An apparent verification of these errors was seen in the experience of the socialist governments of Soviet Russia and Nazi Germany. People do not realize that these were not isolated socialist systems. They were operating in an environment in which the price system still worked. They could resort to economic calculation on the ground of the prices established abroad. Without the aid of these prices their actions would have been aimless and planless. Only because they were able to refer to these foreign prices were they able to calculate, to keep books, and to prepare their much talked about plans.
The socialist tracts deal with everything except the essential and unique problem of socialism, viz., economic calculation. It is only in the last years that socialist writers have no longer been able to avoid paying attention to this primordial matter. They have begun to suspect that the Marxian technique of smearing “bourgeois” economics is not a sufficient method for the realization of the socialist utopia. They have tried to substitute a theory of socialism for the scurrilous Hegelian metaphysics of the Marxian doctrine. They have embarked upon designing schemes for socialist economic calculation. Of course, they have lamentably failed in this task. It would hardly be necessary to deal with their spurious suggestions were it not for the fact that such examination offers a good opportunity to bring into relief fundamental features both of the market society and of the imaginary construction of a nonmarket society.
The various schemes proposed can be classified in the following way:
1. Calculation in kind is to be substituted for calculation in terms of money. This method is worthless. One cannot add or subtract numbers of different kinds (heterogeneous quantities). 6
2. Starting from the ideas of the labor theory of value, the labor-hour is recommended as the unit of calculation. This suggestion does not take into account the original material factors of production and ignores the different qualities of work accomplished in the various labor-hours worked by the same and by different people.
3. The unit is to be a “quantity” of utility. However, acting man does not measure utility. He arranges it in scales of gradation. Market prices are not expressive of equivalence, but of a divergence in the valuation of the two exchanging parties. It is impermissible to neglect the fundamental theorem of modern economics, namely, that the value attached to one unit of a supply of n -1 units is greater than that attached to one unit of a supply of n units.
4. Calculation is to be made possible by the establishment of an artificial quasi-market. This scheme is dealt with in section 5 of this chapter.
5. Calculation is to be made with the aid of the differential equations of mathematical catallactics. This scheme is dealt with in section 6 of this chapter.
6. Calculation is to be made superfluous by resorting to the method of trial and error. This idea is dealt with in section 4 of this chapter.
The entrepreneurs and capitalists do not have advance assurance about whether their plans are the most appropriate solution for the allocation of factors of production to the various branches of industry. It is only later experience that shows them after the event whether they were right or wrong in their enterprises and investments. The method they apply is the method of trial and error. Why, say some socialists, should not the socialist director resort to the same method?
The method of trial and error is applicable in all cases in which the correct solution is recognizable as such by unmistakable marks not dependent on the method of trial and error itself. If a man mislays his wallet, he may hunt for it in various places. If he finds it, he recognizes it as his property; there is no doubt about the success of the method of trial and error applied; he has solved his problem. When Ehrlich was looking for a remedy for syphilis, he tested hundreds of drugs until he found what he was searching for, a drug that killed the spirochetes without damaging the human body. The mark of the correct solution, the drug number 606, was that it combined these two qualities, as could be learned from laboratory experiment and from clinical experience.
Things are quite different if the only mark of the correct solution is that it has been reached by the application of a method considered appropriate for the solution of the problem. The correct result of a multiplication of two factors is recognizable only as the result of a correct application of the process indicated by arithmetic. One may try to guess the correct result by trial and error. But here the method of trial and error is no substitute for the arithmetical process. It would be quite futile if the arithmetical process did not provide a yardstick for discriminating what is incorrect from what is correct.
If one wants to call entrepreneurial action an application of the method of trial and error, one must not forget that the correct solution is easily recognizable as such; it is the emergence of a surplus of proceeds over costs. Profit tells the entrepreneur that the consumers approve of his ventures; loss, that they disapprove.
The problem of socialist economic calculation is precisely this: that in the absence of market prices for the factors of production, a computation of profit or loss is not feasible.
We may assume that in the socialist commonwealth there is a market for consumers’ goods and that money prices for consumers’ goods are determined on this market. We may assume that the director assigns periodically to every member a certain amount of money and sells the consumers’ goods to those bidding the highest prices. Or we may as well assume that a certain portion of the various consumers’ goods in kind is allotted to each member and that the members are free to exchange these goods against other goods on a market in which the transactions are effected through a common medium of exchange, a sort of money. But the characteristic mark of the socialist system is that the producers’ goods are controlled by one agency only in whose name the director acts, that they are neither bought nor sold, and that there are no prices for them. Thus there cannot be any question of comparing input and output by the methods of arithmetic.
We do not assert that the capitalist mode of economic calculation guarantees the absolutely best solution of the allocation of factors of production. Such absolutely perfect solutions of any problem are out of reach of mortal men. What the operation of a market not sabotaged by the interference of compulsion and coercion can bring about is merely the best solution accessible to the human mind under the given state of technological knowledge and the intellectual abilities of the age’s shrewdest men. As soon as any man discovers a discrepancy between the real state of production and a realizable better 7 state, the profit motive pushes him toward the utmost effort to realize his plans. The sale of his products will show whether he was right or wrong in his anticipations. The market daily tries the entrepreneurs anew and eliminates those who cannot stand the test. It tends to entrust the conduct of business affairs to those men who have succeeded in filling the most urgent wants of the consumers. This is the only important respect in which one can call the market economy a system of trial and error.
The distinctive mark of socialism is the oneness and indivisibility of the will directing all production activities within the whole social system. When the socialists declare that “order” and “organization” are to be substituted for the “anarchy” of production, conscious action for the alleged planlessness of capitalism, true cooperation for competition, production for use for production for profit, what they have in mind is always the substitution of the exclusive and monopolistic power of only one agency for the infinite multitude of the plans of the individual consumers and those attending to the wishes of the consumers, the entrepreneurs and capitalists. The essence of socialism is the entire elimination of the market and of catallactic competition. The socialist system is a system without a market and market prices for the factors of production and without competition; it means the unrestricted centralization and unification of the conduct of all affairs in the hands of one authority. In the drafting of the unique plan that directs all economic activities the citizens cooperate, if at all, only by electing the director or the board of directors. For the rest they are only subordinates, bound to obey unconditionally the orders issued by the director, and wards of whose well-being the director takes care. All the excellences the socialists ascribe to socialism and all the blessings they expect from its realization are described as the necessary outcome of this absolute unification and centralization.
It is therefore nothing short of a full acknowledgment of the correctness and irrefutability of the economists’ analysis and devastating critique of the socialists’ plans that the intellectual leaders of socialism are now busy designing schemes for a socialist system in which the market, market prices for the factors of production, and catallactic competition are to be preserved. The overwhelmingly rapid triumph of the demonstration that no economic calculation is possible under a socialist system is without precedent indeed in the history of human thought. The socialists cannot help admitting their crushing final defeat. They no longer claim that socialism is matchlessly superior to capitalism because it brushes away markets, market prices, and competition. On the contrary. They are now eager to justify socialism by pointing out that it is possible to preserve these institutions even under socialism. They are drafting outlines for a socialism in which there are prices and competition. 8
What these neosocialists suggest is really paradoxical. They want to abolish private control of the means of production, market exchange, market prices, and competition. But at the same time they want to organize the socialist utopia in such a way that people could act as if these things were still present. They want people to play market as children play war, railroad, or school. They do not comprehend how such childish play differs from the real thing it tries to imitate.
It was, say these neosocialists, a serious mistake on the part of the older socialists (i.e., of all socialists before 1920) to believe that socialism necessarily requires the abolition of the market and of market exchange and even that this fact is both the essential element and the preeminent feature of a socialist economy. This idea is, as they reluctantly admit, preposterous and its realization would result in a chaotic muddle. But fortunately, they say, there is a better pattern for socialism available. It is possible to instruct the managers of the various production units to conduct the affairs of their unit in the same way they did under capitalism. The manager of a corporation operates in the market society not on his account and at his own peril, but for the benefit of the corporation, i.e., the shareholders. He will go on under socialism in the same way with the same care and attention. The only difference will consist in the fact that the fruits of his endeavors will enrich the whole society, not the shareholders. For the rest he will buy and sell, recruit and pay workers, and try to make profits in the same way he did before. The transition from the managerial system of mature capitalism to the managerial system of the planned socialist commonwealth will be smoothly effected. Nothing will change except the ownership of the capital invested. Society will be substituted for the shareholders, the people will henceforth pocket the dividends. That is all.
The cardinal fallacy implied in this and all kindred proposals is that they look at the economic problem from the perspective of the subaltern clerk whose intellectual horizon does not extend beyond subordinate tasks. They consider the structure of industrial production and the allocation of capital to the various branches and production aggregates as rigid, and do not take into account the necessity of altering this structure in order to adjust it to changes in conditions. What they have in mind is a world in which no further changes occur and economic history has reached its final stage. They fail to realize that the operations of the corporate officers consist merely in the loyal execution of the tasks entrusted to them by their bosses, the shareholders, and that in performing the orders received they are forced to adjust themselves to the structure of the market prices, ultimately determined by factors other than the various managerial operations. The operations of the managers, their buying and selling, are only a small segment of the totality of market operations. The market of the capitalist society also performs all those operations which allocate the capital goods to the various branches of industry. The entrepreneurs and capitalists establish corporations and other firms, enlarge or reduce their size, dissolve them or merge them with other enterprises; they buy and sell the shares and bonds of already existing and of new corporations; they grant, withdraw, and recover credits; in short they perform all those acts the totality of which is called the capital and money market. It is these financial transactions of promoters and speculators that direct production into those channels in which it satisfies the most urgent wants of the consumers in the best possible way. These transactions constitute the market as such. If one eliminates them, one does not preserve any part of the market. What remains is a fragment that cannot exist alone and cannot function as a market.
The role that the loyal corporation manager plays in the conduct of business is much more modest than the authors of these plans assume. His is only a managerial function, a subsidiary assistance granted to the entrepreneurs and capitalists, which refers only to subordinate tasks. It can never become a substitute for the entrepreneurial function. 9 The speculators, promoters, investors and moneylenders, in determining the structure of the stock and commodity exchanges and of the money market, circumscribe the orbit within which definite minor tasks can be entrusted to the manager’s discretion. In attending to these tasks the manager must adjust his procedures to the structure of the market created by factors which go far beyond the managerial functions.
Our problem does not refer to the managerial activities; it concerns the allocation of capital to the various branches of industry. The question is: In which branches should production be increased or restricted, in which branches should the objective of production be altered, what new branches should be inaugurated? With regard to these issues it is vain to cite the honest corporation manager and his well-tried efficiency. Those who confuse entrepreneurship and management close their eyes to the economic problem. In labor disputes the parties are not management and labor, but entrepreneurship (or capital) and the salaried and wage-receiving employees. The capitalist system is not a managerial system; it is an entrepreneurial system. One does not detract from the merits of corporation managers if one establishes the fact that it is not their conduct that determines the allocation of the factors of production to the various lines of industry.
Nobody has ever suggested that the socialist commonwealth could invite the promoters and speculators to continue their speculations and then deliver their profits to the common chest. Those suggesting a quasi-market for the socialist system have never wanted to preserve the stock and commodity exchanges, the trading in futures, and the bankers and moneylenders as quasi-institutions. One cannot play speculation and investment. The speculators and investors expose their own wealth, their own destiny. This fact makes them responsible to the consumers, the ultimate bosses of the capitalist economy. If one relieves them of this responsibility, one deprives them of their very character. They are no longer businessmen, but just a group of men to whom the director has handed over his main task, the supreme direction of the conduct of affairs. Then they—and not the nominal director—become the true directors and have to face the same problem the nominal director could not solve: the problem of calculation.
In recognition of the fact that such an idea would be simply nonsensical, the advocates of the quasi-market plan sometimes vaguely recommend another way out. The director should act as a bank lending the available funds to the highest bidder. This again is an abortive idea. All those who can bid for these funds have, as is self-evident in a socialist order of society, no property of their own. In bidding they are not restrained by any financial dangers they themselves run in promising too high a rate of interest for the funds borrowed. They do not in the least alleviate the burden of responsibility incumbent upon the director. The insecurity of the funds lent to them is in no way restricted by the partial guarantee which the borrower’s own means provide in credit transactions under capitalism. All the hazards of this insecurity fall only upon society, the exclusive owner of all resources available. If the director were without hesitation to allocate the funds available to those who bid most, he would simply put a premium upon audacity, carelessness, and unreasonable optimism. He would abdicate in favor of the least scrupulous visionaries or scoundrels. He must reserve to himself the decision on how society’s funds should be utilized. But then we are back again where we started: the director, in his endeavors to direct production activities, is not aided by the division of intellectual labor which under capitalism provides a practicable method for economic calculation. 10
The employment of the means of production can be controlled either by private owners or by the social apparatus of coercion and compulsion. In the first case there is a market, there are market prices for all factors of production, and economic calculation is possible. In the second case all these things are absent. It is vain to comfort oneself with the hope that the organs of the collective economy will be “omnipresent” and “omniscient.” 11 We do not deal in praxeology with the acts of the omnipresent and omniscient Deity, but with the actions of men endowed with a human mind only. Such a mind cannot plan without economic calculation.
A socialist system with a market and market prices is as self-contradictory as is the notion of a triangular square. Production is directed either by profit-seeking businessmen or by the decisions of a director to whom supreme and exclusive power is entrusted. There are produced either those things from the sale of which the entrepreneurs expect the highest profits or those things which the director wants to be produced. The question is: Who should be master, the consumers or the director? With whom should the ultimate decision rest whether a concrete supply of factors of production should be employed for the production of the consumers’ good a or the consumers’ good b? Such a question does not allow of any evasive answer. It must be answered in a straightforward and unambiguous way. 12
In order to appraise adequately the idea that the differential equations of mathematical economics could be utilized for socialist economic calculation, we must remember what these equations really mean.
In devising the imaginary construction of an evenly rotating economy we assume that all the factors of production are employed in such a way that each of them renders the most highly valued services it can possibly render. No further change in the employment of any of these factors could improve the state of want-satisfaction under prevailing conditions. This situation, in which no further changes in the disposition of the factors of production are resorted to, is described by systems of differential equations. However, these equations do not provide any information about the human actions by means of which the hypothetical state of equilibrium has been reached. All they say is this: If, in this state of static equilibrium, m units of a are employed for the production of p, and n units of a for the production of q, no further change in the employment of the available units of a could result in an increment in want-satisfaction. (Even if we assume that a is perfectly divisible and take the unit of a as infinitesimal, it would be a serious blunder to assert that the marginal utility of a is the same in both employments.)
This state of equilibrium is a purely imaginary construction. In a changing world it can never be realized. It differs from today’s state as well as from any other realizable state of affairs.
In the market economy it is entrepreneurial action that again and again reshuffles exchange ratios and the allocation of the factors of production. An enterprising man discovers a discrepancy between the prices of the complementary factors of production and the future prices of the products as he anticipates them, and tries to take advantage of this discrepancy for his own profit. The future price which he has in mind is, to be sure, not the hypothetical equilibrium price. No actor has anything to do with equilibrium and equilibrium prices; these notions are foreign to real life and action; they are auxiliary tools of praxeological reasoning for which there is no mental means to conceive the ceaseless restlessness of action other than to contrast it with the notion of perfect quiet. For the theorists’ reasoning every change is a step forward on a road which, provided no further new data appear, finally leads to a state of equilibrium. Neither the theorists, nor the capitalists and entrepreneurs, nor the consumers, are in a position to form, on the ground of their familiarity with present conditions, an opinion about the height of such an equilibrium price. There is no need for such an opinion. What impels a man toward change and innovation is not the vision of equilibrium prices, but the anticipation of the height of the prices of a limited number of articles as they will prevail on the market on the date at which he plans to sell. What the entrepreneur, in embarking upon a definite project, has in mind is only the first steps of a transformation which, provided no changes in the data occur other than those induced by his project, would result in establishing the state of equilibrium.
But for a utilization of the equations describing the state of equilibrium, a knowledge of the gradation of the values of consumers’ goods in this state of equilibrium is required. This gradation is one of the elements of these equations assumed as known. Yet the director knows only his present valuations, not also his valuations under the hypothetical state of equilibrium. He believes that, with regard to his present valuations, the allocation of the factors of production is unsatisfactory and wants to change it. But he knows nothing about how he himself will value on the day the equilibrium will be reached. These valuations will reflect the conditions resulting from the successive changes in production he himself inaugurates.
We call the present day D 1 and the day the equilibrium will be established D n . Accordingly we name the following magnitudes corresponding to these two days: the scale of valuation of the goods of the first order V 1 and V n , the total supply 13 of all original factors of production O 1 and O n , the total supply of all produced factors of production P 1 and P n , and summarize O 1 + P 1 as M 1 and O n + P n as M n . Finally we call the state of technological knowledge, T 1 and T n . For the solution of the equations a knowledge of V n , O n + P n = M n , and T n is required. But what we know today is merely V 1 , O 1 + P 1 = M 1 , and T 1 .
It would be impermissible to assume that these magnitudes for D 1 are equal to those for D n because the state of equilibrium cannot be attained if further changes in the data occur. The absence of further changes in the data which is the condition required for the establishment of equilibrium refers only to such changes as could derange the adjustment of conditions to the operation of those elements which are already operating today. The system cannot attain the state of equilibrium if new elements, penetrating from without, divert it from those movements which tend toward the establishment of equilibrium. 14 But as long as the equilibrium is not yet attained, the system is in a continuous movement which changes the data. The tendency toward the establishment of equilibrium, not interrupted by the emergence of any changes in the data coming from without, is in itself a succession of changes in the data.
P 1 is a set of magnitudes that do not correspond to today’s valuations. It is the outcome of actions which were guided by past valuations and faced a state of technological knowledge and of information about available resources of primary factors of production which was different from the present state. One of the reasons why the system is not in equilibrium is precisely the fact that P 1 is not adjusted to present conditions. There are plants, tools, and supplies of other factors of production which would not exist under equilibrium, and other plants, tools, and supplies must be produced in order to establish equilibrium. Equilibrium will emerge only when these disturbing parts of P 1 , as far as they are still utilizable, will be worn out and replaced by items which correspond to the state of the other synchronous data, viz., V , O , and T . What acting man needs to know is not the state of affairs under equilibrium, but information about the most appropriate method of transforming, by successive steps, P 1 into P n . With regard to this task the equations are useless.
One cannot master these problems by eliminating P and relying only upon O . It is true that the mode of utilizing the original factors of production uniquely determines the quality and quantity of the produced factors of production, the intermediary products. But the information that could be won in this way refers only to the conditions of equilibrium. It does not tell us anything about the methods and procedures to be resorted to for the realization of equilibrium. Today we are confronted with a supply of P 1 which differs from the state of equilibrium. We must take into account real conditions, i.e., P 1 , and not the hypothetical conditions of P n .
This hypothetical future state of equilibrium will appear when all methods of production have been adjusted to the valuations of the actors and to the state of technological knowledge. Then one will work in the most appropriate locations with the most adequate technological methods. Today’s economy is different. It operates with other means which do not correspond to the equilibrium state and cannot be taken into account in a system of equations describing this state in mathematical symbols. The knowledge of conditions which will prevail under equilibrium is useless for the director whose task it is to act today under present conditions. What he must learn is how to proceed in the most economical way with the means available today which are the inheritance of an age with different valuations, a different technological knowledge, and different information about problems of location. He must know which step is the next he must make. In this dilemma the equations provide no help.
Let us assume that an isolated country whose economic conditions are those of Central Europe in the middle of the nineteenth century is ruled by a dictator who is perfectly familiar with the American technology of our day. This director knows by and large to what goal he should lead the economy of the country entrusted to his care. Yet even a full knowledge of today’s American conditions could not be of use to him in regard to the problem of transforming by successive steps, in the most appropriate and expedient way, the given economic system into the system aimed at.
Even if, for the sake of argument, we assume that a miraculous inspiration has enabled the director without economic calculation to solve all problems concerning the most advantageous arrangement of all production activities and that the precise image of the final goal he must aim at is present to his mind, there remain essential problems which cannot be dealt with without economic calculation. For the director’s task is not to begin from the very bottom of civilization and to start economic history from scratch. The elements with the aid of which he must operate are not only natural resources untouched by previous utilization. There are also the capital goods produced in the past and not convertible or not perfectly convertible for new projects. It is in precisely these artifacts, produced under a constellation in which valuations, technological knowledge and many other things were different from what they are today, that our wealth is embodied. Their structure, quality, quantity, and location is of primary importance in the choice of all further economic operations. Some of them may be absolutely useless for any further employment; they must remain “unused capacity.” But the greater part of them must be utilized if we do not want to start anew from the extreme poverty and destitution of primitive man and want to survive the period which separates us from the day on which the reconstruction of the apparatus of production according to the new plans will be accomplished. The director cannot merely erect a new construction without bothering about his wards’ fate in the waiting period. He must try to take advantage of every piece of the already available capital goods in the best possible way.
Not only the technocrats, but socialists of all shades of opinion, repeat again and again that what makes the achievement of their ambitious plans realizable is the enormous wealth hitherto accumulated. But in the same breath they disregard the fact that this wealth consists to a great extent in capital goods produced in the past and more or less antiquated from the point of view of our present valuations and technological knowledge. As they see it, the only aim of production is to transform the industrial apparatus in such a way as to make life more abundant for later generations. In their eyes contemporaries are simply a lost generation, people whose only purpose it must be to toil and trouble for the benefit of the unborn. However, real men are different. They want not only to create a better world for their grandsons to live in; they themselves also want to enjoy life. They want to utilize in the most efficient way those capital goods which are now available. They aim at a better future, but they want to attain this goal in the most economical way. For the realization of this desire too they cannot do without economic calculation.
It was a serious mistake to believe that the state of equilibrium could be computed, by means of mathematical operations, on the basis of the knowledge of conditions in a nonequilibrium state. It was no less erroneous to believe that such a knowledge of the conditions under a hypothetical state of equilibrium could be of any use for acting man in his search for the best possible solution of the problems with which he is faced in his daily choices and activities. There is therefore no need to stress the point that the fabulous number of equations which one would have to solve each day anew for a practical utilization of the method would make the whole idea absurd even if it were really a reasonable substitute for the market’s economic calculation. 15
PRIVATE ownership of the means of production (market economy or capitalism) and public ownership of the means of production (socialism or communism or “planning”) can be neatly distinguished. Each of these two systems of society’s economic organization is open to a precise and unambiguous description and definition. They can never be confounded with one another; they cannot be mixed or combined; no gradual transition leads from one of them to the other; they are mutually incompatible. With regard to the same factors of production there can only exist private control or public control. If in the frame of a system of social cooperation only some means of production are subject to public ownership while the rest are controlled by private individuals, this does not make for a mixed system combining socialism and private ownership. The system remains a market society, provided the socialized sector does not become entirely separated from the non-socialized sector and lead a strictly autarkic existence. (In this latter case there are two systems independently coexisting side by side—a capitalist and a socialist.) Publicly owned enterprises operating within a system in which there are privately owned enterprises and a market, and socialized countries, exchanging goods and services with nonsocialist countries, are integrated into a system of market economy. They are subject to the law of the market and have the opportunity of resorting to economic calculation. 16
If one considers the idea of placing by the side of these two systems or between them a third system of human cooperation under the division of labor, one can always start only from the notion of the market economy, never from that of socialism. The notion of socialism with its rigid monism and centralism that vests the powers to choose and to act in one will exclusively does not allow of any compromise or concession; this construction is not amenable to any adjustment or alteration. But it is different with the scheme of the market economy. Here the dualism of the market and the government’s power of coercion and compulsion suggests various ideas. Is it really peremptory or expedient, people ask, that the government keep itself out of the market? Should it not be a task of government to interfere and to correct the operation of the market? Is it necessary to put up with the alternative of capitalism or socialism? Are there not perhaps still other realizable systems of social organization which are neither communism nor pure and unhampered market economy?
Thus people have contrived a variety of third solutions, of systems which, it is claimed, are as far from socialism as they are from capitalism. Their authors allege that these systems are nonsocialist because they aim to preserve private ownership of the means of production and that they are not capitalistic because they eliminate the “deficiencies” of the market economy. For a scientific treatment of the problems involved which by necessity is neutral with regard to all value judgments and therefore does not condemn any features of capitalism as faulty, detrimental, or unjust, this emotional recommendation of interventionism is of no avail. The task of economics is to analyze and to search for truth. It is not called upon to praise or to disapprove from any standard of preconceived postulates and prejudices. With regard to interventionism it has only one question to ask and to answer: How does it work?
There are two patterns for the realization of socialism.
The first pattern (we may call it the Lenin or the Russian pattern) is purely bureaucratic. All plants, shops, and farms are formally nationalized ( verstaatlicht ); they are departments of the government operated by civil servants. Every unit of the apparatus of production stands in the same relation to the superior central organization as does a local post office to the office of the postmaster general.
The second pattern (we may call it the Hindenburg or German pattern) nominally and seemingly preserves private ownership of the means of production and keeps the appearance of ordinary markets, prices, wages, and interest rates. There are, however, no longer entrepreneurs, but only shop managers ( Betriebsführer in the terminology of the Nazi legislation). These shop managers are seemingly instrumental in the conduct of the enterprises entrusted to them; they buy and sell, hire and discharge workers and remunerate their services, contract debts and pay interest and amortization. But in all their activities they are bound to obey unconditionally the orders issued by the government’s supreme office of production management. This office (the Reichswirtschaftsministerium in Nazi Germany) tells the shop managers what and how to produce, at what prices and from whom to buy, at what prices and to whom to sell. It assigns every worker to his job and fixes his wages. It decrees to whom and on what terms the capitalists must entrust their funds. Market exchange is merely a sham. All the wages, prices, and interest rates are fixed by the government; they are wages, prices, and interest rates in appearance only; in fact they are merely quantitative terms in the government’s orders determining each citizen’s job, income, consumption, and standard of living. The government directs all production activities. The shop managers are subject to the government, not to the consumers’ demand and the market’s price structure. This is socialism under the outward guise of the terminology of capitalism. Some labels of the capitalistic market economy are retained, but they signify something entirely different from what they mean in the market economy.
It is necessary to point out this fact in order to prevent a confusion of socialism and interventionism. The system of interventionism or of the hampered market economy differs from the German pattern of socialism by the very fact that it is still a market economy. The authority interferes with the operation of the market economy, but does not want to eliminate the market altogether. It wants production and consumption to develop along lines different from those prescribed by an unhampered market, and it wants to achieve its aim by injecting into the working of the market orders, commands, and prohibitions for whose enforcement the police power and its apparatus of violent compulsion and coercion stand ready. But these are isolated acts of intervention. It is not the aim of the government to combine them into an integrated system which determines all prices, wages and interest rates and thus places full control of production and consumption into the hands of the authorities.
The system of the hampered market economy or interventionism aims at preserving the dualism of the distinct spheres of government activities on the one hand and economic freedom under the market system on the other hand. What characterizes it as such is the fact that the government does not limit its activities to the preservation of private ownership of the means of production and its protection against violent or fraudulent encroachments. The government interferes with the operation of business by means of orders and prohibitions.
The intervention is a decree issued directly or indirectly, by the authority in charge of society’s administrative apparatus of coercion and compulsion which forces the entrepreneurs and capitalists to employ some of the factors of production in a way different from what they would have resorted to if they were only obeying the dictates of the market. Such a decree can be either an order to do something or an order not to do something. It is not required that the decree be issued directly by the established and generally recognized authority itself. It may happen that some other agencies arrogate to themselves the power to issue such orders or prohibitions and to enforce them by an apparatus of violent coercion and oppression of their own. If the recognized government tolerates such procedures or even supports them by the employment of its governmental police apparatus, matters stand as if the government itself had acted. If the government is opposed to other agencies’ violent action, but does not succeed in suppressing it by means of its own armed forces, although it would like to suppress it, anarchy results.
It is important to remember that government interference always means either violent action or the threat of such action. The funds that a government spends for whatever purposes are levied by taxation. And taxes are paid because the taxpayers are afraid of offering resistance to the tax gatherers. They know that any disobedience or resistance is hopeless. As long as this is the state of affairs, the government is able to collect the money that it wants to spend. Government is in the last resort the employment of armed men, of policemen, gendarmes, soldiers, prison guards, and hangmen. The essential feature of government is the enforcement of its decrees by beating, killing, and imprisoning. Those who are asking for more government interference are asking ultimately for more compulsion and less freedom.
To draw attention to this fact does not imply any reflection upon government activities. In stark reality, peaceful social cooperation is impossible if no provision is made for violent prevention and suppression of antisocial action on the part of refractory individuals and groups of individuals. One must take exception to the often-repeated phrase that government is an evil, although a necessary and indispensable evil. What is required for the attainment of an end is a means, the cost to be expended for its successful realization. It is an arbitrary value judgment to describe it as an evil in the moral connotation of the term. However, in face of the modern tendencies toward a deification of government and state, it is good to remind ourselves that the old Romans were more realistic in symbolizing the state by a bundle of rods with an ax in the middle than are our contemporaries in ascribing to the state all the attributes of God.
Various schools of thought parading under the pompous names of philosophy of law and political science indulge in futile and empty brooding over the delimitation of the functions of government. Starting from purely arbitrary assumptions concerning allegedly eternal and absolute values and perennial justice, they arrogate to themselves the office of the supreme judge of earthly affairs. They misconstrue their own arbitrary value judgments derived from intuition as the voice of the Almighty or of the nature of things.
There is, however, no such thing as a perennial standard of what is just and what is unjust. Nature is alien to the idea of right and wrong. “Thou shalt not kill” is certainly not part of natural law. The characteristic feature of natural conditions is that one animal is intent upon killing other animals and that many species cannot preserve their own life except by killing others. The notion of right and wrong is a human device, a utilitarian precept designed to make social cooperation under the division of labor possible. All moral rules and human laws are means for the realization of definite ends. There is no method available for the appreciation of their goodness or badness other than to scrutinize their usefulness for the attainment of the ends chosen and aimed at.
From the notion of natural law some people deduce the justice of the institution of private property in the means of production. Other people resort to natural law for the justification of the abolition of private property in the means of production. As the idea of natural law is quite arbitrary, such discussions are not open to settlement.
State and government are not ends, but means. Inflicting evil upon other people is a source of direct pleasure only to sadists. Established authorities resort to coercion and compulsion in order to safeguard the smooth operation of a definite system of social organization. The sphere in which coercion and compulsion is applied and the content of the laws which are to be enforced by the police apparatus are conditioned by the social order adopted. As state and government are designed to make this social system operate safely, the delimitation of governmental functions must be adjusted to its requirements. The only standard for the appreciation of the laws and the methods for their enforcement is whether or not they are efficient in safeguarding the social order which it is desired to preserve.
The notion of justice makes sense only when referring to a definite system of norms which in itself is assumed to be uncontested and safe against any criticism. Many peoples have clung to the doctrine that what is right and what is wrong is established from the dawn of the remotest ages and for eternity. The task of legislators and courts was not to make laws, but to find out what is right by virtue of the unchanging idea of justice. This doctrine, which resulted in an adamant conservatism and a petrification of old customs and institutions, was challenged by the doctrine of natural right. To the positive laws of the country the notion of a “higher” law, the law of nature, was opposed. From the arbitrary standard of natural law the valid statutes and institutions were called just or unjust. To the good legislator was assigned the task of making the positive laws agree with the natural law.
The fundamental errors involved in these two doctrines have long since been unmasked. For those not deluded by them it is obvious that the appeal to justice in a debate concerning the drafting of new laws is an instance of circular reasoning. De lege ferenda there is no such a thing as justice. The notion of justice can logically only be resorted to de lege lata. It makes sense only when approving or disapproving concrete conduct from the point of view of the valid laws of the country. In considering changes in the nation’s legal system, in rewriting or repealing existing laws and writing new laws, the issue is not justice, but social expediency and social welfare. There is no such thing as an absolute notion of justice not referring to a definite system of social organization. It is not justice that determines the decision in favor of a definite social system. It is, on the contrary, the social system which determines what should be deemed right and what wrong. There is neither right nor wrong outside the social nexus. For the hypothetical isolated and self-sufficient individual the notions of just and unjust are empty. Such an individual can merely distinguish between what is more expedient and what is less expedient for himself. The idea of justice refers always to social cooperation.
It is nonsensical to justify or to reject interventionism from the point of view of a fictitious and arbitrary idea of absolute justice. It is vain to ponder over the just delimitation of the tasks of government from any preconceived standard of perennial values. It is no less impermissible to deduce the proper tasks of government from the very notions of government, state, law and justice. It was precisely this that was absurd in the speculations of medieval scholasticism, of Fichte, Schelling, and Hegel, and the German Begriffsjurisprudenz. Concepts are tools of reasoning. They must never be considered as regulative principles dictating modes of conduct.
It is a display of supererogatory mental gymnastics to emphasize that the notions of state and sovereignty logically imply absolute supremacy and thus preclude the idea of any limitations on the state’s activities. Nobody questions the fact that a state has the power to establish totalitarianism within the territory in which it is sovereign. The problem is whether or not such a mode of government is expedient from the point of view of the preservation and functioning of social cooperation. With regard to this problem no sophisticated exegesis of concepts and notions can be of any use. It must be decided by praxeology, not by a spurious metaphysics of state and right.
The philosophy of law and political science are at a loss to discover any reason why government should not control prices and not punish those defying the price ceilings decreed, in the same way as it punishes murderers and thieves. As they see it, the institution of private property is merely a revocable favor graciously granted by the almighty sovereign to the wretched individuals. There cannot be any wrong in repealing totally or partially the laws that granted this favor; no reasonable objection can be raised against expropriation and confiscation. The legislator is free to substitute any social system for that of the private ownership of the means of production, just as he is free to substitute another national anthem for that adopted in the past. The formula car tel est notre bon plaisir is the only maxim of the sovereign lawgiver’s conduct.
As against all this formalism and legal dogmatism, there is need to emphasize again that the only purpose of the laws and the social apparatus of coercion and compulsion is to safeguard the smooth functioning of social cooperation. It is obvious that the government has the power to decree maximum prices and to imprison or to execute those selling or buying at a higher price. But the question is whether such a policy can or cannot attain the ends which the government wants to attain by resorting to it. This is a purely praxeological and economic problem. Neither the philosophy of law nor political science can contribute anything to its solution.
The problem of interventionism is not a problem of the correct delimitation of the “natural,” “just,” and “proper” tasks of state and government. The issue is: How does a system of interventionism work? Can it realize those ends which people, in resorting to it, want to attain?
The confusion and lack of judgment displayed in dealing with the problems of interventionism are amazing indeed. There are, for instance, people who argue thus: It is obvious that traffic regulations on the public roads are necessary. Nobody objects to the government’s interference with the car driver’s conduct. The advocates of laissez faire contradict themselves in fighting government interference with market prices and yet not advocating the abolition of government traffic regulation.
The fallacy of this argument is manifest. The regulation of traffic on a road is one of the tasks incumbent upon the agency that operates the road. If this agency is the government or the municipality, it is bound to attend to this task. It is the task of a railroad’s management to fix the timetable of the trains and it is the task of a hotel’s management to decide whether or not there should be music in the dining room. If the government operates a railroad or a hotel, it is the government’s task to regulate these things. With a state opera the government decides which operas should be produced and which should not; it would be a non sequitur, however, to deduce from this fact that it is also a task of the government to decide these things for a non-governmental opera.
The interventionist doctrinaires repeat again and again that they do not plan the abolition of private ownership of the means of production, of entrepreneurial activities, and of market exchange. Also the supporters of the most recent variety of interventionism, the German “soziale Marktwirtschaft,” stress that they consider the market economy to be the best possible and most desirable system of society’s economic organization, and that they are opposed to the government omnipotence of socialism. But, of course, all these advocates of a middle-of-the-road policy emphasize with the same vigor that they reject Manchesterism and laissez-faire liberalism. It is necessary, they say, that the state interfere with the market phenomena whenever and wherever the “free play of the economic forces” results in conditions that appear as “socially” undesirable. In making this assertion they take it for granted that it is the government that is called upon to determine in every single case whether or not a definite economic fact is to be considered as reprehensible from the “social” point of view and, consequently whether or not the state of the market requires a special act of government interference.
All these champions of interventionism fail to realize that their program thus implies the establishment of full government supremacy in all economic matters and ultimately brings about a state of affairs that does not differ from what is called the German or the Hindenburg pattern of socialism. If it is in the jurisdiction of the government to decide whether or not definite conditions of the economy justify its intervention, no sphere of operation is left to the market. Then it is no longer the consumers who ultimately determine what should be produced, in what quantity, of what quality, by whom, where, and how—but it is the government. For as soon as the outcome brought about by the operation of the unhampered market differs from what the authorities consider “socially” desirable, the government interferes. That means the market is free as long as it does precisely what the government wants it to do. It is “free” to do what the authorities consider to be the “right” things, but not to do what they consider the “wrong” things; the decision concerning what is right and what is wrong rests with the government. Thus the doctrine and the practice of interventionism ultimately tend to abandon what originally distinguished them from outright socialism and to adopt entirely the principles of totalitarian all-round planning.
According to a widespread opinion it is possible, even in the absence of government interference with business, to divert the operation of the market economy from those lines along which it would develop if left to exclusive control by the profit motive. Advocates of a social reform to be accomplished by compliance with the principles of Christianity or with the demands of “true” morality maintain that conscience should also guide well-intentioned people in their dealings on the market. If all people were prepared not only to concern themselves about profit, but no less about their religious and moral obligations, no government compulsion and coercion would be required in order to put things right. What is needed is not a reform of government and the laws of the country, but the moral purification of man, a return to the Lord’s commandments and to the precepts of the moral code, a turning away from the vices of greed and selfishness. Then it will be easy to reconcile private ownership of the means of production with justice, righteousness, and fairness. The disastrous effects of capitalism will be eliminated without prejudice to the individual’s freedom and initiative. People will dethrone the Moloch capitalism without enthroning the Moloch state.
The arbitrary value judgments which are at the bottom of these opinions need not concern us here. What these critics blame capitalism for is irrelevant; their errors and fallacies are beside the point. What does matter is the idea of erecting a social system on the twofold basis of private property and of moral principles restricting the utilization of private property. The system recommended, say its advocates, will be neither socialism nor capitalism nor interventionism. Not socialism, because it will preserve private ownership of the means of production; not capitalism, because conscience will be supreme and not the urge for profit; not interventionism, because there will be no need for government interference with the market.
In the market economy the individual is free to act within the orbit of private property and the market. His choices are final. For his fellow men his actions are data which they must take into account in their own acting. The coordination of the autonomous actions of all individuals is accomplished by the operation of the market. Society does not tell a man what to do and what not to do. There is no need to enforce cooperation by special orders or prohibitions. Noncooperation penalizes itself. Adjustment to the requirements of society’s productive effort and the pursuit of the individual’s own concerns are not in conflict. Consequently no agency is required to settle such conflicts. The system can work and accomplish its tasks without the interference of an authority issuing special orders and prohibitions and punishing those who do not comply.
Beyond the sphere of private property and the market lies the sphere of compulsion and coercion; here are the dams which organized society has built for the protection of private property and the market against violence, malice, and fraud. This is the realm of constraint as distinguished from the realm of freedom. Here are rules discriminating between what is legal and what is illegal, what is permitted and what is prohibited. And here is a grim machine of arms, prisons, and gallows and the men operating it, ready to crush those who dare to disobey.
Now, the reformers with whose plans we are concerned suggest that along with the norms designed for the protection and preservation of private property further ethical rules should be ordained. They want to realize in production and consumption things other than those realized under the social order in which the individuals are not checked by any obligation other than that of not infringing upon the persons of their fellow men and upon the right of private property. They want to ban those motives that direct the individual’s action in the market economy (they call them selfishness, acquisitiveness, profit-seeking) and to replace them with other impulses (they call them conscientiousness, righteousness, altruism, fear of God, charity). They are convinced that such a moral reform would in itself be sufficient to safeguard a mode of operation of the economic system, more satisfactory from their point of view than that of unhampered capitalism, without any of those special governmental measures which interventionism and socialism require.
The supporters of these doctrines fail to recognize the role which those springs of action they condemn as vicious play in the operation of the market economy. The only reason why the market economy can operate without government orders telling everybody precisely what he should do and how he should do it is that it does not ask anybody to deviate from those lines of conduct which best serve his own interests. What integrates the individual’s actions into the whole of the social system of production is the pursuit of his own purposes. In indulging in his “acquisitiveness” each actor contributes his share to the best possible arrangement of production activities. Thus, within the sphere of private property and the laws protecting it against encroachments on the part of violent or fraudulent action, there is no antagonism between the interests of the individual and those of society.
The market economy becomes a chaotic muddle if this predominance of private property which the reformers disparage as selfishness is eliminated. In urging people to listen to the voice of their conscience and to substitute considerations of public welfare for those of private profit, one does not create a working and satisfactory social order. It is not enough to tell a man not to buy on the cheapest market and not to sell on the dearest market. It is not enough to tell him not to strive after profit and not to avoid losses. One must establish unambiguous rules for the guidance of conduct in each concrete situation.
Says the reformer: The entrepreneur is rugged and selfish when, taking advantage of his own superiority, he underbids the prices asked by a less efficient competitor and thus forces the man to go out of business. But how should the “altruistic” entrepreneur proceed? Should he under no circumstances sell at a price lower than any competitor? Or are there certain conditions which justify underbidding the competitor’s prices?
Says the reformer on the other hand: The entrepreneur is rugged and selfish when, taking advantage of the state of the market, he asks a price so high that poor people are excluded from purchasing the merchandise. But what should the “good” entrepreneur do? Should he give away the merchandise free of charge? If he charges any price, however low, there will always be people who cannot buy at all or not so much as they would buy if the price were still lower. What group of those eager to buy is the entrepreneur free to exclude from getting the merchandise?
There is no need to deal at this point of our investigation with the consequences resulting from any deviation from the height of prices as determined on an unhampered market. If the seller avoids underbidding his less efficient competitor, a part at least of his supply remains unsold. If the seller offers the merchandise at a price lower than that determined on an unhampered market, the supply available is insufficient to enable all those ready to expend this lower price to get what they are asking for. We will analyze later these as well as other consequences of any deviation from the market prices. 17 What we must recognize even at this point is that one cannot content oneself simply by telling the entrepreneur that he should not let himself be guided by the state of the market. It is imperative to tell him how far he must go in asking and paying prices. If it is no longer profit-seeking that directs the entrepreneurs’ actions and determines what they produce and in what quantities, if the entrepreneurs are no longer bound by the instrumentality of the profit motive to serve the consumers to the best of their abilities, it is necessary to give them definite instructions. One cannot avoid guiding their conduct by specified orders and prohibitions, precisely such decrees as are the mark of government interference with business. Any attempt to render such interference superfluous by attributing primacy to the voice of conscience, to charity and brotherly love, is vain.
The advocates of a Christian social reform pretend that their ideal of greed and profit-seeking tamed and restrained by conscientiousness and compliance with the moral law worked rather well in the past. All the evils of our day are caused by defection from the precepts of the church. If people had not defied the commandments and had not coveted unjust profit, mankind would still enjoy the bliss experienced in the Middle Ages when at least the elite lived up to the principles of the Gospels. What is needed is to bring back those good old days and then to see that no new apostasy deprives men of their beneficent effects.
There is no need to enter into an analysis of the social and economic conditions of the thirteenth century which these reformers praise as the greatest of all periods of history. We are concerned merely with the notion of just prices and wage rates which was essential in the social teachings of the doctors of the church and which the reformers want to raise to the position of the ultimate standard of economic conduct.
It is obvious that with theorists this notion of just prices and wage rates always refers and always referred to a definite social order which they considered the best possible order. They recommend the adoption of their ideal scheme and its preservation forever. No further changes are to be tolerated. Any alteration of the best possible state of social affairs can only mean deterioration. The world view of these philosophers does not take into account man’s ceaseless striving for improvement of the material conditions of well-being. Historical change and a rise in the general standard of living are notions foreign to them. They call “just” that mode of conduct that is compatible with the undisturbed preservation of their utopia, and everything else unjust.
However, the notion of just prices and wage rates as present to the mind of people other than philosophers is very different. When the nonphilosopher calls a price just, what he means is that the preservation of this price improves or at least does not impair his own revenues and station in society. He calls unjust any price that jeopardizes his own wealth and station. It is “just” that the prices of those goods and services which he sells rise more and more and that the prices of those goods and services he buys drop more and more. To the farmer no price of wheat, however high, appears unjust. To the wage earner no wage rates, however high, appear unfair. But the farmer is quick to denounce every drop in the price of wheat as a violation of divine and human laws, and the wage earners rise in rebellion when their wages drop. Yet the market society has no means of adjusting production to changing conditions other than the operation of the market. By means of price changes it forces people to restrict the production of articles less urgently asked for and to expand the production of those articles for which consumers’ demand is more urgent. The absurdity of all endeavors to stabilize prices consists precisely in the fact that stabilization would prevent any further improvement and result in rigidity and stagnation. The flexibility of commodity prices and wage rates is the vehicle of adjustment, improvement, and progress. Those who condemn changes in prices and wage rates as unjust, and who ask for the preservation of what they call just, are in fact combating endeavors to make economic conditions more satisfactory.
it is not unjust that there has long prevailed a tendency toward such a determination of the prices of agricultural products that the greater part of the population abandoned farming and moved toward the processing industries. But for this tendency, 90 per cent or more of the population would still be occupied in agriculture and the processing industries would have been stunted in their growth. All strata of the population, including the farmers, would be worse off. If the scholastic doctrine of the just price had been put into practice, the thirteenth century’s economic conditions would still prevail. Population figures would be much smaller than they are today and the standard of living much lower.
Both varieties of the just price doctrine, the philosophical and the popular, agree in their condemnation of the prices and wage rates as determined on the unhampered market. But this negativism does not in itself provide any answer to the question of what height the just prices and wage rates should attain. If righteousness is to be elevated to the position of the ultimate standard of economic action, one must unambiguously tell every actor what he should do, what prices he should ask, and what prices he should pay in each concrete case, and one must force—by recourse to an apparatus of violent compulsion and coercion—all those venturing disobedience to comply with these orders. One must establish a supreme authority issuing norms and regulating conduct in every respect, altering these norms if need be, interpreting them authentically, and enforcing them. Thus the substitution of social justice and righteousness for selfish profit-seeking requires for its realization precisely those policies of government interference with business which the advocates of the moral purification of mankind want to make superfluous. No deviation from the unhampered market economy is thinkable without authoritarian regimentation. Whether the authority in which these powers are vested is called lay government or theocratical priesthood makes no difference.
The reformers, in exhorting people to turn away from selfishness, address themselves to capitalists and entrepreneurs, and sometimes, although only timidly, to wage earners as well. However, the market economy is a system of consumers’ supremacy. The sermonizers should appeal to consumers, not to producers. They should persuade the consumers to renounce preferring better and cheaper merchandise to poorer and dearer merchandise lest they hurt the less efficient producer. They should persuade them to restrict their own purchases in order to provide poorer people with the opportunity to buy more. If one wants the consumers to act in this way, one must tell them plainly what to buy, in what quantity, from whom, and at what prices; and one must provide for enforcing such orders by coercion and compulsion. But then one has adopted exactly that system of authoritarian control which moral reform wants to make unnecessary.
Whatever freedom individuals can enjoy within the framework of social cooperation is conditional upon the concord of private gain and public weal. Within the orbit in which the individual, in pursuing his own well-being, advances also—or at least does not impair—the well-being of his fellow men, people going their own ways jeopardize neither the preservation of society nor the concerns of other people. A realm of freedom and individual initiative emerges, a realm in which man is allowed to choose and to act of his own accord. This sphere of freedom, by the socialists and interventionists contemptuously dubbed “economic freedom,” is alone what makes any of those conditions possible that are commonly called freedoms within a system of social cooperation under the division of labor. It is the market economy or capitalism with its political corollary (the Marxians would have to say: with its “superstructure”), representative government.
Those who contend that there is a conflict between the acquisitiveness of various individuals or between the acquisitiveness of individuals on the one hand and the commonweal on the other, cannot avoid advocating the suppression of the individuals’ right to choose and to act. They must substitute the supremacy of a central board of production management for the discretion of the citizens. In their scheme of the good society there is no room left for private initiative. The authority issues orders and everybody is forced to obey.
In eighteenth-century France the saying laissez faire, laissez passer was the formula into which some of the champions of the cause of liberty compressed their program. Their aim was the establishment of the unhampered market society. In order to attain this end they advocated the abolition of all laws preventing more industrious and more efficient people from outdoing less industrious and less efficient competitors and restricting the mobility of commodities and of men. It was this that the famous maxim was designed to express.
In our age of passionate longing for government omnipotence the formula laissez faire is in disrepute. Public opinion now considers it a manifestation both of moral depravity and of the utmost ignorance.
As the interventionist sees things, the alternative is “automatic forces” or “conscious planning.” 18 It is obvious, he implies, that to rely upon automatic processes is sheer stupidity. No reasonable man can seriously recommend doing nothing and letting things go as they do without interference on the part of purposive action. A plan, by the very fact that it is a display of conscious action, is incomparably superior to the absence of any planning. Laissez faire is said to mean: Let the evils last, do not try to improve the lot of mankind by reasonable action.
This is utterly fallacious talk. The argument advanced for planning is entirely derived from an impermissible interpretation of a metaphor. It has no foundation other than the connotations implied in the term “automatic” which it is customary to apply in a metaphorical sense for the description of the market process. 19 Automatic, says the Concise Oxford Dictionary, 20 means “unconscious, unintelligent, merely mechanical.” Automatic, says Webster’s Collegiate Dictionary, 21 means “not subject to the control of the will,... performed without active thought and without conscious intention or direction.” What a triumph for the champion of planning to play this trump card!
The truth is that the alternative is not between a dead mechanism or a rigid automatism on one hand and conscious planning on the other hand. The alternative is not plan or no plan. The question is whose planning? Should each member of society plan for himself, or should a benevolent government alone plan for them all? The issue is not automatism versus conscious action; it is autonomous action of each individual versus the exclusive action of the government. It is freedom versus government omnipotence.
Laissez faire does not mean: Let soulless mechanical forces operate. It means: Let each individual choose how he wants to cooperate in the social division of labor; let the consumers determine what the entrepreneurs should produce. Planning means: Let the government alone choose and enforce its rulings by the apparatus of coercion and compulsion.
Under laissez faire, says the planner, it is not those goods which people “really” need that are produced, but those goods from the sale of which the highest returns are expected. It is the objective of planning to direct production toward the satisfaction of the “true” needs. But who is to decide what the “true” needs are?
Thus, for instance, Professor Harold Laski, the former chairman of the British Labor Party, would determine as the objective of the planned direction of investment “that the use of the investor’s savings will be in housing rather than in cinemas.” 22 It is beside the point whether or not one agrees with the professor’s view that better houses are more important than moving pictures. It is a fact that the consumers, in spending part of their money for admission to the movies, have made another choice. If the masses of Great Britain, the same people whose votes swept the Labor Party into power, were to stop patronizing the moving pictures and to spend more for comfortable homes and apartments, profit-seeking business would be forced to invest more in building homes and apartment houses and less in the production of expensive pictures. It was Mr. Laski’s desire to defy the wishes of the consumers and to substitute his own will for that of the consumers. He wanted to do away with the democracy of the market and to establish the absolute rule of the production tsar. Perhaps he believed that he was right from a higher point of view, and that as a superman he was called upon to impose his own valuations on the masses of inferior men. But then he ought to have been frank enough to say so plainly.
All this passionate praise of the supereminence of government action is but a poor disguise for the individual interventionist’s self-deification. The great god State is a great god only because it is expected to do exclusively what the individual advocate of interventionism wants to see achieved. Only that plan is genuine which the individual planner fully approves. All other plans are simply counterfeit. In saying “plan” what the author of a book on the benefits of planning has in mind is, of course, his own plan alone. He does not take into account the possibility that the plan which the government puts into practice may differ from his own plan. The various planners agree only with regard to their rejection of laissez faire, i.e., the individuals’ discretion to choose and to act. They entirely disagree with regard to the choice of the unique plan to be adopted. To every exposure of the manifest and incontestable defects of interventionist policies the champions of interventionism react in the same way. These faults, they say, were the results of spurious interventionism; what we are advocating is good interventionism, not bad interventionism. And, of course, good interventionism is the professor’s own brand.
Laissez faire means: Let the common man choose and act; do not force him to yield to a dictator.
In investigating the economic problems of interventionism we do not have to deal with those actions of the government whose aim it is to influence immediately the consumer’s choice of consumers’ goods. Every act of government interference with business must indirectly affect consumption. As the government’s interference alters the market data, it must also alter the valuations and the conduct of the consumers. But if the aim of the government is merely to force the consumers directly to consume goods other than what they would have consumed in the absence of the government’s decree, no special problems emerge to be scrutinized by economics. It is beyond doubt that a strong and ruthless police apparatus has the power to enforce such decrees.
In dealing with the choices of the consumers we do not ask what motives induced a man to buy a and not to buy b . We merely investigate what effects on the determination of market prices and thereby on production were brought about by the concrete conduct of the consumers. These effects do not depend on the considerations which led individuals to buy a and not to buy b ; they depend only on the real acts of buying and abstention from buying. It is immaterial for the determination of the prices of gas masks whether people buy them of their own accord or because the government forces everybody to have a gas mask. What alone counts is the size of the demand.
Governments which are eager to keep up the outward appearance of freedom even when curtailing freedom disguise their direct interference with consumption under the cloak of interference with business. The aim of American prohibition was to prevent the individual residents of the country from drinking alcoholic beverages. But the law hypocritically did not make drinking as such illegal and did not penalize it. It merely prohibited the manufacture, the sale and the transportation of intoxicating liquors, the business transactions which precede the act of drinking. The idea was that people indulge in the vice of drinking only because unscrupulous businessmen prevail upon them. It was, however, manifest that the objective of prohibition was to encroach upon the individuals’ freedom to spend their dollars and to enjoy their lives according to their own fashion. The restrictions imposed upon business were only subservient to this ultimate end.
The problems involved in direct government interference with consumption are not catallactic problems. They go far beyond the scope of catallactics and concern the fundamental issues of human life and social organization. If it is true that government derives its authority from God and is entrusted by Providence to act as the guardian of the ignorant and stupid populace, then it is certainly its task to regiment every aspect of the subject’s conduct. The God-sent ruler knows better what is good for his wards than they do themselves. It is his duty to guard them against the harm they would inflict upon themselves if left alone.
Self-styled “realistic” people fail to recognize the immense importance of the principles implied. They contend that they do not want to deal with the matter from what, they say, is a philosophic and academic point of view. Their approach is, they argue, exclusively guided by practical considerations. It is a fact, they say, that some people harm themselves and their innocent families by consuming narcotic drugs. Only doctrinaires could be so dogmatic as to object to the government’s regulation of the drug traffic. Its beneficent effects cannot be contested.
However, the case is not so simple as that. Opium and morphine are certainly dangerous, habit-forming drugs. But once the principle is admitted that it is the duty of government to protect the individual against his own foolishness, no serious objections can be advanced against further encroachments. A good case could be made out in favor of the prohibition of alcohol and nicotine. And why limit the government’s benevolent providence to the protection of the individual’s body only? Is not the harm a man can inflict on his mind and soul even more disastrous than any bodily evils? Why not prevent him from reading bad books and seeing bad plays, from looking at bad paintings and statues and from hearing bad music? The mischief done by bad ideologies, surely, is much more pernicious, both for the individual and for the whole society, than that done by narcotic drugs.
These fears are not merely imaginary specters terrifying secluded doctrinaires. It is a fact that no paternal government, whether ancient or modern, ever shrank from regimenting its subjects’ minds, beliefs, and opinions. If one abolishes man’s freedom to determine his own consumption, one takes all freedoms away. The naïve advocates of government interference with consumption delude themselves when they neglect what they disdainfully call the philosophical aspect of the problem. They unwittingly support the case of censorship, inquisition, religious intolerance, and the persecution of dissenters.
In dealing with the catallactics of interventionism we do not discuss these political consequences of direct government interference with the citizens’ consumption. We are exclusively concerned with those acts of interference which aim at forcing the entrepreneurs and capitalists to employ the factors of production in a way different from what they would have done if they merely obeyed the dictates of the market. In doing this, we do not raise the question of whether such interference is good or bad from any preconceived point of view. We merely ask whether or not it can attain those ends which those advocating and resorting to it are trying to attain.
An analysis of interventionism would be incomplete if it were not to refer to the phenomenon of corruption.
There are hardly any acts of government interference with the market process that, seen from the point of view of the citizens concerned, would not have to be qualified either as confiscations or as gifts. As a rule, one individual or a group of individuals is enriched at the expense of other individuals or groups of individuals. But in many cases, the harm done to some people does not correspond to any advantage for other people.
There is no such thing as a just and fair method of exercising the tremendous power that interventionism puts into the hands of the legislature and the executive. The advocates of interventionism pretend to substitute for the—as they assert, “socially” detrimental—effects of private property and vested interests the unlimited discretion of the perfectly wise and disinterested legislator and his conscientious and indefatigable servants, the bureaucrats. In their eyes the common man is a helpless infant, badly in need of a paternal guardian to protect him against the sly tricks of a band of rogues. They reject all traditional notions of law and legality in the name of a “higher and nobler” idea of justice. Whatever they themselves do is always right because it hurts those who selfishly want to retain for themselves what, from the point of view of this higher concept of justice, ought to belong to others.
The notions of selfishness and unselfishness as employed in such reasoning are self-contradictory and vain. As has been pointed out, every action aims at the attainment of a state of affairs that suits the actor better than the state that would prevail in the absence of this action. In this sense every action is to be qualified as selfish. The man who gives alms to hungry children does it, either because he values his own satisfaction expected from this gift higher than any other satisfaction he could buy by spending this amount of money, or because he hopes to be rewarded in the beyond. The politician is, in this sense, always selfish no matter whether he supports a popular program in order to get an office or whether he firmly clings to his own—unpopular—convictions and thus deprives himself of the benefits he could reap by betraying them.
In the terminology of anticapitalism the words selfish and unselfish are used to classify people from the point of view of a doctrine that considers equality of wealth and income as the only natural and fair state of social conditions, that brands those who own or earn more than the average as exploiters, and that condemns entrepreneurial activities as detrimental to the common weal. To be in business, to depend directly on the approval or disapproval of one’s actions by the consumers, to woo the patronage of the buyers, and to earn profit if one succeeds in satisfying them better than one’s competitors do is, from the point of view of officialdom’s ideology, selfish and shameful. Only those on the government’s payroll are rated as unselfish and noble.
Unfortunately the office-holders and their staffs are not angelic. They learn very soon that their decisions mean for the businessmen either considerable losses or—sometimes—considerable gains. Certainly there are also bureaucrats who do not take bribes; but there are others who are anxious to take advantage of any “safe” opportunity of “sharing” with those whom their decisions favor.
In many fields of the administration of interventionist measures, favoritism simply cannot be avoided. Take, for example, the case of export or import licenses. Such a license has for the licensee a definite cash value. To whom ought the government grant a license and to whom should it be denied? There is no neutral or objective yardstick available to make the decision free from bias and favoritism. Whether or not money changes hands in the affair does not matter. The scandal is the same when the license is given to people who have rendered or are expected to render other kinds of valuable services (e.g., in casting their votes) to the people upon whom the decision depends.
Corruption is a regular effect of interventionism. It may be left to the historians and to the lawyers to deal with the problems involved. 23
TO keep the social apparatus of coercion and compulsion running requires expenditure of labor and commodities. Under a liberal system of government these expenditures are small compared with the sum of the individuals’ incomes. The more the government expands the sphere of its activities, the more its budget increases.
If the government itself owns and operates plants, farms, forests, and mines, it might consider covering a part or the whole of its financial needs from interest and profit earned. But government operation of business enterprises as a rule is so inefficient that it results in losses rather than in profits. Governments must resort to taxation, i.e., they must raise revenues by forcing the subjects to surrender a part of their wealth or income.
A neutral mode of taxation is conceivable that would not divert the operation of the market from the lines in which it would develop in the absence of any taxation. However, the vast literature on problems of taxation as well as the policies of governments have hardly ever given thought to the problem of the neutral tax. They have been more eager to find the just tax.
The neutral tax would affect the conditions of the citizens only to the extent required by the fact that a part of the labor and material goods available is absorbed by the government apparatus. In the imaginary construction of the evenly rotating economy the treasury continually levies taxes and spends the whole amount raised, neither more nor less, for defraying the costs incurred by the activities of the government’s officers. A part of each citizen’s income is spent for public expenditure. If we assume that in such an evenly rotating economy there prevails perfect income equality in such a way that every household’s income is proportional to the number of its members, both a head tax and a proportional income tax would be neutral taxes. Under these assumptions there would be no difference between them. A part of each citizen’s income would be absorbed by public expenditure, and no secondary effects of taxation would emerge.
The changing economy is entirely different from this imaginary construction of an evenly rotating economy with income equality. Continuous change and the inequality of wealth and income are essential and necessary features of the changing market economy, the only real and working system of the market economy. In the frame of such a system no tax can be neutral. The very idea of a neutral tax is as unrealizable as that of neutral money. But, of course, the reasons for this inescapable non-neutrality are different in the case of taxes from what they are in the case of money.
A head tax that taxes every citizen equally and uniformly without any regard to the size of his income and wealth, falls more heavily upon those with more moderate means than upon those with more ample means. It restricts the production of the articles consumed by the masses more sharply than that of the articles mainly consumed by the wealthier citizens. On the other hand, it tends to curtail saving and capital accumulation less than a more burdensome taxation of the wealthier citizens does. It does not slow down the tendency toward a drop in the marginal productivity of capital goods as against the marginal productivity of labor to the same extent as does taxation discriminating against those with higher income and wealth, and consequently it does not to the same extent retard the tendency toward a rise in wage rates.
The actual fiscal policies of all countries are today exclusively guided by the idea that taxes should be apportioned according to each citizen’s “ability to pay.” In the considerations which finally resulted in the general acceptance of the ability-to-pay principle there was some dim conception that taxing the well-to-do more heavily than those with moderate means renders a tax somewhat more neutral. However this may be, it is certain that any reference to tax neutrality was very soon entirely discarded. The ability-to-pay principle has been raised to the dignity of a postulate of social justice. As people see it today, the fiscal and budgetary objectives of taxation are of secondary importance only. The primary function of taxation is to reform social conditions according to justice. From this point of view, a tax appears as the more satisfactory the less neutral it is and the more it serves as a device for diverting production and consumption from those lines into which the unhampered market would have directed them.
The idea of social justice implied in the ability-to-pay principle is that of perfect financial equality of all citizens. As long as any inequality of income and wealth remains it can as plausibly be argued that these larger incomes and fortunes, however small their absolute amount, indicate some excess of ability to be levied upon, as it can be argued that any existing inequalities of income and wealth indicate differences in ability. The only logical stopping place of the ability-to-pay doctrine is at the complete equalization of incomes and wealth by confiscation of all incomes and fortunes above the lowest amount in the hands of anyone. 24
The notion of the total tax is the antithesis of the notion of the neutral tax. The total tax completely taxes away—confiscates—all incomes and estates. Then the government, out of the community chest thus filled, gives to everybody an allowance for defraying the costs of his sustenance. Or, what comes to the same thing, the government in taxing leaves free that amount which it considers everybody’s fair share and completes the shares of those who have less up to the amount of their fair share.
The idea of the total tax cannot be thought out to its ultimate logical consequences. If the entrepreneurs and capitalists do not derive any personal benefit or damage from their utilization of the means of production, they become indifferent with regard to the choice between various modes of conduct. Their social function fades away, and they become disinterested irresponsible administrators of public property. They are no longer bound to adjust production to the wishes of the consumers. If only the income is taxed away while the capital stock itself is left free, an incentive is offered to the owners to consume parts of their wealth and thus to hurt the interests of everyone. A total income tax would be a very inept means for the transformation of capitalism into socialism. If the total tax affects wealth no less than income, it is no longer a tax, i.e., a device for collecting government revenue within a market economy. It becomes a measure for the transition to socialism. As soon as it is consummated, socialism has been substituted for capitalism.
Even when looked upon as a method for the realization of socialism, the total tax is disputable. Some socialists launched plans for a prosocialist tax reform. They recommended either a 100 per cent estate and gift tax or taxing away totally the rent of land or all unearned income—i.e., in the socialist terminology, all revenue not derived from manual labor performed. The examination of these projects is superfluous. It is enough to know that they are utterly incompatible with the preservation of the market economy.
The fiscal and nonfiscal objectives of taxation do not agree with one another.
Consider, for instance, excise duties on liquor. If one considers them as a source of government revenue, the more they yield the better they appear. Of course, as the duty must enhance the price of the beverage, it restricts sales and consumption. It is necessary to find out by testing under what rate of duty the yield becomes highest. But if one looks at liquor taxes as a means of reducing the consumption of liquor as much as possible, the rate is better the higher it is. Pushed beyond a certain limit, the tax makes consumption drop considerably, and also the revenue concomitantly. If the tax fully attains its nonfiscal objective of weaning people entirely from drinking alcoholic beverages, the revenue is zero. It no longer serves any fiscal purpose; its effects are merely prohibitive. The same is valid not only with regard to all kinds of indirect taxation but no less for direct taxation. Discriminating taxes levied upon corporations and big business would, if raised above a certain limit, result in the total disappearance of corporations and big business. Capital levies, inheritance and estate taxes, and income taxes are similarly self-defeating if carried to extremes.
There is no solution for the irreconcilable conflict between the fiscal and the nonfiscal ends of taxation. The power to tax involves, as Chief Justice Marshall pertinently observed, the power to destroy. This power can be used for the destruction of the market economy, and it is the firm resolution of many governments and parties to use it for this purpose. With the substitution of socialism for capitalism, the dualism of the coexistence of two distinct spheres of action disappears. The government swallows the whole orbit of the individual’s autonomous actions and becomes totalitarian. It no longer depends for its financial support on the means exacted from the citizens. There is no longer any such thing as a separation of public funds and private funds.
Taxation is a matter of the market economy. It is one of the characteristic features of the market economy that the government does not interfere with the market phenomena and that its technical apparatus is so small that its maintenance absorbs only a modest fraction of the total sum of the individual citizens’ incomes. Then taxes are an appropriate vehicle for providing the funds needed by the government. They are appropriate because they are low and do not perceptibly disarrange production and consumption. If taxes grow beyond a moderate limit, they cease to be taxes and turn into devices for the destruction of the market economy.
This metamorphosis of taxes into weapons of destruction is the mark of present-day public finance. We do not deal with the quite arbitrary value judgments concerning the problems of whether heavy taxation is a curse or a benefit and whether the expenditures financed by the tax yield are or are not wise and beneficial. 25 What matters is that the heavier taxation becomes, the less compatible it is with the preservation of the market economy. There is no need to raise the question of whether or not it is true that “no country was ever yet ruined by large expenditures of money by the public and for the public.” 26 It cannot be denied that the market economy can be ruined by large public expenditures and that it is the intention of many people to ruin it in this way.
Businessmen complain about the oppressiveness of heavy taxes. Statesmen are alarmed about the danger of “eating the seedcorn.” Yet, the true crux of the taxation issue is to be seen in the paradox that the more taxes increase, the more they undermine the market economy and concomitantly the system of taxation itself. Thus the fact becomes manifest that ultimately the preservation of private property and confiscatory measures are incompatible. Every specific tax, as well as a nation’s whole tax system, becomes self-defeating above a certain height of the rates.
The various methods of taxation which can be used for the regulation of the economy—i.e., as instruments of an interventionist policy—can be classified in three groups:
1. The tax aims at totally suppressing or at restricting the production of definite commodities. It thus indirectly interferes with consumption too. It does not matter whether this end is aimed at by the imposition of special taxes or by exempting certain products from a general tax imposed upon all other products or upon those products which the consumers would have preferred in the absence of fiscal discrimination. Tax exemption is employed as an instrument of interventionism in the case of customs duties. The domestic product is not burdened by the tariff which affects only the merchandise imported from abroad. Many countries resort to tax discrimination in regulating domestic production. They try, for instance, to encourage the production of wine, a product of small or medium-size grape growers, as against the production of beer, a product of big-size breweries, by submitting beer to a more burdensome excise tax than wine.
2. The tax expropriates a part of income or wealth.
3. The tax expropriates income and wealth entirely.
We do not have to deal with the third class, as it is merely a means for the realization of socialism and as such is outside the scope of interventionism.
The first class is in its effects not different from the restrictive measures dealt with in the following chapter.
The second class encompasses confiscatory measures dealt with in Chapter XXXII.
WE shall deal in this chapter with those measures which are directly and primarily intended to divert production (in the broadest meaning of the word, including commerce and transportation) from the ways it would take in the unhampered market economy. Each authoritarian interference with business diverts production, of course, from the lines it would take if it were only directed by the demand of the consumers as manifested on the market. The characteristic mark of restrictive interference with production is that the diversion of production is not merely an unavoidable and unintentional secondary effect, but precisely what the authority wants to bring about. Like any other act of intervention, such restrictive measures affect consumption also. But this again, in the case of the restrictive measures we are dealing with in this chapter, is not the primary end the authority aims at. The government wants to interfere with production. The fact that its measure influences the ways of consumption also is, from its point of view, either altogether contrary to its intentions or at least an unwelcome consequence with which it puts up because it is unavoidable and is considered as a minor evil when compared with the consequences of nonintervention.
Restriction of production means that the government either forbids or makes more difficult or more expensive the production, transportation, or distribution of definite articles, or the application of definite modes of production, transportation, or distribution. The authority thus eliminates some of the means available for the satisfaction of human wants. The effect of its interference is that people are prevented from using their knowledge and abilities, their labor and their material means of production in the way in which they would earn the highest returns and satisfy their needs as much as possible. Such interference makes people poorer and less satisfied.
This is the crux of the matter. All the subtlety and hair-splitting wasted in the effort to invalidate this fundamental thesis are vain. On the unhampered market there prevails an irresistible tendency to employ every factor of production for the best possible satisfaction of the most urgent needs of the consumers. If the government interferes with this process, it can only impair satisfaction; it can never improve it.
The correctness of this thesis has been proved in an excellent and irrefutable manner with regard to the historically most important class of government interference with production, the barriers to international trade. In this field the teachings of the classical economists, especially those of Ricardo, are final and settle the issue forever. All that a tariff can achieve is to divert production from those locations in which the output per unit of input is higher to locations in which it is lower. It does not increase production; it curtails it.
People expatiate on alleged government encouragement of production. However, government does not have the power to encourage one branch of production except by curtailing other branches. It withdraws the factors of production from those branches in which the unhampered market would employ them and directs them into other branches. It little matters what kind of administrative procedures the government resorts to for the realization of this effect. It may subsidize openly or disguise the subsidy in enacting tariffs and thus forcing its subjects to defray the costs. What alone counts is the fact that people are forced to forego some satisfactions which they value more highly and are compensated only by satisfactions which they value less. At the bottom of the interventionist argument there is always the idea that the government or the state is an entity outside and above the social process of production, that it owns something which is not derived from taxing its subjects, and that it can spend this mythical something for definite purposes. This is the Santa Claus fable raised by Lord Keynes to the dignity of an economic doctrine and enthusiastically endorsed by all those who expect personal advantage from government spending. As against these popular fallacies there is need to emphasize the truism that a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens’ spending and investment to the full extent of its quantity.
While government has no power to make people more prosperous by interference with business, it certainly does have the power to make them less satisfied by restriction of production.
The fact that restricting production invariably involves a curtailment of the individual citizens’ satisfaction does not mean that such restriction is necessarily to be regarded as a damage. A government does not wantonly resort to restrictive measures. It wants to attain certain ends and considers the restriction as the appropriate means for the realization of its plan. The appraisal of restrictive policies depends therefore on the answer to two questions: Is the means chosen by the government fitted to attain the end sought? Is the realization of this end a compensation for the individual citizens’ privation? In raising these questions we look upon restriction of production as we look upon taxes. Payment of taxes also directly curtails the taxpayer’s satisfaction. But it is the price he pays for the services which government renders to society and to each of its members. As far as the government fulfills its social functions and the taxes do not exceed the amount required for securing the smooth operation of the government apparatus, they are necessary costs and repay themselves.
The adequacy of this mode of dealing with restrictive measures is especially manifest in all those cases in which restriction is resorted to as a substitute for taxation. The bulk of expenditure for national defense is defrayed by the treasury out of the public revenue. But occasionally another procedure is chosen. It happens sometimes that the nation’s preparedness to repel aggression depends on the existence of certain branches of industry which would be absent in the unhampered market. These industries must be subsidized, and the subsidies granted are to be considered as any other armaments expenditure. Their character remains the same if the government grants them indirectly by the imposition of an import duty for the products concerned. The difference is only that then the consumers are directly burdened with the costs incurred, while in the case of a government subsidy they defray these costs indirectly by paying higher taxes.
In enacting restrictive measures governments and parliaments have hardly ever been aware of the consequences of their meddling with business. Thus, they have blithely assumed that protective tariffs are capable of raising the nation’s standard of living, and they have stubbornly refused to admit the correctness of the economic teachings concerning the effects of protectionism. The economists’ condemnation of protectionism is irrefutable and free of any party bias. For the economists do not say that protection is bad from any preconceived point of view. They show that protection cannot attain those ends which the governments as a rule want to attain by resorting to it. They do not question the ultimate end of the government’s action; they merely reject the means chosen as inappropriate to realize the ends aimed at.
Most popular among all restrictive measures are those styled prolabor legislation. Here too the governments and public opinion badly misjudge the effects. They believe that restricting the hours of work and prohibiting child labor exclusively burdens the employers and is a “social gain” for the wage earners. However, this is true only to the extent that such laws reduce the supply of labor and thus raise the marginal productivity of labor as against the marginal productivity of capital. But the drop in the supply of labor results also in a decrease in the total amount of goods produced and thereby in the average per capita consumption. The total cake shrinks, but the portion of the smaller cake which goes to the wage earners is proportionately higher than what they received from the bigger cake; concomitantly the portion of the capitalists drops. 27 It depends on the concrete data of each case whether or not this outcome improves or impairs the real wage rates of the various groups of wage earners.
The popular appraisal of prolabor legislation was based on the error that wage rates have no causal relation whatever to the value that the workers’ labor adds to the material. Wage rates, says the “iron law,” are determined by the minimum amount of indispensable necessities of life; they can never rise above the subsistence level. The difference between the value produced by the worker and the wages paid to him goes to the exploiting employer. If this surplus is curtailed by restricting the working hours, the wage earner is relieved of a part of his toil and trouble, his wages remain unchanged, and the employer is deprived of a part of his unfair profit. The restriction of total output curtails only the income of the exploiting bourgeois.
It has been pointed out already that the role which prolabor legislation played in the evolution of Western capitalism was until a few years ago much less important than would be suggested by the vehemence with which the problems involved have been publicly discussed. Labor legislation, for the most part, merely provided a legal recognition of changes in conditions already consummated by the rapid evolution of business. 28 But in the countries which were slow in adopting capitalistic modes of production and are backward in developing modern methods of processing and manufacturing, the problem of labor legislation is crucial. Deluded by the spurious doctrines of interventionism, the politicians of these nations believe that they can improve the lot of the destitute masses by copying the labor legislation of the most advanced capitalistic countries. They look upon the problems involved as if they were merely to be treated from what is erroneously called the “human angle” and fail to recognize the real issue.
It is a sad fact indeed that in Asia many millions of tender children are destitute and starving, that wages are extremely low when compared with American or Western European standards, that hours of work are long, and that sanitary conditions in the workshops are deplorable. But there is no means of eliminating these evils other than to work, to produce, and to save more and thus to accumulate more capital. This is indispensable for any lasting improvement. The restrictive measures advocated by self-styled philanthropists and humanitarians would be futile. They would not only fail to improve conditions, they would make things a good deal worse. If the parents are too poor to feed their children adequately, prohibition of child labor condemns the children to starvation. If the marginal productivity of labor is so low that a worker can earn in ten hours only wages which are substandard when compared with American wages, one does not benefit the laborer by decreeing the eight-hour day.
The problem under discussion is not the desirability of improving the wage earners’ material well-being. The advocates of what are miscalled prolabor laws intentionally confuse the issue in repeating again and again that more leisure, higher real wages, and freeing children and married women from the necessity of seeking jobs would make the families of the workers happier. They resort to falsehood and mean calumny in calling those who oppose such laws as detrimental to the vital interests of the wage earners “labor-baiters” and “enemies of labor.” The disagreement does not refer to the ends sought; it concerns solely the means to be applied for their realization. The question is not whether or not improvement of the masses’ welfare is desirable. It is exclusively whether or not government decrees restricting the hours of work and the employment of women and children are the right means for raising the workers’ standard of living. This is a purely catallactic problem to be solved by economics. Emotional talk is beside the point. It is a poor disguise for the fact that these self-righteous advocates of restriction are unable to advance any tenable objections to the economists’ well-founded argumentation.
The fact that the standard of living of the average American worker is incomparably more satisfactory than that of the average Hindu worker, that in the United States hours of work are shorter and that the children are sent to school and not to the factories, is not an achievement of the government and of the laws of the country. It is the outcome of the fact that the capital invested per head of the employees is much greater than in India and that consequently the marginal productivity of labor is much higher. This is not the merit of “social policies”; it is the result of the laissez faire methods of the past which abstained from sabotaging the evolution of capitalism. It is this laissez faire that the Asiatics must adopt if they want to improve the lot of their peoples.
The poverty of Asia and other backward countries is due to the same causes which made conditions unsatisfactory in the early periods of Western capitalism. While population figures increased rapidly, restrictive policies delayed the adjustment of production methods to the needs of the growing number of mouths. It is to the imperishable credit of the laissez faire economists, whom the typical textbooks of our universities dismiss as pessimists and apologists of the unfair greed of exploiting bourgeois, that they paved the way for economic freedom which raised the average standard of living to an unprecedented height.
Economics is not dogmatic, as the self-styled “unorthodox” advocates of government omnipotence and totalitarian dictatorship contend. Economics neither approves nor disapproves of government measures restricting production and output. It merely considers it its duty to clarify the consequences of such measures. The choice of policies to be adopted devolves upon the people. But in choosing they must not disregard the teachings of economics if they want to attain the ends sought.
There are certainly cases in which people may consider definite restrictive measures as justified. Regulations concerning fire prevention are restrictive and raise the cost of production. But the curtailment of total output they bring about is the price to be paid for avoidance of greater disaster. The decision about each restrictive measure is to be made on the ground of a meticulous weighing of the costs to be incurred and the prize to be obtained. No reasonable man could possibly question this rule.
Every disarrangement of the market data affects various individuals and groups of individuals in a different way. For some people it is a boon, for others a blow. Only after a while, when production is adjusted to the emergence of the new datum, are these effects exhausted. Thus a restrictive measure, while placing the immense majority at a disadvantage, may temporarily improve some people’s position. For those favored the measure is tantamount to the acquisition of a privilege. They are asking for such measures because they want to be privileged.
Here again the most striking example is provided by protectionism. The imposition of a duty on the importation of a commodity burdens the consumers. But to the domestic producers it is a boon. From their point of view decreeing new tariffs and raising already existing tariffs is an excellent thing.
The same is valid with regard to many other restrictive measures. If the government restricts—either by direct restriction or by fiscal discrimination—big business and corporations, the competitive position of small-size enterprises is strengthened. If it restricts the operation of big stores and chain stores, the small shopkeepers rejoice.
It is important to realize that what those benefited by these measures consider an advantage for themselves lasts only for a limited time. In the long run the privilege accorded to a definite class of producers loses its power to create specific gains. The privileged branch attracts newcomers, and their competition tends to eliminate the specific gains derived from the privilege. Thus the eagerness of the law’s pet children to acquire privileges is insatiable. They continue to ask for new privileges because the old ones lose their power.
On the other hand, the repeal of a restrictive measure to the existence of which the structure of production has already been adjusted means a new disarrangement of the market data, favors the short-run interests of some people and hurts the short-run interests of other people. Let us illustrate the issue by referring to a tariff item. Ruritania years ago, let us say in 1920, decreed a tariff on the importation of leather. This was a boon for the enterprises which at the moment happened to be engaged in the tanning industry. But then later the size of the industry expanded and the windfall gains which the tanners enjoyed in 1920 and in the following years petered out. What remains is merely the fact that a part of the world’s leather production is shifted from locations in which the output per unit of input is higher, to locations in Ruritania in which production requires higher costs. The residents of Ruritania pay higher prices for leather than they would pay in the absence of the tariff. As a greater part of Ruritania’s capital and labor is employed in the tanneries than would be the case under free trade for leather, some other domestic industries shrank or were at least prevented from growing. Less leather is imported from abroad and a smaller amount of Ruritanian products is exported as payment for leather imported. The volume of Ruritania’s foreign trade is curtailed. Not a single soul in the whole world derives any advantage from the preservation of the old tariff. On the contrary, everyone is hurt by the drop in the total output of mankind’s industrial effort. If the policy adopted by Ruritania with regard to leather were to be adopted by all nations and with regard to every kind of merchandise in the most rigid way so as to abolish international trade altogether and to make every nation perfectly autarkic, all people would have to forego entirely the advantages which the international division of labor gives them.
It is obvious that the repeal of the Ruritanian tariff on leather must in the long run benefit everybody, Ruritanians as well as foreigners. However, in the short run it would hurt the interests of the capitalists who have invested in Ruritanian tanneries. It would no less hurt the short-run interests of the Ruritanian workers specialized in tannery work. A part of them would have either to emigrate or to change their occupation. These capitalists and workers passionately fight all attempts to lower the leather tariff or to abolish it altogether.
This shows clearly why it is politically extremely difficult to brush away measures restricting production once the structure of business has been adjusted to their existence. Although their effects are pernicious to everybody, their disappearance is in the short run disadvantageous to special groups. These special groups interested in the preservation of the restrictive measures are, of course, only minorities. In Ruritania only the small fraction of the population engaged in the tanneries can suffer from the abolition of the tariff on leather. The immense majority are buyers of leather and leather goods and would be benefited by a drop in their prices. Outside the boundaries of Ruritania, only those people would be hurt who are engaged in those industries which will shrink because the leather industry will expand.
The last objection advanced by the opponents of free trade runs this way: Granted that only those Ruritanians engaged in tanning hides are immediately interested in the preservation of the tariff on leather. But every Ruritanian belongs to one of the many branches of production. If each domestic product is protected by the tariff, the transition to free trade hurts the interests of each industry and thereby those of all specialized groups of capital and labor the sum of which is the whole nation. It follows that repealing the tariff would in the short run be prejudicial to all citizens. And it is short-run interests only that count.
This argument involves a threefold error. First, it is not true that all branches of industry would be hurt by the transition to free trade. On the contrary. Those branches in which the comparative costs of production are lowest will expand under free trade. Their short-run interests would be favored by the abolition of the tariff. The tariff on those products they themselves turn out is of no advantage for them, as they could not only survive, but expand under free trade. The tariff on those products for which the comparative cost of production is higher in Ruritania than abroad hurts them by directing capital and labor, which otherwise would have fertilized them, into those other branches.
Second, the short-run principle is entirely fallacious. In the short run every change in the market data hurts those who did not anticipate it in time. A consistent champion of the short-run principle must advocate perfect ridigity and immutability of all data and oppose any change, including any therapeutical and technological improvement. 29 If in acting people were always to prefer the avoidance of an evil in the nearer future to the avoidance of an evil in the remoter future, they would come down to the animal level. It is the very essence of human action as distinct from animal behavior that it consciously renounces some temporally nearer satisfaction in order to reap some greater but temporally remoter satisfaction. 30
Finally, if the problem of the abolition of Ruritania’s comprehensive tariff system is under discussion, one must not forget the fact that the short-run interests of those engaged in tanning are hurt only by the abolition of one of the items of the tariff while they are favored by the abolition of the other items concerning the products of the industries in which comparative cost is high. It is true that wage rates of the tannery workers will drop for some time as against those in other branches and that some time will elapse until the appropriate long-run proportion between wage rates in the various branches of Ruritanian production will be established. But concomitantly with the merely temporary drop in their earnings, these workers will experience a drop in the prices of many articles they are buying. And this tendency toward an improvement in their conditions is not a phenomenon only of the period of transition. It is the consummation of the lasting blessings of free trade which, in shifting every branch of industry to the location in which comparative cost is lowest, increases the productivity of labor and the total quantity of goods produced. It is the lasting long-run boon which free trade secures to every member of the market society.
The opposition to the abolition of tariff protection would be reasonable from the personal point of view of those engaged in the leather industry if the tariff on leather were the only tariff. Then one could explain their attitude as dictated by status interests, the interests of a caste which would be temporarily hurt by the abolition of a privilege although its mere preservation no longer confers any benefit on them. But in this hypothetical case the opposition of the tanners would be hopeless. The majority of the nation would overrule it. What strengthens the ranks of the protectionists is the fact that the tariff on leather is no exception, that many branches of industry are in a similar position and are fighting the abolition of tariff items concerning their own branch. This is, of course, not an alliance based on each group’s special group interests. If everybody is protected to the same extent, everybody not only loses as consumer as much as he gains as producer. Everybody, moreover, is harmed by the general drop in the productivity of labor which the shifting of industries from more favorable to less favorable locations brings about. Conversely the abolition of all tariff items would benefit everybody in the long run, while the short-run harm which the abolition of some special tariff item brings to the special interests of the group concerned is already in the short run at least partly compensated by the consequences of the abolition of the tariff on the products the members of this group are buying and consuming.
Many people look upon tariff protection as if it were a privilege accorded to their nation’s wage earners, procuring them, for the full duration of its existence, a higher standard of living than they would enjoy under free trade. This argument is advanced not only in the United States, but in every country in the world in which average real wage rates are higher than in some other country.
Now, it is true that under perfect mobility of capital and labor there would prevail all over the world a tendency toward an equalization of the price paid for labor of the same kind and quality. 31 Yet, even if there were free trade for products, this tendency is absent in our real world of migration barriers and institutions hindering foreign investment of capital. The marginal productivity of labor is higher in the United States than it is in India because capital invested per head of the working population is greater, and because Indian workers are prevented from moving to America and competing on the American labor market. There is no need, in dealing with the explanation of this difference, to investigate whether natural resources are or are not more abundant in America than in India and whether or not the Indian worker is racially inferior to the American worker. However this may be, these facts, namely, the institutional checks upon the mobility of capital and labor, suffice to account for the absence of the equalization tendency. As the abolition of the American tariff could not affect these two facts, it could not impair the standard of living of the American wage earner in an adverse sense.
On the contrary. Given a state of affairs in which the mobility of capital and labor is restricted, the transition to free trade for products must necessarily raise the American standard of life. Those industries in which American costs are higher (American productivity is lower) would shrink and those in which costs are lower (productivity is higher) would expand.
Under free trade the Swiss watchmakers would expand their sales on the American market and the sales of their American competitors would shrink. But this is only a part of the consequences of free trade. Selling and producing more, the Swiss would earn and buy more. It does not matter whether they themselves buy more of the products of other American industries or whether they increase their domestic purchases and those in other countries, for instance, in France. Whatever happens, the equivalent of the additional dollars they earned must finally go to the United States and increase the sales of some American industries. If the Swiss do not give away their products as a gift, they must spend these dollars in buying.
The popular opinion to the contrary is due to the illusory idea that America could expand its purchases of imported products by reducing the total sum of its citizens’ cash holdings. This is the notorious fallacy according to which people buy without regard to the size of their cash holdings, and according to which the very existence of cash holdings is simply the outcome of the fact that something is left over because there is nothing more to buy. We have already shown why this Mercantilist doctrine is entirely wrong. 32
What the tariff really brings about in the field of wage rates and the wage earners’ standard of living is something quite different.
In a world in which there is free trade for commodities, while the migration of workers and foreign investment are restricted, there prevails a tendency toward an establishment of a definite relation between the wages paid for the same kind and quality of labor in various countries. There cannot prevail a tendency toward an equalization of wage rates. But the final price to be paid for labor in various countries is in a certain numerical relation. This final price is characterized by the fact that all those eager to earn wages get a job and all those eager to employ workers are able to hire as many hands as they want. There is “full employment.”
Let us assume that there are two countries only—Ruritania and Laputania. In Ruritania the final wage rate is double what it is in Laputania. Now the government of Ruritania resorts to one of those measures which are erroneously styled “prolabor.” It burdens the employers with an additional expenditure the size of which is proportional to the number of workers employed. For example, it reduces the hours of work without permitting a corresponding drop in weekly wage rates. The result is a drop in the quantity of goods produced and a rise in the price of the unit of every good. The individual worker enjoys more leisure, but his standard of living is curtailed. What else could a general decrease in the quantity of goods available bring about?
This outcome is an internal event in Ruritania. It would emerge also in the absence of any foreign trade. The fact that Ruritania is not autarkic, but buys from and sells to Laputania, does not alter its essential features. But it implicates Laputania. As the Ruritanians produce and consume less, they will buy less from Laputania. In Laputania there will not be a general drop in production. But some industries which produced for export to Ruritania will henceforth have to produce for the domestic Laputanian market. Laputania will see the volume of its foreign trade drop; it will become, willy-nilly, more autarkic. This is a blessing in the eyes of the protectionists. In truth, it means deterioration in the standard of living; production at higher costs is substituted for that at lower costs. What Laputania experiences is the same thing that the residents of an autarkic country would experience if an act of God were to curtail the productivity of one of the country’s industries. As far as there is division of labor, everybody is affected by a drop in the amount other people contribute to supplying the market.
However, these inexorable final international consequences of Ruritania’s new pro-labor law will not affect the various branches of Laputania’s industry in the same way. A sequence of steps is needed in both countries until at last a perfect adjustment of production to the new state of data is brought about. These short-run effects are different from the long-run effects. They are more spectacular than the long-run effects. While hardly anybody can fail to notice the short-run effects, the long-run effects are recognized only by economists. While it is not difficult to conceal the long-run effects from the public, something must be done about the easily recognizable short-run effects lest the enthusiasm for such allegedly pro-labor legislation fade away.
The first short-run effect to appear is the weakening of the competitive power of some Ruritanian branches of production as against those of Laputania. As prices rise in Ruritania, it becomes possible for some Laputanians to expand their sales in Ruritania. This is a temporary effect only; in the end the total sales of all Laputanian industries in Ruritania will drop. It is possible that in spite of this general drop in the amount of Laputanian exports to Ruritania, some of the Laputanian industries will expand their sales in the long run. (This depends on the new configuration of comparative costs.) But there is no necessary interconnection between these short-run and long-run effects. The adjustments of the period of transition create kaleidoscopically changing situations which may differ entirely from the final out-come. Yet the short-sighted public’s attention is completely absorbed by these short-run effects. They hear the businessmen affected complain that the new Ruritanian law gives to Laputanians the opportunity to undersell both in Ruritania and in Laputania. They see that some Ruritanian businessmen are forced to restrict their production and to discharge workers. And they begin to suspect that something may be wrong with the teachings of the self-styled “unorthodox friends of labor.”
But the picture is different if there is in Ruritania a tariff high enough to prevent Laputanians from even temporarily expanding their sales on the Ruritanian market. Then the most spectacular short-run effects of the new measure are masked in such a way that the public does not become aware of them. The long-run effects, of course, cannot be avoided. But they are brought about by another sequence of short-run effects which is less offensive because less visible. The talk about alleged “social gains” produced by the shortening of the hours of work is not exploded by the immediate emergence of effects which everyone, and most of all the discharged workers, consider undesirable.
The main function of tariffs and other protectionist devices today is to disguise the real effects of interventionist policies designed to raise the standard of living of the masses. Economic nationalism is the necessary complement of these popular policies which pretend to improve the wage earners’ material well-being while they are in fact impairing it. 33
There are, as has been shown, cases in which a restrictive measure can attain the end sought by its application. If those resorting to such a measure think that the attainment of this goal is more important than the disadvantages brought about by the restriction—i.e., the curtailment in the quantity of material goods available for consumption—the recourse to restriction is justified from the point of view of their value judgments. They incur costs and pay a price in order to get something that they value more than what they had to expend or to forego. Nobody, and certainly not the theorist, is in a position to argue with them about the propriety of their value judgments.
The only adequate mode of dealing with measures restricting production is to look at them as sacrifices made for the attainment of a definite end. They are quasi-expenditures and quasi-consumption. They are an employment of things that could be produced and consumed in one way for the realization of certain other ends. These things are prevented from coming into existence, but this quasi-consumption is precisely what satisfies the authors of these measures better than the increase in goods available which the omission of the restriction would have produced.
With certain restrictive measures this point of view is universally adopted. If a government decrees that a piece of land should be kept in its natural state as a national park and should be withheld from any other utilization, nobody would classify such a venture as anything else than an expenditure. The government deprives the citizens of the increment in various products which the cultivation of this land could bring about, in order to provide them with another satisfaction.
It follows that restriction of production can never play any role other than that of an ancillary complement of a system of production. One cannot construct a system of economic action out of such restrictive measures alone. No complex of such measures can be linked together into an integrated economic system. They cannot form a system of production. They belong in the sphere of consumption, not in the sphere of production.
In scrutinizing the problems of interventionism we are intent upon examining the claims of the advocates of government interference with business that their system offers an alternative to other economic systems. No such claim can reasonably be raised with regard to measures restricting production. The best they can attain is curtailment of output and satisfaction. Wealth is produced by expending a certain quantity of factors of production. Curtailing this quantity does not increase, but decreases, the amount of goods produced. Even if the ends aimed at by shortening the hours of work could be attained by such a decree, it would not be a measure of production. It is invariably a way of cutting down output.
Capitalism is a system of social production. Socialism, say the socialists, is also a system of social production. But with regard to measures restricting production, even the interventionists cannot raise a similar claim. They can only say that under capitalism too much is produced and that they want to prevent the production of this surplus in order to realize other ends. They themselves must confess that there are limits to the application of restriction.
Economics does not contend that restriction is a bad system of production. It asserts that it is not at all a system of production but rather a system of quasi-consumption. Most of the ends the interventionists want to attain by restriction cannot be attained this way. But even where restrictive measures are fit to attain the ends sought, they are only restrictive. 34
The enormous popularity which restriction enjoys in our day is due to the fact that people do not recognize its consequences. In dealing with the problem of shortening the hours of work by government decree, the public is not aware of the fact that total output must drop and that it is very probable that the wage earners’ standard of living will be potentially lowered too. It is a dogma of present-day “unorthodoxy” that such a “prolabor” measure is a “social gain” for the workers and that the costs of these gains fall entirely upon the employers. Whoever questions this dogma is branded as a “sycophantic” apologist of the unfair pretensions of rugged exploiters, and pitilessly persecuted. It is insinuated that he wants to reduce the wage earners to the poverty and the long working hours of the early stages of modern industrialism.
As against all this slander it is important to emphasize again that what produces wealth and well-being is production and not restriction. That in the capitalist countries the average wage earner consumes more goods and can afford to enjoy more leisure than his ancestors, and that he can support his wife and children and need not send them to work, is not an achievement of governments and labor unions. It is the outcome of the fact that profit-seeking business has accumulated and invested more capital and thus increased the marginal productivity of labor.
Interference with the structure of the market means that the authority aims at fixing prices for commodities and services and interest rates at a height different from what the unhampered market would have determined. It decrees, or empowers—either tacitly or expressly—definite groups of people to decree prices and rates which are to be considered either as maxima or as minima, and it provides for the enforcement of such decrees by coercion and compulsion.
In resorting to such measures the government wants to favor either the buyer—as in the case of maximum prices—or the seller—as in the case of minimum prices. The maximum price is designed to make it possible for the buyer to procure what he wants at a price lower than that of the unhampered market. The minimum price is designed to make it possible for the seller to dispose of his merchandise or his services at a price higher than that of the unhampered market. It depends on the political balance of forces which groups the authority wants to favor. At times governments have resorted to maximum prices, at other times to minimum prices for various commodities. At times they have decreed maximum wages rates, at other times minimum wage rates. It is only with regard to interest that they have never had recourse to minimum rates; when they have interfered, they have always decreed maximum interest rates. They have always looked askance upon saving, investing, and moneylending.
If this interference with commodity prices, wage rates, and interest rates includes all prices, wage rates, and interest rates, it is tantamount to the full substitution of socialism (of the German pattern) for the market economy. Then the market, interpersonal exchange, private ownership of the means of production, entrepreneurship, and private initiative, virtually disappear altogether. No individual any longer has the opportunity to influence the process of production of his own accord; every individual is bound to obey the orders of the supreme board of production management. What in the complex of these orders are called prices, wage rates, and interest rates are no longer prices, wage rates, and interest rates in the catallactic sense of these terms. They are merely quantitative determinations fixed by the director without reference to a market process. If the governments resorting to price control and the reformers advocating price control were always intent upon the establishment of socialism of the German pattern, there would be no need for economics to deal with price control separately. All that has to be said with reference to such price control is already contained in the analysis of socialism.
Many advocates of government interference with prices have been and are very much confused with regard to this issue. They have failed to recognize the fundamental difference between a market economy and a nonmarket society. The haziness of their ideas has been reflected in vague and ambiguous language and in a bewildering terminology.
There were and are advocates of price control who have declared that they want to preserve the market economy. They are outspoken in their assertion that government fixing of prices, wage rates, and interest rates can attain the ends the government wants to attain by their promulgation without abolishing altogether the market and private ownership of the means of production. They even declare that price control is the best or the only means of preserving the system of private enterprise and of preventing the coming of socialism. They become very indignant if somebody questions the correctness of their doctrine and shows that price control, if it is not to make things worse from the point of view of the governments and the interventionist doctrinaires, must finally result in socialism. They protest that they are neither socialists nor communists, and that they aim at economic freedom and not at totalitarianism.
It is the tenets of these interventionists that we have to examine. The problem is whether it is possible for the police power to attain the ends it wants to attain by fixing prices, wage rates, and interest rates at a height different from what the unhampered market would have determined. It is beyond doubt that a strong and resolute government has the power to decree such maximum or minimum rates and to take revenge upon the disobedient. But the question is whether or not the authority can attain those ends which it wants to attain by resorting to such decrees.
History is a long record of price ceilings and anti-usury laws. Again and again emperors, kings, and revolutionary dictators have tried to meddle with the market phenomena. Severe punishment was inflicted on refractory dealers and farmers. Many people fell victim to persecutions which met with the enthusiastic approval of the masses. Nonetheless, all these endeavors failed. The explanation which the writings of lawyers, theologians and philosophers provided for the failure was in full agreement with the ideas held by the rulers and the masses. Man, they said, is intrinsically selfish and sinful, and the authorities were unfortunately too lax in enforcing the law. What was needed was more firmness and peremptoriness on the part of those in power.
Cognizance of the issue involved was first reached with regard to a special problem. Various governments long practiced currency debasement. They substituted baser and cheaper metals for a part of the gold or silver which the coins previously contained, or they reduced the weight and the size of the coins. But they retained for the debased coins the customary names of the old ones and they decreed that they should be given and received at the nominal par. Then later the governments tried to enjoin on their subjects analogous constraint with regard to the exchange ratio between gold and silver and that between metallic money and credit money or fiat money. In searching for the causes which made all such decrees abortive, the forerunners of economic thought had already discovered by the last centuries of the Middle Ages the regularity which was later called Gresham’s Law. There was still a long way to go from this isolated insight to the point where the philosophers of the eighteenth century became aware of the interconnectedness of all market phenomena.
In describing the results of their reasoning the classical economists and their successors sometimes resorted to idiomatic expressions which could easily be misinterpreted by those who wanted to misinterpret them. They occasionally spoke of the “impossibility” of price control. What they really meant was not that such decrees are impossible, but that they cannot attain those ends which the governments are trying to attain and that they make things worse, not better, They concluded that such decrees are contrary to purpose and inexpedient.
It is necessary to see clearly that the problem of price control is not merely one of the problems to be dealt with by economics, not a problem with regard to which there can arise disagreement among various economists. The issue involved is rather: Is there any such thing as economics? Is there any regularity in the sequence and interconnectedness of the market phenomena? He who answers these two questions in the negative denies the very possibility, rationality and existence of economics as a branch of knowledge. He returns to the beliefs held in the ages which preceded the evolution of economics. He declares to be untrue the assertion that there is any economic law and that prices, wage rates, and interest rates are uniquely determined by the data of the market. He contends that the police have the power to determine these market phenomena ad libitum. An advocate of socialism need not necessarily negate economics; his postulates do not necessarily imply the indeterminateness of the market phenomena. But the interventionist, in advocating price control, cannot help nullifying the very existence of economics. Nothing is left of economics if one denies the law of the market.
The German Historical School was consistent in its radical condemnation of economics and in its endeavors to substitute wirtschaftliche Staatswissenschaften (the economic aspects of political science) for economics. So were many adepts of British Fabianism and American Institutionalism. But those authors who do not totally reject economics and yet assert that price control can attain the ends sought lamentably contradict themselves. It is logically impossible to reconcile the point of view of the economist and that of the interventionist. If prices are uniquely determined by the market data, they cannot be freely manipulated by government compulsion. The government’s decree is just a new datum, and its effects are determined by the operation of the market. It need not necessarily produce those results which the government wants to realize in resorting to it. It may happen that the final outcome of the interference is, from the point of view of the government’s intention, even more undesirable than the previous state of affairs which the government wanted to alter.
One does not invalidate these propositions by putting the term economic law in quotation marks and by finding fault with the notion of the law. In speaking of the laws of nature we have in mind the fact that there prevails an inexorable interconnectedness of physical and biological phenomena and that acting man must submit to this regularity if he wants to succeed. In speaking of the laws of human action we refer to the fact that such an inexorable interconnectedness of phenomena is present also in the field of human action as such and that acting man must recognize this regularity too if he wants to succeed. The reality of the laws of praxeology is revealed to man by the same signs that reveal the reality of natural law, namely, the fact that his power to attain chosen ends is restricted and conditioned. In the absence of laws man would either be omnipotent and would never feel any uneasiness which he could not remove instantly and totally, or he could not act at all.
These laws of the universe must not be confused with the man-made laws of the country and with man-made moral precepts. The laws of the universe about which physics, biology, and praxeology provide knowledge are independent of the human will, they are primary ontological facts rigidly restricting man’s power to act. The moral precepts and the laws of the country are means by which men seek to attain certain ends. Whether or not these ends can really be attained this way depends on the laws of the universe. The man-made laws are suitable if they are fit to attain these ends and contrary to purpose if they are not. They are open to examination from the point of view of their suitableness or unsuitableness. With regard to the laws of the universe any doubt of their suitableness is supererogatory and vain. They are what they are and take care of themselves. Their violation penalizes itself. But the man-made laws need to be enforced by special sanctions.
Only the insane venture to disregard physical and biological laws. But it is quite common to disdain praxeological laws. Rulers do not like to admit that their power is restricted by any laws other than those of physics and biology. They never ascribe their failures and frustrations to the violation of economic law.
Foremost in the repudiation of economic knowledge was the German Historical School. It was an unbearable idea to those professors that their lofty idols, the Hohenzollern Electors of Brandenburg and Kings of Prussia, should have lacked omnipotence. To refute the teachings of the economists, they buried themselves in old documents and compiled numerous volumes dealing with the history of the administration of these glorious princes. This, they wrote, is a realistic approach to the problems of state and government. Here you find unadulterated facts and real life, not the bloodless abstractions and faulty generalizations of the British doctrinaires. In truth, all that these ponderous tomes report is a long record of policies and measures which failed precisely because of their neglect of economic law. No more instructive case history could ever be written than these Acta Borussica.
However, economics cannot acquiesce in such exemplification. It must enter into a precise scrutiny of the mode in which the market reacts to government interference with the price structure.
The characteristic feature of the market price is that it tends to equalize supply and demand. The size of the demand coincides with the size of supply not only in the imaginary construction of the evenly rotating economy. The notion of the plain state of rest as developed by the elementary theory of prices is a faithful description of what comes to pass in the market at every instant. Any deviation of a market price from the height at which supply and demand are equal is—in the unhampered market—self-liquidating.
But if the government fixes prices at a height different from what the market would have fixed if left alone, this equilibrium of demand and supply is disturbed. Then there are—with maximum prices—potential buyers who cannot buy although they are ready to pay the price fixed by the authority, or even a higher price. Then there are—with minimum prices—potential sellers who cannot sell although they are ready to sell at the price fixed by the authority, or even at a lower price. The price can no longer segregate those potential buyers and sellers who can buy or sell from those who cannot. A different principle for the allocation of the goods and services concerned and for the selection of those who are to receive portions of the supply available necessarily comes into operation. It may be that only those are in a position to buy who come first, or only those to whom particular circumstances (such as personal connections) assign a privileged position, or only those ruthless fellows who chase away their rivals by resorting to intimidation or violence. If the authority does not want chance or violence to determine the allocation of the supply available and conditions to become chaotic, it must itself regulate the amount which each individual is permitted to buy. It must resort to rationing. 35
But rationing does not affect the core of the issue. The allocation of portions of the supply already produced and available to the various individuals eager to obtain a quantity of the goods concerned is only a secondary function of the market. Its primary function is the direction of production. It directs the employment of the factors of production into those channels in which they satisfy the most urgent needs of the consumers. If the government’s price ceiling refers only to one consumers’ good or to a limited amount of consumers’ goods while the prices of the complementary factors of production are left free, production of the consumers’ goods concerned will drop. The marginal producers will discontinue producing them lest they suffer losses. The not absolutely specific factors of production will be employed to a greater extent for the production of other goods not subject to price ceilings. A greater part of the absolutely specific factors of production will remain unused than would have remained in the absence of price ceilings. There emerges a tendency to shift production activities from the production of the goods affected by the maximum prices into the production of other goods. This outcome is, however, manifestly contrary to the intentions of the government. In resorting to price ceilings the authority wanted to make the commodities concerned more easily accessible to the consumers. It considered precisely those commodities so vital that it singled them out for a special measure in order to make it possible even for poor people to be amply supplied with them. But the result of the government’s interference is that production of these commodities drops or stops altogether. It is a complete failure.
It would be vain for the government to try to remove these undesired consequences by decreeing maximum prices likewise for the factors of production needed for the production of the consumers’ goods the prices of which it has fixed. Such a measure would be successful only if all factors of production required were absolutely specific. As this can never be the case, the government must add to its first measure, fixing the price of only one consumers’ good below the potential market price, more and more price ceilings, not only for all other consumers’ goods and for all material factors of production, but no less for labor. It must compel every entrepreneur, capitalist, and employee to continue producing at the prices, wage rates, and interest rates which the government has fixed, to produce those quantities which the government orders them to produce, and to sell the products to those people—producers or consumers—whom the government determines. If one branch of production were to be exempt from this regimentation, capital and labor would flow into it; production would be restricted precisely in those other—regimented—branches which the government considered so important that it interfered with the conduct of their affairs.
Economics does not say that isolated government interference with the prices of only one commodity or a few commodities is unfair, bad, or unfeasible. It says that such interference produces results contrary to its purpose, that it makes conditions worse, not better, from the point of view of the government and those backing its interference. Before the government interfered, the goods concerned were, in the eyes of the government, too dear. As a result of the maximum price their supply dwindles or disappears altogether. The government interfered because it considered these commodities especially vital, necessary, indispensable. But its action curtailed the supply available. It is therefore, from the point of view of the government, absurd and nonsensical.
If the government is unwilling to acquiesce in this undesired and undesirable outcome and goes further and further, if it fixes the prices of all goods and services of all orders and obliges all people to continue producing and working at these prices and wage rates, it eliminates the market altogether. Then the planned economy, socialism of the German Zwangswirtschaft pattern, is substituted for the market economy. The consumers no longer direct production by their buying and abstention from buying; the government alone directs it.
There are only two exceptions to the rule that maximum prices restrict supply and thus bring about a state of affairs which is contrary to the aims sought by their imposition. One refers to absolute rent, the other to monopoly prices.
The maximum price results in a restriction of supply because the marginal producers suffer losses and must discontinue production. The nonspecific factors of production are employed for the production of other products not subject to price ceilings. The utilization of the absolutely specific factors of production shrinks. Under unhampered market conditions they would have been utilized up to the limit determined by the absence of an opportunity to use the nonspecific among the complementary factors for the satisfaction of more urgent wants. Now only a smaller part of the available supply of these absolutely specific factors can be utilized; concomitantly that part of the supply that remains unused increases. But if the supply of these absolutely specific factors is so scanty that under the prices of the unhampered market their total supply was utilized, a margin is given within which the government’s interference does not curtail the supply of the product. The maximum price does not restrict production as long as it has not entirely absorbed the absolute rent of the marginal supplier of the absolutely specific factor. But at any rate it results in a discrepancy between the demand for and the supply of the product.
Thus the amount by which the urban rent of a piece of land exceeds the agricultural rent provides a margin in which rent control can operate without restricting the supply of rental space. If the maximum rents are graduated in such a way as never to take away from any proprietor so much that he prefers to use the land for agriculture rather than for the construction of buildings, they do not affect the supply of apartments and business premises. However, they increase the demand for such apartments and premises and thus create the very shortage that the governments pretend to fight by their rent ceilings. Whether or not the authorities resort to rationing the space available is catallactically of minor importance. At any rate, their price ceilings do not abolish the catallactic phenomenon of the urban rent. They merely transfer the rent from the landlord’s income into the tenant’s income.
In practice, of course, governments resorting to rent restriction never adjust their ceilings to these considerations. They either rigidly freeze gross rents as they prevailed on the eve of their interference or allow only a limited addition to these gross rents. As the proportion between the two items included in the gross rent, urban rent proper and price paid for the utilization of the superstructure, varies according to the special circumstances of each dwelling, the effect of rent ceilings is also very different. In some cases the expropriation of the owner to the benefit of the lessee involves only a fraction of the difference between the urban rent and the agricultural rent; in other cases it far exceeds this difference. But however this may be, the rent restriction creates a housing shortage. It increases demand without increasing supply.
If maximum rents are decreed not only for already available rental space, but also for buildings still to be constructed, the construction of new buildings is no longer remunerative. It either stops altogether or slumps to a low level; the shortage is perpetuated. But even if rents in new buildings are left free, construction of new buildings drops. Prospective investors are deterred because they take into account the danger that the government will at a later date declare a new emergency and expropriate a part of their revenues in the same way as it did with the old buildings.
The second exception refers to monopoly prices. The difference between a monopoly price and the competitive price of the commodity in question provides a margin in which maximum prices could be enforced without defeating the ends sought by the government. If the competitive price is p and the lowest among the possible monopoly prices m, a ceiling price of c, c being higher than p and lower than m, would make it disadvantageous for the seller to raise the price above p . The maximum price could reestablish the competitive price and increase demand, production, and the supply offered for sale. A dim cognizance of this concatenation is at the bottom of some suggestions asking for government interference in order to preserve competition and to make it operate as beneficially as possible.
We may for the sake of argument pass over the fact that all such measures would appear as paradoxical with regard to all those instances of monopoly prices which are the outcome of government interference. If the government objects to monopoly prices for new inventions, it should stop granting patents. It would be absurd to grant patents and then to deprive them of any value by forcing the patentee to sell at the competitive price. If the government does not approve of cartels, it should rather abstain from all measures (such as import duties) which provide business with the opportunity to erect combines.
Things are different in those rare instances in which monopoly prices come into existence without assistance from the governments. Here governmental maximum prices could reestablish competitive conditions if it were possible to find out by academic computation at which height a nonexisting competitive market would have determined the price. That all endeavors to construct nonmarket prices are vain has been shown. 36 The unsatisfactory results of all attempts to determine what the fair or correct price for the services of public utilities should be are well known to all experts.
Reference to these two exceptions explains why in some very rare cases maximum prices, when applied with very great caution within a narrow margin, do not restrict the supply of the commodity or the service concerned. It does not affect the correctness of the general rule that maximum prices bring about a state of affairs which, from the point of view of the government decreeing them, is more undesirable than conditions as they would have been in the absence of price control.
Knowledge of the effects of government interference with market prices makes us comprehend the economic causes of a momentous historical event, the decline of ancient civilization.
It may be left undecided whether or not it is correct to call the economic organization of the Roman Empire capitalism. At any rate it is certain that the Roman Empire in the second century, the age of the Antonines, the “good” emperors, had reached a high stage of the social division of labor and of interregional commerce. Several metropolitan centers, a considerable number of middle-sized towns, and many small towns were the seats of a refined civilization. The inhabitants of these urban agglomerations were supplied with food and raw materials not only from the neighboring rural districts, but also from distant provinces. A part of these provisions flowed into the cities as revenue of their wealthy residents who owned landed property. But a considerable part was bought in exchange for the rural population’s purchases of the products of the city-dwellers’ processing activities. There was an extensive trade between the various regions of the vast empire. Not only in the processing industries, but also in agriculture there was a tendency toward further specialization. The various parts of the empire were no longer economically self-sufficient. They were interdependent.
What brought about the decline of the empire and the decay of its civilization was the disintegration of this economic interconnectedness, not the barbarian invasions. The alien aggressors merely took advantage of an opportunity which the internal weakness of the empire offered to them. From a military point of view the tribes which invaded the empire in the fourth and fifth centuries were not more formidable than the armies which the legions had easily defeated in earlier times. But the empire had changed. Its economic and social structure was already medieval.
The freedom that Rome granted to commerce and trade had always been restricted. With regard to the marketing of cereals and other vital necessities it was even more restricted than with regard to other commodities. It was deemed unfair and immoral to ask for grain, oil, and wine, the staples of these ages, more than the customary prices, and the municipal authorities were quick to check what they considered profiteering. Thus the evolution of an efficient wholesale trade in these commodities was prevented. The policy of the annona, which was tantamount to a nationalization or municipalization of the grain trade, aimed at filling the gaps. But its effects were rather unsatisfactory. Grain was scarce in the urban agglomerations, and the agriculturists complained about the unremunerativeness of grain growing. 37 The interference of the authorities upset the adjustment of supply to the rising demand.
The showdown came when in the political troubles of the third and fourth centuries the emperors resorted to currency debasement. With the system of maximum prices the practice of debasement completely paralyzed both the production and the marketing of the vital food-stuffs and disintegrated society’s economic organization. The more eagerness the authorities displayed in enforcing the maximum prices, the more desperate became the conditions of the urban masses dependent on the purchase of food. Commerce in grain and other necessities vanished altogether. To avoid starving, people deserted the cities, settled on the countryside, and tried to grow grain, oil, wine, and other necessities for themselves. On the other hand, the owners of the big estates restricted their excess production of cereals and began to produce in their farmhouses—the villae—the products of handicraft which they needed. For their big-scale farming, which was already seriously jeopardized because of the inefficiency of slave labor, lost its rationality completely when the opportunity to sell at remunerative prices disappeared. As the owner of the estate could no longer sell in the cities, he could no longer patronize the urban artisans either. He was forced to look for a substitute to meet his needs by employing handicraftsmen on his own account in his villa. He discontinued big-scale farming and became a landlord receiving rents from tenants or sharecroppers. These coloni were either freed slaves or urban proletarians who settled in the villages and turned to tilling the soil. A tendency toward the establishment of autarky of each landlord’s estate emerged. The economic function of the cities, of commerce, trade, and urban handicrafts, shrank. Italy and the provinces of the empire returned to a less advanced state of the social division of labor. The highly developed economic structure of ancient civilization retrograded to what is now known as the manorial organization of the Middle Ages.
The emperors were alarmed with that outcome which undermined the financial and military power of their government. But their counteraction was futile as it did not affect the root of the evil. The compulsion and coercion to which they resorted could not reverse the trend toward social disintegration which, on the contrary, was caused precisely by too much compulsion and coercion. No Roman was aware of the fact that the process was induced by the government’s interference with prices and by currency debasement. It was vain for the emperors to promulgate laws against the city-dweller who “relicta civitate rus habitare maluerit.” 38 The system of the leiturgia, the public services to be rendered by the wealthy citizens, only accelerated the retrogression of the division of labor. The laws concerning the special obligations of the shipowners, the navicularii, were no more successful in checking the decline of navigation than the laws concerning grain dealing in checking the shrinkage in the cities’ supply of agricultural products.
The marvelous civilization of antiquity perished because it did not adjust its moral code and its legal system to the requirements of the market economy. A social order is doomed if the actions which its normal functioning requires are rejected by the standards of morality, are declared illegal by the laws of the country, and are prosecuted as criminal by the courts and the police. The Roman Empire crumbled to dust because it lacked the spirit of liberalism and free enterprise. The policy of interventionism and its political corollary, the Führer principle, decomposed the mighty empire as they will by necessity always disintegrate and destroy any social entity.
The very essence of the interventionist politicians’ wisdom is to raise the price of labor either by government decree or by violent action or the threat of such action on the part of labor unions. To raise wage rates above the height at which the unhampered market would determine them is considered a postulate of the eternal laws of morality as well as indispensable from the economic point of view. Whoever dares to challenge this ethical and economic dogma is scorned both as depraved and ignorant. Many of our contemporaries look upon people who are foolhardy enough “to cross a picket line” as primitive tribesmen looked upon those who violated the precepts of taboo conceptions. Millions are jubilant if such scabs receive their well-deserved punishment from the hands of the strikers while the police, the public attorneys, and the penal courts preserve a lofty neutrality or openly side with the strikers.
The market wage rate tends toward a height at which all those eager to earn wages get jobs and all those eager to employ workers can hire as many as they want. It tends toward the establishment of what is nowadays called full employment. Where there is neither government nor union interference with the labor market, there is only voluntary or catallactic unemployment. But as soon as external pressure and compulsion, be it on the part of the government or on the part of the unions, tries to fix wage rates at a higher point, institutional unemployment emerges. While there prevails on the unhampered labor market a tendency for catallactic unemployment to disappear, institutional unemployment cannot disappear as long as the government or the unions are successful in the enforcement of their fiat. If the minimum wage rate refers only to a part of the various occupations while other sectors of the labor market are left free, those losing their jobs on its account enter the free branches of business and increase the supply of labor in them. When unionism was restricted to skilled labor mainly, the wage rise achieved by the unions did not lead to institutional unemployment. It merely lowered the height of wage rates in those branches in which there were no efficient unions or no unions at all. The corollary of the rise in wages for organized workers was a drop in wages for unorganized workers. But with the spread of government interference with wages and with government support of unionism, conditions have changed. Institutional unemployment has become a chronic or permanent mass phenomenon.
Writing in 1930, Lord Beveridge, later an advocate of government and union meddling with the labor market, pointed out that the potential effect of “a high-wages policy” in causing unemployment is “not denied by any competent authority.” 39 In fact, to deny this effect is tantamount to a complete disavowal of any regularity in the sequence and interconnectedness of market phenomena. Those earlier economists who sympathized with the unions were fully aware of the fact that unionization can achieve its ends only when restricted to a minority of workers. They approved of unionism as a device beneficial to the group interests of a privileged labor aristocracy, and did not concern themselves about its consequences for the rest of the wage earners. 40 No one has ever succeeded in the effort to demonstrate that unionism could improve the conditions and raise the standard of living of all those eager to earn wages.
It is important to remember also that Karl Marx did not contend that unions could raise the average standard of wages. As he saw it, “the general tendency of capitalistic production is not to raise, but to sink the average standard of wages.” Such being the tendency of things, all that unionism can achieve with regard to wages is “making the best of the occasional chances for their temporary improvement.” 41 The unions counted for Marx only as far as they attacked “the very system of wage slavery and present-day methods of production.” 42 They should understand that “instead of the conservative motto, A fair day’s wages for a fair day’s work! they ought to inscribe on their banner the revolutionary watchword, Abolition of the wages system. ” 43 Consistent Marxians always opposed attempts to impose minimum wage rates as detrimental to the interests of the whole labor class. From the beginning of the modern labor movement there was always an antagonism between the unions and the revolutionary socialists. The older British and American unions were exclusively dedicated to the enforcement of higher wage rates. They looked askance upon socialism, “utopian” as well as “scientific.” In Germany there was a rivalry between the adepts of the Marxian creed and the union leaders. Finally, in the last decades preceding the outbreak of the first World War, the unions triumphed. They virtually converted the Social Democratic Party to the principles of interventionism and unionism. In France, Georges Sorel aimed at imbuing the unions with that spirit of ruthless aggression and revolutionary bellicosity which Marx wanted to impart to them. There is today in every nonsocialist country a manifest conflict between two irreconcilable factions within the unions. One group considers unionism a device for the improvement of the workers’ conditions within the frame of capitalism. The other group wants to drive the unions into the ranks of militant communism and approves of them only as far as they are the pioneers of a violent overthrow of the capitalistic system.
The problems of labor unionism have been obfuscated and utterly confused by pseudo-humanitarian blather. The advocates of minimum wage rates, whether decreed and enforced by the government or by violent union action, contend that they are fighting for the improvement of the conditions of the working masses. They do not permit anyone to question their dogma that minimum wage rates are the only appropriate means of raising wage rates permanently and for all those eager to earn wages. They pride themselves on being the only true friends of “labor,” of the “common man,” of “progress,” and of the eternal principles of “social justice.”
However, the problem is precisely whether there is any means for raising the standard of living of all those eager to work other than raising the marginal productivity of labor by accelerating the increase of capital as compared with population. The union doctrinaires are intent upon obscuring this primary issue. They never refer to the only point that matters, viz., the relation between the number of workers and the quantity of capital goods available. But certain policies of the unions involve a tacit acknowledgment of the correctness of the catallactic theorems concerning the determination of wage rates. Unions are anxious to cut down the supply of labor by anti-immigration laws and by preventing outsiders and newcomers from competing in the unionized sectors of the labor market. They are opposed to the export of capital. These policies would be nonsensical if it were true that the per capita quota of capital available is of no importance for the determination of wage rates.
The essence of the union doctrine is implied in the slogan exploitation. According to the union variety of the exploitation doctrine, which differs from the Marxian creed, labor is the only source of wealth, and expenditure of labor the only real cost. By rights, all proceeds from the sale of products should belong to the workers. The manual worker has a fair claim to the “whole produce of labor.” The wrong that the capitalistic mode of production does to the worker is seen in the fact that it permits landowners, capitalists, and entrepreneurs to withhold a part of the workers’ portion. The share which goes to these parasites is called unearned income. The workers are right in their endeavors to raise wage rates step by step to such a height that finally nothing will be left for the support of a class of idle and socially useless exploiters. In aiming at this end, the unions pretend to continue the battle which earlier generations fought for the emancipation of slaves and serfs and for the abolition of the imposts, tributes, tithes, and unpaid statute labor with which the peasantry was burdened for the benefit of aristocratic landlords. The labor movement is a struggle for freedom and equality, and for the vindication of the inalienable rights of man. Its ultimate victory is beyond doubt, for it is the inevitable trend of historical evolution to wipe out all class privileges and to establish firmly the realm of freedom and equality. The attempts of reactionary employers to halt progress are doomed.
Such are the tenets of present-day social doctrine. It is true that some people, although in perfect agreement with its philosophical ideas, support the practical conclusions derived by the radicals only with certain reservations and qualifications. These moderates do not propose to abolish “management’s” share altogether; they would be satisfied with cutting it down to a “fair” amount. As the opinions concerning the fairness of the revenues of the entrepreneurs and capitalists vary widely, the difference between the point of view of the radicals and that of the moderates is of little moment. The moderates also endorse the principle that real wage rates should always rise and never drop. In both world wars few voices in the United States disputed the claim of the unions that the wage earners’ take-home pay, even in a national emergency, should go up faster than the cost of living.
As the union doctrine sees it, there is no harm in confiscating the specific revenue of the capitalists and entrepreneurs partially or altogether. In dealing with this issue they speak of profits in the sense in which the classical economists applied this term. They do not distinguish between entrepreneurial profit, interest on the capital employed, and compensation for the technical services rendered by the entrepreneur. We will deal later with the consequences resulting from the confiscation of interest and profits and with the syndicalist elements involved in the “ability to pay” principle and in profit-sharing schemes. 44 We have examined the purchasing power argument as advanced in favor of a policy of raising wage rates above the potential market rates. 45 What remains is to scrutinize the purport of the alleged Ricardo effect.
Ricardo is the author of the proposition that a rise in wages will encourage capitalists to substitute machinery for labor and vice versa. 46 Hence, conclude the union apologists, a policy of raising wage rates, irrespective of what they would have been on the unhampered labor market, is always beneficial. It generates technological improvement and raises the productivity of labor. Higher wages always pay for themselves. In forcing the reluctant employers to raise wage rates, the unions become the pioneers of progress and prosperity.
Many economists approve of the Ricardian proposition although few of them are consistent enough to endorse the inference the union apologists draw from it. The Ricardo effect is by and large a stock-in-trade of popular economics. Nonetheless, the theorem involved is one of the worst economic fallacies.
The confusion starts with the misinterpretation of the statement that machinery is “substituted” for labor. What happens is that labor is rendered more efficient by the aid of machinery. The same input of labor leads to a greater quantity or a better quality of products. The employment of machinery itself does not directly result in a reduction of the number of hands employed in the production of the article A concerned. What brings about this secondary effect is the fact that—other things being equal—an increase in the available supply of A lowers the marginal utility of a unit of A as against that of the units of other articles and that therefore labor is withdrawn from the production of A and employed in the turning out of other articles. The technological improvement in the production of A makes it possible to realize certain projects which could not be executed before because the workers required were employed for the production of A for which consumers’ demand was more urgent. The reduction of the number of workers in the A industry is caused by the increased demand of these other branches to which the opportunity to expand is offered. Incidentally, this insight explodes all talk about “technological unemployment.”
Tools and machinery are primarily not labor-saving devices, but means to increase output per unit of input. They appear as labor-saving devices if looked upon exclusively from the point of view of the individual branch of business concerned. Seen from the point of view of the consumers and the whole of society, they appear as instruments that raise the productivity of human effort. They increase supply and make it possible to consume more material goods and to enjoy more leisure. Which goods will be consumed in greater quantity and to what extent people will prefer to enjoy more leisure depends on people’s value judgments.