Man, Economy and State

For those in the Austrian School of Economics praxeology is the logic of human action, and economics is a subdivision of praxeology. Economics itself can be subdivided into (1) actions of isolated individuals ("Crusoe economics") and actions of humans engaged in interpersonal exchange (catallactics).

Whereas psychology addresses why humans choose various ends and ethics addresses the ends humans should choose, praxeology is concerned with the formal implications of the fact that humans use means to achieve ends. The Austrian School regards praxeology as an a priori formal discipline comparable to logic & mathematics — not an empirical science.

The use of means to achieve ends can be equated with production to achieve consumption, although Rothbard calls the means to satisfy human wants goods. Goods that can immediately satisfy wants are called consumer's goods, whereas goods that are indirectly serviceable toward the future production of goods are called producer's goods. Consumer's goods can include immaterial things such as friendship, music, medical care or freedom. Factors of production are the resources which enable production. Rothbard calls the original factors of production land (nature) and labor. The produced factors of production are called capital goods.

Since time is a scarce resource humans must have a scale of preferences (values) in order to choose what actions to take at any given moment. Humans prefer the shortest time for production to achieve desired ends, the principle of time preference (less waiting time). Humans also prefer for goods to satisfy wants for the longest possible time.

The law of marginal utility (or, more precisely, the law of diminishing marginal utility) states that the ranked value of any good will decline for each additional unit. A second apple will be valued less than the first apple and the third apple will be valued less than either the first or the second. How much less the second apple is valued than the first apple is an empirical fact of subjective value — not a praxeological principle. But it is certainly not true that the first apple is exactly equal in value to the second apple. The greater the supply of the good, the lower the marginal utility. Although water is essential to life, because water is plentiful it is marginally valued less than diamonds, which are far more scarce.

Rothbard completes this chapter on the fundamentals of human action by using the isolated individual Robinson Crusoe on a deserted island to exemplify economic principles ("Crusoe economics"). Crusoe can produce berries by climbing trees and picking berries with his hands. Or Crusoe can bind sticks together to make a long pole that can be used to shake berries from trees. Time that could be spent producing berries (a consumer's good) must be invested in fashioning a pole (a capital good), but the pole may increase Crusoe's hourly production of berries. Capital goods are stored-up labor, land and time. If Crusoe has a very high time preference for berries (is extremely hungry) he may be unwilling to forego immediate consumption by investing time, material and labor to fashion a pole.

Crusoe might also have reduced his berry-picking time by finding a grove of smaller berry trees which did not require climbing to obtain berries. But Crusoe would have no way of knowing whether such a grove exists on his island without investing time and labor to look. In choosing to spend his time fashioning a pole rather than in looking to see if he could find a grove of smaller trees, Crusoe was forecasting that the probability of finding such a grove was low — and that his time was better spent fashioning the pole than searching for the grove — an act of entrepreneurship. Investment in capital goods always involves thinking about the future, which necessarily entails uncertainty.

Crusoe could also invest his time, labor and material resources ("land") building a house that would last 3,000 days. For the first day after being built, 1/3000^th of the house is a present good and the rest is a future good. Any expenditure of labor involves foregoing of the good known as leisure.

Interpersonal exchange of goods & services (catallactics) can be done through barter (direct exchange) or by the use of money (indirect exchange). Chapter 2 deals with the subject of barter.

Several conditions must be in place for barter between two people to occur. First, both persons must recognize the concept of ownership/property and acknowledge the ownership of the goods/services by the other party to the exchange. Second, both parties must foreswear the use of violence — otherwise goods will be obtained by theft and services (labor) obtained by threats (slavery, in the extreme case). Third, both parties must have reverse valuations for the goods in question.

To illustrate reverse valuations, imagine that Smith owns some fish and that Crusoe owns a stockpile of berries. Smith would be willing to trade one of her fish (her marginal one fish) to Crusoe for 70 berries or more. But if Crusoe would not be willing to trade more than 60 berries (his marginal 60 berries) for a fish, then no transaction will occur. Smith values her fish too much and the berries too little, whereas Crusoe values his berries too much and the fish too little for the two of them to trade.

It is an economic fallacy to assume that there is an objective "fair" price or true worth for the berries or fish. To Crusoe his marginal 61 berries are worth more than a fish. To Smith, her marginal fish is worth more than 69 berries. Her next marginal fish might be worth more than 89 berries. Another person would probably have other valuations. Praxeology (Austrian Economics) recognizes that valuation is done by individual human beings and that valuation is the product of feelings & circumstance — ie, is subjective.

A related fallacy is the idea that an exchange would occur only when both Crusoe and Smith place equal valuation on berries and fish. Crusoe being willing to trade 65 berries or less for a fish and Smith being willing to trade 65 berries or more for fish might result in a transaction, but both parties would be close to indifference about trading at that price. By contrast, If Crusoe was willing to trade 100 berries for a fish and if Smith would be willing to trade her fish for 25 berries, both Smith and Crusoe would receive great benefit by a trade at 65 berries. Mutual benefit of this nature is why human beings trade.

Although both Smith & Crusoe are both buyers & sellers, for convenience I will call Crusoe the buyer and Smith the seller of a fish. Now imagine that Smith would sell her fish for any price of 70 berries or more and that Crusoe would buy the fish for any price of 90 berries or less. The valuations of Smith & Crusoe now result in a range between 70 & 90 berries which will allow both parties to profit from the exchange. Smith will try to obtain as many berries as possible (ask as high a price as she can) for the fish and Crusoe will try to sacrifice as few berries as possible to obtain the fish (bid as low a price as he can). The final price will depend on negotiating skill — within the range limits of 70 & 90.

Now suppose that a second seller of fish enters the market — a person named Jones. Jones would sell his fish for any price of 80 berries or more. Now if all three persons began negotiation, it would soon be clear to Crusoe that in the price range of 80 to 90 berries per fish, both Smith & Jones are eager sellers. Eventually — in the price range of 70 to 79 fish, Jones would no longer be willing to sell and Crusoe & Smith would now negotiate a price between 70 & 79.

At a price below 80 berries, at least one fish would remain unsold (a "shortage of fish" due to the fact that Jones will not sell) and at a price above 85 berries at least one fish will remain unsold (a "shortage of berries" due to the fact that Davis will not buy). Jones is the marginal seller and Davis is the marginal buyer. The market will only "clear" at a price between 80 to 85 berries. This is the law of supply & demand.

In a market with many buyers & sellers of fish (or other goods) for berries (or for money), economists draw supply & demand curves on graphs that depict P (price) on the vertical axis and Q (quantity) on the horizontal axis. Since such graphs are typically drawn only for illustrative purposes, whether the lines are actually straight or curved is an arbitrary choice.

The supply curves illustrate that at a high price the quantity of goods offered for sale will be high, whereas at a low price the quantity of goods offered for sale will be low. (That is, high prices are high incentives to sell and low prices are low incentives to sell.) The demand curves illustrate that at a low price quantity demanded (quantity of goods people will want to buy at that price) will be high, and at a high price the quantity demanded will be low. (That is, low prices are high incentives to buy and high prices are low incentives to buy.)

The two curves intersect at a price (the "clearing price") where the quantity of goods offered for sale exactly equals the quantity of goods people will buy at that price — the price that "clears the market" (leaving no unsold stock selling at that price and no unfulfilled desire to buy at that price). The term "clear" is something of a misnomer, because at the so-called clearing price the sellers in this case might still own fish and the buyers still own berries. If the price were much higher, the owners of fish would want to sell more of their fish (the upper right portion of the supply curve) and the consumers of fish would be less inclined to buy fish (the lower right portion of the demand curve). Only the most marginal fish will be available for sale at the lowest prices.

In contrast to the sciences, the supply-demand graphs of economics treat the vertical axis (price) as the independent variable and the horizontal axis (quantity) as the dependent variable (probably a choice made by Alfred Marshall, who established the use of supply-demand graphs). Rothbard emphasizes that the phrase "increase in demand" does not mean movement along a demand curve but, rather, a shift of the demand curve to the right (the dashed line in diagram I) — meaning there is an increase in quantity demanded at every price (and amount supplied). For example, an effective advertising campaign would increase the public appetite for berries (shifting the demand curve), whereas an increase in the supply of berries would lower the clearing price (a movement along the demand curve). Diagram II shows an "increase in supply" (curve shift to the right) such as might occur when there is a bumper crop in berries due to exceptionally favorable weather.

The demand curve is described as being elastic or inelastic. An elastic demand curve will be more horizonal — small increases in price will result in large decreases in the quantity people will want to buy. An inelastic demand curve will be more vertical — large changes in price will have little effect on the quantity demanded. Necessities tend to have a more inelastic demand than luxuries. A good example of an inelastic demand curve would be insulin, since users are unlikely to increase or decrease the quantity demanded within a wide range of prices. An inelastic supply curve will be more vertical — large changes in price would have little change on the quantity offered for sale.

Barter (direct exchange) can present serious logistical problems in the fulfillment of economic wants. If Crusoe has berries he would like to trade for fish from Smith, he may find that Smith has no interest in berries at any reasonable price — and Smith is far more interested in obtaining eggs from Johnson. If Johnson had no interest in fish, but wanted berries from Crusoe, then Crusoe could trade his berries for Johnson's eggs and use the eggs to get fish from Smith. In this case, an indirect exchange has occurred in which Crusoe traded for eggs he did not want in order to obtain the fish he did want. If eggs were the most universally desired commodity on Crusoe's island, then eggs could become a medium of exchange — a money.

When a commodity is very well-established as a medium of exchange it will be demanded for use as money far more than for direct use-value — and the exchange-value will greatly exceed its use-value. Money will have marginal utility, just like any other commodity. So as the stock of money increases, its marginal utility to the owner of the money declines (the marginal money is needed less urgently).

Money that is saved (or "hoarded") provides security against future uncertainty and future needs. This money is fulfilling a demand for the owner as surely as the money the owner spends on goods & services — and this money is no less "idle".

Money makes markets more efficient by providing prices for all goods & services. Money prices for goods & services have a certain predictability — despite changing somewhat from day-to-day — that allows for better forecasting & planning.

Rothbard makes the point that all consumer's goods are partial substitutes for one another. A consumer may choose between travel, more expensive dining or a sophisticated audio system. Potatoes, yams or onions may be substituted. The more substitutes for any given good, the more elastic the demand curve for that good. By contrast, some goods will have correlated demand schedules. A fall in the price of golf balls will increase the demand (and price) for golf clubs.

Rothbard describes an economy in which all goods & services have reached prices & quantities (supply & demand) that clear the market as an Evenly Rotating Economy (ERE). In an ERE, if capitalists can earn 3% per annum in one production process and 5% per annum in another, resources will be shifted to the second production process until both processes yield the same annual return (everything else being equal). In the ERE there is no entrepreneurial uncertainty and the rate of return for all lines of production becomes equal to the pure rate of interest.

In a real economy, however, there are always changing circumstances — and the economy is continually responding to those changes by shifting to a new equilibrium position. Entrepreneurs are those who can see new unfulfilled demands and who can profit above the pure rate of interest by fulfilling those demands. Eventually, competitors will be attracted by the profits of the entrepreneur, and the competitors will increase the supply to meet the unfulfilled demand until returns match the pure rate of interest of the ERE.

The forecasting ability, risk capital and willingness to take risks by entrepreneurs increases the efficiency of markets. Of course, many would-be entrepreneurs forecast incorrectly and lose money by their misallocation of resources. When inefficient entrepreneurs are mistaken enough they will eventually no longer have enough money to be engage in entrepreneurial efforts that misallocate resources — and they will be driven off the market.

It is a fallacy to equate the price of a product with the costs of production. In the ERE prices of products will be close to costs of production, plus a profit which is the pure rate of interest. Entrepreneurs anticipating future demand correctly may be able to price above the pure rate of interest. But those who incorrectly forecast future demand may find themselves with unsold inventory — and be required to sell below cost to minimize losses. Buyers will not pay cost price if they can buy the product cheaper elsewhere — or if the product is of little value to them. This is subjective value theory — what matters most to the buyer is the personal worth of the product, not how much it costs to make the product.

Eugene Böhm-Bawerk founded production-structure analysis in the Austrian School of Economics. In his view, economic progress and higher productivity is associated with capital accumulation that is increasingly removed from the production of consumer goods. This could be described as capital goods that produce capital goods — or perhaps as machines that produce better machines for making machines that produce consumer goods. The role of capital is more subtle than just the production of machines, however. Improved means of raising money for venture capital — and for evaluating the merits of new products for venture capital — would quality as being part of the production-structure increasingly removed from direct production of consumer goods. Interest rates play a key role in capital accumulation because "a lower pure rate of interest increases the quantity and value of capital goods available".

Money represents demand for goods & services on the market both for individuals and for all participants in the market in aggregate. One can speak of the supply & demand for money, the marginal utility of money and of time preferences for money.

In the hierarchy of values of a woman named Jackson, her first loanable $100 (her most marginal $100) may be worth between $108 and $109 to her in one year's time. In other words, if she had to choose between $100 now and $109 in one year's time, she would take the $109 (but would not take $108). But this does not mean that her absolute time preference for money is between 8% & 9%. Because both present money & future money have marginal utility, her second loanable $100 (next most marginal $100) may be more needed for consumption and her time preference for lending that $100 might be between $110 & $111 (10% & 11%).

For a man named Jillson, the respective time preferences for the first loanable $100 might be between 6% & 7% while the second loanable $100 might be valued between 14% & 15%. Time preferences are subjective, ie, relative to individual persons.

As with the examples of berries & fish in Chapter 2, when all individuals bring their money & time preferences into a market place, supply & demand will result in a "clearing price" for money — the pure rate of interest — where the supply & demand curves meet. In this case, the Price (vertical axis) corresponds to interest rate and the Quantity (horizontal axis) is the amount of money offered for loan (supply) or borrowed (demand) at each rate of interest. Supply of loanable present money is equated with demand for future money, ie, these are the same curve. Pure rate of interest is purely an expression of the weighted (by amount of money owned) time preferences of all market participants.

Specific factors of production are factors that can be used in only one line of production — for example, a machine that can only produce one particular product. Nonspecific factors have varying degrees of convertibility. For example, a piece of land in a remote & inhospitable location, but is rich in oil or a mineral, would be a more specific factor of production than land in the center of a city. Labor too has varying degrees of specificity — depending on the mobility, adaptability & trainability of the laborers.

Rothbard rejects the classical model of "land, labor & capital" earning "rents, wages & interest". Capital goods are a derivative factor — derived from land, labor & time preference. Money is always a non-specific factor of production, and in an evenly rotating economy the return of monetary investment will be the pure rate of interest.

Time preferences is not restricted to money or the loan market. Money invested in capital goods that are expected to last for 10 years is expected to compensate the investor not only with pure rate of interest (opportunity cost), but for lack of liquidity and the risk that production may not be profitable. And production may not be profitable — the risk is real. Money borrowed for spending on capital goods will require a return to compensate for borrowing costs in addition to the pure rate of interest.

In the market for land as a factor of production, investors will compare the return from growing wheat, raising cattle or being the site for a factory against the pure rate of interest. Any of these investments which do not compensate for the costs and risks will be excluded by capitalists with good forecasting ability. Entrepreneurs must compete with consumers in the land market, because land can also be used for personal residence or other private uses.

Rothbard regards labor as having a more elastic supply than land because there is a higher demand for unused labor. Specifically, the laborer has demand for his/her own labor-time. A laborer can choose between work & leisure — and when prices for labor are low there is a greater incentive to choose leisure (especially with marginal time).

In the market for loanable money there will be competition for money between entrepreneurs seeking to borrow to invest in producers' goods (capital goods) and consumers borrowing to pay for consumers' goods. Borrowing for consumers' goods is dissaving, where expenditures exceed income. Primarily dissaving consists of credit card debt and mortgages on homes. Time preferences govern levels of consumer debt just as time preferences govern levels of savings & investment.

It is commonly claimed (especially by Keynesians) that because consumer spending accounts for two-thirds of all spending that consumer spending is the basis for prosperity. Rothbard denies this, saying that "almost the reverse is true". The more resources are spent on current consumption, the fewer resources are available for investment. Investment is what lowers production costs, increases the quality of available goods & services and results in prosperity. If Crusoe spends his time climbing trees to pick & eat berries rather than fashioning a pole to increase the number of berries he can get from a tree in an hour, he is sacrificing prosperity. Similarly, if Smith spends her money on consumer goods rather than on buying a fishnet to increase the amount of fish she can catch, she sacrifices prosperity.

Rothbard challenges the Marxist caste structure of society (class warfare) by saying that only time preference prevents any person from being a capitalist. Most people do not need to spend every penny of their income — and more — on consumer goods. Most people could choose to reduce consumption and thus choose to save or invest in stocks. Large numbers of people owning shares of software companies will provide money for the development of better software — increasing prosperity & productivity.

This chapter consists of a rather tedious discussion of factors of production, and I cannot see that much is accomplished in the process. Since describing the material seems like more trouble than it is worth, I will say nothing more about Chapter 7.

The profit (or loss) of an entrepreneur can be described as the difference between the pure rate of interest and the monetary return. If the pure rate of interest is 5% and an entrepreneur had a 9% return, the profit was 4%. If the return was 2%, this amounts to a 3% loss because it is that much less than what could have been earned from a passive savings plan.

In an evenly rotating economy, the rate of return on any investment tends toward the pure rate of interest. If an entrepreneur finds an opportunity that earns a profit above the pure rate of interest, others will soon enter the same field with their capital — driving the return down to the pure rate of interest. Conversely, those earning less than the pure rate of interest in a field will withdraw money, increasing the rate of return for those who remain toward the pure rate of interest (those losing the most money would presumably be the first to withdraw).

In accordance to the scenarios just described, Rothbard calls the phrase "rate of profit" a contradiction in terms. A profit is by definition an ephemeral reward achieved by an entrepreneur who either had superior forecasting ability, or who was lucky. In an evenly rotating economy, the "profit" earned by the self-employed owner of a grocery store or other business is simply the wages of managerial labor plus the pure rate of interest and compensation for lack of liquidity. There would be a risk premium, as well, since every business involves some risk — even the most established ones.

Rothbard's description of entrepreneurial activity as finding & combating maladjustments in the economy strikes me as a negative way of looking at things. I believe that an entrepreneur's role in discovering & implementing new ideas & products is far more important — and increasingly so as technology accelerates.

Rothbard defends the view that what limits productivity is "a scarcity of saved capital, not the state of technological knowledge". He adds that "there is always an unused shelf of technological projects available and idle" and that "technology, while important, must always work through investment of capital". Rothbard (drawing on Mises) makes the argument that so-called "underdeveloped countries" have ready access to "Western know-how", but lack the saved capital to implement these ideas. I am surprised that neither Rothbard nor Mises show acknowledgement of the extent to which dictatorial, anti-capitalist governments with predatory, oppressively-regulating bureaucracies stifle enterprise in the so-called underdeveloped world.

Mises distinguishes between class probability and case probability in describing entrepreneurial uncertainty. Class probability refers to actuarial risk, the kind of risk insurance companies take in assessing a class of homogenous cases. Entrepreneurial uncertainty is different — involving unique cases & circumstances surrounding an individual business. But entrepreneurial uncertainty is not the same as gambling (a loser's game of class risk). Entrepreneurs are seeking to reduce uncertainty as much as possible. The most successful entrepreneurs will be those with the superior forecasting ability and good judgement that allows them to correctly assess probable outcomes in situations where others see only confusing uncertainty.

Land & labor are the ultimate factors of production, with capital goods being derived from land & labor. Land can be rented or capitalized, but labor can only be rented ("hired") in a free economy, since capitalization would amount to owning a person (slavery).

Rothbard makes the peculiar assertion that "labor factors have always been relatively scarcer than land factors" because "the poorest land factors will be left idle, so that labor will be free to work the most productive land." I don't think a comparison of the relative scarcity of land & labor is possible or sensical. Rothbard could as easily have said that the poorest labor factors will be left idle in hospitals — just as the poorest land factors are left idle.

Rothbard criticizes the Keynesian emphasis on unemployment by saying that there will never be unemployment in a free market. The supply & demand for labor will find a clearing price — for labor collectively and for individual laborers (wages commensurate to anticipated productivity). The market cannot, however, guarantee that every worker is productive enough to command a subsistence wage. Rothbard adds that " 'full employment,' as an absolute ideal, is absurd in a world where leisure is a positive good." Rothbard also criticizes the concept of technological unemployment by asking "How many workers have been 'displaced' because of the invention of the shovel?" Only workers who are unwilling or unable to learn new skills or do different kinds of labor are displaced by technology (and the adaptive effort is not great).

Rothbard criticizes the view of Henry George that speculation in land holds productive land from use. Rothbard asserts that withholding land from use by an owner is "silly" — because it means unnecessarily refusing monetary rents.

And Rothbard criticizes the view that factors of production can be classified as either "fixed" or "variable". He asserts that any factor of production that proves to be unproductive and has no prospects of becoming productive will quickly be seen to be "variable" when they disappear. All costs have differing degrees & circumstances of variability.

Rothbard discusses many reasons why monopolies — ie, monopolies not created by government legislation — are not economically harmful or morally offensive. In a free society, each person has absolute control over his or her own actions and is free to buy or not buy from the so-called monopolist on the basis of price or any other basis. For this reason, Rothbard is not very concerned that a monopoly or cartel could exploit a relatively inelastic demand curve. Libertarians who place a high value on freedom are likely to agree with this argument, but others concerned only with their economic well-being would not be interested in the morality of freedom if it may mean higher prices.

Business cartels tend to be unstable, with the most efficient members of the cartel facing the greatest incentives to leave the cartel so that they are not limited by quotas. (The same logic might not apply as strongly to a cartel of governments, like OPEC, since governments are inherently inefficient.)

A milk producers' cartel that forces one of its members to destroy milk to keep prices high will get a lot of media attention, but such actions are rare. It is far more costly to produce and then destroy milk than to refrain from producing milk. Any individual cartel member would be better off selling the milk at a loss than to destroy it. Destruction would only be done to yield to pressure from the cartel (or done through bad judgement).

It is often argued that large firms can engage in a "price-cutting war" that drives their smaller competitors off the market — and later charge monopolistically high prices once the competition has been bankrupted. But there is nothing to prevent the smaller firms from stopping business during the "price war" (letting the big firms take the losses of below-cost prices) and reopening for business once the "price war" is over. Or if a business has actually been bankrupted by a "price war", its assets can be sold at bargain prices to a new entrant into the market.

If one competitor is vastly superior to all the others — driving the competition off the market — that is no proof that customers suffer. The customers have chosen the winning competitor. It may be more efficient for a given industry to be dominated by the most efficient firm in that industry — and the economies of scale may be more efficient.

There are many who would agree that IBM's OS2 was a superior operating system to MicroSoft Windows. But the costs of a wide variety of incompatible operating systems are high for an economy — and the benefits of standardization are great. Consumers freely made Windows a "monopoly" by overwhelmingly choosing Windows over OS2, MacIntosh OS, Amiga, NeXT and many other Operating Systems for PCs. McDonald's is popular for a similar reason — people like to be able to go anywhere in the country (or in the world) and know exactly what kind of food they can expect from a recognized fast-food business (familiar cost & quality) without spending time investigating (even knowing that superior alternatives are probably available).

Rothbard makes some interesting observations about unions — and he exposes the double-standards of class-warfare. Unions are, after all, a cartel of laborers attempting to charge monopoly prices, mostly by laws requiring unionization. Any individuals who would seek to freely compete with members of a labor cartel are branded "scabs" and "strikebreakers" — immoral lowlifes. Labor cartels enforce their monopolies not only through moral intimidation, but by violence on the picket line and by government laws.

Governments create many monopolies that are rarely recognized as such. For example, only pharmacists are licensed to sell prescription drugs — and pharmacists can charge monopoly prices above those which would exist without the pharmacists' monopoly. The fact that certain drugs cannot be obtained freely, but only by prescription from a licensed physician is itself monopolistic and anti-libertarian. Government licensing permeates society with professional monopolies, including licences to operate an airline, to broadcast, to have a taxicab, to operate a bank, etc. (fascism in the "public interest").

Rothbard concludes this chapter with a peculiar argument against patents, but in favor of copyrights. He holds that it is very easy for two people to independently create the same invention — and that by preventing one inventor from freely using the product of his/her independent creation, patents violate property rights. By contrast, Rothbard says that it is almost impossible for literary works to be independently created. But is it not possible for two people to create the same 10-word sentence? The same 50-word paragraph? Musical pieces can sound very similar. Rothbard does not say whether he thinks copyrights should be permanent property or lapse into the public domain after a certain period of time.

In this chapter Rothbard discusses many of the themes that are familiar to libertarian economics, such as price controls, product controls (resulting in "black markets"), advertising, public ownership, business subsidies, social security, etc. — which I will not summarize. He notes that when coercion is used, the person being coerced always loses utility.