a fixed and absolute middle point
all the other phenomena of value turn? Or is cost, the value of
materials of production, in spite of all contradictory appearances,
the variable part, determined by the value of the product?
That is a question as fundamental for political economy as the
question between the Ptolemaic and Copernican systems was for
astronomy. The sun and earth turn, as every child knows, but one
cannot be much of an astronomer to-day without knowing whether the
earth turns about the sun or the sun about the earth. Between the
value of the product and the value of the materials of production
there exists a no less obvious and indubitable relation. But whoever
wishes to understand this relation and the countless phenomena that
depend upon it must know whether the value of the materials of
production is derived from the value of the product or the reverse.
From the first instant when this alternative comes into view in
discussion everyone who wishes to be an economist must have an
opinion, and a definite opinion. An eclectic vacillation, such as up
to this time has been almost universal, will not do. In a scientific
system we cannot have the earth turning about the sun and the sun
turning about the earth alternately. Whoever, therefore, to-day wishes
to contend that the cost of production is "the ultimate regulator
of value" may continue to do so; but he will not find his task so
easy as it has been heretofore. We shall justly expect him to attempt
to explain to the bottom, with out deficiency or contradiction, in
accordance with his principle, the phenomena of value, and especially
the value of materials of production. Probably, if he takes his task
seriously, he will come upon difficulties. If he does not find them
himself he must at least take account of those which others have met
in the same path, by which they have finally been compelled to attempt
the explanation of phenomena of value according to the opposite
principle. At any rate, this part of economic theory will in future be
treated with a considerably greater degree of care and scientific
profundity than has before now been customary, unless our science wish
to deserve the reproach which has both in former and later days been
so often cast upon it; that it is more a babbling over economic
matters than a real, earnest science.(11*)
The question of the relation of cost to value is properly only a
concrete form of a much more general question -- the question of the
regular relations between the values of such goods as in causal
interdependence contribute to one and the same utility for our
well-being. The utility furnished by a quantity of materials from
which a coat can be produced is apparently identical with the utility
which the completed coat will furnish. It is thus obvious that goods
or groups of goods which derive their importance to our welfare
through the medium of one and the same utility must also stand in some
fixed, regular relation to one another in respect to their value. The
question of this regular relation was first put into clear and
comprehensive form by the Austrian economists; it had previously been
treated only in a very unsatisfactory manner under the head of "cost
of production." There is, however, a corollary to this general
and important proposition which is not less important and interesting,
but which has hitherto never received the modest degree of attention
in economic theory which has been bestowed upon the problem of cost.
Very commonly several goods combine simultaneously to the production
of one common utility; for example, paper, pen, and ink serve together
for writing; needle and thread for sewing; farming utensils, seed,
land and labor for the production of grain. Menger has called goods
that stand in such relation to one another "complementary goods."
Here rises the question, as natural as it is difficult: How much of
the common utility is in such cases to be attributed to each of the
cooperative complementary factors? and what law determines the
proportionate value and price of each?
The fate of this problem hitherto has been very remarkable. The older
theory did not rank it as a general problem at all, but was
nevertheless compelled to decide a series of concrete cases which
depended implicitly upon that problem. The question of the
distribution of property especially gave occasion for such decisions.
Since several factors of production -- soil, capital, hired labor, and
labor of the employer himself -- cooperate in the production of a
common product, the question as to what share of value shall be
assigned to each of the factors, in compensation for its assistance,
is obviously a special case of the general problem.
Now, how were these concrete cases decided? Each one was decided by
itself without regard to the others, and hence, eventually, they
formed a complete circle. The process was as follows: If rent was to
be explained, it was decided that to the soil belonged the remainder
of the product after the payment of cost of production, under which
term was included the compensation of all the other factors --
capital, labor, and profit of manager. Here the function of all the
other factors was regarded as fixed or known and the soil was put off
with a remainder varying according to the quantity of the product. If
then it was necessary in another chapter to determine the profits of
the entrepreneur, it was decided again that to him should be given the
overplus left after all the other factors were compensated. In this
case the share of the soil, the rent, was reckoned along with labor,
capital, etc., as fixed, and the entrepreneur's profit was treated as
the variable, rising and falling with the quantity of the product. In
just the same manner the share of capital was treated in a third
chapter. The capitalist, says Ricardo, receives what is left from the
product after the payment of wages. And as if to satirize all these
classical dogmas, last of all, Mr F.A. Walker has completed the circle
by stating that the laborer receives what is left over from all the
other factors.
It is easy to see that these statements lead in a circle, and to see,
also, why they so lead. The reasoners have simply neglected to state
the problem in a general form. They had several unknown quantities to
determine, and instead of taking the bull by the horns and straightway
inquiring after the general principle, according to which a common
economic result should be divided into its component factors, they
tried to avoid the fundamental question -- that of the general
principle. They divided up the investigation, and in this partial
investigation allowed themselves each time to treat as unknown that
one of the unknown quantities which formed the special object of the
investigation, but to treat the others, for the time being, as if
known. They thus shut their eyes to the fact that a few pages earlier
or later they had reversed the operation and had treated the supposed
known quantity as unknown, the unknown as known.
Part
2
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