TGIF: The Objectively Invaluable Menger

Many people are uneasy with the free market. I think that's because they subscribe, implicitly if not explicitly, to the labor theory of value. Workers, people lament, seem not to reap the full and just reward for their labors. Belief in the labor theory puts adherents in good company. Adam Smith and his successor, David Ricardo, were labor theorists. Fédéric Bastiat held a variant of the labor theory.

Of course, labor theorists are also in some bad company, like Karl Marx, a true enemy of the people in whose name hundreds of millions have been murdered. In fairness, it should be acknowledged that Marx did not subscribe to a naïve labor theory, as it is sometimes assumed. He would not have thought a mud pie that took an hour to make would or should fetch the same price as a cherry pie that took as long. Marx wrote in Capital, "A thing cannot have value, if it is not a useful article. If it is not useful, then the labor it contains is also useless, does not count as labor and hence does not create value.” (Austrian economist Eugen von Böhm-Bawerk reproduced this quote in Karl Marx and the Close of His System.)

Nevertheless, the labor theory was the basis of Marx's influential exploitation theory. In the market, so it is said, bosses get away with paying workers less than the value of their product, leaving them to toil for subsistence wages. Never mind the mind-blowing rise in workers' living standards since the Industrial Revolution. Who are you going to believe, Marx or your own eyes? Hey, didn't another guy named Marx say that? (Hint: It wasn't Groucho.)

The evidence of our senses aside, if you refute the labor theory, you also refute the exploitation theory. If the market price of a good is higher than what the workers were paid per unit, the reason is not that their boss screwed them. The chief reason is that time is valuable. Workers want to be paid now, not later, when and if the goods are sold. The employer is willing to wait and take the risk. His return includes, among other things, the implicit interest rate that permeates intertemporal human action.

Opposing the labor theory of value is the subjective theory of value, which has been most consistently developed by the Austrian school. As I noted in a previous article, subjectivism in economics is not the same as subjectivism in philosophy. It means that when economists analyze markets, they must take as given the personal preferences that human beings demonstrate by their actions, which by nature entail choice. This view need not conflict with philosophical objectivism (or Objectivism, for that matter).

Carl Menger radically shifted economics from the labor theory to the subjective marginal utility theory. (People choose among units of goods "on the margin.") We are forever in his debt. Here's some of what he had to say in Part III of his landmark work, Principles of Economics:

When I discussed the nature of value, I observed that value is nothing inherent in goods and that it is not a property of goods. But neither is value an independent thing. There is no reason why a good may not have value to one economizing individual but no value to another individual under different circumstances. The measure of value is entirely subjective in nature, and for this reason a good can have great value to one economizing individual, little value to another, and no value at all to a third, depending upon the differences in their requirements and available amounts. What one person disdains or values lightly is appreciated by another, and what one person abandons is often picked up by another. While one economizing individual esteems equally a given amount of one good and a greater amount of another good, we frequently observe just the opposite evaluations with another economizing individual. Hence not only the nature but also the measure of value is subjective. Goods always have value to certain economizing individuals and this value is also determined only by these individuals.

I hardly think that anyone could disagree. Note that these differences present people with potential mutual gains from trade. Two people exchange things only because they value the things exchanged differently; each prefers what the other has to what he himself has. Neither sees the items as equivalent in value, and what would be the point in trading equivalents? Prices emerge in a money economy when people with diverse preferences seek their well-being by selling in the dearest market and buying in the cheapest. Competition limits the price range of goods.

I would, however, take issue with Menger's use of the word measure. As one of Menger's intellectual heirs, Ludwig von Mises, would later write, we rank our values; we cannot measure them. No unit analogous to ounces or inches exists. Ordinal, not cardinal, numbers are the order of the day. Note that you can't do math with ordinal numbers. What's first plus second? Third?

Menger now gets to the labor theory:

The value an economizing individual attributes to a good is equal to the importance of the particular satisfaction that depends on his command of the good. There is no necessary and direct connection between the value of a good and whether, or in what quantities, labor and other goods of higher order were applied to its production. A non-economic good (a [superabundant] quantity of timber in a virgin forest, for example) does not attain [exchange] value for men if large quantities of labor or other economic goods were applied to its production. Whether a diamond was found accidentally or was obtained from a diamond pit with the employment of a thousand days of labor is completely irrelevant for its value. In general, no one in practical life asks for the history of the origin of a good in estimating its value, but considers solely the services that the good will render him and which he would have to forgo if he did not have it at his command.

Again, who would disagree? When you shop, does the usefulness of a good depend on how long or how intensely someone worked on it? Do you even inquire?

Goods on which much labor has been expended often have no value, while others, on which little or no labor was expended, have a very high value. Goods on which much labor was expended and others on which little or no labor was expended are often of equal value to economizing men. The quantities of labor or of other means of production applied to its production cannot, therefore, be the determining factor in the value of a good. Comparison of the value of a good with the value of the means of production employed in its production does, of course, show whether and to what extent its production, an act of past human activity, was appropriate or economic. But the quantities of goods employed in the production of a good have neither a necessary nor a directly determining influence on its value....

The determining factor in the value of a good, then, is neither the quantity of labor or other goods necessary for its production nor the quantity necessary for its reproduction, but rather the magnitude of importance of those satisfactions with respect to which we are conscious of being dependent on command of the good. This principle of value determination is universally valid, and no exception to it can be found in human economy. The importance of a satisfaction to us is not the result of an arbitrary decision, but rather is measured by the importance, which is not arbitrary, that the satisfaction has for our lives or for our wellbeing. The relative degrees of importance of different satisfactions and of successive acts of satisfaction are nevertheless matters of judgment on the part of economizing men, and for this reason, their knowledge of these degrees of importance is, in some instances, subject to error.... Error is inseparable from all human knowledge...

Economics, then, is about how mortal, fallible individuals peacefully cooperate in a world of time and scarcity to obtain the things they believe will improve their lives. The arrangement is imperfect, but the coercively utopian conjurings of Marx, Lenin, Trotsky, Mussolini, Stalin, Hitler, Mao, Castro, and even Richard Wolff don't even qualify as alternatives. Read some economic history and trust your own eyes.

TGIF: The Great Carl Menger

There can be no doubt among competent historians that if ... the Austrian School has occupied an almost unique position in the development of economic science, this is entirely due to the foundations laid by this one man.... [I]ts fundamental ideas belong fully and wholly to [?].... [W]hat is common to the members of the Austrian School, what constitutes their peculiarity and provided the foundations for their later contributions is their acceptance of the teaching of [?]. —F. A. Hayek

Who was Hayek writing about?

Carl Menger, of course. Menger (1840-1921), a professor at the University of Vienna, launched the Austrian school of economics with his trailblazing Principles of Economics, published in 1871. (It was not translated into English until 1950.) He is famous for being one of three economists who independently and nearly simultaneously shifted economics onto a radically different track: marginal utility. Hence, the term marginal revolution in economics.

This was a radical recasting of value and price theory. "The value of goods arises from their relationship to our needs, and is not inherent in the goods themselves. With changes in this relationship, value arises and disappears...," Menger wrote. "It is a judgment economizing men make about the importance of the goods at their disposal for the maintenance of their lives and well-being." Menger was not a moral philosopher but an economist, explaining how human action generates market phenomena such as prices.

While the classical economists thought in terms of entire classes of goods and subscribed to the labor, or cost-of-production, theory of value and price, the marginal-utility theorists focused on how individuals act to satisfy their wants. A person chooses and necessarily makes tradeoffs among discrete units of goods—a quart of milk, a dozen eggs, a pound of ground beef—according to his unique personal circumstances: his preferences, purposes, aspirations, likes, and dislikes. He doesn't care how much labor or material went toward making a product. He cares about how useful a product is to his prioritized purposes. The more units he has of a given good, the less valuable any one unit is because he would abandon his lowest ranked purpose if a unit were lost. That's the law of diminishing marginal utility. Overall, that consumers value particular goods imparts value to the factors of production—not vice versa. Means are valued for their contribution to ends. Menger emphasized this change in direction in the flow of value.

In this sense, value is subjective; it's a relationship between a valuer (the subject, or actor) and something he believes will increase his well-being. A person can err about whether a good will affect his well-being, but so long as he expects to benefit, he will value and pursue it. That will influence the market somewhat. (Hence, the commitment to subjectivism in economic analysis does not commit one to subjectivism in philosophy.)

Since personal circumstances vary widely, so do individuals' relative valuation of goods, creating potential mutual gains from trade. In other words, people exchange unequal values from their points of view, contrary to what the classical economists thought. 

Menger took economic subjectivism and marginalism further than his co-revolutionists, William Stanley Jevons and Leon Walras. For instance, he realized that value scales rank rather than measure preferences. There are no utils.

Despite his plan, Menger did not develop his new approach all the way, but he got the ball rolling. That ball was moved further along by his intellectual heirs, including Eugen von Böhm-Bawerk; Ludwig von Mises: F. A. Hayek, who won a Nobel Prize in 1974; Murray Rothbard; Israel Kirzner; and far too many next-generation economists to name. (For more on Menger's achievements, see David Henderson's article "Carl Menger" and Steven Rhoads's "Marginalism." Also see Peter Klein's foreword to the Menger book linked above.)

What I find interesting about Menger lately is his commentary on Adam Smith and the issue Smith is so famous for, the division of labor. I quote from Menger's Principles:

“The greatest improvement in the productive powers of labour,” says Adam Smith, “and the greater part of the skill, dexterity, and judgment with which it is anywhere directed, or applied, seem to have been the effects of the division of labour.” And: “It is the great multiplication of the productions of all the different arts, in consequence of the division of labour, which occasions, in a well-governed society, that universal opulence which extends itself to the lowest ranks of the people.”

In such a manner Adam Smith has made the progressive division of labor the central factor in the economic progress of mankind—in harmony with the overwhelming importance he attributes to labor as an element in human economy. I believe, however, that the distinguished author I have just quoted has cast light, in his chapter on the division of labor, on but a single cause of progress in human welfare while other, no less efficient, causes have escaped his attention.

What escaped Smith's attention? you ask. In reply, Menger described a primitive economy that enjoyed the advantages of dividing up and specializing in the various laborious tasks. To be sure, the people in that economy would be better off than otherwise. But:

Let us now ask whether a division of labor carried so far, would have such an effect on the increase of the quantity of consumable goods available to the members of the tribe as that regarded by Adam Smith as being the consequence of the progressive division of labor. Evidently, as the result of such a change, this tribe (or any other people) will achieve either the same result from their labor with less effort or, with the same effort, a greater result than before. It will thus improve its condition, insofar as this is at all possible, by means of a more appropriate and efficient allocation of occupational tasks. But this improvement is very different from that which we can observe in actual cases of economically progressive
peoples. [Emphasis added.]

Menger here says that the mere division of labor will take a group only so far, but its progress must fall short of what we see in the world. What does he mean?

Let us compare this last case with another. Assume a people which extends its attention to goods of third, fourth, and higher orders, instead of confining its activity merely to the tasks of a primitive collecting economy—that is, to the acquisition of naturally available goods of lowest order (ordinarily goods of first, and possibly second, order). If such a people progressively directs goods of ever higher orders to the satisfaction of its needs, and especially if each step in this direction is accompanied by an appropriate division of labor, we shall doubtless observe that progress in welfare which Adam Smith was disposed to attribute exclusively to the latter factor. We shall see the hunter, who initially pursues game with a club, turning to hunting with bow and hunting net, to stock farming of the simplest kind, and in sequence, to ever more intensive forms of stock farming. We shall see men, living initially on wild plants, turning to ever more intensive forms of agriculture. We shall see the rise of manufactures, and their improvement by means of tools and machines. And in the closest connection with these developments, we shall see the welfare of this people increase.

By "goods of third, fourth, and higher orders," Menger of course meant producer, or capital, goods, that is, intermediate manmade products intended to produce goods for or closer to the consumer level.  Tools, equipment, and machines magnify the productivity of labor many times. Without them, human output is meager, even with a division of labor. This is Menger's complex structure of production, the stages of which are classified according to how close or far in time they are from the retail level.

Time (which implies risk) is revealed as critical. The higher the order, the longer the period until the final good is ready for sale to consumers. "Thus," Menger wrote, "in the process of change by which goods of higher order are gradually transformed into goods of first order, until the latter finally bring about the state called the satisfaction of human needs, time is an essential feature of our observations." Radical.

The further mankind progresses in this direction, the more varied become the kinds of goods, the more varied consequently the occupations, and the more necessary and economic also the progressive division of labor. But it is evident that the increase in the consumption goods at human disposal is not the exclusive effect of the division of labor. Indeed, the division of labor cannot even be designated as the most important cause of the economic progress of mankind. Correctly, it should be regarded only as one factor among the great influences that lead mankind from barbarism and misery to civilization and wealth....

The Austrian school thus started with Menger's observation that Adam Smith, widely held to be the father of economics, overlooked "the most important cause of the economic progress of mankind." That took some confidence.

In its most primitive form, a collecting economy is confined to gathering those goods of lowest order that happen to be offered by nature. Since economizing individuals exert no influence on the production of these goods, their origin is independent of the wishes and needs of men, and hence, so far as they are concerned, accidental.

People in such a condition are fundamentally passive concerning their environment. A low standard of living should surprise no one.

But if men abandon this most primitive form of economy, investigate the ways in which things may be combined in a causal process for the production of consumption goods, take possession of things capable of being so combined, and treat them as goods of higher order, they will obtain consumption goods that are as truly the results of natural processes as the consumption goods of a primitive collecting economy, but the available quantities of these goods will no longer be independent of the wishes and needs of men. Instead, the quantities of consumption goods will be determined by a process that is in the power of men and is regulated by human purposes within the limits set by natural laws. Consumption goods, which before were the product of an accidental concurrence of the circumstances of their origin, become products of human will, within the limits set by natural laws, as soon as men have recognized these circumstances and have achieved control of them.

Human beings moved from passive to active in satisfying their wants. That was a turning point in history.

The quantities of consumption goods at human disposal are limited only by the extent of human knowledge of the causal connections between things, and by the extent of human control over these things. Increasing understanding of the causal connections between things and human welfare, and increasing control of the less proximate conditions responsible for human welfare, have led mankind, therefore, from a state of barbarism and the deepest misery to its present stage of civilization and well-being, and have changed vast regions inhabited by a few miserable, excessively poor, men into densely populated civilized countries. Nothing is more certain than that the degree of economic progress of mankind will still, in future epochs, be commensurate with the degree of progress of human knowledge. [Emphasis added.]

If only he could see what reason, capital accumulation, division of labor, and trade have wrought! The lesson we should take from Menger is that all government actions that obstruct the formation of capital and free exchange—such as tariffs, to pick a random example—torpedo human welfare.

TGIF: Freedom or Power

Eugen von Böhm-Bawerk, the Austrian-school economist who learned from Carl Menger and taught Ludwig von Mises, speaks to the ages. We ignore his lessons to our peril. One hundred ten years ago, in a journal article titled "Control or Economic Law," he wrote:

[J]ust as natural phenomena are governed by immutable eternal laws, quite independent of human will and human laws, so in the sphere of economics there exist certain laws against which the will of man, and even the powerful will of the state, remain impotent; and that the flow of economic forces cannot, by artificial interference of societal control, be driven out of certain channels into which it is inevitably pressed by the force of economic laws.

In other words, contrary to what politicians say, we as a society cannot do anything "if only we have the will." Böhm-Bawerk went on:

Such a law, among others, was considered to be that of supply and demand, which again and again had been observed to triumph over the attempts of powerful governments to render bread cheap in lean years by means of “unnatural” price regulations, or to confer upon bad money the purchasing power of good money. And inasmuch as in the last analysis, the remuneration of the great factors of production—land, labor, and capital—in other words, the distribution of wealth among the various classes of society, represents merely one case, although the most important practical case of the general laws of price, the entire all-important problem of distribution of wealth became dependent upon the question of whether it was regulated and dominated by natural economic laws, or by the arbitrary influence of social control.

Böhm-Bawerk was not saying that economic laws were invulnerable to political and social interference or institutions—far from it. The government distorts the market all the time. That's why his lesson is so important. We'd hardly need to be taught about the importance of economic laws if intervention bounced off market participants like bullets off of Superman.

Price controls bring forth not an abundance of low-priced goods to help the poor but shortages of wanted products. Today many people suffer the hardship of government suppression of the building of new houses and apartments. (See Bryan Caplan's Build, Baby, Build: The Science and Ethics of Housing Regulation.)

In any given case, how much influence market forces and nonmarket control have is not an easy question. It takes study rather than dogmatism. However, even political intervention must operate within the law of price. Repeated efforts to abolish interest on loans (usury) have failed because lenders and borrowers eagerly found ways around the prohibition. Markets—bargaining based on subjective marginal utility—will operate despite the formidable obstacles rulers place in their way. That's true for all prices. Thank goodness for that. But consumers will be harmed, and the state's ostensible objectives won't be achieved. 

Böhm-Bawerk notes that the most "selfish" single-seller in the market (assuming no government protection) must contend with the economic laws: "Generally speaking, the fear of outside competition forms perhaps the greatest safeguard against too unscrupulous a use of monopolies preying on the general public." Nothing invites competition like abnormally high prices and profits. That's why would-be monopolists turn to the government for help. Their dreams of power are doomed without it. (Antitrust law is a fraud. It protects inferior companies, not consumers.)

The same is true in a labor market where only one buyer of labor services (employer) is active. If he pays too much or too little under market conditions, economic forces will let him know -- if the government stays out. Profit or loss, success or bankruptcy? That is the question. 

Böhm-Bawerk would understand what's happening with fast-food restaurants in California, where the government has mandated a large increase in the minimum wage:

If an entrepreneur is induced, through the motive of self-interest, to select the “minor evil,” and permits a wage increase exacted from him, then an analogous motive of self-interest will urge him to reorganize the various factors of production by means of which he produces his goods. If the factor of production called “labor” has become more expensive than before, in comparison with the other factors of production, through an extorted wage increase, then it is almost unthinkable that the same relative apportionment of the various factors of production would remain the most rational in an economic sense....

California fast-food joints are closing, substituting machines for human beings, or raising prices. It's happened many times all over the country.

[T]he most imposing dictate of power ... can never effect anything in
contradiction to the economic laws of value, price, and distribution; it must always be in conformity with these; it cannot invalidate them; it can merely confirm and fulfill them.

Mises picked up his teacher's theme. As Israel Kizner writes in his book Ludwig von Mises: The Man and His Economics, quoting from his teacher's Epistemological Problems of Economics,

Mises saw the emergence of economic understanding in the eighteenth and early-nineteenth centuries as introducing a genuinely revolutionary insight into man's understanding of the conditions within which society exists.... With the advent of economic science, [Mises wrote,] "Now it was learned that in the social realm too there is something operative which power and force are unable to alter and to which they must adjust themselves if they hope to achieve success, in precisely the same  way as they must take into account the laws of nature."

Society does not face a choice between control and economic law. Rather, the choice is between unhampered consumer-enhancing economic law and economic law twisted against consumers by bureaucrats. That is because, as Mises wrote in Omnipotent Government: The Rise of the Total State and Total War, "economic laws are inexorable, and ... government interference with business cannot attain its ends but must result in a state of affairs which—from the point of view of the government and the supporters of its policy—is even less desirable than the conditions which it was designed to alter."

TGIF: Ducking Hayek

May 8 marked the 124th anniversary of the birth of F. A. Hayek, the 1974 Nobel-winning economist of the Austrian school. (He died in 1992.) That makes it a good time to acknowledge one of his many contributions, his epistemic case for the free and competitive market order. It's well-suited to the information age.

One of Hayek's best-known articles was published in 1945 in the American Economic Review: "The Use of Knowledge in Society" (reprinted in Individualism and Economic Order). He got right to the point:

What is the problem we wish to solve when we try to construct a rational economic order? On certain familiar assumptions the answer is simple enough. If we possess all the relevant information, if we can start out from a given system of preferences, and if we command complete knowledge of available means, the problem which remains is purely one of logic. That is, the answer to the question of what is the best use of the available means is implicit in our assumptions....

This, however, is emphatically not the economic problem which society faces.... The reason for this is that the “data” from which the economic calculus starts are never for the whole society “given” to a single mind ... and can never be so given.

The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is ... a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know.

This is an important matter of course. In a world of scarcity and incomplete knowledge, where much vital information is not "data" at all but unarticulated "knowing how," we don't want resources and labor services used in just any old way. Rather, we want them put to the best use in the eyes of diverse and fickle consumers -- and at the lowest cost possible so can we have more goods and more choices. We also want inevitable errors in production to be readily discovered and corrected. Finally, in a division of labor we want coordination to be as easy as possible.

Can we have all that? Fortunately a solution is available.

Thus Hayek wrote:

Fundamentally, in a system in which the knowledge of the relevant facts is dispersed among many people, prices can act to coördinate the separate actions of different people in the same way as subjective values help the individual to coördinate the parts of his plan....

We must look at the price system as such a mechanism for communicating information if we want to understand its real function....  The most significant fact about this system is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action.... It is more than a metaphor to describe the price system as a kind of machinery for registering change, or a system of telecommunications which enables individual producers to watch merely the movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their activities to changes of which they may never know more than is reflected in the price movement.

He illustrated the point by describing how consumers and producers tend to economize on a material (he used tin) when the price goes up, even though only a few people know why the price has gone up. The price rise will encourage people to use less and or to use known substitutes and even discover substitutes. Others will be induced to search for new supplies of that material using new technology. Innovation will result. An economy run by politicians cannot approach this process.

What the price system accomplishes when left free is no mean feat. It makes longer and more prosperous lives possible for everyone. In a world of eight billion people, the unsexy price system is literally a lifesaver on a mass scale. Keep that in mind when politicians and activists call for interference with production and commerce.

We can't acknowledge Hayek's contribution without also paying tribute to his teacher Ludwig von Mises, which Hayek indeed did in other articles. For example, "Professor Mises' [1920s critique of socialism] represents the starting point from which all the discussions of the economic problems of socialism, whether constructive or critical, which aspire to be taken seriously, must necessarily proceed." Hayek, who had favored socialism before he met Mises, also wrote that Mises's "central thesis could not be refuted." (Hayek, "Socialist Calculation I: The Nature and History of the Problem," in Individualism and Economic Order.)

Hayek was referring to Mises's 1920 pathbreaking paper, "Economic Calculation in the Socialist Commonwealth," and his 1922 book, Socialism: An Economic and Sociological Analysis. Mises's fundamental point, which logically precedes Hayek's later addition, was that without real, honest market prices for all inputs, the economic calculation required for rational and efficient mass production would be impossible. And, he went on, you can't have honest market prices without private ownership and markets in resources and producer goods. (The Marxists sought the abolition of private property.) Flourishing and even life itself thus depend on prices and their prerequisites -- prices that cannot be ascertained or even generated except in the market, where producers and consumers act according to their personal and often improvised preferences, make unpredictable discoveries about what circumstances they prefer, and choose among real, not hypothetical alternatives. Bureaucrats and economists cannot simulate this process, no matter how powerful their supercomputers are.

This critique was devasting to all forms of socialism (including fascism), and history has proved Mises and Hayek correct. Remember, socialism was supposed to be the all-around better way to deliver prosperity to all.

Many people who should know better pretend that Mises and Hayek never found these flaws in socialism. Shame on them. As for others who say they favor socialism, what's concerning is not that they've heard Mises's and Hayek's critiques and answered them, but that they have never heard them at all! Enter the libertarians.

TGIF: Equal Rights Now!

A pet peeve of mine is the distinction, drawn even by some market enthusiasts, between so-called personal liberty (or civil liberties) and economic liberty. The former, which usually includes freedom of conscience and religion, speech, and press, is thought to be noble and spiritual, while the latter, related to commerce and the pursuit of wealth, is held to be vulgar and materialistic. This has its roots in the thinking of the ancients.

The distinction thrills the hearts of those who disparage markets and "economic freedom," Pro-market thinkers use the distinction for understandable analytical purposes. but I see no reason to leave the anti-market activists unchallenged on the point.

A New Deal-era Supreme Court case -- upholding the federal power to ban interstate commerce in filled milk -- embraced the division of freedoms when the majority in a famous footnote stated that "there may be narrower scope for operation of the presumption of constitutionality when legislation appears on its face to be within a specific prohibition of the Constitution, such as those of the first ten Amendments, which are deemed equally specific when held to be embraced within the Fourteenth." That sentence meant in essence that government interference with economic liberty did not require the same strict scrutiny that interference with personal liberty required. How the justices ignored the protection of property rights in the Fifth and Fourteenth Amendments or Article I, Section 10's protection of contracts against the states is a mystery to me, but the upshot is that Congress and the state legislatures were given greater latitude to regulate what were regarded as economic activities.

Calling this "arguably the most important footnote in U.S. constitutional law," one commentator wrote, "Footnote four of United States v. Carolene Products Company, 304 U.S. 144 (1938) presages a shift in the Supreme Court from predominately protecting property rights to protecting other individual rights, such as those found in the First Amendment." (Emphasis added.) With the word other, this statement at least includes property rights among our individual rights, which is more than most fans of the footnote and its underlying philosophy do.

Any way you slice it, over 80 years ago the Supreme Court declared that some rights or freedoms are more equal than others. Most of the intellectual elite would agree. So the idea of equal rights became old-fashioned. And so it is today.

This two-tiered system in which some rights are second-class -- which means they are not really rights at all! -- ought to be rejected. Individuals are integrated beings who pursue ends of many kinds every waking hour. Moreover, material possessions are as important to people's life-affirming pursuits as any nonmaterial values.

Thomas Sowell put it well when he wrote in Basic Economics: "Of course there are non-economic values. In fact, there are only non-economic values."

Economics is indispensable because it explores what goes on socially and individually when people engage in exchange for any reason or abstain from doing so. The discipline focuses on the intended and especially unintended consequences of exchange, including the emergence of money to replace barter and the generation of relative prices in markets. That economists ignore some kinds of activities does not make those activities nobler than other sorts.

Besides, engaging in so-called personal liberty has economic implications because such liberty involves material objects. Free speech requires the use of resources, which in a modern society are acquired in the market. At the very least, a speaker has to stand somewhere. All activities have some, even if only slight, consequences in the market. They affect employment; they favor and disfavor certain kinds of businesses; and they change the prices of goods. If someone works long hours for money in order to visit the world's great museums, architectural wonders, and symphony halls, is that perso engaged in an economic or non-economic pursuit?

At any rate, it makes no sense to artificially divide (non-invasive) human activities in the conventional way, especially when the disparagement of commerce is the purpose. All natural rights deserve equal protection under the law. The government should have no power to discriminate.

Two economists who emphasized the general character of all human action were Ludwig von Mises, a pillar of the Austrian school, and the British economist Philip Wicksteed. Mises called the analysis of the logical structure of all human action praxeology, and he pointed out that economics is simply the best-developed branch of that discipline. He wrote in Epistemological Problems of Economics, "Everything that we say about action is independent of the motives that cause it and of the goals toward which it strives in the individual case. It makes no difference .... whether it is directed toward the attainment of materialistic or idealistic ends...."

And in The Common Sense of Political Economy, Wicksteed, who has been called the "British Austrian" because of his work's compatibility with the Austrian school, wrote, "It follows that the general principles which regulate our conduct in business are identical with those which regulate our deliberations, our selections between alternatives, and our decisions, in all other branches of life.... I shall try to shew that it is time frankly and decisively to abandon all attempts to ... establish any distinction whatever between the ultimate motives by which a man is actuated in business and those by which he is actuated in his domestic or public life. Economic relations constitute a complex machine by which we seek to accomplish our purposes, whatever they may be." (Read more here and here.)

So let's have no more about the unequal status of economic and personal liberty. They are one.

Cost-Benefit Analysis Is Poor Guide to Government Action

My latest column for the American Institute for Economic Research is "Cost-Benefit Analysis Is Poor Guide to Government Action."

TGIF: Immortal Keynes?

Whatever you may think of Keynesian economics, you have to give it credit for one thing: its staying power.

 Read about it here.

Bastiat and Subjective Marginal Utility

Frederic Bastiat really was a precursor of the Austrian school. 

Menger was indeed a revolutionary, but that does not mean that no one before him glimpsed ideas that would later blossom into the Austrian school. As far back as Socrates, thinkers grasped the theory of subjective value in the praxeological sense, and we find a nearly complete subjectivist-marginalist framework 20 years before Menger took pen to paper — in the work of Frédéric Bastiat.

In Bastiat’s unfinished magnum opus, Economic Harmonies (1850), he, like Menger, put the spotlight on the choosing individual and what she tries to accomplish through exchange. Trade, for Bastiat, is an exchange of services that will render useful things: I’ll do something for you (furnish a useful thing, for example) if you do something for me. It’s up to each individual to evaluate the terms and decide if the exchange is worthwhile. Methodological individualism, marginalism, and subjectivism are all to be found in Bastiat.

Read about it here.

TGIF: Loving Economics

TGIF this week is a review essay of Peter Boettke’s new book, Living Economics: Yesterday, Today, and Tomorrow. Enjoy!

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TGIF: "Economy or Catallaxy?
Op-ed: "The Ominous U.S. Presence in Northwest Africa"
Op-ed: "Mali: Here We Go Again"
TGIF: "Government Undermines Social Cooperation"
"World War II Spending Did Not End the Great Depression"
"No More Corporate Welfare"
"Against Government Debt"

How the Rich Rule

My article by that name is now online at The American Conservative. One aspect of the article has been criticized by market monetarist Scott Sumner at his blog (and previously here and here). It has set off quite a debate over the Austrian position on "Cantillon effects" from government-created money; this is the idea that when the Fed creates money it enters at particular points in the economy and through the possession of particular individuals. It doesn't get evenly distributed throughout the economy with no real effects.

Another critic, Nick Rowe, weighs in too.

The Law of Cost, cont’d.

More from Philip Wicksteed, The Common Sense of Political Economy:

We can now see how "cost of production," which is simply and solely "the marginal significance of something else," directly affects the quantity of anything produced, and thereby indirectly affects its price, so that there is a constant tendency for prices to conform to cost of production; that is to say, for the price of the thing I make and the price of the thing I might have made instead of it to coincide….

The Law of Cost

For anyone who thinks that costs do not govern value and price, hear Philip Wicksteed, the British "Austrian," thoroughgoing subjectivist, and critic of Alfred Marshall (not to mention admired by Mises). From The Common Sense of Political Economy:

In no case can the cost of production have any direct influence upon the price of a commodity, if the commodity has been produced and the cost has been incurred; but in every case in which the cost of production has not been incurred, the manufacturer makes an estimate of the alternatives open to him before determining whether, and in what quantities, the commodity shall be produced; and the stream of supply thus determined on fixes the marginal value and the price. The only sense, then, in which cost of production can affect the value of one thing is the sense in which it is itself the value of another thing. Thus what has been variously termed utility, ophelemity, or desiredness, is the sole and ultimate determinant of all exchange values.

TGIF: Value, Cost, Marginal Utility, and Bohm-Bawerk

Does cost of production determine price or does price determine cost of production? In the world of economic caricatures, the classical economists (Smith, Ricardo, et al.) took the former position, the Austrians the latter. Specifically, the Austrian view supposedly is that that demand driven by marginal utility determines the price of consumer goods, which is then imputed backward to the factors of production.

But like all caricatures, the picture is an imperfect reflection of reality.

The rest of TGIF is here.

The Austrians and the Classicals

It is not without wisdom that Lionel Robbins says, in his introduction to Wicksteed’s Common Sense of Political Economy, “a very good case could be made out for the view that, with all their differences, the systems which seem to make the clearer break with the past are, in fact, nearer in spirit to the classical system than those which have preserved more closely the classical terminology and apparatus.” The system making the clearer break, of course, is that of Austrian economics. The one more closely preserving the classical terminology is that of Alfred Marshall.

--George Reisman
"Eugen von Böhm-Bawerk’s 'Value, Cost,
and Marginal Utility'" (pdf)

TGIF: The Importance of Subjectivism in Economics

For an exchange to take place, the two parties must assess the items traded differently, with each party valuing what he is to receive more than what he is to give up.

Read the rest of TGIF: The Importance of Subjectivism in Economics.

Setting the Price

Someone once said that economics is about price formation. The price of a reproducible good is set between two boundaries. The upper limit is governed by subjective marginal utility. I don't want to pay more for a product than it's worth to me, meaning: I will not forgo something of I value more in order to obtain something I value less. Neither will anyone else. Luckily the price is not set (in the long run) by utility. Why is this a good thing? Because I and everyone else I know love consumer surplus. We want maximum value at minimum sacrifice.

Under freedom of entry and open competition -- without government privilege or monopoly -- the price can be expected to be driven down from the upper boundary toward the lower boundary.

But what governs the lower boundary? The floor can't be zero because by and large people don't produce goods in order to give them away. They intend to sell them. So the lower boundary must be greater than zero. What determines that amount?

Talk amongst yourselves.

TGIF: Austrian Exploitation Theory

Eugen von Böhm-Bawerk (1851-1914), the second-generation giant of Austrian economics, famously refuted the theory, most commonly associated with Marx, that the employer-employee relationship is intrinsically exploitative. Less well known is that Böhm-Bawerk had an exploitation theory of his own.

The rest of TGIF: Austrian Exploitation Theory is here.

TGIF: Jefferson's Economist

In 1817 the Frenchman the Count Destutt de Tracy (1754-1836) published his Treatise on the Will and Its Effects. Thomas Jefferson, who several decades earlier had been the U.S. representative in France, was so enthusiastic about Tracy’s book that he had it translated, then edited and revised the translation himself. He renamed itA Treatise on Political Economy.

The rest of TGIF is here.

TGIF: Being for the Free Market Isn't Enough

Harold Meyerson, an op-ed columnist for the Washington Post, this week launched a devastating attack on what he calls "mainstream economists." Too bad he’s oblivious of Austrian economics.

The rest of TGIF is here.