Tag: Great Economists

By Richard Ebeling

Originally published on August 1, 2019 for The Future of Freedom Foundation

September 15, 2019, marks 70 years since the appearance of Ludwig von Mises’ Human Action: A Treatise on Economics, one of the truly great “classics” of modern economics. Too often a “classic” means a famous book considered to have made important contributions to some field of study and that is reverentially referred to but is unfortunately rarely ever read any-more.

In economics, Adam Smith’s Wealth of Nations is a typical example of such a work. Every economist and a good number of people in the general public have heard of the “invisible hand” and the notion that self-interest furthers the public interest through the incentive mechanism of free-market competition; but in fact few economists nowadays have actually read more than a handful of snippets and brief passages from Smith’s profound treatise. Among the general public, the number of people who even know the snippets dwindles to almost nothing.

A still-read and still-relevant classic

However, Ludwig von Mises’ Human Action uniquely stands out as a classic in the literature of economics. Not only among “Austrian” economists but also for a growing number of other people, Mises’s brilliant treatise continues to be read and taken seriously as a cornerstone for understanding the nature of the free society and the workings of the market economy.

It has taken on even more relevance and significance in these first decades of the 21st century because of the economic crisis of 2008-2009, the full effects from which the American economy has still not fully recovered, and in the wake of a dangerous revival of a call for a “democratic socialism” that demands the implementation of various forms and degrees of government central planning. They have made the economic reasoning and public-policy analysis that runs through most of Human Action as timely today as when its first edition appeared in bookstores on September 14, 1949.

A few days after its publication, the famous free-market journalist Henry Hazlitt reviewed Human Action in his column in Newsweek magazine. He emphasized its importance by telling his readers,

[The] book is destined to become a landmark in the progress of economics.… Human Action is, in short, the most uncompromising and the most rigorously reasoned statement of the case for capitalism that has yet appeared…. It should become the leading text of everyone who believes in freedom, in individualism, and the ability of a free-market economy not only to outdistance any government-planned system in the production of goods and services for the masses, but to promote and safeguard, as no collectivist tyranny can ever do, those intellectual, cultural, and moral values upon which all civilization ultimately rests.

Keys to human progress

If the field of sociology did not have such a controversial history and so many conflicting notions about what its subject matter and approach are supposed to be about, it would not be misplaced to say that in Human Action, Mises demonstrated himself to be not only one of the greatest economists of the last century, but one of its leading sociologists as well.

In the most appropriate meaning of the term, Mises formulated a “science of society” in the tradition of Scottish philosophers such as Adam Smith. All that happens in the social world begins in the thinking and actions of individual human beings. They are the starting point for understanding society: man, as a purposefully acting being, gives assigned meanings to the world around him, selects desired ends, decides upon possibly useful means to their attainment, and undertakes courses of action through time in attempts to bring his desired plans to fruition.

Humans rose above animal existence through their developed capacity to reason, conceptualize, imagine possible futures, and conceive of ways of bringing them into reality. But on his own, man’s mental and physical powers are too limited for achieving much above bare subsistence. The profound key to the betterment of the human condition, Mises insisted, was man’s discovery of the benefits that could come from a division of labor through which men could specialize in their tasks and mutually gain through cooperative association that slowly but surely improved the standards of living, the quality of life, and the cultural elements that mark off “civilization.”

But how shall human beings collaborate — through plundering conquest or peaceful trade? It took thousands of years for people to stumble upon the superiority of market-based cooperation over politically based power and privilege. As production and trade become ever more complex owing to the extension of the system of division of labor, there had to arise a method by which the participants in the emerging relationships of supply and demand could know how and what to do.

Economic calculation

A central theme through much of the Human Action is Mises’s insistence on the essential importance of economic calculation. In the early decades of the 20th century, socialists of almost all stripes were certain that the institutions of the market economy could be done away with — either through peaceful means or violent revolution — and replaced with direct government ownership or control of the means of production with no loss in economic productivity or efficiency.

Mises’s landmark contribution 100 years ago in 1920 was to demonstrate that only with market-based prices expressed through a medium of exchange could rational decision-making be undertaken for the use and application of the myriad means of production to ensure the effective satisfaction of the multitudes of competing consumer demands in society.

“Monetary calculation is the guiding star of action under the system of division of labor,” Mises declared in Human Action. “It is the compass of the man embarking on production.” The significance of the competitive process, as Mises had expressed it in his earlier volume Liberalism (1927), is that it facilitates “the intellectual division of labor that consists in the cooperation of all entrepreneurs, landowners, and workers as producers and consumers in the formation of market prices. But without it, rationality, i.e., the possibility of economic calculation, is unthinkable.”

Such rationality in the use of means to satisfy ends is impossible in a comprehensive system of socialist central planning. How, Mises asked, will the socialist planners know the best uses for which the factors of production under their central control should be applied without such market-generated money prices? Without private ownership of the means of production, there would be nothing (legally) to buy and sell. Without the ability to buy and sell, there would be no bids and offers, and therefore no haggling over terms of trade among competing buyers and sellers. Without the haggling of market competition there would, of course, be no agreed-upon terms of exchange. Without agreed-upon terms of exchange, there are no actual market prices. And without such market prices, how will the central planners know the opportunity costs and therefore the most highly valued uses for which those resources could or should be applied to satisfy the consumer demands of “the people”?

With the abolition of private property, and therefore market exchange and prices, the central planners would lack the necessary institutional and informational tools to determine what to produce and how, in order to minimize waste and inefficiency.

Therefore, Mises declared in 1931,

From the standpoint of both politics and history, this proof [of the impossibility of socialist planning] is certainly the most important discovery by economic theory.… It alone will enable future historians to understand how it came about that the victory of the socialist movement did not lead to the creation of the socialist order of society.

Government intervention and monetary manipulation

At the same time, Mises demonstrated the inherent inconsistencies in any system of piecemeal political intervention in the market economy. Price controls and production restrictions on entrepreneurial decision-making bring about distortions and imbalances in the relationships of supply and demand, as well as constraints on the most efficient use of resources in the service of consumers. The political intervenor is left with the choice of either introducing new controls and regulations in an attempt to compensate for the distortions and imbalances the prior interventions have caused or repealing the interventionist controls and regulations already in place and allowing the market once again to be free and competitive. The path of one set of piecemeal interventions followed by another entails a logic in the growth of government that eventually results in the entire economy’s coming under state management. Hence, interventionism consistently applied could lead to socialism on an incremental basis through an unintended back door.

The most pernicious form of government intervention, in Mises’s view, was political control and manipulation of the monetary system. Contrary to both the Marxists and the Keynesians, Mises did not consider the fluctuations experienced over the business cycle to be an inherent and inescapable part of the free-market economy. Waves of inflations and depressions were the product of political intervention in money and banking. And that included the Great Depression of the 1930s, Mises argued.

Under various political and ideological pressures, governments had monopolized control over the monetary system. They used the ability to create money out of thin air through the printing press or on the ledger books of the banks to finance government deficits and to artificially lower interest rates to stimulate unsustainable investment booms. Such monetary expansions always tended to distort market prices resulting in misdirections of resources, including labor, and malinvestments of capital. The inflationary upswing that is caused by an artificial expansion of money and bank credit sets the stage for an eventual economic downturn. By distorting the rate of interest — the market price for borrowing and lending — the monetary authority throws savings and investment out of balance, with the need for an inevitable correction.

The “depression” or “recession” phase of the business cycle occurs when the monetary authority either slows downs or stops any further increases in the money supply. The imbalances and distortions become visible, with some investment projects having to be written down or written off as losses, with reallocations of labor and other resources to alternative, more profitable employments, and sometimes significant adjustments and declines in wages and prices to bring supply and demand back into proper order.

The errors of Keynesianism

The Keynesian revolution of the 1930s, which then dominated economic-policy discussions for decades following the Second World War, was based on a fundamental misconception of how the market economy worked. What Keynes called “aggregate demand failures” (to explain the reason for high and prolonged unemployment) distracted attention from the real source of less-than-full employment: the failure of producers and workers on the supply side of the market to price their products and labor services at levels that potential demanders would be willing to pay. Unemployment and idle resources were a pricing problem, not a demand-management problem. Mises considered Keynesian economics basically to be nothing more than a rationale for special-interest groups, such as trade unions, who didn’t want to adapt to the reality of supply and demand, and of what the market viewed as their real worth.

Thus Mises’s conclusion from his analysis of socialism and interventionism, including monetary manipulation, was that there is no alternative to a thoroughgoing, unhampered, free-market economy — and one that included a market-based monetary system such as the gold standard.  Both socialism and interventionism are, respectively, unworkable and unstable substitutes for open, competitive capitalism.

The classical liberal defends private property and the free-market economy, Mises insisted, precisely because it is the only system of social cooperation that provides wide latitude for freedom and personal choice to all members of society, while generating the institutional means for coordinating the actions of billions of people in the most economically rational manner.

The apparent triumph of capitalism over collectivism, following the demise of the Soviet bloc in the 1990s, has, unfortunately, turned out to be mostly an illusion. Governments in the Western world did not reduce their size or intrusiveness in the economic affairs of their citizens. The interventionist-welfare state has remained alive and well, and continued to grow along with the government debts to pay for the entire redistributive largess.

Central banking and free banking

But the heart of the interventionist system is government control of the monetary system — indeed, it has remained an untouched element of monetary central planning through the institution of central banking.

Fortunately, over the last forty years, Mises’s analysis and defense of gold-backed, private competitive banking in place of government-monopoly central banking has finally begun to win over a growing number of Austrian and other advocates. (See my ebook Monetary Central Planning and the State.)

Monetary manipulation by central banks inserts one of the most disruptive distortions into the process of economic calculation. Interest rates — which are meant to inform market participants about the availability of savings relative to the demands for investment expenditures, and which facilitate the coordination of resource use over periods of time relative to the demands of income earners for consumption in the present versus the future — send out misinformation to both producers and consumers under the pressure of monetary expansion.

The financial crisis and its interventionist aftermath

In the wake of Federal Reserve monetary mischief during the early years of the 21st century, imbalances and distortions were once again generated by monetary policies that resulted in the financial and economic crisis of 2008-2009.

There soon occurred the return of the “ghost of Keynes past.” In the face of the inescapable need for the rebalancing and re-coordination of misdirected resources and malinvested capital for a full return to normal and sustainable, market-based growth, government spending and budget deficits to “stimulate” the economy out of a recession were once again insisted upon.

The focus remained on “aggregate” output and employment, which always hides from view the underlying microeconomic relations that are at the core of the market process. How can the multitudes of market participants discern where and to what extent market errors have been made under the pressure of past monetary and interest-rate manipulations if the price system is not permitted to perform its job of telling the truth about the reality of supply and demand? That is, the degree to which resources were misallocated and wrongly priced during the preceding boom. Or the extent to which men, material, and savings-backed financial funds need to realign themselves to restore a properly understood full-employment market-driven economy.

The recovery period was drawn out for almost ten years, longer than most other periods of post-boom readjustments since the end of the Second World War. How could people know what to do and where to do it in the social system of division of labor, when the crucial tool of economic calculation was undermined by government bailouts, subsidies, price floors, capital-market interventions, and continuing monetary manipulation and near-zero interest-rate policies that threatened new misdirections of capital and labor, with the risk of another boom-bust cycle to come?

In the immediate aftermath of the 2008-2009 downturn, the argument was constantly made that many banks were too big to fail, that depositors needed to have their various bank accounts protected and guaranteed, and that the repercussions of allowing the financial markets to adjust on their own to the post-boom reality would have been too harsh. In fact, Mises had responded to such arguments in his 1928 monograph, Monetary Stabilization and Cyclical Policy, even before the Great Depression began, by warning of what today is understood as “moral hazard,” that is, the danger of reinforcing the repetition of bad decisions by the government’s bailing out mistakes made in the market:

In any event, the practice of intervening for the benefit of banks, rendered insolvent by the crisis, and of the customers of these banks, resulted in suspending the market forces that otherwise would have served to prevent a return of the expansion, in the form of a new boom, and the crisis which inevitably follows. If the banks emerge from the crisis unscathed, or only slightly weakened, what remains to restrain them from embarking once more on an attempt to reduce artificially the interest rate on loans and expand circulation credit? If the crisis were ruthlessly permitted to run its course, bringing about the destruction of enterprises which were unable to meet their obligations, then all entrepreneurs — not only banks but also other businessmen — would exhibit more caution in granting and using credit in the future. Instead, public opinion approves of giving assistance in the crisis. Then, no sooner is the worst over, than the banks are spurred on to a new expansion of circulation credit.

Mises’s warning

Just as there was a huge shift toward more and bigger government in the years leading up to the publication of Human Action, so today we are seeing an expansion of governmental presence and domination of social life, especially in health care, education, and the energy sector — as well as the financial and capital markets.

But where will all the money come from to fund this new gargantuan largess for expanded political paternalism? In the Austria of the interwar period of the 1920s and 1930s, Mises had witnessed and explained the consequences from unrestrained government spending that finally resulted in the “eating of the seed corn” — capital consumption. Mises warned of this danger, too, in the pages of Human Action, and the fact that there must be a point at which the interventionist welfare state will have exhausted “the reserve fund” of accumulated wealth, after which the consumption of capital becomes the only basis upon which to continue to feed the fiscal demands of the redistributive state. Those currently in political power in Washington seem hell-bent on bringing that about in the decades ahead.

The enduring value and importance of Human Action

A “predecessor” of Human Action had appeared in German in 1940. Shortly after it appeared, Friedrich A. Hayek reviewed it, emphasizing its astonishingly unique qualities:

There appears to be a width of view and an intellectual spaciousness about the whole book that are much more like that of an eighteenth-century philosopher than that of a modern specialist. And yet, or perhaps because of this, one feels throughout much nearer reality, and is constantly recalled from the discussion of the technicalities to the consideration of the great problems of our time…. It ranges from the most general philosophical problems raised by all scientific study of human action to the major problems of economic policy of our time…. [The] result is a really imposing unified system of a liberal social philosophy. It is here also, more than elsewhere, that the author’s astounding knowledge of history as well as of the contemporary world helps most to illustrate his argument.

The years since the original appearance of Human Action in 1949 have done nothing to diminish the validity of Hayek’s interpretation. Indeed, the social, political, and economic conditions of our world today give Ludwig von Mises’s treatise a refreshing relevance matched by few other works written over the last century.

That is what has resulted in its being read by more and more people today, rather than simply being one of those many “classics” collecting dust on a shelf. If enough people discover and rediscover the timeless truths in the pages of Human Action, the ideas of Ludwig von Mises may well assist us in stemming the growing tide toward an even larger leviathan state that dangerously looms in front of us.

By Richard Ebeling

Originally published on May 20, 2024 for The Future of Freedom Foundation

When the English-language edition of Ludwig von Mises’s The Theory of Money and Credit was published 90 years ago, in 1934, the world was in the midst of the Great Depression. The American stock market crash in October 1929 soon snowballed into a severe economic downtown in 1930 and 1931 that reached its lowest point in terms of rising unemployment and falling industrial and agricultural output in 1932 and early 1933.

In Europe, the economic conditions were no better. Great Britain and France, for instance, were experiencing the same negative effects of falling outputs and rising joblessness, though the worst of it, in terms of these two indicators of economic “bad times,” was being experienced in Germany. Intensifying the global impact of the economic downturn was a return to trade protectionism in many of the leading economies, including the United States, along with foreign exchange controls that led, not surprisingly, to a dramatic fall in international trade and investment.

Government and the Great Depression

Why was the severity and depth of this economic depression the most serious in virtually anyone’s living memory? In Mises’s view, it was due to the degree to which governments almost everywhere were introducing policies that hindered and prevented the market economy from readjusting and rebalancing following what had turned out to be the false prosperity of the 1920s. Not that all that had happened in the 1920s was unsustainable or lost. Technological innovations, cost-
efficiencies, improvements in organization and management of industry and manufacturing, had represented real improvements in the standards and qualities of life for many around the world, especially in the United States.

But overlaying these impressive improvements in production potentials had been monetary policies followed in the United States and in Europe that had brought about mismatches and imbalances between savings and investment that had set the stage for an inescapable period of correction, due to unsustainable price and wage relationships and resource and capital uses, if there was to be a return to longer term growth and stability of the market economies in these countries.

There had been economic booms and busts, inflations and depressions in the past. These earlier downturns, however, had rarely been anywhere nearly as severe and disruptive as was being experienced in the 1930s. In the past, governments, for the most part, had kept a fairly “hands off” policy approach, allowing financial and investment and consumer markets to adjust and find their new coordinating price and wage patterns and resource and capital uses across sectors of the economy to return to full employment and output potentials.

The gold standard and growing government intervention

However, in the 1930s, governments did the opposite. The British government had ended the gold standard as the basis of the country’s monetary system in September 1931. Following the inauguration of Franklin D. Roosevelt in the United States in March 1933, the United States was taken off the gold standard in June of that year with the command that Americans had to turn in their gold coins and bullion in exchange for Federal Reserve paper money under threat of arrest, confiscation, and imprisonment.

First under Republican President Herbert Hoover and then under FDR’s New Deal programs, the U.S. government ran large budget deficits, raised taxes on business, undertook sizable public works projects, and interfered with market-based adjustments of wages and prices to restore balance between supplies and demands. Indeed, with the coming of the New Deal, Roosevelt imposed a fascist-style system of economic planning over industry and agriculture that for all intents and purposes did away with the American market economy. Only a series of Supreme Court decisions in 1935 and 1936 that declared some of the major New Deal programs as unconstitutional saved America from the possibility of a permanent command economy.

In the 1920s, Germany had a weak post–World War I democratic government, known as the Weimar Republic. In 1931 and 1932, the three largest political parties represented in the German parliament were the Social Democrats, the National Socialists (Nazis), and the Communists. In January 1933, Adolf Hitler was appointed Chancellor (prime minister), and within months, the Nazis were rapidly transforming the country into a totalitarian dictatorship, with government-directed spending and investment as the keystones of the National Socialist economic program. The Nazis formally introduced four-year central planning in 1936.

In neighboring Austria, where Mises was living and working as a senior economic analyst for the Vienna Chamber of Commerce, a brief civil war broke out in February 1934 between the fascist-oriented government and the armed forces of the Social Democratic Party, which ended with the defeat of the Austrian socialists. Soon after, a new constitution was instituted that officially established an authoritarian political system and a corporativist economy. In October 1934, Mises left Austria and took up his first full-time professorship at the Graduate Institute of International Studies in Geneva, Switzerland. This enabled him to escape both from living under the fascist dictatorship in his home country and the rising tide of aggressive anti-Semitism in both Nazi Germany and in the Republic of Austria that became violent and deadly in Mises’s homeland after Hitler entered Vienna in March 1938 and Austria was annexed into the German Third Reich. (See my article “Celebrating the Arrival of Ludwig von Mises in America,” Future of Freedom, August 2020.)

Mises on the causes of the Great Depression

In February 1931, Mises delivered a lecture on “The Causes of the Economic Crisis,” which was soon afterwards published in German in an expanded version. The countries of Europe and the United States were caught in this Great Depression precisely because governments had failed to allow market-based readjustments and rebalancing to restore production and employment.

Instead, governments did their utmost to maintain prices and wages at nonmarket levels through various forms of intervention and regulation. Tariffs protected uncompetitive domestic producers from foreign rivals; trade unions were privileged with unofficial power to shut down businesses and use violence to prevent nonunion workers from filling the jobs of union workers on strike as part of the attempt to impose higher-than-market wages; unemployment insurance was used to reduce the pressure on unions from the jobless; taxes on private enterprise reduced investment and threatened the consumption of capital; and government deficit spending was used to “create” jobs bound to be found to be mostly wasteful and unnecessary. From this Mises concluded:

If everything possible is done to prevent the market from fulfilling its function of bringing supply and demand into balance, it should come as no surprise that a serious disproportionality between supply and demand persists, that commodities remain unsold, factories stand idle, many millions are unemployed, destitution and misery are growing and that finally, in the wake of all these, destructive radicalism is rampant in politics.… With the economic crisis, the breakdown of interventionist economic policy — the policy being followed today by all governments, irrespective of whether they are responsible to parliaments or ruled opening as dictatorships — becomes apparent.

The corrupting influence of the interventionist state

The corrosive effect such interventionist policies had on the functioning of the market and the perverse antisocial incentives it fostered in the private sector was explained by Mises a year later, in 1932, in an essay entitled, “The Myth of the Failure of Capitalism”:

In the interventionist state it is no longer of crucial importance for the success of an enterprise that the business should be managed in a way that it satisfies the demands of consumers in the best and least costly manner. It is far more important that one has “good relations” with the political authorities so that the interventions work to the advantage and not the disadvantage of the enterprise. A few marks more tariff protection for the products of the enterprise and a few marks less for the raw materials used in the manufacturing process can be of far more benefit to the enterprise than the greatest care in managing the business. No matter how well an enterprise may be managed, it will fail if it does not know how to protect its interests in the drawing up of the customs rates, and in the negotiations before the arbitration boards, and with cartel authorities. To have “connections” becomes more important than to produce well and cheaply.

So, the leadership positions within enterprises are no longer achieved by men who understand how to organize companies and to direct production in the way the market situation demands, but by men who are well thought of “above” and “below,” men who understand how to get along with the press and all the political parties, especially with the radicals, so that they and their company give no offense. It is that class of general directors that negotiate far more with state functionaries and party leaders than with those from whom they buy and to whom they sell.

Since it is a question of obtaining political favors for these enterprises, the directors must repay the politicians with favors. In recent years, there have been relatively few large enterprises that have not had to spend very considerable sums … [on] campaign contributions, public welfare organizations and the like…. The crisis from which the world is suffering today is the crisis of interventionism and of national and municipal socialism, in short, it is the crisis of anti-capitalist policies.

The German economic environment was one in which a symbiotic relationship closely connected those in politics and the bureaucracy with special-interest groups desiring favors and privileges at others’ expense. It is not too surprising that a year later, in 1933, the corrupt and corrupting interventionist state transitioned easily into the National Socialist command and control economy — and that in Mises’s own country of Austria, authoritarian fascism and the planned economy followed a year later in 1934.

Mises’s theory of the business cycle

However, even if a growing spiderweb of government interventionist policies explains how and why the Great Depression of the 1930s became so deep and prolonged, there still was the question of how and why the depression had occurred at all. In other words, what were the monetary and banking policies that preceded the Great Depression that made an economic downturn inevitable. Mises had first presented what later became known as the Austrian theory of the business cycle in The Theory of Money and Credit, and then in his monograph, Monetary Stabilization and Cyclical Policy (1928).

Mises’s theory of money, banking, and the business cycle was a synthesis of Carl Menger’s theory of money, Eugen von Böhm-Bawerk’s theory of capital, and Knut Wicksell’s theory of interest rates and prices. As we saw, earlier, building on Menger, Mises developed an analysis of the non-neutrality of money, that is, how changes in the money supply works its way through the market in temporal-sequential patterns that influence the structure of relative prices and wages and the allocations of resources and capital among sectors of the economy.

Mises adapted Böhm-Bawerk’s theory of a time structure of investment and production, focusing on the price-coordinating market processes by which resources and labor are combined in the required stages of production to both produce capital goods and with capital to manufacture desired finished goods wanted by consumers. Each of these of stages of production must be successfully coordinated with the others. The “length” of the respective time-structures must also be consistent with the amount of overall savings in the economy so the needed and necessary resources, labor, and capital goods may be available to complete and maintain the complex processes of production through period after period of time.

As we also saw, the market-generated rate of interest assures that investments undertaken are able to be maintained and kept within the bounds of the savings set aside by income-earners. In a world of scarcity, the uses for the resources of any society are in competition between different applications of them both in the present and between the present and time horizons of the future. More of them used in one direction means that there is less available to utilize in alternative ways.

Knut Wicksell on interest rates and the inflationary process

The Swedish economist Knut Wicksell (1851–1926) argued in Interest and Prices (1898) that if goods in the present directly traded for goods in the future, that is, as in barter transactions, the intertemporal competitively determined price between goods in the present and the future would tend to assure that investment was kept in balance with savings. The intertemporal price of present goods for future goods is the equilibrium “natural rate of interest.” However, in actual markets, all trades, including those across time, are undertaken through the medium of money. Money in the present (and the purchasing power over various goods that sum of money represents) is traded for a sum of money in the future (and the purchasing power over various goods that sum of money is expected to represent).

If the money rate of interest coincides with the hypothetical equilibrium “natural” rate of interest, then savings and investment are kept in coordinated balance even in a money-using economy. The problem, Wicksell pointed out, is that the quantity of money offered through the banking system for investment purposes may exceed the quantity of money that income-earners had originally deposited in the banking system as desired savings. Or banks could lend less in the form of money loans than had had been deposited with them as money savings. Thus, there could be either total money investments undertaken greater than money savings, or more money savings than money loans issued within the banking system. Thus, total investments greater than available savings, or total investments less than available savings.

Banks might try to extend money loans greater than deposited savings by setting the interest rate below the natural rate through the creation of bank notes or increased checking deposits for those additional borrowers to spend. But since scarcity continues to limit the real total of economic activities that can be undertaken, the increased quantity of money only ends up generating a cumulative rise in prices (price inflation) for as long as the money rate of interest is kept below the natural rate. Similarly, if the money rate of interest were to be set above the natural rate, total money loans undertaken would be less than available money savings, with part of the total quantity of money in the economy taken out of circulation, resulting in a cumulative decline in prices (price deflation) for as long as the money rate of interest was kept higher than natural rate.

Free banking and the limits on inflationary currencies

This was the backdrop to Mises’s theory of the business cycle. As he developed the theory through the 1920s and 1930s, Mises argued that if there prevailed private competitive free banking, there would be market-based checks and balances preventing such imbalances between savings and investment from occurring to any significant degree. If any one or number of banks decided to increase their respective quantity of bank notes or checking accounts by lowering the money rate of interest at which they were extending loans to potential borrowers, the sums borrowed would soon be spent by those borrowers on various goods and services they wanted to buy.

Those receiving the banknotes issued in this way by, say, the Adam Smith Bank would deposit them in their own banks, say, the Thomas Malthus Bank and the David Ricardo Bank. The Thomas Malthus and David Ricardo Banks, receiving deposits of the banknotes of Adam Smith Bank from their bank customers, would trade them in through what is called the “clearing house,” demanding the gold or silver that those banknotes represent from the bank that issued them. Banks that have overissued their banknotes relative to other banks will experience a net outflow of their gold and silver deposit reserves. If they continue their own monetary expansion in this manner, they threaten, over time, to face insolvency or even bankruptcy as the total number of banknotes claimed against them threaten a loss of all their gold and silver reserves.

At the same time, if their own depositors become concerned about the bank’s solvency, that bank would risk facing a bank run, that is, many of their depositors all demanding their gold and silver money more or less simultaneously. Thus, in their own self-interest, under the pressures of the clearing house process and maintaining the confidence of their own depositor customers, private banks, under a competitive free-banking system, would have incentives to resist excessive creation of fiduciary media (banknotes and deposits not fully covered by gold and silver reserves).

Unjustifiable creations of bank-notes and checking deposits (that is, in excess of actual gold and silver money deposited with that financial institution) would be kept in narrow bounds under private competitive banking. Looking over the market as a whole, therefore, investment would be kept within the scarcity constraints of actual savings set aside by income-earners for such purposes. As Mises explained it in Monetary Stabilization and Cyclical Policy, in a free banking environment, there might still be fiduciary media issued by banks:

However, banks would have to be especially cautious because of the sensitivity to loss of reputation of their fiduciary media, which no one would be forced to accept. In the course of time, the inhabitants of capitalistic countries would learn to differentiate between good and bad banks…. The management of solvent and highly respected banks, the only banks whose fiduciary media would enjoy the general confidence essential for money-substitute quality, would have learned from past experiences.

The cautious policy of restraint on the part of respected and well-established banks would compel the more irresponsible managers of other banks to follow suit.… For the expansion of circulation credit can never be the act of one individual bank alone, nor even a group of individual banks…. If several banks of issue, each enjoying equal rights, existed side by side, and if some of them sought to expand the volume of circulation credit while others did not alter their conduct, then at every bank clearing, demand balances would regularly appear in favor of the conservative banks. As a result of the presentation of notes for redemption and withdrawal of their cash balances, the expanding banks would very quickly be compelled once more to limit the scale of their emissions…. It may be that a final solution of the problem of [unjustifiable monetary expansion] can be arrived at only through the establishment of completely free banking.

Central banks and monetary expansion

However, this was not how the banking systems had developed in Europe or North America. It is true that in the nineteenth century, after earlier experiences with paper-money inflations caused by governments or their central banks, new rules were established under which many of the leading central banks managed their systems according to the rules of the gold standard. But these remained, nonetheless, monopoly monetary systems controlled and managed by government central banks.

Governments and their central banks would periodically oversee undue expansions of fiduciary media and the artificial lowering of money interest rates through the banking systems under their control. This would set the stage for the types of price inflationary booms and price deflationary busts that Wicksell had outlined in Interest and Prices. This was only exacerbated in the twentieth century when central banks were taken off the gold standard by their respective governments, with no longer the check and fear of losing gold reserves underlying a country’s monetary system.

The additional aspect to the Wicksellian process that Mises developed was a focus on the non-neutral manner in which monetary and credit expansions through the banking system distorted the relative price structure and the allocations and use of capital and labor across sectors of the market. Such an artificial lowering of the money rate of interest below the “natural” rate results in the newly created money and credit first passing into the hands of borrowers who utilize the new money at their disposal to undertake investment projects for which the amounts of real resources to complete and sustain them will be found to be insufficient in the longer-run.

They place orders with the suppliers of capital equipment and construction enterprises to start or expand investment projects, and they hire workers to assist in these endeavors. The resources, labor and capital for these undertakings are drawn from more immediate consumption goods production through the offering of higher prices and wages made possible by the expansion of the money and credit by which those loans have been extended to them.

If these factors of production had been redirected into the more time-consuming investment sectors due to actual increases in people’s savings preferences (and therefore an implied decrease in preferences for consumer goods), the increased demands for inputs in investment goods production would have been counter-balanced by a decrease in the demands for consumer goods production. The changes in relative prices and wages, and reallocations of inputs from some areas of the market to others, would have brought about the needed recoordinated equilibrium. In time, the greater savings and completed investment activities would bring forth the improved and increased supplies of consumer goods that would be the future “reward” for foregone consumption in the more immediate present.

Monetary expansion and misallocation of resources

But this is not the case. Instead, the central bank monetary authority increases the lending reserves of the banks (in the case of the Federal Reserve of the United States, most frequently by purchasing U.S. government securities that the federal government has issued to cover deficit spending), which expands their ability to extend additional investment loans to interested borrowers in the private sector at lower rates of interest made possible by the increase in loanable funds in the banking system.

Borrowers compete away the resources, labor, and capital to initiate their investment projects by offering higher factor prices from their current employments in the consumer-goods sectors. But there are no corresponding decreases in consumer goods prices or the factor prices in these parts of the market since there has been no decrease in consumer demands. Those drawn into the investment goods sectors may be presumed to have the same consumption-savings preferences they had before their new employments. They use their higher money incomes to demand the same proportions of consumer goods as before. Therefore, prices in the consumer goods and complementary factor markets rise, with those still employed in consumer-goods sectors experiencing also increases in their money wages and factor prices. But these higher prices and wages in the consumer goods parts of the economy act as a “pull” to attract workers and resources away from the investment goods markets and back to consumer-goods production.

If the monetary expansion, with the resulting lower rates of interest and greater investment borrowing, was a “one-off” act by the central bank, relative prices and wages and resource, labor, and capital uses would reestablish themselves after a short period of time in the pattern reflecting income earners’ underlying preferences for consumption and savings. But historically, the central-banking authorities, once they have initiated an expansionary monetary and lower interest-rate policy, continue it period after period, with new injections of lendable funds into the banking system and with interest rates pressed down below where the market would set them in a noninflationary environment.

Prices continue to rise following in the temporal sequence in which the money is introduced, spent first on investment activities, followed by rising factor incomes, and then by increased money demand for consumer and other goods and services. A tug-of-war occurs with investment goods producers and consumer goods producers competing against each other in the attempt to pull the factors of production in one direction and then another.

If the “twisted” production house of cards is to be maintained indefinitely, the central-bank authority finds it necessary to accelerate the rate of monetary expansion so in the temporal sequence of rising prices, the “injections” are great enough to keep the relative prices of production goods ahead of the relative prices of consumer goods. Otherwise, if consumer goods prices completely catch up with or start to rise at a faster rate than production good prices, the monetary-induced investment patterns will be found to be unsustainable, and the recession phase of the business cycle will set it. And, indeed, unless the monetary authority allows the inflation to get completely out of control, with a resulting hyperinflation of economic chaos, the inflation must be ended or significantly slowed down, at which point the recession can no longer be avoided.

Stabilizing the price level destabilized the market process

In the 1920s, the Federal Reserve had attempted to maintain a stabilized “price level” in an economy of growing output, productivity increases, and cost efficiencies that would have otherwise resulted in falling consumer prices to the betterment of the buying public now able to purchase more and better goods at lower prices. Instead, the Federal Reserve increased the money supply in an attempt to counteract this benign price deflation. As a result, it in fact created a hidden price inflation by keeping prices in general higher than they otherwise would have been if the money supply had not been increased.

Thus, beneath the surface of a relatively stable “price level,” central bank monetary policy had set in motion a distortion and mismatch between savings and investment that inevitably had to end in an economic downturn. But an economic downturn became the Great Depression only because government interventions of sundry sorts had prevented the market process from bringing about a healthy rebalancing of supplies and demands and prices that would have brought back full employment without the economic disaster of the 1930s.

By Richard Ebeling

Originally published on April 23, 2024 for The Future of Freedom Foundation

When the second German-language edition of Ludwig von Mises’s The Theory of Money and Credit appeared 100 years ago, in 1924, it was less than a year since the great German and Austrian inflations had come to an end in 1923. The huge monetary expansions had pushed prices in general to astronomical heights, bringing social and economic havoc in their wake. It had these effects precisely because of the inherent and inescapable “non-neutral” manner in which increases in the money supply are “injected” and introduced into society.

During the war years, the monetary expansions had been primarily used to feed the fiscal needs of the imperial German and Austrian governments to finance their military expenditures. In the postwar period between 1918 and 1923, the monetary printing presses had been set loose to cover the interventionist and welfare statist policies and programs of the new “democratic” governments in the German “Weimar” Republic and the much smaller Republic of Austria. The unevenness with which prices rose, with some prices rising before others, in both systematic and unsystematic patterns, distorted the structures of relative prices and wages, bringing about the appearances of profits in some sectors of the German and Austrian economies and losses in others that influenced the attempted uses of resources, labor, and capital.

One aspect of this monetary inflationary process was what became known as “forced savings,” the rising of selling prices before input prices, especially wages, which resulted in the real incomes of many workers falling relative to profit margins of investors and capital owners. It was called forced savings due to it leading to attempts for greater capital investment than would have seemed possible and profitable in a noninflationary environment. This twisted process was highlighted due to the exaggerated nature of it under a hyperinflation, when prices were rising at hundreds of percent per month. The noted Italian economist Constantino Bresciani-Turroni, the author of The Economics of Inflation (1931), pointed out:

Inflation, and more especially “hyperinflation,” may be compared with a magnifying glass, which has allowed of distinctly observing many of the facts not easy to disentangle when following the sequence of events during an ordinary Trade Cycle. The changes in the structure of production, brought about by inflation, and later by a currency stabilization [in 1924], were most apparent in Germany. During the inflation period the substantial fall in real wages, which meant a ‘forced savings’ on a large scale, allowed the productive resources of the country to be deflected from the production of consumer goods to that of fixed capital. This continued as long as the new issues of paper money exerted a pressure upon real wages.

But when the German inflation came to an end in November 1923, there set in a “stabilization crisis” in which the German economy went through a reversal, with capital values falling relative to consumer goods prices, and a rebalancing of labor and capital uses and prices to reflect the new noninflationary setting. Bresciani-Turroni concluded, “It seems to me that these facts are significant” as an “inductive verification” of the Austrian theory of inflationary processes.

Another aspect of money’s non-neutrality, matching forced savings, was that of “capital consumption,” already emphasized by Mises in his earlier book, Nation, State, and Economy(1919), before the worst of the German and Austrian inflations had occurred. With selling prices often running ahead of input prices (including money wages) for a period of time, the inflation created the impression of increased profit margins that acted as the incentives to undertake capital investments and expand output levels. However, when private enterprises reentered resource markets to continue production processes anew, they often found that input prices now had (with a lag) risen more than the higher input prices they had previously earned; as a result, these recently earned sales revenues were sometimes not sufficient to purchase all of the needed inputs to continue output at the same and higher levels, with often the inability to replace capital that had been used up in production processes.

Hence, capital was “consumed,” bringing about declines in the productive capacities of the economy as a whole. All the inflationary “good times” turned out to be a great illusion with disastrous effects from a more longer-term perspective. Or as Mises expressed it in The Theory of Money and Credit, “Inflation had the great advantage of evoking the appearance of economic prosperity and of increased wealth, of falsifying calculations made in terms of money, and so concealing the consumption of capital.”

Money and choices in the present vs. the future

The other important aspect to Mises’s analysis of money and the monetary system, therefore, was the role of a medium of exchange in the relationship between savings and investment. All economic decision-making revolves around the problem of how best to use the means at our disposal to attain the desired ends. Many of these decisions involve us choosing between a variety of alternatives. Shall I use some of my available means to buy a hat today or a new shirt? Shall I order ham and eggs for breakfast at a local restaurant or pancakes with maple syrup? Shall I read the morning newspaper for the next half hour or watch my favorite 30-minute sitcom on my streaming service?

But other decisions involve us making choices between alternatives over and across time. Having graduated from high school, do I enter the job market right away and start earning a full-time income to buy many of the things I would like to have in the here-and-now? Or do I forego all or part of that earnable income for the next four years to go to college and finish with a degree that puts me on a career track that will result in my very likely earning far more income in the future than if I take a job right out of high school? Do I spend all or most of my earned income now, or do I put some of it aside to start accumulating a nest egg for retirement, or into savings in case of an unexpected emergency, or to have most or all of the tuition ready to pay for my child’s future college education?

These and many similar types of choices concern options nearer to the present or further into the future. These are time preference decisions and choices between alternatives. Indeed, our decisions about the purposes for which we will use some of our available means in the present always include the implicit choice of deferring some consumption desires today for some gain in the future (when that future could be minutes, hours, days, or years away from right now). And like all other choices, time preference decisions are also made “at the margin,” that is, a little bit less of something in the present in order to have a bit more of something desired in the future.

Time preference, gains from trade, and the rate of interest

Sometimes, individuals find themselves with differing time preferences. One person has less means at his disposal for some project that he would like to undertake over time, the desired outcome of which would not be until some point in the future. Another individual, however, might be willing to defer using some of his available means today for a desired end if there is a financial incentive to wait to use them until sometime in the future.

In the old Popeye-the-Sailor cartoons, Wimpy would say, “I will gladly pay you Tuesday for a hamburger today.” But the person asked to wait until Tuesday to be paid by Wimpy for that hamburger might reasonably reply, “Why should I forgo eating that hamburger myself today, or not selling it to someone else willing to pay for it right now?” Then Wimpy would have to ask himself how much more might he be willing to pay in the future for today’s hamburger, and how much the owner of that hamburger would want to be paid in the future to forgo his own consumption, or the premium over today’s hamburger price, to make it worth his while for him to wait until the future to be paid. That premium in the future over the item’s current value or price is the basis of a market rate of interest.

The rate of interest, in other words, as the Austrian economists argued almost from the origin of the Austrian school, is the price of future goods over present goods. Of course, in the developed market economy, goods in the present do not directly trade for goods in the future. As in all market transactions, the exchange is facilitated through the medium of money to overcome the difficulties and “impossibilities” of barter, due to a lack of a coincidence of wants or indivisibilities in the goods to be bought and sold, or because goods offered in the present are not necessarily the same goods to be received in the future.

The saver who consumes less than the full income he has earned lends to the borrower an agreed amount of money. The saver forgoes his demand for particular goods in the present that he might otherwise have spent his money in purchasing, and for which particular resources would have been used to meet that demand. Instead, that sum of money passes into the hands of the borrower for the period of the loan, and he demands other types of goods than the lender would have. Resources, labor, and capital (tools, equipment, machinery) are devoted to different uses over that period of time, the outcome of which will be a finished good or product of some sort that the borrower anticipates will meet a future demand and earn a profit that more than justifies the expenses incurred and the interest payments to be made to the lender. When the loan is repaid, the lender may roll over that sum of money to lend it again to earn additional interest income, or spend all or part of the original principal and interest income on some of the present demands he wishes to satisfy.

Maintaining and increasing capital through savings

Imagine that there is a baker who possesses an oven that enables him to bake one thousand loaves of bread each day. No matter how diligent the baker may be in repairing and maintaining his oven, at some point wear and tear will require it to be replaced.

There needs to be enough savings by some in the society for sufficient resources, labor, and certain other types of capital to be “freed up” from current consumption so that others on the production side of the market may have them available to manufacture the new replacement oven in a market-coordinated manner such that the new oven will be available for sale and installation when the old oven needs to be replaced. Only in that manner could a given level of production of a thousand loaves of bread per day be ensured.

We can also imagine that the time preferences of some members of the society change, such that they save more; that is, they demand fewer consumer goods today and therefore free up more resources for investment purposes. By some consuming less and saving more, the greater supply of savings on the loan market would tend to competitively lower the rate of interest. Since the lower rate of interest has, other things held the same, lowered the costs of producing ovens, the oven manufacturer could borrow the additional savings to now produce, say, two ovens. He could then offer the two to the baker at a lower price that makes it sufficiently attractive for the baker to purchase both the replacement oven and a second oven to expand his daily output of bread.

If the technology of the ovens has not changed, then the baker, with two ovens, could now supply two thousand loaves of bread every day on the market at a lower per unit price, bringing about a general rise in the standard of living with more food available for consumption. Thus, the “sacrifice” of some consumption satisfactions in the past due to greater savings is “rewarded” with more goods to consume when the future has arrived. While admittedly presented in a very simplified manner, this is, in essence, how societies economically grow and become wealthier in terms of more desired goods to better satisfy the wants of their members.

Investment and the time structure of production

At the same time, all such investment processes take time and usually go through a variety of stages of production. We can imagine that from start to finish, such an investment process passes through five stages to be completed, with each stage, just for the sake of the example, requiring one month of time. Again, for simplification, we might assume that at each of the stages, the inputs (resources, labor, use of capital equipment) require expenditures of $100. We can further suppose that each stage is undertaken by a separate enterprise, which sells its partially completed version of the product to the next enterprise, until at the end of the fifth month, the product is in its finished form and ready for sale to an interested buyer.

Thus, the value added at each stage cumulatively comes to $500; if we presume that the entrepreneurial decisions at each stage had correctly anticipated the demand at the next stage, the final, finished product would sell for the $500 that has gone into its successful completion. If consumer demand for the product continues month after month, then each of these stages of production must be in process simultaneously through time. If this product is wanted for consumption in May, then the first of the five stages must be set in motion in January if it is to go through the remaining stages and be ready for sale at the end of May.

If the product is also wanted in June, then the same process must begin, again, in February, while the product to be sold in May is presently in stage two of this five-stage production process. If the product is also wanted in July, then stage one must start in March, while the May product is simultaneously in stage three and the June product is in stage two. In other words, each product planned to be brought to market must go through its own timeline
of production simultaneously with the others for the period-after-period desired output of the desired goods.

At each stage of production in the manufacture of every product, there is employed not only labor but some forms of capital equipment (machines, tools, etc.), which, like the oven in the earlier example, have to be eventually replaced due to wear and tear. In other investment sectors of the market, there must be in progress projects whose purposes are to plan and anticipate the demand by other enterprises needing replacement capital equipment. And each of these must be planned ahead so they will have gone through their respective stages of production and are ready for sale and installation so that other investment activities can continue in smooth coordination, with supplies tending to match future demands based on entrepreneurial anticipation of what future market conditions will be.

All of this overlapping and interdependent complexity of investment, production, supply, and demand are held together through the competitive price system. This price system facilitates the economic calculations concerning possible profits and losses that are estimated to be possible in changing circumstances and how best to produce what others want at the least cost. This is what enables a developed and extensive social system of division of labor to exist and coordinate the actions of multitudes of people, all of whom rely upon all those unknown others doing all the unknown things that generate the goods and services desired, and which results in the rising standards of living that so many of us simply take for granted with little or no thought about the social and economic institutional arrangements that make it possible.

Banking as the intermediary institution linking savings and investing

Key to all of this is a banking system that coordinates the willingness of savers to forgo current consumption so others may borrow what is saved (and the resources that savings represents) to undertake the time-consuming investment projects that enable capital and time-using production activities to begin. The rate of interest is not only the intertemporal price that brings saving and borrowing decisions into balance (like any other price that coordinates supply and demand). It also acts as a “break” on the time horizons of the investment projects undertaken, so the multi-stage production activities can be successfully completed (given the accuracy with which supply-side entrepreneurs effectively anticipate what consumers want and the prices they may be willing to pay in the future when goods in their finished forms are available for sale).

Of course, errors and misreading of particular future market conditions are not only possible but inescapable in a world in which all of us have less than perfect knowledge about the future. The problem that Mises became interested in were the frequent cycles of booms and busts, inflations followed by recessions or depressions. That is, disharmonies in the market process that impact not just one or few sectors of the economy at any particular time but economy-wide imbalances simultaneously. The answer, in his view, was to be found in the distinctive qualities of a money economy and modern banking systems.

Whenever a product is produced and sold in the market, its sale represents the seller’s demand for other things that he would like to buy. After all, in a system of division of labor, we each specialize in one line of activity and use what we produce as the means to pay for all the other things we desire that other individuals produce. Why else would anyone devote the time and trouble to produce an item and bring it to market?

But money turns what is one exchange under barter – a hat traded directly for a pair of shoes – into two transactions: the trading of one good for money and then the trading away of the money earned for some other good that is wanted. The hat I produce and sell need not be to the particular individual who has the shoes I want. The shoe manufacturer may have no need for my hats. So, instead, I sell my hat to someone in need of a hat in exchange for money, even though I may have no interest in buying the shirts or pants that the buyer of my hat specializes in offering on the market. Instead, having earned that sum of money, I use some of it to buy the pair of shoes I desire. Or as Mises expressed it in The Theory of Money and Credit:

Anybody who sells commodities and is paid by means of a cheque and then immediately uses either the cheque itself or the balance that it puts at his disposal to pay for commodities that he has purchased in another transaction, has by no means exchanged commodities directly for commodities. He has undertaken two independent acts of exchange, which are connected no more intimately than any other two transactions.

Saving and investing through the medium of money

The peculiarities of the modern banking system in facilitating the coordination of savings and investment, Mises argued, enables an understanding and analysis of how things may go wrong and bring about the business cycle, especially under central banking. Mises suggests a particular terminology to better appreciate the reason banking systems may be susceptible to economy-wide fluctuations. The starting point is when savers loan money directly to interested borrowers. What is lent is a sum of money that represents an amount of purchasing power in the market given the market value of the monetary unit.

That sum of purchasing power is transferred to the borrower, and it is used to demand and direct the use of scarce resources into the production of the particular goods the borrower wishes to invest in and use, rather than the particular goods that would have been demanded and supplied if the original income earner had chosen to spend it on current  consumption rather than lending it for investment purposes to someone else. Thus, some of the scarce resources in society, instead of being used to supply, say, more dinners out at restaurants in the present, are freed up to be used to make that second oven, from the earlier example, that would enable an increase in bread production.

The trade-offs in society, as we saw earlier, involve not only whether to demand more shirts versus to demand more meals in the present, given the scarcity of means to serve the ends we desire; the trade-offs are also between shirts and meals in the present versus more goods of various types in the future by freeing up some of those resources from current uses.

Now, if banking had evolved in such a way that only the money saved by some was lent to others, the connection between foregoing more goods in the present in exchange for more goods in the future would have remained a fairly close fit. Even through that two-transaction exchange process of goods traded for money and then money traded for goods, there still would have been maintained a fairly close balanced relationship between the decisions of savers with those of borrowers to assure a coordination between consumption and investment activities consistent with the limited means at people’s disposal.

Banknotes and fractional reserve banking

One of the uses and conveniences of banking was that it made possible the use of banknotes issued by banks as claims to sums of commodity money — gold and silver — deposited with them as a “money substitute” for everyday transactions in lieu of directly using actual gold and silver left with the banks for safekeeping. If a bank had a good and reliable reputation of always “making good” when any holder of their banknotes demanded the withdrawal of the quantity of gold and silver the banknotes represented, that bank had greater leeway in issuing such money-substitute banknotes to those who wanted to borrow for some future-oriented investment plan that they might have in mind.

Suppose that the bank’s depositor clients were to deposit $10,000 in gold and silver into their accounts for which banknotes were issued as claims to the specie money. If these were literal savings accounts, and if the bank managers were confident that holders of those deposits would not make any significant or noticeable withdrawals from their accounts for, say, two years, then that bank could lend that $10,000 for two-year loans to those deemed “credit worthy,” with limited concern that the borrowed sum would not be repaid at the end of the two-year period, when it was  anticipated that its savings depositors might make significant withdrawals. The savings-investment nexus would have been kept in a reasonably close demand and supply balance in the use of scarce resources across time.

But banks also discovered that on the basis of those deposits of $10,000 in gold and silver into their accounts, they could extend loans to borrowers significantly greater than that $10,000. Every day, there are bank customers making new deposits, while others are making withdrawals. Suppose the bank learns from experience that, on average, those who hold and use their banknotes for transactions in the marketplace only make, on net, withdrawals in gold or silver equal to 10 percent of whatever the bank’s total banknote liabilities may be. Thus, if depositors have $10,000 of actual gold and silver in the bank, depositors are unlikely to demand more than $1,000 in actual specie or commodity money during any particular period of time.

The bank could issue total loans, in the form of banknotes of, say, $20,000. If that bank’s business pattern were to hold, only 10 percent of those outstanding $20,000 bank-notes are likely to be turned in for redemption, or $2,000 of actual gold or silver withdrawn from the bank. Likewise, if the bank’s depositor and banknote users’ patterns were to remain the same, the bank could issue a maximum of $100,000 in banknotes, $10,000 of them representing the actual gold and silver of their claimants who deposited that actual specie or commodity money with it, plus $90,000 of
additional banknotes issued as loans to presumed credit-worthy borrowers.

Mises used the term commodity credit (or transfer credit) to represent the $10,000 of actual savings lent to some of those deemed to be credit-worthy borrowers; Mises called the amount of banknotes issued by such a bank in excess of that actual savings fiduciary media, or circulation credit (or created credit), that is, not backed by actual gold and silver deposited as savings by bank customers. Here, in Mises’s view, was the origin and the bases of the savings-investment relationship being thrown out of balance, resulting in an attempt to undertake investment projects, with their time structures of production, inconsistent with the actual available real savings to bring them to a profitably successful conclusion, or to be profitably maintained if completed before or after an economic crisis finally sets in.

Why an economic crisis grows out of this type of savings-investment imbalance, and what Ludwig von Mises considered to be the institutional changes needed to prevent or reduce the likelihood of the business cycle sequences to continue, will be the theme of part 3 in this series.

By Richard Ebeling

This article is based on a paper delivered during a session at the annual Mont Pelerin Society meeting held in the Canary Islands, September 30-October 6, 2018.

We are living in a world of the anti-liberal counter-attack against individual liberty, free markets and limited government. Prominent voices for the free society in the 20th century, like the Austrian economists, Ludwig von Mises and Friedrich A. Hayek, are among the targets that opponents of free market liberalism are taking aim. In doing so, the anti-liberals distort the facts and twist the historical record. It is necessary to clarify those facts and set the record straight. 

For most of the last quarter of a century, many took it for granted that the case for socialism had been defeated.  With the fall of the Berlin Wall in 1989, the end of the Soviet Union in 1991, and the shift in several remaining communist countries – China in particular – to market-oriented policies, it was presumed that “socialism” as an economic system was dead. Who seriously wanted to retain or restore comprehensive socialist central planning as an alternative to a relatively free and functioning market economy? 

In this sense, the “Austrians” had won, that is to say, the criticisms of socialist central planning made by Ludwig von Mises and Friedrich A. Hayek in the 1920s, the 1930s, and the 1940s, had been shown to be correct. Without private property in the means of production and a competitive market process with a functioning price system, there could not be effective economic calculation for efficient cost-accounting, consumer-directed production decision-making, and on-going coordination of a complex system of division of labor reflected in the patterns of market supply and demand. 

The Persistence of the Socialist Critique of Capitalism

But it is also clear in these early decades of the 21st century that socialism had not passed into the dustbin of history. Instead, it had taken refuge in the ivory towers of academia and related intellectual circles. What had not been abandoned and was still sulking in the corners of society was the socialist critique of market, or capitalist, society. Market outcomes were “unfair,” “unjust” and “unequal.” Private production for profit left the “social needs” of society unfulfilled, such as health care and job security. Capitalism not only mistreated and exploited “the workers,” but various racial and gender, and other social minority groups, as well.

The financial crisis of 2008-2009 and the slow and lopsided recovery for much of the last ten years offered the opening in the door for all the old criticisms of capitalism to once more seem timely and relevant, especially when clothed in the latest fads and fashions of ‘political correctness.” 

In some ways, the advocates of socialism are back to where they were more than a century ago before the First World War. This is the case not only with their moral fervor and self-righteous certainty that capitalism and liberalism are evils that must be done away with, but in the practical uncertainty of which of the competing forms of economic collectivism should replace the current market economy. Should it be central planning with nationalized industry? Should it be worker-managed syndicalism? Should it be a form of economic fascism in which not all industry is taken over by the government, but under which the government controls, directs and restricts how private enterprises may go about their business for the “social good”? Or shall it be some peculiar combination of all three?

All the competing socialist visions strongly believe in the need and necessity for greater income and wealth redistribution to bring about social and economic “equality.” There is an unreflective presumption on the part of many of these critics of liberal capitalism that all the social “safety nets,” infrastructure projects, and environmental protections can be funded simply by taxing “the rich” and the large corporations, as if they are self-renewing bottomless wells of money to be extracted in any amount and at any time. 

Progressives: Democracy Mystically Good, Neoliberalism Despicably Evil 

These critics of capitalism and advocates of some form of government-managed or planned economic systems rhetorically use terms to categorize all that they consider to be “good” and “evil.” These terms, respectively, are: “democracy” and “neoliberalism.” Democracy and “democratic socialism” have become verbal expressions of all that “progressives” consider to be right and just for the world. 

Democracy is treated as a hallowed word, a word representing “the masses” of society insisting upon and ready to establish a “better world” through the willpower of a voting majority. Unchecked and unrigged, the new generation of collectivists knows that the democratic process will bring about the progressive and socialist world they long for, dream of, and fight for. 

If the electoral process does not produce it, it must be because “the system” is perverted and manipulated. Either “the rich” have used their wealth to bribe people and politicians to preserve the present system of injustice; or fascist-like demagogues have confused too many of the people with hateful references to national greatness or racist sentiments; or the existing electoral procedures prevent the will of the majority from determining who wins high political office because of archaic constitutional rules. 

In all of this, “democracy” has taken on a mystical, almost religiously sacred quality to be held in awe and reverence.  Democracy is the gateway to an earthly nirvana. 

Democracy’s nemesis is neoliberalism. Into this term is poured everything that progressives, socialists and anti-capitalist thinkers in general consider to be wrong with existing society. Neoliberalism is the political ideology of unrestrained capitalism guided by nothing but the self-interested profit motive; it is the camouflage behind which  the “rich” and the corporate “powerful” are trying to maintain and extend their exploitation of workers, women, racial and gender minorities, and the physical planet; it is the false consciousness of thinking that “free markets” mean freedom when, in fact, it means control over the many by the few; it represents the use of government to assure the power of “capital” over “labor.” 

Economic Liberals as Globalist “Enemies of the People”

Prominent members of the Mont Pelerin Society – an international association of friends of freedom established in 1947 in Mont Pelerin, Switzerland – have been among the targets of such accusations and attacks in works that purport scholarly detachment and archival detail. But a bit of scratching beneath the surface of their texts throws doubt upon the charges and the claims. 

One of the recent ones is by Quinn Slobodian, in his book, Globalists: The End of Empire and the Birth of Neoliberalism (2018). His chosen narrative is to demonstrate that neoliberalism emerged out of the wreckage of World War I due to the challenges faced by existing economic elites who had controlled and managed the world for their own benefit through the European Empires starting in the 19th century. In the interwar period of the 1920s and 1930s these empires were facing disintegration, along with the passing of belief and confidence in the old liberalism of laissez-faire and limited government.

A new market-based globalism needed to be rationalized and designed to preserve the existing power structure of “capital” against the democratic wishes of people both in the West and in the awakening colonial areas around the world. Dr. Slobodian, a professor of history at Wellesley College in Massachusetts, argues that the intellectual focal point for the creation of a neoliberal defense to hold back the winds of change and to create a new international system for the existing, though challenged, elite power structure can be found among the faculty and visiting scholars of the Graduate Institute of International Studies in Geneva, Switzerland in the interwar period. 

The Geneva Graduate Institute: Liberal Haven for Refugees from Tyranny

Founded in 1927 under the joint directorship of William E. Rappard and Paul Monteux, in the 1930s the Graduate Institute became a haven for market-oriented liberal economists, historians, political scientists, and legal scholars, many of whom were escaping from or threatened by the fascist regimes in Central Europe. These included Ludwig von Mises, Wilhelm Röpke, Michael Heilperin, Guglielmo Ferrero, Hans Kelsen and others.

In the 1930s, the Graduate Institute was frequently visited by market-oriented academics who delivered guest lectures on liberal economic and political themes. These included Friedrich A. Hayek, Lionel Robbins, Louis Rougier, Gottfried Haberler, Fritz Machlup, Bertil Ohlen, Moritz J. Bonn and many others. A good number of these names should be familiar because several of them were leading members of the Mont Pelerin Society, including some who were at the founding meeting in 1947.

Reading Professor Slobodian’s words, he lives in a world of conceptual realism and institutional anthropomorphism. That is, the analytical concepts created by the theorist are assumed to have real existence. Thus, he speaks of neoliberals wishing to create a world order that would secure and protect “the rights of capital” against people’s democratic expressions for redistribution of wealth. 

He speaks about “capitalism” securing the needed institutional forms so “it” can exist. These are more than short hands. Yes, clearly there are owners of capital who wish to go wherever they want around the world in pursuit of profits. But he expresses this in various places as if the capitalist system has a life of its own and that it is struggling to protect and secure itself from “the people’s” wishes and desires for a more socially just society (pp. 4; 12-13; 16).

Mises Falsely Portrayed as Handmaiden of Capitalist Tyranny

In this drama Ludwig von Mises and Friedrich A. Hayek are starring players determined to “save” capitalism and the “rights of capital” from the democratic desires of those clearly harmed by the system of private property. In telling his narrative, Professor oSlobdian takes both Mises and Hayek’s ideas and words grievously out of context and in fact frequently distorts what they said and what they advocated. 

Looking at events in the Vienna of the 1920s and 1930s, Mises is portrayed as an active proponent of the Austrian state using dictatorial means to violently crush the workers who merely wanted a better life; Mises’s role was as a good servant of “business interests,” in his position as a senior economist analyst at the Vienna Chamber of Commerce during much of the interwar period. Following Professor Slobodian’s footnotes, however, soon shows that things that he says Mises said are sometimes not to be found in the passages referenced. Even giving the benefit of the doubt by searching for the quote somewhere on another related page also finds no results.

Professor Slobodian sneers at Mises’s defense of democracy (p. 118). Why? Because all that Mises is concerned with, he says, is a “minimal” equality of all before the law; but if “democracy” went beyond this, then “it was perfectly legitimate to suspend it and enforce order by other means,” i.e., dictatorship and violent repression. This is, in fact, the exact opposite of what Mises argued. And if the government’s policing authority did use force to prevent or suppress violent labor union or mob actions against persons or property, Professor Slobodian then claims that Mises believed in “the right to kill with impunity” in defense of “capital” (p 45). Talk about twisting a person’s ideas to fit the conclusion the author wants!

Mises’s Defense of Democracy and Against Demagoguery and Dictatorship

In reality, in his Memoirs (1940), Mises discusses the growing tensions between the Austrian Christian Social Party that controlled the national government of the country and the militant Social Democratic Party that controlled the city government of Vienna. Both political parties had their own separate paramilitary forces that in numbers were two or three times larger than the Austrian army in the late 1920s and early 1930s. Mises explains that some of his acquaintances argued that only an alternative “anti-socialist” paramilitary could stand up to the physical threats from the Social Democrats. He said he watched these developments “with horror.” The paramilitary forces organized to oppose that of the Social Democrats were manned, Mises goes on, with “adventurers without education and desperados  . . . Their social ideal was a military state in which they alone could give orders” in a fascist corporativist system, with which Mises had absolutely no sympathy. (p. 75)

Likewise, in his 1927 book, Liberalism: The Classical Tradition, Mises insisted that neither demagogic deceptions nor non-democratic (that is, dictatorial) means could save the free society. Only a victory in the battle of ideas could assure a prosperous and stable society based on the liberal principles of individual liberty and private property on competitive markets. Democracy must be preserved and defended because it is the only viable institutional mechanism that makes violent revolution unnecessary for political change. The only legitimate and lasting weapons for ideological and public policy change were reason and persuasion. (pp. 119-120)

Another instance of such a distortion of the facts is Professor Slobodian’s discussion of Mises’s proposal for a political and economic federation among the countries of Eastern Europe in the post-World War II era as a bulwark against nationalistic wars among the member nations and a unified force against any threats in the future by either Germany or Soviet Russia. 

Misinterpreting Mises’s Plan for Postwar Eastern Europe Peace 

In the detailed outline that Mises offered for what he called the “Eastern Democratic Union” of nations, there would be a strong central government that would limit the domestic discretion of the member national governments. Their budgetary powers would be restricted, there would be private education instead of public schools, and domestic regulations within the member countries would be narrowly confined as well. The central government of this Union would assure unrestricted freedom of trade, and free movement of people and capital among the member nations (See Ludwig von Mises’s, “An Eastern Democratic Union: A Proposal for the Establishment of a Durable Peace in Eastern Europe” [1941], in Selected Writings of Ludwig von Mises, Vol. 3, pp. 169-201).

What conclusion does Professor Slobodian reach from all of this? “The constituent nations of the union would bear all the outward marks of sovereignty, yet this sovereignty would be ornamental, undermined by the authority of the central government,” he states. This would create “an invisible government of the economy first, and a visible government of neutered nations second.” (p. 112). In Professor Slobodian’s view this Union is designed to thwart the democratic decision-making of the citizens of the constituent nation-states on the altar of the unhampered interests of “capital” and unimpeded markets.  

An Eastern European Union for Liberty, Prosperity and Minority Rights

But, in fact, what concerns motivated Mises to propose such a political system and structure? The entire interwar period had seen the emergence of both political and economic nationalism. Borders were closed; protectionism reduced the opportunities and benefits from the international division of labor, and thus all experienced lower standards of living compared to what could have been under greater freedom of trade and investment. In addition, in an environment of hyper-nationalism based on language or “race,” governments, particularly in Central and Eastern Europe, used their regulatory powers to discriminate against ethnic or linguistic minorities unable to prevent majoritarian oppression. 

Said Mises:

“If, for instance, members of the minority are alone engaged in a specific branch of business, the government can ruin them by means of customs provisions. In other words, they can raise the price of essential raw materials and machinery. In these countries, every measure of government interference – taxes, tariffs, freight rates, labor policy, monopoly and price control, foreign exchange regulations – was used against minorities. If you wish to build a house and you use the services of an architect from the minority group, then you find yourself beset by difficulties raised by the departments of building, of health and fire. You will wait longer to receive your telephone, gas, electric, and water connections from the municipal authorities. The department of sanitation will discover some irregularities in your building. If members of your minority group are injured or even killed for political reasons, the police are slow in finding the culprit.” (Ludwig von Mises, “Postwar Reconstruction” [1941], Selected Writings of Ludwig von Mises, Vol. 3, p.13)

Mises’s proposal for restraints on national majorities in the member countries in his idea for a European Democratic Union was precisely to protect and defend the linguistic and cultural and ethnic minorities from majoritarian discrimination, abuse, and obliteration. Thus, when in a different passage, Professor Slobodian suggests that liberals such as Mises did not have the freedom of the individual as their “core value,” (p. 24), what can be more of a concern with the autonomy of the individual than a desire to assure people’s personal choices and decisions concerning the cultural and linguistic values they wish to preserve and cultivate peacefully and voluntarily among themselves, free from the coercing hands of intolerant majorities using the state against those unable to ever secure on their own fifty-one per cent of the votes in the country in which they live? 

Mises’s additional proposal for private education over public schooling was equally based on the observed practice in these Eastern European countries during the interwar period of using compulsory attendance laws as a way to impose the majority group’s language, history and cultural heritage on the children of linguistic and ethnic minorities, whose parents could not refuse to send their sons and daughters to government-mandated schooling. 

Removing politics from the social and economic spheres, Mises reasoned, reduced the possibility of using government against some to benefit the economic, cultural or ideological purposes of others who were more successful or more numerous in using the democratic process to have their compulsory way. 

The democratic mystique was less than awe-inspiring for those who were the victims of its cruel use to undermine their individual and minority senses of identity and belonging. Professor Slobodian and others like him seem to turn a blind eye to the dark-sides of unrestrained majoritarian democracy, the dangers from which others like Mises pointed out; precisely in the name of justice and fairness to individuals and minority groups it was necessary to impose constitutional limits on what majorities may indiscriminately do. Protections for individual liberty and freedom of association should inhibit the intolerant and coerced impositions of majorities, argued Mises. One feels that the good professor needs to take the time to re-read central parts of John Stuart Mill’s essay On Liberty devoted to the dangers from the tyranny of the majority.  

Misinterpreting Hayek’s Proposal for an Economic Federation

Friedrich Hayek becomes Professor Slobodian’s target when it comes to the issue of national democratic autonomy versus a peaceful and prosperous international order. In his eyes, Hayek worshiped at the altar of a world order of open international trade, investment and migration, with the suppression of the democratic wishes of the peoples in the nation-states. The political authority of national governments in a partial or fully global federation of countries would be held in check against any attempts by them to implement interventionist and welfare statist policies that democratic majorities in those nations might want to implement to protect themselves from the capitalist global elites. 

All could be sacrificed for the global capitalist good. This meant that “the ‘solidarity of interests’ that naturally cohered when groups of people having the same economic interests” would be undermined and kept in check. “The goal of [Hayek’s] federation was to break the link between political citizenship and economic ownership” (p. 102) and “The nation-state must not be allowed its full independence” (p. 112).

By why did Hayek propose an international structure of institutions and law that would restrict the autonomy of national governments? Was it a ruse to allow the unbridled movement of “capital” so the few could exploit the many, in a world system of property over people? That’s how it reads, reading Professor Slobodian. 

The Lost Liberal World of Peace, Prosperity and Liberty

The context, in fact, was the world in the wake of World War I. For the generation that was old enough to remember the world before 1914, the world after 1918 was jolting and horrifying. The institutions, values and beliefs of the twilight years of the earlier liberal epoch were in stark contrast to the reality of the interwar period. Let us hear the forlorn words of the anti-fascist Italian philosopher, Benedetto Croce, in 1932, who while a political and cultural liberal was not a supporter of economic liberalism or laissez-faire: 

“We remember the old Europe with its riches, its flourishing trade, its abundance of goods, its ease of life, its bold sense of security; we see today the new Europe – impoverished, discouraged, crisscrossed with high tariff walls, each nation occupied with its own affairs, too distraught to pay heed to the things of the spirit and tormented by the fear of worse to come . . . Impatience with free institutions, has led to open dictatorships, and, where dictatorships do not exist, to the desire for them. Liberty, which before the war was a faith, or at least a routine acceptance, has now departed from the hearts of men even if it survives in certain institutions.” 

Especially in Central and Eastern Europe, the political nationalism of the new nations created out of the dismembered German, Russian and Austro-Hungarian Empires was complemented with economic nationalism: high and often prohibitive tariff barriers, attempts at autarky (national economic self-sufficiency), nationalized or heavily regulated industry and enterprise in the name of national interests, discriminatory fiscal policy, and confiscations of foreign properties. 

These led to tensions, animosities, and threats of military conflict due to territorial disputes over borderlands with mixed ethnic or linguistic populations. Political and economic nationalism threatened wars, and reduced senses of international solidarity for common causes and against common dangers from larger surrounding aggressor nations. 

For liberals like Hayek, once World War II was over, unless something was done to calm the international scene, the cycle of nationalistic confrontation and conflict would raise its dangerous head all over again. More wars, more economic barriers against international collaboration and material betterment, more antagonisms among and between peoples due to the atavistic ideas of racial, linguistic or cultural identity imposed through government coercion and command; more national socialism through economic planning for national “greatness.” 

Hayek’s Federation Limits State Power to Assure Peace and Prosperity

This is the backdrop to Hayek’s essay on “The Economic Conditions of Interstate Federalism” (1939) and the chapter on ‘The Prospects of International Order’ in The Road to Serfdom (1944, pp. 223-236), to which Professor Slobodian draws the reader’s attention. The goal was to devise ways of reducing, if not eliminating, the factors and forces making for international war and economic conflicts. For Hayek, the primary means for doing so was the depoliticizing of economic life, to end the pattern of private market rivalry among competitors who happened to reside in different countries becoming matters of, “for reasons of state.” The task was to reduce the arbitrariness of national borders becoming the basis of international antagonisms and disputes over “national honor” that required governments to use their interventionist powers and policies to prevent foreign producers and products from “invading” the home country.

Whether Hayek’s conception of how and with what specific authority such a regional or global federation should be organized and operated is a separate issue. The fundamental point is, what guided and directed his thinking along these lines? And the answer to that question is a universal principle of freedom, peace, prosperity, and justice for humanity as a whole. He was not against local self-government or national democratic decision-making. Indeed, he insisted that without it a proper sense of responsible citizenship for the preservation a free society could be lost (1944, p. 234). But it was necessary to reduce special interest groups of all sorts – labor unions or private enterprises wanting government privileges and favors – from using political means (democratic or not) that threatened the peace and possible prosperity both within or between countries. (1939, p.  258-261)

Professor Slobodian clearly believes that unless national populations control their own economic destinies through democratic decision-making concerning planning, regulation and income redistribution, then the malevolent forces of international “capital” will enslave “the people.” Denied democratic means of fighting back, “the people” are unarmed against an ethereal “capitalism” that menacingly haunts the world.

Professor Slobodian and others sharing his views implicitly create this feeling of a Rousseauian “general will” through an unrestricted democratic voting process that is separate from and superior to the wills of the individuals comprising society.  Somehow, if everyone is voting with the greatest latitude of decision-making power as a collective body, with no restrictions or restraints concerning individual liberty, or private property rights, or rights of free association, the higher and “real” good of the community as a whole will be expressed and be transformative in bringing about that better collectivist social order.

But there is no “general will,” or higher communal or collective good. There are only individuals with their own ideas, beliefs, values and visions of what is good, better or best.  In spite of the near- mystical aura around which the idea of democracy is enveloped by Professor Slobodian, it is merely a political mechanism for, as the phrase goes, “counting heads, rather than breaking them.”

The benefit of a free society with limited government is that it is not necessary for everyone or even many people to agree about what is better or best to do in any of the mundane or momentous aspects of life. Individuals and small or large groups sharing similar values and agreeing amongst themselves about what seem to be the better or best means to attain them may, each, go their own way. That is the benefit and value of voluntary and market-based human association. It enables a diversity-generating system of “participatory democracy” with proportional representation, outside of and independent from political power.

It separates “economy” from the “state.” This may be anathema to Professor Slobodian and he clearly considers it a terrible thing (pp. 133-135), but it actually frees and liberates people by enabling them to live their lives peacefully and cooperatively with others without their resorting to coercion over others to get their way, or fearing that others will use such coercion to make them conform to what the others insist they want. By extension, separating economy from the state reduces the causes for and the likelihood of wars or economic conflicts between governments; wars and conflicts that reduce the possibilities for human cooperation for mutual benefit through the avenues of peaceful international trade and investment. 

For economic liberals like Mises and Hayek, the task of informed public policy was to reduce the use of government coercion in both domestic or international affairs so as to minimize the bases of conflict and maximize the possibility for peaceful cooperation through market association and exchange. Attempting to use political democracy for collaborative purposes necessarily requires the will of the voting majority to be compulsorily imposed on the losing electoral minority. 

For as Hayek emphasized, the more the government extends into regulatory or planning activities within a society, the more it must decide upon a common hierarchy of ends or values to which all in the society will have to conform if the goals reflected in that common scale are to be achieved. But the more complex and diverse the interests, purposes and preferences of the members of that society, the more the individuals’ ranking of ends may diverge from the over-arching one in the government’s planning or regulating schema. So, the government must make those of the individuals’ in the society subservient to the politically established collective one. 

Or as Mises expressed it more directly and succinctly in his treatise, Human Action (1966):

“It is important to remember that government interference always means either violent action or the threat of such action. 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” (p. 719).

Conclusion

So, unfortunately, there are still socialists and anti-liberal interventionists, actively working to challenge and undermine the rationales and ethical basis for a liberal free market society. But as “scholarly” works such as Quinn Slobodian’s Globalists demonstrate, the anti-capitalists and anti-liberals are also determined to make and win their case through factual fabrications and scandalous misinterpretations of what classical liberals such as Ludwig von Mises and Friedrich A. Hayek really said and advocated. This makes the defense of liberty not only a battle of ideas, but also an intellectual combat in the name of truth.

This article is based on a paper delivered during a session at the annual Mont Pelerin Society meeting held in the Canary Islands, September 30-October 6, 2018.

By Richard Ebeling

Originally published on February 9, 2024 for The Future of Freedom Foundation

Eighty years ago, in March 1944, the British edition of Friedrich A. Hayek’s The Road to Serfdomwas published. An American edition appeared six months later, in September 1944. During these eight decades, Hayek’s book has become a classic work in defense of the liberal free-market society and against socialist central planning.

Often, when a book has received the status of being a “classic,” it means that many know of it and have heard some general and vague things about it but few actually have read it. This has not been true of Hayek’s book. It fairly quickly became a best seller in both Britain and America. Its reception in the United States was dramatically heightened when a condensed version of it appeared in the April 1945 edition of Reader’s Digest, which back then was regularly subscribed to and read by over 8.7 million Americans. Hayek later remarked that he thought that the Reader’s Digest condensed version more concisely and clearly got all his arguments across than the full text in the book! Shortly after, Look magazine did a cartoon version of the essential aspects of Hayek’s argument that reached millions more.

Throughout the years, The Road to Serfdom has had a constant readership, with bursts of increased attention. This was certainly the case after Hayek was awarded the 1974 Nobel Prize in Economics. Forbes magazine had a cover issue with a drawing of Hayek holding a candle of liberty in the darkness of collectivism, with a copy of The Road to Serfdom in his other hand. This was reinforced when it became known in 1979, shortly after Margaret Thatcher became prime minister of Great Britain, that Hayek’s ideas were the basis of the policy agenda she said she wanted to implement. When Glenn Beck told his large television audience in 2010 that America was still moving down Hayek’s road to serfdom, the book reached the New York Times bestseller list. As of 2021, more than two million copies of the book had been sold, a very large number for a nonfiction work with a political and economic message penned eight decades ago.

Hayek on money and the business cycle

Friedrich A. Hayek was born in May 1899 and in his late teens served in the Austro-Hungarian Army on the Italian front during the First World War. After returning home to Vienna in 1918, he enrolled at the University of Vienna, earning two doctoral degrees, one in law (1921) and the other in political science (1923). With the help of the Austrian economist Ludwig von Mises (1881–1973), Hayek became in 1927 the first director of the Austrian Institute for Business Cycle Research, a position he held until 1931, when he accepted a position at the London School of Economics after delivering a series of lectures that were later published as Prices and Production(1931).

In the 1930s, Hayek attained international recognition in academic and some political circles due to his views on the causes and cures of the Great Depression. This was the case especially against the emerging “new economics” of John Maynard Keynes, who insisted that capitalism was an irrational economic system due to investor “animal spirits” that created unpredictable waves of optimism and pessimism that resulted in periods of prolonged high unemployment. The only potential “savior” in the system, Keynes argued, would be an activist government that used fiscal policy to boost “aggregate” employment through deficit spending programs.

Hayek, on the other hand, said that the 1929 financial crisis that then snowballed into the Great Depression was caused by misguided monetary and interest-rate manipulations by the American Federal Reserve authorities that distorted savings and investment patterns. They eventually required significant corrections and adjustments to bring the consumer and investment sectors of the economy back into balance to create sustainable, long-run prosperity and high employment.

Instead, governments almost everywhere chose to introduce interventions, regulations, and trade restrictions that “froze” supplies and demands into persistent mismatches, one result of which was rising unemployment. Hayek’s policy prescription was to eliminate the price-and-wage interventions, return to international free trade, reduce government spending and taxation, and allow free markets to competitively find their “full-employment” supply and demand relationships.

Hayek’s views on ending the Great Depression became increasingly unpopular in an intellectual and ideological environment dominated by strongly interventionist and socialist ideas that “capitalism” needed to be replaced with heavy-handed government control, regulation, and redistribution at the very least, and most likely with some forms of direct government central economic planning to ensure “full employment.” In this setting, Hayek turned his attention to whether a socialist economy could actually and effectively replace a functioning free-market system.

Hayek on socialism and the use of knowledge in society

In 1935, Hayek edited a collection of essays entitled Collectivist Economic Planning, which included an English translation of Ludwig von Mises’s article titled “Economic Calculation in the Socialist Commonwealth” (1920), in which Mises argued that without private ownership of the means of production and competitive markets upon which they might be freely bought, hired, and sold, there would be no market-based pricing system to determine the value and opportunity costs of how labor, resources, and capital should be efficiently applied to most effectively produce those goods and services actually wanted by the consuming public.

In the opening essay to the volume, Hayek summarized the German-language debate in the 1920s over the viability of a socialist economy, including Mises’s arguments, and in the closing essay, he extended the analysis to critically analyzing the socialist planning literature in English. This was followed by an article in 1940 criticizing those who advocated a type of “market-socialism” in which the managers of state-owned enterprises would play at being entrepreneurs by adjusting what and how they produced various goods based on selling prices and resource prices that would be set by a socialist central-planning agency.

However, it was in his essay “The Use of Knowledge in Society,” which appeared as the lead article in American Economic Review (September 1945), that Hayek made what has been considered to be his most penetrating argument against socialist planning. He argued that it was inherently impossible for central planners to ever know enough about everything relevant in the economy to successful plan a society. All the knowledge in society, Hayek said, is divided, decentralized, and dispersed among all its members. Each one of us, in our own corners of the world, knows bits of all that knowledge that others do not and cannot know, appreciate, and utilize in an ever-changing environment better than each one of us working and interacting in the social system of division of labor.

If all that dispersed, decentralized, and divided knowledge is to be taken advantage of in ways that will benefit others besides the individual possessors of that knowledge, each must be left free to best apply what they know, guided by the communications network of a market economy – the competitive price system. Prices serve as a shorthand means of people telling each other what goods they want and the value they place on them as consumers — and what goods and services they may be willing and able to produce and supply given their opportunity costs on the supply side of the market.

The diverse and multilayered forms and types of knowledge that people possess can never be fully shared with and passed on to “higher-up” central planners in all their textured nuance and nonverbal patterns that much of this knowledge takes on. It is either left to the possessors of that knowledge to use it as they think best, or it is lost and not fully utilized to the detriment to everyone else who could have gained from its successful application.

These arguments were, for the most part, directed to an audience of Hayek’s fellow academics and intellectuals he was attempting to influence in the battle of ideas over the cases for competitive capitalism versus socialist central planning. They were not intentionally directed to the general public, who in a democracy help decide the direction of their society through the government policies and candidates for public office they support and vote for.

Writing and publishing The Road to Serfdom

In 1939, shortly after the Second World War began in Europe, Hayek volunteered to work for the British government on anti-Nazi propaganda to be clandestinely spread in Germany. While he had become a naturalized British subject in 1938, due to his Austrian origins, the British government turned down his request to “do his bit” for the war effort. Instead, he continued teaching at the London School of Economics, including after the school had been evacuated to Cambridge University due to the German bombings of London. Hayek decided to write a book that would emphasize the value and importance of the ideas and institutions of a liberal and free society and point out the dangers to political and economic freedom if Great Britain were to follow a socialist and central-planning agenda when the war was finally over.

The Road to Serfdom was written mostly in 1941 and 1942 and was accepted by a British publisher in 1943. What was far more difficult was finding an American publisher. Many of the major American publishing houses turned it down, saying, in effect, that it was too out-of-step with its liberal, pro-market ideas in an intellectual climate strongly in the direction of far more political paternalism. Finally, it was accepted by the University of Chicago Press through the assistance of some free-market friends. Little did the British or American publishers realize how successful the book would be, with new print runs having to be soon ordered due to the high demand for it at bookstores in both countries. (Duke University economist Bruce Caldwell, who has served as the general editor of Hayek’s collected works, explains the history of the book’s writing and publication in great detail in his introduction to the 2007 edition prepared as volume 2 of The Collected Works of F. A. Hayek.)

The socialist roots of Nazism

The underlying theme in much of the book is that any type of fairly comprehensive system of government central planning is incompatible with and a danger to a free, liberal society. As part of this argument, Hayek also debunked the widely believed idea that Nazism was an ideological and political defense of a decadent and “reactionary” capitalist system that was opposed to socialism.

In an especially insightful chapter on “The Socialist Roots of Nazism,” Hayek traced out the origins of German National Socialism to the nationalistic and strongly anti-capitalist ideas of many of the leading German intellectuals of the late nineteenth and early twentieth centuries, individuals such as Werner Sombart, who during the First World War penned a work on Merchants and Heroes (1915). Sombart showed contempt for the peace-loving, market-oriented “shopkeepers” of Great Britain versus the self-sacrificing German warriors who placed the collective good of their nation over the self-interested gains of the profit-seeking individual.

The socialist agenda of national health care, government social-security pension programs, regulation of business to serve the “greater good” and the “national interest,” and the need for government ownership and/or control of essential sectors of the German economy purely on grounds of political expediency, were all socialist-based ideas blended with German nationalism that finally culminated in the triumph of Hitler’s National Socialist (Nazi) Party in 1933. The group interest over the individual, disapproval of the profit motive and peaceful self-interest, and the call for political paternalism over the lives of all the citizenry were the socialist roots and contributions to the rise of the Nazis to power. These socialist ideas had prepared and indoctrinated the German people to believe in and think they needed a powerful state and “Fuhrer” (Leader) to bring them to political and economic salvation out of the wilderness of the Great Depression so Germany could be “great again.”

A good number of young American academics and some British academics went off to study and complete their graduate degrees at German universities in the last decades of the nineteenth century and the first decade of the twentieth. There they were imbued with the ideas of the German nationalist and socialist professors with whom they studied. Many of these American graduate students returned to the United States and became the leaders of the American Progressive movement, calling for adopting much of the political paternalist policies they had learned while in Imperial Germany. After completing their German studies, they almost all rejected the free-market, limited-government ideas that had been the hallmark of the American political tradition for more than a hundred years. The centralizing, controlling state to regulate business and redistribute income was their new ideal for a “progressive” America.

It was this very centralization of political power and control that Hayek warned was at the heart of the danger from all forms of collectivism, whether it be National Socialism in Hitler’s Germany or Marxian socialism as in Stalin’s Soviet Russia or “democratic” socialism as was being called for in a postwar Great Britain once Nazi Germany had been defeated.

Rule of law, constitutions, and individual rights

A free society, Hayek said, is based on the premise and value of individual liberty and on the concept that every individual should be viewed as a distinct and unique person possessing certain essential rights that neither other individuals nor government should be allowed to restrict or suppress. The rule of law under written constitutions has had as its historical purpose, Hayek argued, the restraint of governments to clearly defined duties and responsibilities, outside of which political interference in the lives of the citizenry was not to occur.

The purpose of government, therefore, was not to guide and direct the population according to some political plan but rather to leave each individual at liberty to design and plan his own life based on the goals and values that give meaning and purpose to his existence. In Hayek’s words:

Under the rule of law, the government is prevented from stultifying individual efforts by ad hoc action. Within the known rules of the game, the individual is free to pursue his own personal ends and desires, certain that the powers of government will not be used deliberately to frustrate his efforts…. Whatever form it [constitutional orders] takes, such recognized limitations of the powers of legislation imply the recognition of the inalienable rights of the individual, inviolable rights of man.

The critics of the liberal market society have frequently argued that the problem is that it has no general plan to ensure that desired and necessary “social ends” are attained. In response, Hayek insisted it is not a matter of socialist planning versus no planning under liberal capitalism but whether each individual shall be at liberty to peacefully make his own plans versus having one central plan imposed on him along with everyone else, all of whom must then conform to it and be confined within it.

Individual choice and the democracy of the marketplace

The very notion of a “plan” is that the planner has decided upon a set of goals or ends considered to be important and which have been arranged in some rank order of preference. It presumes that the planner also has an idea of what the most useful means may be to attain those desired ends in terms of their quantities and qualities. Furthermore, the planner weighs at “at the margin” how far it is worthwhile using those means in one direction rather than some other to try to achieve some “optimally preferred” combination.

In the liberal free society, each individual makes his own plans, deciding on the means and the ends to pursue. A useful imagery is the checkout counters at supermarkets. Each shopper brings to the checkout counter a cart of goods taken off the shelves that reflects his desired ends, his chosen means, and his preferred relative amounts.

If you look at other people’s shopping carts, you may notice that some of your fellow shoppers have similar types of goods in their cart as you (bread, milk, canned corn or peas, chicken, or hamburger meat, etc.). But chances are the brands of many of the goods and the quantities of each may be noticeably different from those in your cart. That is, some people eat lots of meat, while others may like to have more fish in their diet. Some are big milk buyers (maybe because they have small children), while others purchase just enough to put a touch in their coffee or tea. You may like pork chops, while another shopper is a vegetarian; you may like butter on your bread, while the other person tries not to eat too much bread and likes to spread hummus or peanut butter and jelly on it instead.

The marketplace is truly “democratic” in that it reflects and serves the wants and desires of each consumer. It is, however, not a majoritarian democracy in which 50 percent plus one determines what everyone must have but a pluralistic democracy under which multitudes of minority wants and desires are satisfied along with those of the majority. As long as a particular segment of the population has sufficient numbers and willingness and ability to pay a price for certain things to make it economically profitable for some suppliers to bring those goods and services to market, their wants and desires are likely to be satisfied, not just the majority’s wants and desires.

When I was growing up, due to government regulation of the airwaves, there were only three major national television networks (ABC, CBS, and NBC), with a small number of their local affiliates. Viewer choices were few and designed to cater to the lowest common dominator of the population. Once the broadcasting airwaves began to be deregulated starting in the late 1970s, and cable and satellite television began to have the economic opportunities to develop with less government control and authority over them, television offerings increased into the dozens, then into the hundreds, with niche viewing markets and audiences all being satisfied at the same time.

Central planning means centralized power over people

Hayek’s point was that government centralized planning requires a politically determined hierarchy of ends that all the members of “society” as a whole are made to follow. The same centralized authority determines how all the means at “society’s” deposal (land, resources, labor, capital) will be allocated and applied to serve and fulfill those nationwide ends, with the central authority deciding how much of each of those “social ends” will be produced and supplied for “society as a whole.” Each individual’s desired ends and use of means are replaced with the central plan imposed on all. The central plan replaces all of our personal plans. Explained Hayek:

Whoever controls all economic activity controls the means for all our ends and must therefore decide which are to be satisfied and which not…. Economic control is not merely control of a sector of human life which can be separated from the rest; it is the control of all the means for all our ends. And whoever has sole control of the means must also determine which ends are to be served, which values are to be rated higher and which lower — in short, what men should believe and strive for….

[The central planning authority] would have complete power to decide what we are to be given and on what terms. It would not only decide what commodities and services were to be available, and in what quantities; it would be able to direct their distribution between districts and groups and could, if it wished, discriminate between persons to any degree it liked….

How in a planned world “freedom of travel and migration” is to be secured when not only the means of communication and currencies are controlled but also the location of industries planned, or how the freedom of the press is to be safeguarded when the supply of paper and all the channels of distribution are controlled by the planning authority are questions to which [the individual socialist] provides as little answer as any other planner.

Government planning then and now

When in 1944 Hayek was warning of the dangers from any and all forms of collectivist central planning in The Road to Serfdom, Great Britain and the United States were engulfed in a world war against two of these centrally planned countries, Nazi Germany and fascist Italy, and in a de facto political and military alliance with a third, the Soviet Union. Underground communist resistance forces in European countries like Nazi-occupied France and Italy were insisting that the Marxist model should be followed when the war was over. In Great Britain, the socialist Labour Party was in a wartime coalition government with the Tory Party under Winston Churchill as prime minister and was designing plans for nationalizing British industry and expanding the welfare state in a postwar era of central planning. The United States was in the 11th year of Franklin Roosevelt’s presidency, with administrative officials and economic-policy pundits insisting that if America was to avoid a postwar economic depression, the government’s planning and regulating and spending hands had to remain large and powerful.

It might be argued, that was then, and this is now. The Nazi and fascist tyrannies and systems of central planning are almost 80 years long gone. And even the Soviet system of central planning disappeared over 30 years ago when the Soviet Union ended. All that is just history now. If only that was completely true.

Few countries anywhere around the world impose the older type of comprehensive, all-encompassing system of central planning. Instead, the directing hands of government today take the form of government spending and regulation over the private sectors of economic activity. More along the lines of a “soft,” fascist-style planning.

According to the Organization for Economic Cooperation and Development (OECD), government spending absorbs huge percentages of the Gross Domestic Products (GDP) of many of the 38 member nations. Here are a few examples from the OECD’s most recent data:

France   60 percent
Greece   57 percent
Austria   56 percent
Finland   56 percent
Belgium   55 percent
Italy   54 percent
Germany   51 percent
Spain   50 percent
Denmark   50 percent
Iceland   49 percent
Sweden   49 percent
U.K.   48 percent
Norway   48 percent
Netherlands   46 percent
U.S.   45 percent
Japan   45 percent
Australia   41 percent
Israel   41 percent
Switzerland   36 percent

Government planning through taxing and spending

In many of these countries, government spends close to or significantly more than 50 percent of GDP. This means that half or more of the wealth created and produced in these countries is siphoned off by the government. The use of those societies’ resources, land, labor, and capital is determined by those in political power deciding — planning — how they shall spend the money (and the resources the money represents) that has been either taxed or borrowed (due to deficit spending) from the citizens of these countries.

To this extent, the choice of ends, the selection of means, and the decisions concerning preferred combinations of desirable goods and services to be produced and used, and for what purposes, are removed from the hands of the individual members of society and shifted into the paternalistic hands of the government. The individual does not decide, given his personal circumstances, values, and judgments, what type of retirement plan seems best for him, or the healthcare insurance coverage that reflects his personal and family requirements given the opportunity costs of best using the total income he has earned.

The government has taken out of his hands the choice of what type of education his children should have, both in terms of curriculum and pedagogy. By subsidizing through either direct government expenditures or various types of tax breaks and write-offs, the government planners determine what industries will be fostered or hindered; what agricultural products will be favored or disfavored; and what exports will be encouraged, and which imports will be restricted. The planners decide on how town and country will be laid out and for what purposes in terms of numbers of people, location of various forms of residences, recreational facilities, commercial enterprises, and infrastructures. The taxing-and-spending planners modify and determine what individuals and groups of people will receive or not receive through redistribution of wealth.

In most countries around the world, governments subsidize the arts and sciences, use amorphous language about “hurtful” and “hateful” words and phrases to restrict, control, and even punish the ideas that individuals express as a means of planning how we think, communicate, argue, and debate by keeping such things within linguistic corridors of the politically acceptable. Governments impose their planning preferences about who we may interact with and on what terms.

The continuing relevance of The Road to Serfdom

These forms of government intervention, regulation, restriction, and redistribution are no less types of government planning than the older and more direct and explicit forms of central planning against which Hayek argued 80 years ago. They are more subtle and more fascist-like in that they do not overtly nationalize the means of production, as the Marxists did in Soviet Russia. Instead, it all remains under nominal private ownership but is “guided,” “led,” and “influenced by,”  even sometimes directly controlled by the government planners.

In a 1976 foreword to a new paperback edition of The Road to Serfdom, Hayek said that for a long time he was a bit embarrassed by the book, since it has resulted in many of his colleagues in the economics profession accusing him of having left his “scientific” roots as an economic theorist to become a mere political polemicist on the wrong side of history in opposing socialism. That he had followed a path that was, in a sense, beneath a real scholar.  But having reread his own book after many, many years, Hayek said: “I feel no longer apologetic, but for the first time am rather proud of it…. I am now prepared unhesitatingly to recommend this early book to the general reader who wants a simple and nontechnical introduction to what I believe is still one of the most ominous questions we have to solve,” that is, the liberal, free-market society versus the command-and-control planned society.

The Road to Serfdom remains an invaluable guidebook on the dangers from all forms of collectivist planning, both 80 years after the book was published and nearly 50 years after Hayek re-endorsed it to the reading public.

By Richard Ebeling

Originally published on July 1, 2000 for the Foundation for Economic Education

During the first week of July in 1936, an international conference on the “Problems of Economic Change” was held in Annecy, France. It brought together such notable economists as Ludwig von Mises, Wilhelm Röpke, Oskar Morgenstern, Bertil Ohlin, Lionel Robbins, Dennis Robertson, Charles Rist, William Rappard, John B. Condliffe, John Van Sickle, Alvin Hansen, John Maurice Clark, and Jan Tinbergen.

They had come to this attractive French city south of Lake Geneva to discuss the problem of business cycles and their effect on the world economy. Little agreement was reached over the three days during which these leading economists met. But there was a single consensus among the attendees. One of the other participants at the conference, Gottfried Haberler, had set an example and standard for how research on the subject of business cycles should be undertaken. According to the official summary of the conference:

There was throughout the whole conference one matter which secured the wholehearted support of all those present, namely the new technique in research which has been followed during the last two years in the study of the theory of the business cycle by Dr. Haberler. It will be recalled that he was appointed to a special post on the staff of the Economic and Financial Section of the League [of Nations] . . . . He was charged with the duty of examining the present state of knowledge in the theory of the business cycle and was to draw up a report on this subject . . . . [T]here can be no doubt that everyone present was greatly impressed by the very valuable results that had been achieved by the procedure followed in the case of Dr. Haberler’s work. Indeed, “Haberler-like methods” became a catch-phrase of the entire conference.

Haberler had spent two years carefully researching and consulting on the various competing theories of the causes and consequences of business cycles and formulated a “synthetic” alternative, the result of which was published in early 1937 under the title Prosperity and Depression: A Theoretical Analysis of Cyclical Movements.^[2] For over 60 years it has been considered the classic summary and critical evaluation of the literature on this subject. Indeed, Joseph A. Schumpeter referred to it as a “masterly presentation of the modern material” for which he had the greatest “admiration.” And one of America’s leading Keynesian economists, Paul A. Samuelson, hailed it as “the definitive study of business cycles, both pre- and post-Keynesian.” Austrian economist E A. Hayek drew attention to Haberler’s “excellent exposition” criticizing some of the fundamental assumptions and concepts of Keynesian economics.

But this work was only one of Gottfried Haberler’s many important contributions to economic theory and policy. In an economic career that spanned seven decades in the twentieth century, he made original contributions to monetary theory and policy, the theory of wages and union power, international trade theory, and the theory of economic development and growth.

Haberler was born on July 20, 1900, in Purkersdorf, near Vienna, Austria; the centenary of his birth offers the opportunity for an appreciation of his writings and his defense of the free market.

Early Studies

Haberler studied at the University of Vienna with three of the leading figures of the Austrian school of economics in the years immediately after the First World War: Friedrich von Wieser, Ludwig von Mises, and Hans Mayer. At the university his closest friends were three other students who, like himself, were to become internationally renowned economists in the decades to come: Hayek, Morgenstern, and Fritz Machlup. After Haberler earned his degrees in political science (1923) and law (1925), Mises helped arrange for him to receive a Spelman Fund (later Rockefeller Foundation) grant that enabled him to have two years of further study in the United States and Great Britain.

After returning to Austria, Haberler became a privatdozent (an unsalaried lecturer) at the University of Vienna, teaching a joint seminar with Hayek and Morgenstern. Mises arranged a paid position for him in the library at the Austrian Chamber of Commerce, where Mises was employed as a senior economic analyst. Haberler was a visiting professor of economics and statistics at Harvard University in 1931-1932. In 1934, he accepted the two-year appointment with the League of Nations in Geneva, Switzerland, that led to the publication of Prosperity and Depression. In the autumn of 1936, Haberler began a professorship in economics at Harvard University that lasted until his retirement in 1971. He also served as an economic consultant with the Board of Governors of the Federal Reserve System from 1943 to 1947. From 1971 until shortly before his death on May 6, 1995, at the age of 94, he was a senior scholar at the American Enterprise Institute in Washington, D.C.

Many of Gottfried Haberler’s writings in the 1920s and 1930s were devoted to problems in monetary and business cycle theory. Like other Austrian economists during this time, especially Mises and Hayek, Haberler focused his attention on price-level stabilization and monetary stability. In the 1920s the argument was made that a monetary policy that stabilized the general price level through changes in the money supply would assure economy-wide economic stability. In a series of articles and in his book The Mean of Index Numbers: An Inquiry in the Concept of the Price Level and the Methods of Its Measurement (1927), Haberler challenged the fundamental assumptions of a price-level stabilization policy.

He argued that in fact there is no way to strictly measure and determine the general value of money through the use of index numbers of various types. The only precise definition of the value of money is that it is represented by the network of individual exchange ratios between money and all of the individual goods against which it trades. Every general index of prices is necessarily constructed by selecting some prices (various consumer or producer prices) as representative of the subgroup of goods under study. They are weighted according to their proportion of purchases, summed together, and mathematically averaged to create a statistical composite that is then tracked through time.

Thus every price index is “arbitrary,” in that it depends on the types of goods or industries the economic analyst is interested in studying, the choice made concerning the weights to assign and the averaging method chosen to calculate their mean value, and the assumption that what is taken to be “constant” does not significantly change over the period during which the selected “price level” is being tracked.

Furthermore, Haberler argued, precisely because a price-level index is an average of the set of individual market prices from which it is constructed, it may hide all the significant individual relative price changes beneath its statistical surface. “The relative position and change of different groups of prices are not revealed, but are hidden and submerged in a general index,” said Haberler. “Not the movement of the general price level, but the chronological succession of special price and price combinations . . . are regarded as significant for the waves of business life . . . . Such a general index rather conceals and submerges than reveals and explains those price movements that characterize and signify the movement of the [business] cycle.”

Also, Haberler maintained, a focus on an average price level tends to distract attention from the underlying microeconomic causes that result in a tendency for prices in general to move in one direction or another. And like his fellow Austrians, Haberler reasoned that a price-level “deflation” due to technological improvements and increased output resulting from lower costs of production is not a symptom suggesting a tendency toward a depression in the market economy. Instead, falling prices from those causes represent the market’s method of bringing about an increase in people’s real standard of living.

Austrian Business Cycle

Building on this reasoning, Haberler delivered one of the clearest expositions of the Austrian theory of the business cycle at a conference at the University of Chicago in 1932. He explained that in the process of increasing the money supply sufficiently to prevent prices in general from declining owing to lower costs and greater output, a monetary expansion through the banking system pushes interest rates below the market level that would have been established by actual savings and investment demand in the economy. In the 1920s, this policy induced long-term investment projects in excess of real savings in the market, resulting in an imbalance that finally manifested itself in the economic downturn and depression that began in 1929 and intensified in the early 1930s.

During the 1930s Haberler took a view different from either Mises or Hayek about the solution to the Great Depression. His Austrian colleagues argued that the market had to be freed of government intervention, for supply and demand, and savings and investment to re-establish their own new equilibrium. Haberler reached a conclusion closer to that of Wilhelm Röpke, that once begun, the economic downturn of the early 1930s had increased to such an intensity that a “secondary depression” had set in, having little to do with any healthy correction from the mal-investments created by the Federal Reserve’s monetary policy of the 1920s.^[10] Rigid costs resistant to downward adjustment, bank panics and failures that caused an actual contraction in the supply of money and credit, and pessimistic expectations on the part of the investment community generated a situation in which only a government-initiated stimulus of spending and “effective demand” could bring about a reversal of the depressionary forces.

While Haberler’s anti-depression policy perspective might seem to have shifted him into a position similar to that advocated by John Maynard Keynes and the emerging Keynesian economics that came to dominate the economics profession beginning in the 1940s, that conclusion would only be partially correct. He did think that Keynes had made a number of valuable and influential contributions to economic understanding. But in general, Haberler considered Keynes’s “new economics” to be inferior to the traditional body of economic and monetary theory.

A cornerstone of Keynes’s argument had been that even if market prices and money wages were flexible and adjusted downward during a depression, there was no guarantee that this would result in a return to economic balance and full employment. Haberler argued in the 1939 revised edition of Prosperity and Depression, as part of his critical evaluation of Keynes’s The General Theory of Employment, Interest and Money, that Keynes had failed to appreciate what has become known as the “real cash balance effect.”

Even if people were reluctant to spend in the depression because of pessimism and a desire to hold their wealth in a more liquid form, as prices and wages decreased, the real value and purchasing power of their money assets would be increasing, since each unit of money at lower prices could now buy more. A point would be reached at which people would find it advantageous to start spending again, at which time prices and wages would no longer have to fall and all those desiring employment would find employers willing to hire them to satisfy this renewed demand for goods and services. Haberler did not argue that an economic policy that fostered or permitted prices and money wages to fall during a severe depression until they found their own market level was necessarily the most desirous one. But he did insist that Keynes was wrong in stating that falling prices and wages could not restore equilibrium to the market.

Inflation Opponent

Throughout the post-World War II era, Haberler was a vocal and forceful opponent of Keynesian-inspired inflationary policies to maintain full employment. He insisted that this was an economically dangerous path to follow, that it merely reinforced the very market rigidities that were causing any persistent and significant levels of unemployment in the economy. Neither private business practices nor powerful unions could bring about a permanent and continuing rise in prices in the market. If the money supply was not increased, prices or wages pushed above their market-clearing levels could only result in unsold inventories and unemployment. In the 1950s, 1960s, and 1970s, Haberler argued that any problem of prolonged and high unemployment was caused by anticompetitive trade union practices that priced a portion of the work force out of the market through money wage demands set above what market employers considered labor to be worth.

Any prolonged price inflation had its origin in expansionary monetary policy. Government inflationary policies could temporarily reduce the unemployment generated by union wage demands only by creating enough money in the economy so that employers could afford to pay higher money wages. But this was only a short-run solution, since unions would then demand even higher money wages for their members to compensate for the lost purchasing power resulting from the higher prices caused by the monetary expansion. Equally counterproductive and harmful was the imposition of wage and price controls in 1971 by the Nixon administration, Haberler insisted. This not only failed to deal with the real source of the inflationary problem—the monetary policy of the Federal Reserve System—but it inevitably created more distortions and imbalances by preventing prices and wages from adjusting to changing conditions of supply and demand.

In the late 1970s there developed the strange phenomenon of both rising prices and rising unemployment, a mix of inflation and unemployment that seemed to defy the standard Keynesian ideas of the time. Haberler explained that “stagflation,” or an “inflationary recession,” was a frustrating but easily understood combination of events. Unions and other special-interest groups had become so used to inflation that they now demanded money wage and price increases in expectation of future price inflation. When the actual increasing rate of price inflation turned out to be less than expected, greater unemployment resulted because money wages had been pushed above even what the expanding money supply was able to validate. And Haberler was doubtful that even the most “rational” of expectations could ever assure that such mismatches did not occur.

In an analysis of what the best of economic policy worlds should be, Haberler said that the federal government should run a budget surplus and pay off the national debt so the funds could be rechanneled into productive, private-sector investment and capital formation; taxes should be significantly lowered to enhance work and investment incentives; monetary policy should be limited to a low, steady increase in the money supply equal to the annual average rise in real gross domestic product; and deregulation should be the order of the day, eliminating the various privileges, restrictions, protections, and subsidies that restrain or prevent an open, competitive market from more fully functioning. The same rules applied to the international economic order as well.

Opportunity Cost and International Trade

Gottfried Haberler’s other main contribution to economic theory and policy in the twentieth century was in the field of international trade and economic development. Beginning in the late nineteenth century, the Austrian economists, along with William Stanley Jevons and Leon Walras, had radically changed the foundations of economic theory by developing the theory of marginal utility in place of the labor theory of value championed by the classical economists from Adam Smith and David Ricardo to John Stuart Mill. But in the theory of international trade it was still common to demonstrate the benefits from the division of labor among nations on the basis of the labor theory of value. Comparing the relative costs in labor time for different countries to manufacture various goods showed the comparative advantage that different nations might have for specialization of production.

Haberler helped revolutionize the foundations of international trade theory by restating the theory of the international division of labor on the basis of the Austrian theory of opportunity cost. The relevant cost was not the labor time to produce something, but the alternative end that has to be forgone. Haberler demonstrated the logic of this principle by being the first to construct that simple diagram that is now found in every principles of economics textbook: the production possibilities frontier, which depicts the trade-offs that an economy faces between producing, say, one of two products. The members of that economy can produce either one of the goods or some combination of the two. The curve shows the additional amount of one good that can be obtained by forgoing a particular quantity of the other.

Haberler explained that even when one of two countries is absolutely more efficient in producing both goods, each country should still specialize in manufacturing and trading those commodities in which it has relatively greater efficiency. In developing and consistently applying this reformulated theory of the benefits of international specialization, he was able to prove the continuing superiority for a policy of free trade over protectionism or autarkic self-sufficiency.

In the years following World War II, Haberler argued forcefully against various forms of international trade restriction and protectionism, including artificial foreign exchange-rate regulations and manipulation, import and export quotas, and tariffs. While admitting that a number of hypothetical exceptions to the free trade doctrine can be formulated, in the real world both the theoretical and practical case for the greatest degree of international freedom of trade remains the benchmark for any serious economic policy discussion.

Finally, Haberler insisted that the underdeveloped countries of the “Third World” were moving in the wrong direction by turning to planning, controls, and protectionism in the name of economic development and growth. He reasoned forcefully that international trade would not create either permanent underindustrialized dependency on Western industrial nations or worsening terms of trade. Nor would government-induced domestic production either create real industrial efficiency or raise the standard of living of the people in those countries, in comparison to participation in the international division of labor. The best policy for all nations remains the freest exchange of goods and capital for economic improvement and rising living standards for the greatest number of participants in the global marketplace.

As Gottfried Haberler once ended one of his essays, “The conclusion is obvious. The task of freeing the market economy from as many of its fetters as possible, and of promoting free competition, is of paramount importance.” His long, productive professional life was a testament to this goal.

By Richard Ebeling

Originally published on January 9, 2017 for The Future of Freedom Foundation

Those of us who have been fortunate enough to have been born in what is often still referred to as the Western World (Europe and North America) rarely appreciate the historical uniqueness of our material and related cultural well being compared not only to many still around the globe today, but relative to those who lived in that Western World just a handful of generations ago.

A mere 200 years ago, in 1820, the world population numbered only around 1.1 billion people. Out of that 1.1 billion people, it estimated that about 95 percent lived in poverty, with 85 percent existing in “extreme poverty.” By 2015, the world population had increased to over 7 billion, but less than 10 percent of this 7 billion people lived in poverty. Indeed, over the last quarter of a century, demographers calculate that every day there are 137,000 fewer people around the world living in extreme poverty.

This escape from poverty originated in Western Europe in the eighteenth and nineteenth centuries with the coming of the Industrial Revolution and the freeing of men and markets from the heavy-handed regulations and commercial restrictions of government. Especially in the second half of the twentieth century and now into the twenty-first century that liberation from poverty has been slowly but surely enveloping more of the people in what is still often referred to as the “developing countries.”

Before this economic revolution of human betterment was made possible by free, or at least freer, markets, life around the world was (borrowing part of Thomas Hobbes’s famous phrase) basically nasty, brutish and short for virtually all of mankind.  The idea and ideal of material prosperity for humanity as a whole was merely the dream of a few dreamers who concocted utopian fantasies of remaking society to make a better world. For some at the end of the 1700s, the French Revolution served as the inspiration to believe that now that the “old regime” of power, privilege and political position was being overthrown a “new dawn” was opening for humanity.

The destruction of the ancient institutional order opened the door for remaking society and it’s structure; and with the institutional transformation could come a change in man. There emerged a new version of Plato’s belief that human nature was primarily a product of the social environment. Change the institutions within which men lived and the character of man could be transformed over time, as well.

William Godwin and the Collectivist Remaking of Man and Society

A leading voice in support of this “transformative” vision was William Godwin, a British social philosopher and critic, who argued that selfishness, poverty, and the form and content of human relationships could be radically made over, if only the institution of private property and the political order protecting it was abolished.

He argued for this new understanding and conception of man and society in his books, An Enquiry Concerning Political Justice (1793), and The Inquirer (1798). Indeed, some have argued that Godwin was one of the first of the modern advocates of “anarchism” – an ideal society without a system of political coercion in which men will cooperatively and collectively live and work for a higher “common good.”

The guiding principles in Godwin’s political and economic philosophy (which received some revision and modification between the three editions that he published of Political Justice during his life) were:

First, the moral foundation of all human actions should be based on the individual being concerned with the interests and betterment of the collective society, and not himself; any judgment concerning the ethics in men’s behavior should not be based on the results those actions produce, but the intention or motive behind the actions undertaken.

Second, that human nature is not a universal “given,” but rather man is born like a “blank slate,” the content of which can be influenced by the social environment and the education experienced by the new mind.

Third, that poverty is not and need not be an essential part of the human condition; rather, it is the result of the institution of private property that gives what rightly belongs and should be shared equally by all men to some by arbitrary political power and legitimacy; a “new society” of communal work and sharing will raise production to unimaginable levels, abolishing poverty and creating plenty.

Fourth, this would be coupled with the fact that as there was less concern with material want, people would turn their minds to intellectual pursuits; this would result in a reduction in the sex drive, and a falling off in reproduction and the number of people in society. Thus, concerns that a materially better off world might mean a growth in population exceeding the capacity to feed it was down played. Besides, there were plenty of places around the world to which any excess population could migrate.

Said William Godwin in Political Justice:

If justice have any meaning, it is just that I should contribute everything in my power to the benefit of the whole . . . It is in the disposition and view of the mind, and not in the good which may accidentally and intentionally result, that virtue consists . . .

Human beings are partakers of a common nature; what conduces to the benefit or pleasure of one man will conduce to the benefit or pleasure of another. Hence it follows, upon the principles of equal and impartial justice, that the good things of the world are a common stock, upon which one man has as valid a title as another to draw for what he wants . . . What can be more desirable and just than that the produce itself should, with some degree of equality, be shared among them?

What if some individuals refused to sacrifice for the collective, and were unwilling to bend their own self-interest to the betterment of the societal group? Godwin was equally direct that the individual had no right to his own life if his forgoing it served the needs and necessities of the collective:

He has no right to his life when his duty calls him to resign it. Other men are bound . . . to deprive him of life or liberty, if that should appear in any case to be indispensably necessary to prevent a greater evil . . .

Thomas Malthus on the “Natural” Limits to Human Betterment

Thomas Malthus (1766-1834) was an ordained minister who became interested in various themes in political economy, and became famous for arguing against the theories espoused by William Godwin. His father, Daniel Malthus, took a view sympathetic to Godwin’s on man, human nature, and society. Thomas took the opposite view, and ended up writing his famous, An Essay on the Principle of Population as It Affects the Future Improvement of Society, with Remarks on the Speculations of Mr. Godwin, M. Condorcet, and Other Writers (1798).

The gist of Thomas Malthus’s argument was that physical capacities to regularly increase the supply of food for human survival falls far short of the natural inclinations of human reproduction. Thus, the growth in population, when left unchecked, and given the “passions” of men and women, has the tendency to outrun the supply of food.

Hence, there were natural limits on the improvement of the material conditions of man, which no change in the political, economic, and social institutions of society, by themselves, can assure or bring about a “heaven on earth,” as prophesied and promised by Godwin and others.

Not surprisingly, the book caused a firestorm of controversy among those supporting and opposing the views of Godwin and Malthus. Malthus’s apparent “pessimism” concerning the ability of humanity to improve the human condition through conscious social change led the British social critic and essayist, Thomas Carlyle, to call economics, “the dismal science.”

Malthus argued that human existence is bound by two inescapable principles that have not and are not likely to change, given all of human history: the need for food to exist, and the degree of sexual passions of men and women for each other, which he enunciates in his Essay on the Principle of Population:

I think I may fairly make two postulata. First, that food is necessary to the existence of man. Secondly, that the passion between the sexes is necessary, and will remain nearly in its present state.

These two laws ever since we have had any knowledge of mankind, appear to have been fixed laws of his nature; and as we have not hitherto seen any alteration in them, we have no right to conclude that they will ever cease to be what they now are . . . I do not know that any writer has supposed that on this earth man will ultimately be able to live without food.

But Mr. Godwin has conjectured that the passion between the sexes may in time be extinguished. As, however, he calls this part of his work, a deviation into the land of conjecture, I will not dwell long upon it at present, than to say, that the best arguments for the perfectibility of man, are drawn from a contemplation of the great progress that he has already made from the savage state, and the difficulty of saying where he is to stop.

But towards the extinction of the passion between the sexes, no progress whatever has hitherto been made. It appears to exist in as much force at present as it did two thousand, or four thousand years ago.

The Checks on Mouths to Feed: Misery and Vice 

Malthus then made his famous statement concerning the relationship between the “geometric” rate of unchecked population growth in comparison to the “arithmetical” growth in the rate of food production. Eventually, the rate of population growth would overtake the rate of food production, the result of which would be a “natural check” on population through poverty, starvation and death.

Assuming then, my postulata as granted, I say, that the power of population is indefinitely greater than the power in the earth to produce subsistence for man. Population, when unchecked, increases in a geometrical ratio. Subsistence increases only in an arithmetical ratio. A slight acquaintance with numbers will show the immensity of the first process in comparison to the second.

By the law of our nature which makes food necessary to the life of man, the effects of these two unequal powers must be kept equal. This implies a strong and constantly operating check on population from the difficulty of subsistence. This difficulty must fall somewhere; and must necessarily be severely felt by a large portion of mankind . . .

This natural inequality of the two powers of population and of production in the earth, and that great law of our nature which must constantly keep their effects equal, form the great difficulty that to me appears insurmountable in the way of the perfectibility of society.

All the arguments are of slight and subordinate consideration in comparison of this. I see no way by which man can escape from the weight of this nature. No fancied equality, no agrarian regulation in their utmost extent, could remove the pressure of it even for a single century. And it appears, therefore, to be decisive against the possible existence of a society, all the members of which, should live in ease, happiness, and comparative leisure; and feel no anxiety about providing the means of subsistence for themselves and families.

Malthus argued that taking periods of 25 years as a benchmark, the accelerating growth in population would finally reach a crisis point relative to the rate of food growth.  What, then, may check this growth in an unsustainable population? Malthus concluded only two factors. What he called “vice” and “misery.”

Fearful of marrying before he can support a family and bring about starvation and ruin to his off-spring, a man may delay and defer marriage until he feels financially able to care for a wife and children. But this results in “vice,” since the sexual urges lead men to search out physical gratification outside the bonds of matrimony, and the birth of illegitimate offspring.

Or it brings about “misery,” due to a failure to defer marriage, and the bringing into the world children for which means of subsistence do not adequately exist. This results in starvation and premature death of children and adults that brings the population and its growth down, again, to a level sustainable from existing food production.

Malthus added that if Godwin’s proposal for a greater community of property and equality of distribution of its output were to be introduced it would soon diminish the incentives for work and effort and set men into conflict with each other. Or as he put it, weakened private property rights would soon set in motion “the black train of distresses, that would inevitably be occasioned by the insecurity of property.”

Tempering Nature’s Constraints through Moral Restraint

In 1799, after the publication of An Essay on the Principle of Population, and then again in 1802, Thomas Malthus went on trips around parts of Europe. He collected a large amount of historical and demographic data on population (to the extent that such data then existed). He used this to publish a second edition of the book in 1803 that was substantially increased in size and factual information, as he had been able to gather it.

To his previous argument, Malthus now added an additional factor that could serve as a check on population, and could even keep population growth sufficiently under control so that standards of living might rise, even in the long run. This was what he called “moral restraint.”  This was a conscious act to defer marriage until an individual had the financial means to adequately support a family, and the will to renounce the temptations of “vice.” That is, to abstain from sexual gratification outside of marriage. Said Malthus:

It is of the utmost importance to the happiness of mankind that population should not increase too fast; but it does not appear that the object to be accomplished would admit of any considerable diminishment in the desire for marriage.

It is clearly the duty of each individual not to marry till he has a prospect of supporting his children; but it is at the same time to be wished that he should retain undiminished his desire for marriage, in order that he may exert himself to realize this prospect, and be stimulated to make provision for the support of greater numbers . . .

And if moral restraint be the only virtuous mode of avoiding the incidental evils arising from this principle, our obligation to practice it will evidently rest exactly upon the same foundation as our obligation to practice any of the other virtues.

Unleashing of Free Markets Negated Malthus’ Prediction

Given what was pointed out at the beginning about the seven-fold increase in world population since 1820, accompanied by an even more dramatic fall in global poverty over the last two hundred years, Malthus’ warnings and fears seem to have been totally undermined by the facts of history. Population has exploded beyond all experience in human history during the last two centuries, yet all of these billions of additional mouths are increasingly fed and with a rising standard of living for a growing number of them.

Clearly, Malthus, writing in the late eighteenth and early nineteenth centuries under estimated one important influence that was beginning during his lifetime: market-based industrialization. Investment in productive capital equipment, especially in agriculture, began to dramatically increase the output and the nutritive quality of food produced per unit of land brought into cultivation. This included the development of modern chemistry to increase harvests and productive strains of crops. Thus, food production has grown exponentially, and not, as Malthus feared, “arithmetically.”

Urbanization has resulted in a conscious choice by married couples to reduce the size of families. In farming societies with limited mechanization each child is an additional mouth that comes with two hands to help in the working of the land.  Hence, children are “investment goods” in agricultural society, both for work to be done and offering support for parents in their old age.

In industrial, urban society children are additional mouths to feed that supply little or no extra income to the family during most of childhood. Hence, children are “consumer goods” that consume income, and reduce the standard of living of the family the more children that need to be taken care of.  In addition, the cost of urban residential living space has influenced the incentives about sizes of families. And, of course, the development of birth control has greatly influenced the ability and widened of the choice of how many children to have, and when.

In fairness, what Malthus and many others failed to see or anticipate was the explosion of production, industry, and commerce that was soon set loose by expanding economic liberty in the nineteenth century. This unleashed entrepreneurial innovation and discovery of market opportunities in the pursuit of profits that was made possible by ending the trade protectionism, domestic regulation, heavy tax burdens, and paper money inflations that enveloped all of Europe, including Great Britain, during nearly the quarter of a century of war from 1791 to 1815 between first Revolutionary and then Napoleonic France against practically all of the rest of Europe.

Only with the arrival of peace and the beginning of a conscious introduction of economic liberalism, first in Great Britain and then other parts of the European continent, and, of course, independently at the same time in the United States, was free market capitalism’s potential horn-of-plenty able to begin to release its bounty upon humanity.

Malthus’s Contributions to Human Understanding

Many historians of economic thought have pointed out the various weaknesses, exaggerations, inconsistencies and factual errors in Malthus’s argument and the changing premises and arguments in the various editions of his Essay on the Principle of Population. Indeed, one of the leading of such historians, Edwin Cannan, stated that Malthus’s analysis, “falls to the ground as an argument, and remains only a chaos of facts collected to illustrate the effect of laws which do not exist.” And Joseph A. Schumpeter even said that the actual pattern of birth rates with industrialization and urbanization accompanied by growth in food production suggested “a sort of Malthusianism in reverse.”

But even with its weaknesses and factual errors others have seen an enduringly valuable contribution in Malthus’s theory of population. No less than an authority than the Austrian economist, Ludwig von Mises, in his treatise, Human Action, suggested that in Malthus’s work can be seen a contribution equal to the discovery of the logic of division of labor and the spontaneous workings of the market order for the betterment of human circumstances:

The Malthusian law of population is one of the great achievements of thought. Together with the principle of the division of labor it provided the foundation for modern biology and the theory of evolution; the importance of these two fundamental theorems for the sciences of human action is second only to the discovery of the regularity in the intertwinement and sequence of market phenomena and their inevitable determination by the market data . . .

Malthus showed that nature in limiting the means of subsistence does not accord to any living being a right of existence, and that by indulging heedlessly in the natural impulse of proliferation man would never have risen about the verge of starvation. He contended that human civilization and well-being could develop only to the extent that man learned to rein in his sexual appetites by moral restraints . . .

Nonhuman beings are entirely subject to the operation of the biological law described by Malthus . . . But the case is different with man. Man integrates the satisfaction of the purely zoological impulses, common to all animals, into a scale of values, in which a place is also assigned to specifically human ends.

Acting man also rationalizes the satisfaction of his sexual appetites. Their satisfaction is the outcome of a weighing of the pros and cons. Man does not blindly submit to a sexual stimulation . . . He refrains from copulation if he deems the costs – the anticipated disadvantages – too high.

Thomas Malthus, even with the limits and incompleteness of his analysis, can be seen to have made essential contributions to understanding the inescapable human condition. First, man at any time exists under a scarcity of the means for his ends.  Other things held given, the larger the population the greater needs to be the available supply of food and other necessities of life, if the standard and quality of life are not to be diminished or reduced. The only way to prevent a decline in standards of living is for there to be increases in capital investment that increase production and the productivity of the workforce more than any increase in the population.

Second, given the level of capital investment and technological knowledge, there is an optimal size of a society’s population, below which more people means greater net output, and above which there results less net output. And, third, the political and economic institutional circumstances can make a difference in that they may foster capital investment, more forward-looking choices by individuals, and incentives to save and work.

On this latter point, Malthus was well aware of the dangers from overreaching and expanding governmental power in terms of their threat to liberty and its resulting restraint on people having the freedom to guide their own lives as they think best to improve themselves. In the expanded, fifth edition of his Essay on Population, which appeared in 1817, he warned of how ignorance of the laws of nature and the essential the institutions of free commercial society can easily lead astray mobs of people whose violent actions may open the door to despotism.

This sets the stage for a dangerous confrontation between individual liberty and political authority, in which people must always be watchful and knowledgeable so as to check the government’s drive for unchecked power. Malthus warned:

The checks which are necessary to secure the liberty of the subject will always to some degree embarrass and delay the operations of the executive government. The members of the government feeling these inconveniences while they are exerting themselves, as they conceive, in the service of their country, and conscious perhaps of no ill intention towards the people, will naturally be disposed on every occasion to demand the suspension or abolition of these checks; but if once the convenience of ministers be put in competition with the liberties of the people and we get into the habit of relying on fair assurances and personal character, instead of examining with the most scrupulous and jealous care the merits of each particular case, there is an end of British freedom.

If we once admit the principle that the government must know better with regard to the quantity of power which it wants than we can possibly do with out limited means of information, and that therefore it is our duty to surrender up our private judgments, we may just as well at the same time surrender up the whole of our constitution. Government is a quarter in which liberty is not nor cannot be very faithfully preserved. If we are wanting to ourselves, and inattentive to our great interests in this respect, it is the height of folly and unreasonableness to expect that government will attend to them for us.

Thus, Thomas Malthus’s contribution may be said to be the following: Man is above all other life forms on earth in that he is able to use his reason to control his passions when they may entail costs greater than the anticipated benefits; at the same time he can use his rational faculties to devise ways to escape limits that nature places upon him by planning ahead to increase his future productive and income earning capacities to improve his standard of living. And that to do so most successfully there must be the necessary institutional prerequisites, among which freedom, property, and peace are the most essential.

By Richard Ebeling

Originally published on October 31, 2016 for the Future of Economic Education

In the middle decades of the eighteenth century two schools of thought emerged, one in France and the other in Great Britain, that were critical of Mercantilism, the government system of economic planning and regulation in the 1700s. In Great Britain, the primary thinkers were members of what has become known as the Scottish Moral Philosophers.

Property and, consequently, security and liberty of enjoyment are the essence of the natural and fundamental order of society.

In France the proponents of the new ideas of economic freedom were known as the Physiocrats. The term came from the ancient Greek word, “physiocracy,” meaning “rule by nature.” They also liked to call themselves “the economists.”

Central to their critique of the regulatory state of their time was insistence that there was a “natural order” to things in the social world as much as in the physical world. A proper arrangement of the institutions of society required reflection on the nature of man, his requirements for survival and betterment, and his relationship to others in society.

As Austrian economist, Murray Rothbard, summarized,

“In political economy, the Physiocrats were among the first laissez-faire thinkers . . . They called for complete internal and external free enterprise and free trade unfettered by subsidies, monopoly privileges or restrictions. By removing such restrictions and exactions, commerce, agriculture and the entire economy would flourish . . . They also supported the operation of a free market and the natural rights of person and property.”

The Physiocrats and a Natural Order to Society

Pierre-Paul Mercier de la Riviere presented one of the clearest statements of the Physiocrat’s conception of man and the social order in, The Natural and Essential Order of Political Societies (1767). Each man, Riviere said, has a natural right to secure what was necessary for his survival. This was, also, the cornerstone for deducing the relationships that would be both just and wealth generating for all men:

“I do not think that anyone will deny the existence of the natural right to secure one’s own survival. This basic right is, indeed, only the result of a basic duty that is imposed upon man under penalty of pain or even death . . .”

“Now, it must be clear that man’s right to secure his own survival includes the right to acquire, by his own work, those things that are useful to his existence as well as the right to keep them after their acquisition. It is evident that this second right is only part of the first, for one cannot be said to have acquired what one has not a right to keep; the right to acquire and the right to keep form together only one and the same right although considered at different times . . .”

“The exclusive property of his person, which I am going to call personal property is thus for each man a right by absolute necessity; and since this exclusive personal property would be nil without the exclusive ownership right to those things which man acquires by his own labor, this second exclusive right of property, to which I shall give the name of negotiable property is an absolute necessity, like the first from which it is derived . . .”

“Once it is realized that it is absolutely necessary that personal and movable property are exclusive rights we are able to realize that each man has also duties which are of absolute necessity. These duties consist in the obligation not to invade the property rights of others, for it is evident that without these duties right would cease to exist . . .”

“Property and, consequently, security and liberty of enjoyment are the essence of the natural and fundamental order of society. This order is part of the physical order, and therefore its principle characteristics are in no way arbitrary.”

Francois Quesnay and Circular Flow of Economic Coordination

If there was a natural order to society, how did it ensure harmony and balance in the productive activities among men? An explanation was given by one of the leading figures among the Physiocrats, Francois Quesnay.

Quesnay insisted that government had no essential role directing or controlling the circular flow of goods between town and country.

For two decades Quesnay served as royal physician to the king of France, Louis XV. But his attention and interests were focused equally on the social system and it’s functioning. He blended his knowledge of agriculture with his training as a medical doctor.

He insisted that it was the production of the land – resources and food production – that was the basis of all prosperity in society. Manufacturing and industrial crafts were derivative and not primary sources of wealth. There would be nothing to transform into finished goods for consumption and other productive uses if the resources of the earth had not been mined, and the soil had not been tilled so both those who worked the land and those who were employed in industrial enterprises could have the means of material survival. Thus, in the division of labor, it was the agricultural sectors that were the foundation of society and its economic wellbeing, Quesnay argued.

In 1758, Quesnay prepared for the King his famous Tableau Economique (“The Economic Table”) It was designed to demonstrate the interdependency and flow of goods and money through the various sectors of the economy: farmers, landowners, manufacturers and merchants. It showed a harmonious and self-balanced coordination in the division of labor.

Quesnay’s Tableau Economique outlined the interdependency of the various specialized activities within the economic order. The resources and foodstuffs produced by the agricultural sectors were exchanged for the manufactured goods of the towns. The town manufacturers and craftsmen supplied those who worked in agriculture with the tools and implements that increased their productive capability on the land as well as with finished items for consumption that the farmers could not as easily produce for themselves.

The more abundant the output from the countryside, the more the people could be freed from agriculture to specialize in manufacturing in the towns. And the more improvements from specialized manufacturing there were, the better the tools and equipment that those in agriculture could acquire to improve their own productivity over time.

Goods circulated in exchange from countryside to towns and from towns to countryside. And the circulation of all these various goods between town and country was facilitated by the medium of money. Quesnay’s intricate diagram showed how goods for money and money for goods flowed through the various parts of the economic system and how wealth was distributed among the farmers, the manufacturers and merchants, and the king and the Church.

“Stop, my friend, stop and do not be misled by political speculations that aim to persuade you that in commerce you can take advantage at the expense of other nations.”

Leaving Markets Free to Set Prices and Direct Production

He insisted that government had no essential role directing or controlling the circular flow of goods between town and country and the matching flow of money between agriculture and manufacturing to facilitate the exchanges. There was no need for the government to regulate the prices at which goods were bought and sold. “Do not attempt to fix the prices,” Quesnay declared. “Only competition can regulate prices with equity.”

The same applied to international trade. The Mercantilist dogma that trade among nations always resulted in a gain for one of the traders and a loss for the other was wrong. Declared Quesnay: “Stop, my friend, stop and do not be misled by political speculations that aim to persuade you that in commerce you can take advantage at the expense of other nations. For a just and good God has seen to it that that is impossible.”

The best policy for government to follow is “laisser passer, laisser faire” — let goods pass and leave men alone to their own decisions.

The French Enlightenment thinkers of those middle decades of the eighteenth century were equally concerned about the financial burden that government’s placed on the people due to extravagant and unnecessary taxation, which squanders the hard-earned wealth of the citizens and undermines their incentives for work and industry. This was said in especially insightful and eloquent words by Baron de Montesquieu (1689-1755) in his, The Spirit of the Laws (1748):

“The revenues of the state are a portion each citizen gives of his goods in order to have the security or the comfortable enjoyment of the rest. In order to fix these revenues well one must consider both the necessities of the state, and the necessities of the citizens. One must not take from the real needs of the people for the imaginary needs of the state.”

“Imaginary needs are the ones sought by the passions and weaknesses of those who govern, the charm of an extraordinary project, the sick envy of vainglory, and a certain impotence of spirit in the face of their fancies. Often those who, with restless spirit, were at the head of public business under a prince have thought that the needs of their small souls were the needs of the state.”

“There is nothing that wisdom and prudence should regulate more than the portion taken away from the subjects and the portion left to them. Public revenues must not be measured by what the people can give but by what they should give, and if they are measured by what the people can give, it must at least be by what they can always give . . .”

“The effect of the wealth of a country is to fill all hearts with ambition; the effect of poverty is to bring them to despair. Ambition is excited by work; poverty is consoled by laziness. Nature is just toward men. She rewards them for their pains; she makes them hard workers because she attaches greater rewards to greater work. But if an arbitrary power removes nature’s rewards, the distaste for work recurs and inaction appears to be the only good . . .”

“If some citizens do not pay enough, there is no great harm; their plenty always reverts to the public; if some individuals pay too much, their ruin turns against the public. If the state matches its fortunes to that of individuals, the plenty of the individuals will soon make its fortune increase.”

“Everything depends on the moment. Will the state begin by impoverishing its subjects in order to enrich itself? Or will it wait for its subjects to enrich it at their own pace? Will it have the first advantage or the second? Will it begin by being rich, or will it end by being so?”

Jacque Turgot’s Experiment with Free Market Reform

Turgot presided over the abolition of this crude and despised forced labor in the entire country.

Another member of the Physiocrat School, Anne-Robert-Jacques Turgot, brought some of the ideas of greater economic freedom into practice, at least to a limited degree. In 1761 Turgot was appointed the intendant (or governor) of the French province of Limoges — a position that he held for 12 years, with virtually complete administrative powers within the province’s boundaries as the local representative of the central authority in Paris.

He did away with one of the most oppressive and hated taxes in the province, the corvee, which was the compulsory labor required of the peasantry to construct and repair roads, for which labor the workers received no pay. Any who resisted or failed to show up to perform their required work could be imprisoned or arrested and compelled to work. Turgot, instead, paid salaries for skilled workers to perform the roadwork and assessed a moderate tax on all the taxpayers within the province to cover the cost. Within a short time, the roads in Limoges were considered some of the finest in France.

One of Turgot’s contemporaries said of his abolition of the corvee: “A benefit which will cause the name of Turgot to be blessed by succeeding generations is the abolition of the corvee. There are deeds on which we do not compose an ode, as on a battle gained, but which are worth more than victories.”

Later, when Turgot served as the comptroller-general for all of France, he presided over the abolition of this crude and despised forced labor in the entire country. He insisted that it was important “not to sacrifice the liberty of the king’s subjects.”

Free Trade Among the Provinces of France

Another reform that Turgot fostered was the abolition of the laws restricting the free flow of agricultural goods from one part of France to another, particularly during a time of famine. Freedom of trade among the provinces of France would ensure a partial shift of available wheat supplies to those provinces experiencing famine and a high price for cereals from those provinces experiencing a greater abundance and therefore lower prices for bread. Said Turgot,

“It is necessary, then, that the transport and the storage of grain should be entirely free, for if the inhabitants of a particular town arrogate the right to prevent the grain going elsewhere, the other towns will believe themselves to have the same right, and thus the places where the dearth is greatest, not being succored by the others, will be condemned to suffer famine.

“Also, if merchants who form magazines of wheat are exposed to the insults, to the violence of the populace, if the magistrates by their suspicions, by imprudent inquisitions, by injunctions to sell at a low price, sanction the popular prejudice against this commerce . . . no one will give himself to it . . .

“What designs have the people in their blind excitement? That the merchants should be obliged to sell cheap? That they should be forced to lose? In this case who would bring grain to them? The pavements of the towns would not produce it. Soon, in places of mere scarcity, a famine would ensue.”

Turgot also ended the forced billeting of soldiers in the homes of people in the province. Instead, he rented several houses and built others to end what had been an especially hated practice of the government.

Turgot wrote to the king saying that bankruptcy of the government had to be avoided but taxes should not be increased.

In his last year as intendant of Limoges, in 1773, Turgot spoke out in favor of greater economic liberty in general, saying, “I know no other means of quickening any commerce whatever than by granting it the greatest liberty, and the freedom from all taxes.”

Turgot as Comptroller-General and France’s Financial Chaos

In August 1774, Jacque Turgot was appointed comptroller-general of the finances of France by the new king, Louis XVI. The finances of the French government were in total chaos because of the exorbitant expenditures of the royal house, with an accumulated debt of 2,470,000,000 livres (a livre then being worth about 20c). The royal expenses for 1774 alone were 399,200,000 livres, with tax receipts of only 371,980,000, leaving a deficit of 27,220,000 livres.

Turgot wrote to the king saying that bankruptcy of the government had to be avoided but taxes should not be increased and there should be no more borrowing to cover expenses. Instead, he said that the government should institute a policy of retrenchment through deep cuts in spending. He also told the king that he realized the anger he could expect from those who had become accustomed to financial favors, privileges, and subsidies from the government. Said Turgot:

“I foresee that I shall be alone in fighting against abuses of every kind, against the power of those who profit by these abuses, and against the crowd of prejudiced people who oppose themselves to all reform, and who are such powerful instruments in the hands of those interested parties for perpetuating the disorder. I shall have to struggle even against the natural goodness and generosity of your Majesty, and of the persons who are most dear to you. I shall be feared, hated even, by nearly all the Court, by all who solicit favors.”

But before his removal from office, Turgot attempted to carry out the free market reforms he considered essential for the betterment of the people of France. All that Turgot anticipated in his letter to the King came true.

Turgot’s Free Market Reforms

He abolished all restrictions on the free trade in grain within France, declaring, “It shall be free to all persons whatever to carry on, as it may seem best to them, their trade in corn and flour, to sell and to buy it, in whatever places they choose throughout the kingdom.”

He abolished the practice of the comptroller-generals being paid huge bribes for appointing tax gatherers for the various provinces of the country. Restrictions on and financial abuses against foreigners residing in France were ended. He eliminated discriminatory taxing practices against various segments of the French public that discouraged investment and work.

He demanded that provincial authorities reduce their regulatory infringements on the manufacturers and merchants in their areas of jurisdiction. He went about breaking the power of privileged monopolies by ending legal restrictions that prohibited new competitors from entering various markets and local taxes that made entry too costly.

Finally, to bring the government’s finances under control, Turgot began the arduous process of eliminating layers of bureaucracy and privileged court intermediaries who used their positions to obtain bribes from special interests desirous of political privileges and benefits. Turgot said,

“It is the interest of the whole kingdom we have to consider, the interests and the rights of all our subjects, who, as buyers or as sellers, have an equal right to find a market for their goods and to procure the object of their needs on the terms most advantageous to themselves.”

Special Interests Bring Turgot Down

The more Turgot instituted such sweeping free-market-oriented reforms, the greater the number of special interests who found themselves with a common goal to defeat him. The nobility and the clergy formed a common front to oppose him — the latter group because Turgot was suspected of “liberal” views on religion.

The manufacturing interests, who feared the free winds of competition in their corners of the market, worked hard to defeat him. The bureaucracy and the members of the royal court who saw their privileges, tax revenues, and sources of bribes and favors being eaten away intrigued against him.

Finally, on May 12, 1776, the king dismissed Turgot. The power of the interests had triumphed against the “economist” reformer who dreamed of making France free and prosperous. This was also France’s last real chance for economic transformation before the corruption and financial chaos of the government would lead to the catastrophe and terror of the French Revolution that began in 1789.

By Richard Ebeling

Originally published in the January 2023 edition of Future of Freedom

It is probably not too much of an exaggeration to say that British economist Lionel Robbins (1898–1984) was one of the most influential economists of the last hundred years without most economists, nowadays, being aware of it. This is all because of a relatively short book that he published over 90 years ago, An Essay on the Nature and Significance of Economic Science (1932).

He left this impact by defining economics as “the science which studies human behavior as a relationship between ends and scarce means which have alternative uses.” That is, the foundational aspect of economics is the logic of choice, or the formal decision-making process of individuals to determine how best to allocate scarce means among competing ends. As Robbins more fully expressed it:

The time at our disposal is limited. There are only twenty-four hours in the day. We have to choose between the different uses to which they may be put. The services which others put at our disposal are limited. The material means of achieving ends are limited…. Everywhere we turn, if we choose one thing we must relinquish others which, in different circumstances, we would wish not have relinquished. Scarcity of means to satisfy ends of varying importance is an almost ubiquitous condition of human behavior. Here, then, is the unity of Economic Science, the forms assumed by human behavior in disposing of scarce means.

Economics a Universal Science of Human Choice and Action

From the time of Adam Smith, economics was, at first, looked at as An Inquiry into the Nature and Causes of the Wealth of Nations (1776). Beginning with David Ricardo in the early nineteenth century, most books on political economy (as economics used to be called) viewed its subject matter to be a study of the production, consumption, and distribution of wealth. In fact, this phrase often appeared in the title or subtitle of volumes on “the principles of political economy.” Economics was seen as an investigation into the “material side” of human endeavors. Anything not concerned with the production and sale and use of material wealth that had been bought and sold on the market was said to be matters of the “noneconomic aspects” of human life.

In the late nineteenth century and the early decades of the twentieth century, some economists began looking for a wider understanding and more unifying conception of human decision-making. This culminated in Robbins’ 1932 definition of economic science, quoted above. Among the primary influences on Robbins had been the “Austrian” economists, in particular, Ludwig von Mises. Certainly, since the 1940s, virtually every principles of economics textbook from which millions of students have learned their basic understanding of the subject have been introduced to it through some version of Lionel Robbins’ definition of economics, with its universal reference to all human conduct. “It is clear that behavior outside of the exchange economy is conditioned by the same limitations of means in relation to ends as behavior within the economy, and is capable of being subsumed under the same fundamental categories,” Robbins said. No human conduct is without its economic aspect.

One implication of this was that all social analysis must start with the individuals who are the building blocks of societal interaction. Only individuals reason; only individuals have wants and desires; only individuals decide on goals or ends to pursue; and only individuals imagine possible means to attend their ends. Therefore, to speak of “society wanting,” or the “community desiring,” or the “nation acting” is to assign to a shorthand conceptualization a misplaced reality to what are the interactions of multitudes of deciding and choosing individuals in various settings inside and outside of the marketplace. This also means that there are “no free lunches,” that is, everything we do necessitates trade-offs, the forgoing of one thing to obtain another, given the insufficient means to attain any and all of our desired ends.

Indeed, all the core concepts of economics, ends and means, costs and benefits, marginal decisions, trade-offs, exchanges, and gains from trade, profit, and loss are not narrowly present and limited to the institutional workings of a market economy. No, they are present in each and every choice and action we undertake, whether in splendid self-sufficient isolation, or in the arena of free-market competition, or under regimes of socialist central planning or the interventionist-welfare state. “Economics,” therefore, is in us, and not in some external given societal setting such as “capitalism.”

Or as Robbins’ mentor on much of this, Ludwig von Mises, explained in 1931, a year before Robbins’ book appeared:

If, however, every conscious conduct is an act of rational economizing, then one must be able to exhibit the fundamental economic categories involved in every action, even in action that is called ‘non-economic’ in popular usage. And, in fact, it is not difficult to point out in every conceivable human — that is, conscious — action the fundamental categories of catallactics, namely, value, good, exchange, price, cost…. In this sense [economics] is universally human, and not limited to nationality, bound to a particular time, or contingent upon any social class.

Not Falling into Collectivist Fallacies of Supposed Free Lunches

To forget this is to risk a wide variety of collectivist fallacies, all of which end up restricting or preventing through political coercion the free choices and actions of many individuals in the name of “society,” or “community,” or the “nation.” What this really means is that one group of individuals use political means to impose its preferred ends, goals, and purposes on other individuals under the sleight-of-hand of saying that what they want is really “society” demanding, “the people” insisting, or “the nation” deciding to go in particular directions.

Too frequently, these elements in all human decision-making get hidden from view in many economic policy discussions, when the presumed benefits from various governmental programs are highlighted with little or no discussion or even reference to the questions: From whence will come the needed scarce means to pursue the politically chosen end? What, therefore, will have to be foregone or sacrificed to obtain it? And who — which real individuals — will have to pay the price in terms of redistributed income, or restricted choices from government regulation, or reduced freedom due to imposed political plans that nullify the plans and voluntary interactions of millions of individuals?

Using the History of Economic Ideas to Explain Free Markets

Robbins was not a proponent of strict laissez faire in social and economic affairs, indeed, rather far from it. In his later years, especially, he viewed himself as, broadly defined, a classical liberal who appreciated the importance of the freedom of the individual, the benefits from voluntary association, and open, competitive markets. Robbins was also a master of the history of economic ideas and often used this wealth of knowledge to explain the theoretical and policy perspectives of the eighteenth- and nineteenth-century classical economists and liberals, and in the process also implicitly told the reader what his own policy views were through their words.

For instance, in his The Theory of Economic Policy (1952), Robbins presents in detail what he understood to be the ideas of the classical economists of the eighteenth and nineteenth centuries. In enunciating their premises and perspectives, Robbins also shows what he considered to be the guideposts for sound economic policy:

It is the specific contribution of the Classical Economists … that they recommended … the System of Economic Freedom. Given a certain framework of law and order and certain necessary government services … they conceived that the object of economic activity was best attained by a system of spontaneous cooperation. As consumers, the citizen should be free to buy what best pleased their fancy. As producers, as workers or owners and organizers of the means of production, they should be free to use their labor power or their property in ways which, in their judgment, would bring them the maximum reward in money or satisfaction. It is the impersonal mechanism of the market, which, on this view, brings it about that the interests of the different individuals are harmonized…. It follows that it should be the prime object of policy that trade and industry should be free, and that where obstacles to this spontaneous cooperation exist, they should be swept away.

Robbins made a point of emphasizing the views of the classical economists on the necessity for a rule of law with impartial justice and proper enforcement to ensure that the competitive free-market “rules of the game” are respected and protected. And that they had, in fact, a fairly long list of additional things they thought government should do, even in a primarily classical-liberal, free-market setting.

He also summarized the classical economists’ views on socialism and the central direction of economic affairs by a controlling governmental authority. Allowing a number of these classical economists to speak for themselves, for example, in extended quotes from Adam Smith, Jeremy Bentham, and especially Nassau Senior, Robbins concluded this part of his discussion with Senior’s words: “If this system [socialism] should ever be attempted to be adopted … it will be necessary to substitute fear, in the socialist nation, unless it is to starve, and must be divided into slaves and slave drivers.” It was not difficult to associate Robbins’ own views on collectivism with the voices of those he chose to highlight.

Robbins’ Role and Influence at the London School of Economics

But it was in the period between the two world wars, in the 1920s and 1930s, that Robbins’ contributions to classical-liberal thinking was particularly noteworthy. Robbins was born in 1898. He served on the western front in France during the First World War. His first intention upon returning from the war was to study literature at university, but he ended up turning to economics at the London School of Economics (LSE) and was especially influenced by lecturers such as classical-liberal-oriented economists Edwin Cannan and Theodore E. Gregory.

The LSE had been founded in 1895 by two leading Fabian socialists, Beatrice and Sidney Webb. Their vision was for incremental and democratic change in moving society toward socialist reforms through influencing the climate of ideas and, therefore, public opinion. But the LES had a variety of eclectic views in the form of the teaching faculty. In the late 1920s, Robbins was hired on to the faculty and took over responsibility and oversight for a good deal of the academic economic content of the institution.

He greatly influenced the LSE’s development and growing international stature as an institution of higher learning in the 1930s. For instance, in 1931, he brought Austrian economist Friedrich A. Hayek to the school to deliver a series of lectures that became Hayek’s book Prices and Production(1931), which then led to Hayek being offered a position at the school he held until the late 1940s. Indeed, under Robbins’ and Hayek’s influence, the LSE came to have a distinctively, though far from exclusively, “Austrian” tilt. Arnold Plant, who also taught at the LSE, recalled that when he was in Kiel, Germany, in 1933 and the first waves of university professors were being expelled by the Nazis, a young German academic said to him, “I suppose … that LSE will have no vacancy for me, now that you have become ‘ein Vorort von Wien’ — a suburb of Vienna.”

Robbins’ Austrian analysis of the Great Depression

Inspired by Mises’s and Hayek’s “Austrian” theory of the business cycle, Robbins published in 1934 The Great Depression, an insightful and in places eloquent analysis of the causes and cures for the depression of the early 1930s. Out of the wreckage and imbalances left in the wake of the First World War, the European economies attempted to return to some economic order and normality. But monetary mismanagements in Great Britain’s return to a gold standard in 1925 and price level “stabilization” policies, followed by the Federal Reserve in America during much of the 1920s, succeeded only in creating the instabilities that helped bring about the stock-market crash of 1929.

This was followed by a large array of government interventionist policies, all of which ended up exacerbating the distortion and misdirection of capital and labor through attempts to prevent the needed competitive adjustments in the relative structure of prices and wages. The cumulative effect was the economy-wide declines in output and employment. The policy prescription that Robbins offered was, in effect, a return to competitive free markets, at home and abroad, noninflationary monetary policies, and an end to government interventions in the marketplace.

Economic Benefits From a Liberal International Order

His next book was Economic Planning and International Order (1937). Robbins’ analytical canvas was the global economy from a classical-liberal, cosmopolitan point of view. Explaining the liberal perspective, Robbins said:

Here on one side are the hundreds of millions of consumers who constitute the population of the planet. On the other side are the self-same people with their various aptitudes and opportunities as producers and the mechanical and natural resources which are available. What are the essentials of an organization which shall bring it about that these productive powers are used in such a way as to satisfy as fully as possible the various wants of the citizens?

Clearly two things are necessary. Firstly, we need an apparatus which will register the strength of demand and the relative capacity of the different instruments of production to satisfy it. Secondly, we need institutions of decentralized initiative operating in such a way as to involve a continuous tendency to apply productive resources at the point of highest return. We need to know the demands of the consumers and the relative effectiveness of different ways of satisfying them: and we need an organization of production which will bring it about that no resources can be devoted to produce any but the highest return without loss falling on those responsible for controlling them….

The essentials of such an organization are provided by the free market and the institution of private property. A free market prices both products and the factors of production which produce them. It rewards with higher gains, and transfers to lines of production where production is most urgently needed. It punishes, with loss and reduction of income, continuance of production when the factors of production involved can produce a higher return elsewhere. The institutions of private property provide for decentralized initiative; and this initiative in turn creates the market as an organizing principle.

Given their power to demand, which springs from the past value of their services and property, the citizens exercise through the market continuous control over the future disposal of their work and their resources. The citizen, as producer, is not compelled by physical or legal coercion to put his services and property to the uses in which they produce most in value terms. But if he chooses to refrain from doing so, his own power to consume in the future is curtained to the extent of his refusal… In this way the maximum division of labor which is compatible with given tastes and given technique is continuously reinforced.

This, Robbins argued, is the essential institutional framework and workings of the (classical) liberal economic plan for interpersonal prosperity. The free-market order is not an ideal just for Great Britain, or America, or any other particular country or people. It is an ideal for all of humanity, in which everyone, everywhere, may be bound together in a global social system of personal freedom as consumers and producers, demanders and suppliers, through the voluntary associations of peaceful and mutually beneficial production, trade, and commerce reflected in an international network of division of labor.

Peace, Freedom, and Prosperity Under Liberalism

This makes the liberal, free-market ideal cosmopolitan and universal in its possibility and promise. Eliminate barriers to the free movement of goods, money, and even people, and not only are the widest economic improvements made possible: It also diffuses many if not most of the rationales and justifications for war. What’s the point of militarily and politically conquering other nations if anything that is wanted is peacefully and noncoercively purchased from others looking for buyers for their resources and wares.

Robbins also pointed out that even if the entire world was not yet ready to follow the liberal plan for peace and prosperity, “It still remains true that the more liberalism it introduces into its arrangements the greater will be the resulting gain of wealth and stability. A single country or group of countries can pursue many of the aims of international liberalism in a world given over otherwise to interventionism and central planning and enjoy some at least of its benefits.” Unilateral freedom and free trade are means for nations to move in the direction of more liberty.

The greater part of Economic Planning and International Order offers a critique of the rationales and attempts to supplant a competitive market system with various forms of extensive government intervention, regulation, and comprehensive central planning. Domestic interventionism and trade protectionism are simply methods of piecemeal government planning. Introduced in democratic countries in which interest groups attempt to influence the interventionist policies of those running for and holding office, they often result in a hodgepodge of often inconsistent and contradictory purposes and outcomes that represent various types of economic irrationality.

Attempts to overcome this with the implementation of overarching central plans present a different set of problems and dangers. The world is divided into nation-states, so central planning results in various forms of national socialism, in which national central planners must politicize international relationships as each respective government monopolistically determines the allocation of its own nation’s resources, capital, and labor supplies. Trade between countries becomes “affairs of state” and runs the risk of conflicts among nations as each limits and determines what other nations may obtain from them via politicized trade decision-making.

Trade Barriers Can Lead to Deadly and Destructive Wars 

Indeed, in his later books, The Economic Basis of Class Conflict (1939) and The Economic Causes of War (1939), Robbins strongly suggested that protectionist trade barriers designed to control and secure domestic markets and jobs serve as an avenue to war when nations restricted from one country’s market go in search of others by conquest if it is a more profitable means of getting what it wants. Robbins saw this at work in Japan’s invasion of China in the 1930s:

Whatever we may think of the justice of the Japanese attack on China, there can be no doubt of its connection with the restriction of the Japanese market [in the U.S. and the British Empire]…. I would say nothing to extenuate this ghastly crime [Japan’s invasion of China in 1937] against humanity. But I should be glad to think that some of those leaders of English opinion who wrote so glibly … on the necessity of checking Japanese exports in the interest of Lancashire cotton could have it brought home to them that they, too, are not wholly guiltless of the desolation of the Chinese peasantry and the murder of women and children…. The connection between such events and the invasion of China is so obvious as to need no elaboration.

Robbins Under the Influence of Keynes and Interventionism

Soon after the war in Europe had broken out, Robbins was employed as an economic consultant in the Office of the War Cabinet for the duration of the conflict. During the years he worked in government and had a variety of contacts with John Maynard Keynes, he moved in a far more “moderate” direction on matters of macroeconomic “activism” and positive roles for government in society.

He remained, nonetheless, a strong advocate of a competitive and functioning market economy. He continued to warn of the dangers from monetary mismanagement and its inflationary consequences. And he most certainly continued to emphasize the fundamental principle of personal liberty in its various facets for the preservation and morality of a free society. In a lecture entitled Liberty and Equality (1977), he said:

From my point of view the concept of liberty essentially means personal freedom from coercion by other people…. If we say that a man has liberty of action, we mean that he is not impeded by deliberate interference by someone else…. It is only action or expression which is free, which can be the subject of moral judgement at all…. Unless it is present, human action is not susceptible to ethical judgement.

Again, while in these later decades he was not immune from suggested policies of limited redistribution, he still believed that the central elements of any notion of “equality” were equality before the law and equality of opportunity in the sense of the abolition of all government regulations and prohibitions that prevented or restricted any individual’s attempt to improve his circumstances on the open and competitive market. Likewise, Robbins warned of the political and social dangers from attempts to impose redistributive economic equality among the members of society.

Robbins, a Master of His Subject

In the early 1980s, I taught in Ireland for two years, with frequent visits to London. During one of those trips in 1982, I had the opportunity to meet Lionel Robbins at the LSE. I attended two of his lectures on the history of economic thought. Robbins’ subject during those two sessions was Thomas Malthus and his theory of population. With delightful wit and rhetorical charm, he took the students though the premises of Malthus’s theory, along with its evolution through its various revised editions, and its meaning and relevance today. At the end of both classes, the students gave Robbins a standing ovation, which was fully deserved given the brilliance of the form and content of the presentations.

I also had the chance to spend a few hours with him in his office at the LSE. His vast knowledge of the history of economic ideas soon became apparent, matched only by his amazing memory of the details of the ideas of almost any old economist that he or I brought up in the conversation. He sometimes quoted them from memory, verbatim, in both English and in German when referring to the Austrian economists of the late nineteenth century! If anyone was a true master of his subject, Lionel Robbins was an embodiment of it.

By Richard Ebeling

This article was originally published in the September 2023 edition of Future of Freedom.

Human beings have had two fundamental ways of associating with each other: conflict or cooperation. Both methods have run through all recorded human history, as well as long before human beings left intelligible residues of their actions to be deciphered by those who came after them. Group conflicts have seemed to have a variety of causes: religious, political, linguistic, or racial, as well as the desire for physical possession of things. All of these have been inseparable from death and destruction.

At the same time, human beings have also peacefully cooperated with each other. They have sought bases of agreement and collaboration for mutual purposes and benefits that have spared or reduced the occurrence of violence and the use of force in human relations. Rather than death and destruction, peaceful cooperation can bring forth prosperity and harmony among people.

It should not be too surprising that economists turned their attention to understanding and analyzing both the reasons for and the institutions facilitating either conflict or cooperation. One of these in the early part of the twentieth century was Thomas Nixon Carver. If mentioned at all nowadays, Carver is remembered as one of the early formulators of the marginal productivity theory of the determination of relative income shares in a competitive market system, outlined in his book The Distribution of Wealth (1904).

From Iowa Farm Boy to Harvard Professor

Thomas Nixon Carver was born into an Iowa farming family in 1865 and never went to high school. However, he applied and was accepted to Wesleyan College, although his education was constantly interrupted by responsibilities on the family farm. He completed his undergraduate degree at the University of Southern California after his father decided to move the family out west to start another farm.

Wanting to pursue an academic career, Carver entered the graduate program at Johns Hopkins University and completed his doctoral degree at Cornell University. After graduation he taught both economics and sociology at Oberlin College in Ohio. In 1902, he was appointed to a chair in political economy at Harvard University in Boston, a position he held until his retirement in 1932.

Carver wrote a series of economic textbooks, including The Principles of Political Economy (1919) and The Principles of National Economy (1921), focusing on the core concepts of economics as a means of drawing a variety of policy implications from the perspective of desiring to create and increase the economic well-being of the country. In other words, like Adam Smith, he attempted to enable the student or interested reader to understand the nature and causes of the wealth of nations. In this sense, Carver may be categorized as a national liberal. He was concerned with the economic and ethical well-being of the United States, but he saw no inherent conflict between the economic well-being of the United States and other countries. He believed that one’s own country’s well-being was bettered by opportunities for gains from trade with potential trading partners. The better off they were economically, the greater the gains from trade resulting from exchange with those in other lands.

A Liberal Though Not a Laissez-Faire Market Economist

Carver had been influenced by the writings of Herbert Spencer as a young man, and he adopted not only Spencer’s philosophy of individualism and free association but also Spencer’s emphasis on social evolution from simple to complex social orders and the transformation from the “militant” society of war and plunder to that of “industrial” society based on contract and individualism rather than the tyranny of the collective. The unique characteristics of the American social and economic landscape, highlighting the reality and potential of the free “industrial” society, were emphasized by him in The Present Economic Revolution in the United States (1926) and This Economic World, and How It May Be Improved (1928).

He was not as laissez-faire in his economic philosophy as Herbert Spencer had been, especially on the issue of restrictions on immigration of the unskilled, whose numbers, Carver feared, constantly put undue downward pressure on the wages of American citizens. Some “progressive” critics have highlighted his views on immigration and the similar negative effects from the unskilled and uneducated excessively increasing the domestic population from irresponsible early marriage before the parents had the market income to appropriately support a family at a decent standard of living on their own.

They have attempted to tar him as a racist and a xenophobe. No doubt the rhetoric and turn of phrases he sometimes used ring uncomfortably on the modern ear, given the greater sensitivity in today’s use of language. No doubt he was influenced by some of the now out-of-date sociological views of the early twentieth century, but there is little or nothing to suggest that Carver believed that racial or ethnic minorities should be selected for “special treatment.” Indeed, Carver was adamant in various places in his writings that to treat certain people in such discriminatory ways based on race or religion or language was inconsistent with the spirit of American liberty for all and contradicted the principles of the U.S. Constitution. The desirable goal was assimilation of those coming to America into a common culture of liberty and individualism.

Other classical liberals may challenge his views on immigration restrictions and early marriage in terms of their effects on wages and the labor supply based on the general principles of the freedom of movement and association; in fact, Carver called for an open debate on these topics rather than any presumed dogmatic position. It would be wrong to conclude that he was a “racist” in that he wanted to restrict the immigration of unskilled labor from Europe just as much as from other parts of the world.

Critic of New Deal Collectivism and the War Economy

Carver moved back to southern California after leaving Harvard and came to know Leonard E. Read, (the future founder of the Foundation for Economic Education), who was then working for the Los Angeles Chamber of Commerce. In fact, according to former FEE resident scholar Ed Opitz, it was Carver who introduced Leonard Read to the writings of the nineteenth-century French liberal economist Frederic Bastiat when they met in southern California in the 1930s.

Though retired, Carver continued to write on the political-economic issues confronting the United States stemming from Franklin D. Roosevelt’s New Deal programs during the Great Depression. His books on these issues, including What Must We Do to Save Our Economic System(1935), How Can There be Full Employment After the War? (1945), and The Economics of Freedom1948), all criticized the expansion of the government’s command and control of economic affairs before and during the Second World War. He forcefully argued that Roosevelt’s policies were anathema to the preservation of personal freedom, economic liberty, and limited government in the United States. Indeed, he said, they were the opposite of the American tradition.

All of Man’s “Conflicts” Arise from Inescapable Scarcity

Carver was one of the American economists thoroughly imbued with the ideas of the marginalist, subjective-value revolution of the late nineteenth century that had begun with such economists as those of the Austrian School, especially Carl Menger and Eugen von Böhm-Bawerk. He saw in the logic of marginal decision-making the analytical key to understanding individual conduct and the workings of much of the social order.

This included an analysis of the origins and forms of human conflict and cooperation. His most detailed study of this is found in his Essays on Social Justice (1915) and Human Relations: An Introduction to Sociology (1923), though he uses and applies it in various forms in many of his later writings.

If all that men wanted were in sufficient quantities and qualities to satisfy more than all their conceivable uses for them, no human wants would go unfulfilled, and no conflicts could ever arise. After all, in such a material utopia, nothing would be foregone or done without due to its unavailability, and no disputes could ever arise among people, since one person having or using more of any one thing would not result in some other individual having to do without or with less than what was desired.

But in the world in which we live, Carver explained, individuals find themselves in conflict with three things: nature, themselves, and with others. Man is in conflict with nature because nature does not provide most things in the amounts or the qualities needed to satisfy his needs, whether it be food,  clothing, or protection from the elements. To have more, man must work to extract greater amounts than nature provides. He must plant and harvest crops, he must hunt for wild game to have for food and materials to cover his body, and he must construct forms of shelter to protect himself from animals and from the rain, heat, and the cold.

Scarcity Forces Man to Make Choices

This scarcity of material goods puts man in conflict with himself. Since he cannot have all that he wants from nature without effort, and given the limits to his own abilities and only so many hours in the day, he must now decide in what directions to assign his labor, skills, and time. To have more of some things extracted from nature, he must give up, forego, delay, or permanently renounce the opportunities to fulfill or better satisfy other desired ends and purposes.

Conflict is therefore inseparable from the human condition, even for that hypothetical Robinson Crusoe alone on his island. He fights with a niggardly nature to obtain more of what it can surrender through his appropriately applied labor and effort, and he battles with himself to decide what he is willing to give up to obtain (marginal) amounts of other things that he wants. Shall he not work at all and live off what he can pick off the trees by simply lifting up his hand? Or shall he incur the cost of physical and mental effort to clear a field, plant a crop, and bring it to harvest?

Will he devote time, imagination, and effort to make the tools — the capital equipment — to cut down a tree, hollow out its truck to carve out a canoe, and shape the paddle, along with pulling down the tree vines to construct a net, so he may fish more successfully in terms of quantity and variety of catch? In weighing these decisions, Carver also pointed out, man had to consider the element of time and his willingness to forego satisfaction and benefits in the present in order to provide more satisfaction and benefits in the future.

The individual, Carver argued, must find within himself a “balance” to solve his battle with nature and the conflict in his own mind concerning how to apply his means to obtain his desired ends at the margins of choice. But the human conflict does not stop there. The world in which we each live is populated with other human beings, each of whom finds himself in the same dilemma of conflict with nature and within himself.

Destruction or Production as Answers to Conflict Among Men

The inescapable scarcity of means to serve human ends also means that humans find themselves in conflict with each other, since more of the scarce things of the world obtained and used by one individual or group of individuals limits the amounts available for others. For primitive man, those scarce things included the waterhole, the wild animals to hunt for food and clothing, and the limited fruits and vegetables nature provides for simple picking. Explained Carver:

We talk and argue interminably about proper adjustment of antagonistic interests of various kinds, all of which, it must be remembered, grow out of the initial fact of scarcity — the fact that there are not as many things as people want…. In this antagonism of interests, growing out of scarcity, the institutions of property, of the family, and of the state, all have their common origin…. By the Militant form of conflict is meant any form in which one’s success depends on one’s power to destroy, to harm, or to inflict pain or injury [on others]…. In order to succeed in this form of conflict, one must develop one’s powers to destroy.”

If we repress, for example, all the militant forms of conflict, the combative instincts of mankind together with the conflict of interests will cause them to compete or contest with one another in other fields…. Of the forms of economic competition, the most advantageous and least harmful is that of competitive production; production in service. Competitive production is, therefore, rivalry in the performance of service…. Of all the forms of human conflict, economic competition is the highest. In no other form of conflict does success depend so much upon production or service and so little upon destruction or deception.

In the free, peacefully competitive marketplace and system of law and individual rights of the type which Adam Smith referred to as a “system of natural liberty,” Carver said, individuals are restrained and incentivized to apply themselves in ways to better themselves by improving the circumstances of others. The goods and resources in the legally recognized possession of others may only be obtained from them by offering some alternative good, service, or resource that they value more highly than that which you are asking them to part with.

Under a system of productive competition, the reward of success in one’s own betterment comes from devising ways to produce more of what people want, in the forms and qualities they desire, and at lower costs of purchase than other peaceful and honest individuals attempting to offer the same goods and services to other members of society. This avenue of solving conflicts through production and trade cumulatively reduces the scarcities that generate the conflicts among people.

Nonetheless, it remains an unending conflict due to the fact, Carver reminded his readers, there are two counteracting influences at work: first, the fact that people’s wants for the new, the better, and the different constantly outstrips the satisfaction of our desires from existing supplies of goods and services, and second, the reality that the number of mouths to feed and wants to be fulfilled increases as the  population grows.

Carver’s Misplaced Fears Concerning Immigration

The latter can arise within any country when procreation outstrips the number of  those who pass away. But it also can grow due to net increases in the number of people due to immigration. Carver was not opposed to immigration, per se. His concern was that increases in certain segments of the unskilled working population would outrun the rate of growth in complementary capital formation and therefore result in lower wages relative to the other factors of production.

In retrospect, his concerns were unfounded. In 1900, the number of people in the United States was 76.3 million. In 1920, that had grown to 106 million, and now, more than 100 years later, in 2023, there are an estimated 333 million people. Since 1900, the number of immigrants to the United States has totaled about 40 to 50 million, or almost 20 percent of the population increase in the country since the beginning of the twentieth century.

In 1900, the average real income was about $9,000 a year (in 2022 dollars). Today, average real income is over $70,000, or an almost eight-fold increase in real income during this period when there was a 4.4-fold increase in the number of people. By some estimates, 56 percent of the U.S. population in 1900 lived in poverty. Currently, using the government’s somewhat biased benchmarks, poverty in the United States is said to be 14.5 percent of the population, a 75 percent decline since the beginning of the last century.

Capital formation for greater and better output, technological improvements in the use of land, resources and raw materials, and dramatic increases in skills and educational training (all of which Carver said could counterbalance increases in the unskilled population) have been more than enough to bring about the dramatic rise in the standards of living for a much larger American population than Carver could imagine. Contrary to Carver’s fears, population growth from births and immigrants have been a boon and not a burden on the American economy, especially with the complementary growth in capital and technological innovations that have raised the marginal value and real wages of workers in general, while eating away at the poverty that has been the plague of mankind for all of human history.

Political Competition Creates Waste and Reinforces Prejudices

Carver was a strong proponent of the case for free markets under constitutionally limited government. Any and all growth in the size and scope of government beyond the protection of individual rights and honestly acquired and used property not only slowed down the peaceful and protective competition of the marketplace, it also shifted human conflict into an alternative unproductive and destructive direction. If market competition is reduced or repressed or regulated by government, it merely shifts the resolution of conflicts to the political arena. Explained Carver:

The more the state absorbs the enterprises now carried on by private initiative, the more will political competition displace economic competition. Political competition is a lower form…. Under such a system as this [of government control and regulation]…. We show our rivalry and our preference for ourselves by struggling more intensively than we now do for political office or preferment…. This would be an exceedingly wasteful form of competition…. When two farmers compete with one another in producing corn, more corn is likely to be grown as the result of that competition. When two candidates compete for a given office, the time they spend in campaigning is wasted — it produces nothing.

Furthermore, Carver argued, the market is a far more “democratic” means of expressing the desires of the population and more pluralistic in not limiting the results to majoritarian outcomes, including racial and religious prejudices. As Carver wrote:

Does the average man when he votes spend his vote as intelligently as he does his dollar when he buys products or services? If he is more likely to be prejudiced in his votes than in his purchases or is more likely to vote ignorantly than he is to purchase ignorantly, one should conclude that buying is a more accurate test of merit than voting, and vice versa. Suppose that a private individual should produce and put on the market a good product which appeals to a buyer, but the producer is a member of an unpopular race or an unpopular religious body, that is, that there is a great deal of prejudice again him and his class; is this prejudice as likely to interfere with the sale of his product or his services as it is to interfere with his getting votes for a desirable position? It would seem not. To that extent, at least, buying is a less inaccurate method of determining merit than voting, that is, racial and religious prejudices are less likely to be factors in buying than in voting. If that be true, the man who succeeds in getting the money of purchasers is in this respect, at least, more likely to have earned that money than is the man who gets votes through racial and religious prejudices likely to have deserved their votes….

Anyone who will examine himself or his own experience will probably agree that he votes very unintelligently, that is to say, he knows very little about the candidates whose names appear on the ballot, and he has very inadequate methods of finding out about them…. It would seem to imply that the average man votes very unintelligently, and therefore there is little reason to expect that the individuals who get his votes have earned them or deserved them…. If that is the case, then the economic form of rivalry is superior to the political form, in that business rivalry merit wins more frequently or less infrequently than in the political form of rivalry. It is the author’s deliberate opinion that the process of buying and selling, when it is properly safeguarded [from force or fraud], is a better method of testing economic value of men than is the process of voting.

Market Competition Depoliticizes Racial and Other Prejudices 

Economic competition, Carver was saying, depoliticizes religious and racial prejudices far more than political competition. How many of us know or think about which church someone may go to or the color of the skin of the numerous individuals who have participated in the growing and the processing of the foods we eat, or in the manufacturing of the cloths we wear, or in the producing of the household items we purchase?

We are interested instead in the quality of the products we are interested in buying, along with the competitive attractiveness of the price at which they are offered to us. The anonymity of many market relationships in the complex system of division of labor helps remove racial and other prejudices from the potential for mutual gains from trade.

In more direct face-to-face settings of buying and selling, it may be the case that a prejudiced person may choose not to buy from or sell to someone belonging to a group against whom they are negatively biased. Or that they refuse to hire or accept employment from someone against whom they hold negative prejudices. But Carver’s point was that this forces such a biased person  to confront an element of that conflict within himself. He cannot follow his prejudice against someone  without incurring the cost of missing out on the opportunity to acquire a better or less expensive product, or without losing out on the chance to hire an experienced or skilled or less expensive employee that reduces his profit opportunities. In the competitive marketplace, racial and other bigotries are not costless alternatives to follow.

Market Democracy and Civilized Man vs. the Savage

In addition, compared to the political democracy, market decision-making allows for entrepreneurial opportunities without majoritarian approval.

The simple fact is that industry is more democratic without the ballot than government can possibly be made even with the ballot…. First as to the open road to talent; that has always existed industry in a higher degree than in politics. However meritorious a man may be in politics, if his opinions are in advance of those of the majority he gets no advancement. A very small and select minority may approve his work in industry and reward it. He secures his advancement as the result of this without waiting for the crude majority to approve…. It is obviously easier for an advanced person to secure the support of a small and highly intelligent minority than to transform this into a majority, which would require that much less intelligent people should be convinced…. Individuals come more nearly getting what they want from businessmen than they do from politicians and government agents.

This led Thomas Nixon Carver to the stark distinction between “civilized man” and “the savage” in his 1923 volume on Human Relations:

So long as one is pursuing the method of production or usefulness, he needs no weapon, when dealing with other good citizens, except the power to bargain freely with his fellow citizens. He can get what he wants by voluntary agreement with other free citizens. The savage, however, needs other weapons than his productive power. His weapons are of destruction, or weapons which add to his power to terrorize….

A civilized tribe is one in which the dominant element is made up of men each of whom stakes his prosperity or success on his ability to contribute to the life of others in exchange for the means of his own livelihood; the savage community is one in which the average citizen is willing to resort to terrorism to get what he wants. So long as the former class of citizens is gaining in numbers and power, the community is growing more civilized. When the latter class is gaining in numbers and power, civilization is declining.

When Thomas Nixon Carver wrote these last words exactly 100 years ago, America was still a country mostly made up of what he called “civilized” men interested in pursuing peaceful and voluntary trade for mutual betterment. Now,  in 2023, America is populated far more with those he classified as “savages,” as more and more of our fellow citizens turn to the destructive and terrorizing methods of coercion and force to get what they want through the power of the state.