University of Virginia Library

Search this document 
Dictionary of the History of Ideas

Studies of Selected Pivotal Ideas
  
  

expand sectionV. 
expand sectionIV. 
expand sectionVI. 
expand sectionVI. 
expand sectionVI. 
expand sectionV. 
ECONOMIC HISTORY
expand sectionV. 
expand sectionV. 
expand sectionII. 
expand sectionIV. 
expand sectionIV. 
expand sectionI. 
expand sectionI. 
expand sectionI. 
expand sectionVI. 
expand sectionV. 
expand sectionV. 
expand sectionVI. 
expand sectionVI. 
expand sectionIII. 
expand sectionI. 
expand sectionVI. 
expand sectionI. 
expand sectionIII. 
expand sectionVI. 
expand sectionIII. 
expand sectionIV. 
expand sectionVI. 
expand sectionVI. 
expand sectionV. 
expand sectionIV. 
expand sectionVII. 
expand sectionV. 
expand sectionI. 
expand sectionIII. 
expand sectionIII. 
expand sectionIII. 
expand sectionVI. 
expand sectionVI. 
expand sectionVI. 
expand sectionVI. 
expand sectionIII. 
expand sectionVI. 
expand sectionIII. 
expand sectionI. 
expand sectionVI. 
expand sectionVI. 
expand sectionVI. 
expand sectionVI. 
expand sectionVI. 
expand sectionV. 
expand sectionIV. 
expand sectionIV. 
expand sectionIV. 
expand sectionVI. 
expand sectionIV. 
expand sectionIII. 
expand sectionVI. 
expand sectionVI. 
expand sectionV. 
expand sectionV. 
expand sectionVI. 
expand sectionIII. 
expand sectionII. 
expand sectionI. 
expand sectionII. 
expand sectionVII. 
expand sectionI. 
expand sectionI. 
expand sectionIII. 
expand sectionVI. 
expand sectionVI. 
expand sectionV. 
collapse sectionVII. 
  
  
  
  
  
  
  
expand sectionV. 
expand sectionV. 
expand sectionV. 

ECONOMIC HISTORY

The Meaning of the Topic. The title refers to the
history of the science dealing with the general and
hence abstract principles of “economic” conduct and
of the free “economic” social order, based on ex-
change—rather than with the concrete history of either
subject matter. “Pivotal ideas” include a large part of
the important things to be said about modern “liberal”
civilization, a revolutionary development in Western
Europe following the Middle Ages. As the adjective
in quotation marks indicates, the central and distinctive
feature of this civilization is liberty, or the closely
synonymous term, “freedom.” About that, of course,
many books have been written, and many more will
be. Briefly, it refers here to the comparative absence
or minimizing of “compulsory” control over personal
conduct by “society”—its governmental agents and
laws enforced by penalties for infraction—interfering
with people doing as they like and associating on terms
initially agreed upon. Freedom does not mean absence
of “natural” obstacles to action, relative to a person's
“power” to act, which is taken as “given.” It implies
absence of arbitrary interference by other persons,
which liberalism views as the primary function of
coercive law and government to prevent, to assure
maximum freedom for all.

The freedom in question applies in three major
forms, which are inseparable. Primary is freedom of
thought and expression, which largely entails freedom
of action or conduct; and these freedoms are meant
to be assured by political freedom, or “democracy”
in the modern meaning of the term. All exist in an
“institutional” social order—partly compulsory in a
broad “moral” meaning, but largely consisting of usage
established by custom and mostly followed automati-
cally or by voluntary choice. The type of these laws
is that of the language current in a society, but will
include its accepted proprieties or “manners.” Men feel
in varying degree restrained and compelled by custom
as such, as well as by the agencies which have evolved
for securing conformity, chiefly government and reli-
gion. There is some plausibility in Rousseau's famous
statement that men are born free but are everywhere
in chains; but the first part of the statement asserting
natural freedom, though repeated by Jefferson and
Lincoln, is manifestly false or without practical mean-
ing; for a newborn babe has neither will nor power
to act. And in general, the idea of human beings living
outside of limiting social conditions is so unrealistic
as to be essentially self-contradictory.

Institutions, or in the aggregate a “culture,” are of
the essence—the primary distinctive human trait. (The
word “freedom” is used with respect to animals, plants,
and even inanimate objects; but this meaning must not
be confused with that of the human freedom in ques-
tion here. The word “economy” is also used in connec-
tion with living organisms, though not with inert ob-
jects. This causes confusion only as implying a kind
of purposiveness, which dogmatic devotees of mecha-
nistic science often deny—even to human beings—
though the denial itself is a purposive act.)

The problems of a free society, both of explanation
and of guiding its policies in acting as a unit, focus
in the relations among the three main social expressions
or embodiments of freedom—the democratic state, an
“economic” organization through exchange of goods
and services, and the general freedom of communi-
cation and association by voluntary assent and agree-
ment. Logically, and especially in a historical view,
the first requirement for freedom is religious, i.e., ab-
sence of exercise of power by persons or a “mob”
ostensibly acting for a supernatural source. This calls
for notice especially because modern free society
developed out of an antecedent medieval social order
explicitly based on religion—and practically because
of the persistence of such presuppositions in the short
modern epoch in which democratic ideals have been
nominally accepted. These were first effectively born
in seventeenth-century Britain, out of a three-cornered
struggle for power between a sovereign claiming to
rule by divine right, a partly representative Parliament,
and a judiciary and legal profession.

Many features had existed before in varying degree,
in Greece and Rome and even in medieval Europe (and
some non-European lands)—notably the rule of law in
contrast with government by arbitrary command; but
the “pivotal idea” of free society is government by
consent of the governed, or in ideal terms, self-rule.
For a group this is possible in only one way, by having
the laws made and enforced by the people subject to
them, as far as possible; i.e., by agents chosen by a
majority, under free and equal suffrage. Majority tyr-
anny is limited only by moral forces and finally overt
resistance.


045

The analytical science of economics, under its pres-
ent name, goes back less than a century. The discipline,
in its most distinctive features, is about a generation
older; it grew out of the preceding “political econ-
omy,” which arose in the late eighteenth century as
an aspect of the “Enlightenment” and revolutionary
period, marked by the American and French Revolu-
tions; it is also called the Age of Reason. This period
of individualism followed a few centuries of “national-
ism” beginning at the “Renaissance” with the founding
of modern states as monarchies, through concentration
of feudal power. This individualistic efflorescence,
along with modern science, led to the Protestant Revolt
and Wars of Religion, resulting in displacement of the
Church as the supreme authority by a plurality of
states. Renaissance civilization was as much, if not
more a new birth as a rebirth (of classical antiquity).
Its most “pivotal” concrete aspect was surely the
launching or impetus given to modern science through
the work of Copernicus (1543) and Galileo (ca. 1610)
in astronomy and mechanics, and of Vesalius (also 1543)
in anatomy. Growth of trade, after the Crusades, was
an important stimulus to liberalization. A major fore-
runner was Leonardo da Vinci (d. 1519). Newton,
roughly speaking, completed the movement in physical
science, and in mathematics; René Descartes should
be named, but after the beginning in Italy and
Germany, the main development was British. The
effective religious revolt started, of course, in Germany
with Luther, but England had important forerunners
of both aspects, in John Wycliffe and Sir William
Gilbert.

The Idea of Economics. The history of analytical
economics should begin with the coining by Plato's
contemporary, Xenophon, of the word oikonomikos. It
combines two words meaning a house, household or
estate, and a verb, to manage, or rule. In the Middle
Ages, the Latin form was used with several meanings,
one theological. In the seventeenth century the concept
began to be applied to the management of a “state”—
under the French name économie politique; this fol-
lowed when the establishment of absolute monarchy
made the state the “estate” of the king. In German,
the doctrine was called “cameralism.” At about the
same time, the word “economy” and its relatives began
to take on the general meaning it now bears—the
“effective” use of means to achieve an end, both means
and end being “given.” The doctrine of the preceding
nationalistic literature is commonly called “mercantil-
ism,” because the writers advocated increase of na-
tional wealth by an excess of exports over imports, the
difference to be received in “money” (gold or silver).
Exposure of the fallacy of confusing money with
wealth, especially in the Essays of David Hume, at
the middle of the eighteenth century, is important for
the transition to political economy, later replaced by
economics.

During the mercantilistic period, apart from the
propaganda for a “favorable” balance of trade, some
writers in England discussed governmental activities
more descriptively, and with some reference to policy.
They also broached topics which were to become
central later, notably the meaning and determination
of economic value. The leader along this line was Sir
William Petty, who wrote in the latter part of the
seventeenth century. He is most famous for his Political
Arithmetick
(1691), which founded the modern science
of statistics. He and contemporaries, such as John
Locke, discussed taxes, interest, and money, and also
wages. The mercantilists held that both wages and
interest should be low, to favor effective trade rivalry
with other nations. Toward the end of the same cen-
tury, writers began to advocate liberalizing interna-
tional trade—sometimes twisting the balance-of-trade
argument to serve this cause. Notable for reasonable
views on trade policy was the work, Discourses on
Trade
(1691; ed. J. H. Hollander, 1935), by Sir Dudley
North, as discovered by modern scholarship.

The Modern Cultural Revolution. What “funda-
mentally” happened in this transition was a culture-
historical or “spiritual” revolution, a “conversion” in
the general mental and social attitude. Such events are
characteristic of the history of Western Europe. Politi-
cally, its civilization first blossomed in Greek city-
states, which were succeeded by Hellenistic and Roman
empires—these in turn by the church-religion culture
of the Middle Ages joined with politico-economic feu-
dalism; this feudal order gave place in the Renaissance
to monarchic “stat-ism.” The Enlightenment replaced
the idea of “L'État, c'est moi” with the radically new
idea of individualism, i.e., freedom. The twin value of
freedom was progress—the two combined as progress
through freedom and freedom for progress, directed
by intelligence. This “Liberal Revolution” is perhaps
the greatest cultural overturn of history. A major result
is that modern men, set relatively free from tradition
and authority, are largely motivated by rivalry. But
this is in large part turned to constructive action by
several “invisible hands”: mutual “material” advan-
tage, sportsmanship, workmanship, and scientific
curiosity—along with public spirit, sympathy, and
benevolence. None of these factors was entirely new,
but the degree to which they burst forth and their
combination constituted a historical revolution.

The new “science” of political-economy was intro-
duced in 1776 by the Scot, Adam Smith, with his
famous book, The Wealth of Nations. Its main thesis
was practical and it dominated its field until about


046

1870, when the modern analytical science of economics
began substantially to develop. The pivotal idea of the
new movement also is freedom, but now as a scientific
postulate based on reason—the (inseparable) economic
and political aspects are more directly pertinent here,
though humanly less important than the religious and
cultural. (Smith's great manifesto for economic free-
dom was nearly simultaneous with Jefferson's Declara-
tion of American Independence, its counterpart in the
political field.) Apart from the fact that freedom itself
is a negative idea—the absence of coercion—it will
be more realistic and more in point to consider as
pivotal the fallacious ideas replaced rather than the
essentially obvious ones introduced.

A major lesson to be learned from the history of ideas
is to realize the “glacial” tardiness of men, including
the best minds, in seeing what it later seems should
have been obvious at the first look. This is strikingly
illustrated by the concept of economy. People have
always practiced it—have “economized,” in many
connections—but have been unaware of the principle,
much as the famous M. Jourdain in Molière's le Bour-
geois Gentilhomme
had talked prose from childhood
but was surprised to learn the fact. People have even
specialized, and exchanged products in crude markets,
and for millenniums have used “money” of some form.
But in physical nature it also took many centuries to
grasp the idea of “inertia,” a fact seriously encountered
constantly in everyday life; Aristotle and later great
thinkers thought that any motion once started would
cease unless maintained by the continuous action of
some force—until Galileo showed the opposite to be
the case.

Adam Smith did not entitle his book “political econ-
omy,” presumably because this had recently been used
by his countryman Sir James Denham Steuart for a
major work, Inquiry into the Principles of Political
Economy
(1767), which properly belonged more to the
preceding “mercantilist” school. Both economic and
political freedom had been developing through “his-
torical forces” for over a century, notably in Britain,
and Smith's book was essentially “propaganda” for
more complete economic freedom (later called “laisser-
faire,” now “laissez-faire”). Neither he nor his political-
economist followers argued their case in terms of what
is now considered rational economic analysis. They had
no conception of a maximum return from resources,
specifically as obtained through correct allocation
among alternative uses. (And they took little notice
of “technology,” though they wrote at the height of
the “industrial revolution,” in which that was the major
factor, and it is surely the crucial fact in the popular
conception of economy.) The two main themes of
economic analysis, price and distribution, were ap
proached by way of absurd presuppositions, especially
the second, which the writers failed to see as a matter
of pricing the means of production. They adopted a
moralistic or social-empirical conception of a division
of the social product into three “shares,” wages, land-
rent, and “profit,” the three forms of income popularly
recognized, which were wrongly assumed to come
from three distinct sources and to be received by three
different social classes.

Epochs in the Evolution of Economic Thought.
Before taking up the transition to analytical economics,
it seems in order to relate the whole development to
West-European history by distinguishing its main
stages. Such a scheme will fit the recognized historical
periods, and happens to present a neat cross-dichotomy
—two main divisions, each with two subdivisions,
which may be labelled I-A, I-B, and II-A and II-B. The
main changes affect the objectives attributed to people
by writers and thought to be proper as ends of social
policy. In the first major epoch, extending from the
beginnings in Greece through the Middle Ages (I-A
and I-B), the aim was social and may be called idealistic
or spiritual, in contrast with later “individualism” and
“materialism.” Ends were stressed, rather than means.
(Max Weber thought the Greek spirit that of comrades
in arms.) Writers looked to the persistence and pros-
perity of the small city-state with its culture, which
bequeathed to later times a great literature and
art—and the word “democracy,” though not the fact
as now conceived.

The next sub-epoch (I-B) begins with the decline of
imperial Rome and conversion to mystery cults, finally
to ecclesiastical Christianity. (Gibbon called it the
triumph of barbarism and religion.) The purported end
of living was “salvation,” for a future eternal life, this
world being given up as a vale of tears and man as
born to sin, curable only by supernatural action. The
political order—while waiting for the Parousia (Second
Coming, end of the world) was a theocracy, i.e., a
clerocracy, headed by the autocratic Pope of Rome.
As typical for authoritarian regimes, its first real con-
cern was its own power. In the West, “feudalism” was
variously joined with this; in the East, several patri-
archates were subject to the Emperor in Constantinople
(new Rome) until the rise of Islam. This church-state
conquered most of the old Roman empire, though
turned back by the Franks at Tours in 732; in 1453
the Turks took Constantinople, ending the Byzantine
Empire (and for some it marks the end of the Middle
Ages).

The transition to the second major epoch (II-A) was
made at the “Renaissance”—in many ways more a new
birth than a rebirth. In Northern Europe it was marked
by the Protestant Revolt (“Reformation”). Feudal


047

power became concentrated in nominally “absolute”
monarchies, and in the ensuing Wars of Religion, polit-
ical (and economic) interests increasingly predomi-
nated. None of the protagonists wanted religious toler-
ation, let alone general freedom, and the main result
was a transfer of authority from the Church to new
states, monarchies under sovereign by divine right.
Social thinking became state centered, aimed at na-
tional aggrandizement. However, the states were sev-
eral, and rivalry for power forced them to tolerate,
even encourage, freedom in trade and industry and
hence in science, for the sake of the new wealth they
yielded, which the monarchs could tax.

Political authority, though also historically sacred,
has been less bound by sanctity than the priestly, and
secularism increased. Passing over details of the history,
most pertinent here is the fact that for a few centuries
“economic” thought was nationalistic—the doctrine of
mercantilism, noticed before. But policy and formal
government were gradually liberalized, specifically in
Britain, notably by the victory of Parliament, defeating
Stuart absolutism, in the Civil War, the “glorious revo-
lution” of 1688, and the ensuing settlement.

The next stage (sub-epoch II-B) begins at the En-
lightenment, the late eighteenth century, centered
largely in France; with American independence, that
new nation took the lead, while in France, revolution
was followed by reaction, causing a setback for liberal-
ism in Britain.

It is the age of individualism, hence of freedom, and
in economic thought, of “laissez-faire.” But from this
viewpoint, it should be subdivided: first came a century
of “political economy”—propaganda for laissez-faire—
extending from Smith's Wealth of Nations of 1776 to
the rise of objective economic analysis in the “subjec-
tive-value revolution” of around 1870—promoted in-
dependently by W. S. Jevons, Carl Menger, and Léon
Walras. The major premiss of individualistic philosophy
is that the only value is personal well-being, and each
is the best judge of his own and of the action that will
promote it—particularly in contrast with the state.
(Other groups, notably churches, were in liberal theory
reduced to voluntary associations, without authority—
science and criticism having destroyed the supernatural
appeal.) The state is practically a means only, its chief
function to maintain freedom by preventing “preda-
tion” i.e., force and fraud. (Adam Smith had added two
other functions, defense and “certain public works.”)
In politics, liberalism introduced democracy—self-
government through laws made by freely chosen rep-
resentatives—meant chiefly to prevent government
from trespassing on liberty, and at the time to reduce
greatly its scope of action with that of law. Necessary
sweeping qualifications of the liberal credo have been
recognized and will be noticed here in due course.

The Major Fallacy of the Political Economists.
Pivotal, as the fountainhead of analytical fallacy, was
an apparent mental fixation on labor as alone really
productive. (The idea came from folklore; cf. Genesis
3:19.) Smith began his book with the statement that
“The annual labor of every nation [italics added]...
originally supplies it with all the necessaries and con-
veniences which it annually consumes....” He at once
qualified this to read “useful” labor—a part of that
performed by the fraction of the people who work at
all—later defined in a confusing way. The main deter-
minant of the productivity of labor is the proportion
of those who perform useful labor. His first chapter
is to deal with the “greatest improvement,” which is
specialization (he calls it “division of labor,” though
other means of production are as much specialized).
This, he says, works in three ways: to increase skill,
to save the time of shifting from one task to another,
and to increase the application of proper machinery.
(This is a main component of “capital,” but generations
were required to correct the classical view of that
concept—and much of the world still views “property”
as a means for exploiting workers; even the free nations
commonly impute all “productivity” to labor.) “Stock”
(capital) is the subject of Book II; it is defined as sup-
port for laborers, chiefly food, “advanced” by persons
who have a surplus beyond their own needs for con-
sumption. Book III (“Of the Different Progress of
Opulence in Different Nations”) is short and chiefly
historical and propagandistic.

The main thesis of the whole work is found in Book
IV, on “Systems of Political Economy,” and is practical,
not analytical. Two systems, the commercial or mer-
cantile, and the agricultural, are considered and con-
demned, on vague grounds, so that “the obvious and
simple system of natural liberty establishes itself of its
own accord” (Modern Library [1937], p. 651). How-
ever, Smith at once introduces three qualifications, as
tasks (and “expenses”) of the sovereign: “defense,” an
exact system of justice, and maintaining certain public
works. These might be construed to allow an indefinite
scope of public action, but the author's long discussions
need not be considered in detail. (Especially note-
worthy is an eloquent, almost florid plea for a little
rudimentary education, by local parishes, to offset the
evil effects on human beings of extreme specialization.)

Returning to Book I, Chapters II and III continue
with the division of labor. Chapter IV treats the “origin
and use of money,” but is chiefly remarkable because
the author turns abruptly at the end to discuss exchange
value, and introduces the labor theory. Contrasting
exchange value and use value, he rejects the latter as
a cause, noting that things which have the greatest


048

value in use have frequently little or no value in ex-
change (and conversely), illustrated by the famous
contrast between water and diamonds. And his polit-
ical-economist followers followed this lead for nearly
a century. “Utility” was held to be a condition of value,
but not a cause—or measure, two things which were
badly confused. Ignored were the two essential and
obtrusive facts: first, that prices pertain to units of
goods, which men buy and sell, not whole categories;
and secondly, that the use value of a unit decreases
as the quantity of the good increases. A buyer adds
and a seller subtracts an “increment” of a stock (per-
haps beginning or ending with none). The comparison
is between having a little more or less of one good
and of the other, making incremental utility relative.

However, but for the fact of separately diminishing
marginal utility, one's purchasing power would all be
spent on the good with the greatest initial appeal.
Furthermore, the law of decrease holds under any
realistic conditions; the want for (satisfying power of)
any good is progressively satiable. Discovery (effective
recognition) of this obvious fact came nearly a century
after Smith. It will be stressed as the pivotal idea
marking the break from political economy to econom-
ics, and still later it was gradually seen that a parallel
principle holds for applying resources in production.

Smith's Chapter V of Book I—on “Real and Nominal
Price”—constantly asserts the labor theory, and con-
fuses value measurement with its causality. “Equal
quantities of labor,” we read, are of equal value to
the laborer. This is false for exchange value and hardly
makes sense. One might rate two tasks as (about)
equally irksome, but could hardly pronounce one a
numerical multiple of the other in that respect; and
where different workers are involved, any comparison
becomes dubious. However, there is sense in Smith's
proposal to take the customary day's wage for common
labor as indicating the relative value of money in
comparable situations separated in space or time. A
statistical tabular standard (index number) of prices was
suggested after Smith's death in 1790, but was rejected
by David Ricardo (Smith's most famous follower) as
not measuring production cost (in labor or wages), by
which he practically measured and defined economic
value.

To Smith's credit, his further discussion of value
(Book I, Chapters VI, VII) though imputing the whole
product to labor, with other shares as deductions,
qualifies labor cost for differences in irksomeness and
skill and also restricts the labor theory of value to a
(fictitious) primitive society. Then, when “stock” has
accumulated and land been appropriated, the product
must be shared with their owners, and these payments
enter into exchange value. (Of course it is the scarcity
of land and competition between uses, not private
ownership, which makes rent a cost.) The view of labor
as the essence of value is replaced by the more realistic
one that the precise worth of a thing is its real cost,
consisting of the rent, wages, and profit that must be
paid to bring it to market (op. cit., p. 55). This is the
“natural” price, which Smith indicates (correctly and
pivotally, if not too clearly) will in fact be set in the
long run by movement of some resources from uses
of less to greater yield. Demand and supply may tem-
porarily fix a “market” price somewhat lower or
higher. Or a “monopoly” may exist, always charging
“the highest price which can be got” (op. cit., p. 61).
This “pivotal absurdity” was repeated by Ricardo, who
added two others (Principles, Groffa and Dorr ed., I,
249).

A pivotal error in the labor-cost theory (and others)
is the failure to see that no cost directly affects price,
if men act with economic rationality. Cost enters into
price only as limiting supply and is the value of re-
sources for other uses, including direct enjoyment out-
side the market; this is the meaning of the irksomeness
of work, and it applies also to nonhuman agents. The
true relation between cost and price, a pivotal idea,
was stressed in general terms by N. W. Senior, in his
Outline of Political Economy, in 1836. Senior also
stated the underlying pivotal idea of “diminishing util-
ity,” but these insights were not recognized until much
later. Senior became famous for introducing the idea
of “abstinence” as a “subjective cost,” along with labor,
to explain profit, and this was endorsed by J. S. Mill.
Both used it to define “capital,” but did not treat it
as a determinant of the supply of the latter and the
price of its use. This came much later, and gradually—
perhaps most clearly stated by Irving Fisher.

“Abstinence” tended to be replaced by “waiting”
(notably with Alfred Marshall). This implies two fal-
lacies: first, that of a “production period”—meaning
that an investment regularly is returned at a later date,
with an increase; and second, that production goods
are produced by primary factors—labor and capital.
People more typically save as social accumulation
requires—for an increased future income of indefinite
duration; thus the waiting is perpetual, i.e., is absti-
nence. Further analysis of these phenomena belongs
to a later point. Senior gave a brief and general state-
ment, correct as far as it goes, of the role of capital
as the use of the produce of industry to increase pro-
duction in the future.

Returning to Smith, it is to be noted that he turned,
in Book I, Chapters VI to XI, to a general discussion
of his “component parts of price” (the costs of produc-
tion): wages, profits, and rent. Some advance toward
analytical economics is made in his Chapter X, “Wages


049

and Profits in Different Employments of Labor and
Stock.” Here he makes his nearest approach to a theory
of “distribution” as now conceived, but he strangely
fails to consider rent. His short Book II deals with the
Nature, Accumulation, and Employment of Stock.
First, under “Divisions,” he distinguishes arbitrarily
between “Circulating” and “Fixed” capital. The for-
mer consists of goods for the owner's consumption, or
purchased for sale at a profit or for productive use by
employing workers. The second includes improvement
of land, and all instruments of production, including
buildings which yield revenue, and also the “acquired
and useful abilities” of the population. Circulating
capital further includes money—specie or paper, sepa-
rately discussed at length in Chapter II—with “provi-
sions,” and partial or complete manufactures.

Especially interesting, and historically pivotal, is
Chapter III, “Of the Accumulation of Capital or of
Productive and Unproductive Labor” [italics added].
Smith states clearly that productive and unproductive
do not mean useful and useless, but refer only to
whether the worker reproduces the “capital” he con-
sumes. (The importance of maintaining capital is well
emphasized in this fallacious view of it.) The main
concern is with the amount of “circulating” capital—
an aspect of the fallacious view just noted—and with
the increase of this through saving (“frugality”). “The
uniform, constant and uninterrupted effort of every
man to better his condition” (op. cit., p. 326) is stressed
as an offset to the extravagance of government and
errors of administration, and also the inclination of the
rich to spend on luxuries (especially on “menial serv-
ants,” rather a pet aversion of his). The “pivotal fal-
lacy” that a given amount of capital in any form can
maintain a definite amount of labor or industry, reflects
an assumption that workers have a fixed living require-
ment; and also the “Malthusian” population theory,
which implied that their numerical increase keeps
wages at this level, regardless of the amount assigned
to their support. (And this was sometimes fallaciously
treated as a fixed “wages fund.”) Diminishing returns
to labor and capital applied to land was also assumed—
perhaps first explicitly stated by Malthus. Only genera-
tions later it was recognized as valid only if technolog-
ical advance is ignored, also that such a law holds for
the use of any factor in increasing ratio to others. The
historical fact has of course been a vast rise of wages,
in spite of redoubling of numbers of workers.

Adam Smith's treatment of prices as in effect ex-
plained by money cost of production—composed of
wages, profit, and rent—implies relations so obvious
for a modern reader that it is rather his failure to state
them clearly that seems to call for explanation. When
we turn to the treatment of these incomes themselves
and look for a tenable view of “distribution,” there
is little to be found. Again to Smith's credit, there is
little of the absurdity introduced by Ricardo (taken
from Malthus and others) that became a cornerstone
of classical political economy—the “residual” or sur-
plus view of rent, with the idea that the main problem
is “to determine the laws which regulate the distribu-
tion” of the social product among three “classes,”
landlords, owners of capital, and laborers (Ricardo,
Principles, original Preface). Smith does speak of dis-
tribution among “ranks and conditions of men” (Part
I, v. iii) and later of the “three great constituent orders
... of every civilized society (op. cit., p. 248). Such
statements shed no light on the distribution that is of
interest today—payments for productive agents, which
are incomes to their owners, and determine their scale
of living.

The “class” distribution idea may derive in part from
the French “Physiocratic” school. It calls for mention
here because it was taken over from Ricardo or his
followers as the basis of Marxism. Marx's pivotal
idea, quite logical, is that since only labor produces,
receiving income from property is robbery of the
workers—Proudhon's famous dictum that property
is “theft.”

The Marxist (pseudo) economic analysis follows
Ricardo logically, drawing the opposite policy impli-
cation, the attack on versus the support of property
and market freedom. Both ignored the distinct role of
the “entrepreneur,” imputing it to owners of wealth.
Both held a subsistence theory of wages and a Malthus-
Ricardo view of land and its rent (but for Marx all
property income is filched from laborers). Profit (in-
cluding interest) arises because labor produces more
than is required for its support. This was most clearly
stated by J. S. Mill (Principles of Political Economy,
Ashley edition, p. 416). By Mill's time, “rent” was
under fire; Mill called it a “surplus,” but opposed
current confiscation yet favored that of future in-
crease—a palpably absurd distinction. Land value is
speculative; any prospect of increase enters into pres-
ent value, and as in gambling, is generally overesti-
mated, so that on the whole losses exceed gains.

The treatment of income distribution in the polit-
ical-economy classics consists of chapters on the three
“shares,” which have little bearing on people's relative
means of support or provision for the future. The dis-
tinction between income and wealth was ignored or
confused; only J. S. Mill discussed “property.” The
three kinds of income were wrongly conceived though
at the time they bore a vague relation to population
sectors with some “class” attributes; and they mean
even less today. As with water and diamonds, land,
labor, and capital are not marketed as categories, but


050

by bits and discrete items which differ vastly within
each class.

No orderly relation among the shares appears; that
inferred now by analysis centers in a few dogmas—first,
the three “factors,” implicitly distinct and homogene-
ous. Labor, applied to land, is supported by “capital”
as provisions advanced—at a subsistence level, due to
the “Malthusian” pressure of population, and “dimin-
ishing returns.” Machinery and other forms of capital
were mentioned—chiefly by Smith and J. S. Mill, but
never fitted into the concept. (By Ricardo, machinery
is mentioned in a puzzling chapter, XXXI, added in
his third edition; and his Chapter XX on Value and
Riches also defies interpretation.) A generous reading
assigns to wages-and-profit what would now be called
their (joint) “marginal” product, of which labor gets
subsistence, capital the rest, and land (the owners en
bloc) take the “surplus.” As simple economic analysis
shows, this is the marginal product of the land, taken
empirically, in small units; and in production land
stands in a symmetrical relation with other kinds of
agents (as does any kind with all others). The chapters
dealing with the “shares” state various conditions
tending to make each larger or smaller (logically in
varying degree).

Economics as a Science. Economics, as noted before,
describes “economic” behavior and an “economic”
social organization, insofar as human conduct conforms
to certain rules, assumed to be known axiomatically,
but not excluding other motives. Since its root idea
is “economy,” which is relative to intentions and these
are not observed by the senses, it is not a strictly
empirical or inductive science. People economize—use
means more or less effectively to achieve ends—but
as certainly, they do not succeed completely in achiev-
ing their ends to the maximum degree possible with
the means under their control; and the ends may not
be ideally good. Ignorance and error play much the
role of “friction” in mechanics, to which science the
study of economics bears a fairly close analogy in
methodology. Motives play the role of forces, which
also are metaphysical, not observed but inferred from
effects—though the basis of knowledge is different in
the two cases. (Friction may be useful, and “efficiency,”
the objective in economizing, is harmful if the end is
bad.) To reduce economic friction (ignorance), men
develop the role of “expert,” and agency relations
permeate free society. Freedom relates largely to
choice of agents, in economics and politics. The main
source of economic knowledge, i.e., of people's minds,
is communication, chiefly by language—the rational
use of which is the special attribute, and mystery, of
man.

The pivotal new logical idea of the subjective-value
revolution is what came to be called “marginalism,”
which happened to be “discovered” first in consump-
tion (later seen to hold in production also). It dawned
on a few minds that the classical rejection of use-value
as a cause of price had been an error because the
economic value of a good reflects the use-value of an
increment (acquired or given up), not that of the com-
modity in the abstract; also that this value depends
on the amount of the good used or transferred, de-
creasing as this amount increases. That is, wants are
satiable (the want for any one good, “other things being
equal”).

This may (and should) seem trivial, but its publica-
tion started controversy, and not all the implications
are yet settled. The simplicity is marred by the fact
(finally recognized) that any good is wanted (used) in
combination with others, hence an increase or decrease
in quantity is a change in proportions, and goods may
be complementary or antagonistic. This does not
weaken the principle of appraisal “at the margin,”
which is valid under all conditions. Proportioning to
equalize marginal utilities clearly “maximizes” the
total: if an increment yields more satisfaction in one
use than in another, the total will be increased by
moving some of it into the field of greater yield, until
equality, for equal indivisible increments, is reached.
The principle had really been expressed by several
writers decades before it got wide recognition through
the works of William Stanley Jevons, Carl Menger, and
Léon Walras—most notably perhaps by N. W. Senior
and W. F. Lloyd in Oxford (in the 1830's); also earlier
by Jules Dupuit and C. J. Garnier in France, H. H.
Gossen in Germany (1854), and others.

In this period also the idea found parallel application
in the field of production and the yield of productive
services—distribution in the modern and relevant
meaning. Diminishing returns (incremental yield—
often misstated as proportional yield even by Alfred
Marshall, in his Principles of Economics [1890], p. 153)
from increasing application of one agent to a given
combination of others takes the place of diminishing
marginal utility. The increments of physical yield de-
cline, and the value product still more. (In this connec-
tion notable contributions had been stated by Senior,
the German J. H. v. Thünen, and M. Longfield, to be
recognized later.) Near the end of the century, the
incremental principle was applied especially to distri-
bution by P. H. Wicksteed in England and J. B. Clark
in the U.S.A., Wicksteed for the three traditional “fac-
tors,” Clark for two, labor and capital. A controversy
arose as to whether payment by marginal increments
would exactly exhaust the product. This is strictly true
only under subtle mathematical conditions; it is
roughly true empirically, since producers must act on


051

the principle, and the product does get distrib-
uted—after a fashion.

The Fallacy of Three Productive Factors. The most
important defect in the traditional theory is that its
“factors” are unreal. Persons (as productive) and “nat-
ural agents” both largely qualify as “capital goods.”
They have been produced at a cost and require main-
tenance and replacement. Natural agents cost invest-
ment in exploration and development, a distinctly
speculative activity; the classical “land” as “original
and indestructible” is unknown on the market, and
these qualities pertain separately, in different ways and
degrees to all concrete productive agents—even in-
cluding human beings. And all kinds, however distin-
guished, are mutually complementary in use. Differ-
ences economically significant for classification may be
alleged first in the conditions of supply, by investment
affected by luck. These involve varying durability and
the possibility, and cost, of reduplication or production
of agents equivalent or more or less similar in function;
also differences in transferability among a range of uses,
but this is largely a matter of obsolescence and re-
placement, i.e., transfer of the “investment in” the
agents, without moving these themselves. Typical in
a progressive economy is mobility, in effect, through
differential increase. No general classification by eco-
nomic qualities is realistic, since differences are a mat-
ter of indefinite detail. Laborers in a free society are,
in human and social terms, a category distinct from
“property,” i.e., “capital goods”; but further classifica-
tion depends on law and morals, or on technology.

The principle of “decreasing returns” relates to any
kind of productive agent applied in increasing propor-
tions to any combination of kinds. And all “means”
are means of production. There is no corresponding
law of “increasing returns” except, rigorously speaking,
for a short threshold on a minimal dosing of one kind
of means onto others. The expression “increasing re-
turns” is confusingly used for an increasing ratio of
output to inputs with an expanding scale of units in
organizations, due to increasing specialization so made
possible. The “unit” in production has various mean-
ings. The subject calls for mention because the two
expressions falsely suggest antithesis; but more espe-
cially because of the tendency of many people, and
some economists, to think that increasing returns with
larger scale is also a general law. It holds only for an
early stage in a hypothetical expansion of a “unit,”
beginning at zero. The gains from more minute spe-
cialization are soon offset by increased difficulty of
coordination, unwieldiness, and costs of management.
And if the market conditions do not call for a large
number of units of roughly the size of greatest effi-
ciency, competition is impossible; the result will be
monopoly, or “oligopoly.” The one gives rise to an
abstractly simple price problem, while the other term
may stand for a group of vague monopoloid situations,
given inconvenient Greek names by Edward H.
Chamberlin (The Theory of Monopolistic Competition,
Cambridge, Mass. [1933], and revisions).

Greater output from equal resources results from use
of better technology, which calls for mention of a
pivotal fact: that new technology is usually created
by investment. Such investment, however, is very
different from the production of more productive
agents of kinds already in use, or kinds already known.
It calls for “invention,” a creative act, perceiving and
solving a problem. Here the end cannot possibly be
known in advance, and so the activity cannot be “eco-
nomic” in the strict meaning; in many cases such efforts
fail outright. The fact of technological progress sug-
gests that on the whole, the results of research and
development are worth more than they cost. But much
cost is unrecorded and unknown, and this holds in part
for the results also. For progress is no definable equi-
librium position, and the product value may exceed
or fall below its cost in particular cases.

What is true of invention holds also for exploration
for natural resources; the significance of this hardly
needs detailed explanation, or in particular its bearing
on the “classical” theory of rent. Statistics—grouping
cases—may reduce the error or “chance” but never
remove it. And all economic activities are affected by
some uncertainty, with general consequences that must
be taken up later. (It is somewhat puzzling that statis-
tics and probability theory apply to real “error,” and
even crime, as well as purely chance events, but the
fact is familiar.)

The Concept of an Economic System. The pivotal
idea in the next great advance of economic science
to be noticed here is that of an economic system, or
the concept of a general equilibrium relation among
all the main variables—prices and quantities—treated
in economic analysis. This results from combining and
interrelating the several “partial equilibria” typified by
demand and supply, the quantities offered and pur-
chased of a particular good, in relation to its price.
On the analogy of mechanics, mentioned before,
change is explained by an imbalance of forces causing
movement toward a balance. The basic fact is that over
a period of time the quantity of a good sold must equal
the quantity bought; hence if at a moment, buyers (say)
will take more or less than sellers offer, market compe-
tition will raise or lower the price as long as there
is a difference. Utility theory explains why less will
generally be bought at a higher price than at a lower,
and more sold (of an existing supply in the hands of
owners—or in a longer view, more will generally be


052

produced; but exceptions here require explanation).

The concept of a unitary economic system results
from recognizing that different consumables are mostly
produced by the same fund of resources which an
entrepreneur producing any good acquires by outbid-
ding those who want them for making other goods.
The payments made are his costs of production, while
to those who sell him the productive services they are
income, which they use to buy portions of the joint
social real product, thus performing the function of
distribution. The idea of a system was perhaps first
effectively proposed, in the form of a crude system
of equations, by L. Walras, in his Éléments d'économie
politique pure
of 1874 and 1877 (where he also inde-
pendently stated the principle of utility theory).

Divisions of Modern Economic Science. It seems
fitting at this point to turn from history to outline the
content of modern analytical economics in terms of
its pivotal ideas. This content happens, like the history,
to fall naturally into four parts, forming a cross dichot-
omy; i.e., there are two main divisions, each with two
subdivisions, which may be schematized as I-A, I-B,
and II-A and II-B. The first main division deals with
the economic conduct of an individual, first (I-A) under
fixed general conditions, and second (I-B) with these
subject to change through economic conduct by the
acting person. The two together are introductory to
the main subject matter, which fills the second major
division. This describes the social organization of eco-
nomic conduct (a national economy), as worked out
under mutual freedom, through exchange of goods and
services in markets. The second main part has similar
subdivisions, the first assuming fixed general conditions,
the second dealing with economic activity partly
directed to changing these. The given conditions in
question are wants and the resources available to the
person or persons acting for satisfying them; the re-
sources used are internal or external to the persons.
They include a stock of technical knowledge (and
“know-how”), which may either be considered as an
internal resource or treated as a third main datum.
(Economic conduct which changes basic conditions
presumably causes progress, here meaning fuller satis-
faction of given wants; action to improve wants—one's
own or another's—does not fit the general concept of
economy.)

The task of the first main division (two sub-parts)
is to analyze the economic conduct of an isolated
person (a “Crusoe” economy), abstracting from all
social interests and relations. This is necessary in order
to avoid serious fallacies that pervade economic dis-
cussion, particularly of economic progress, achieved
through saving and investing. A full treatment would
require much explanation and qualification. Economic
analysis is abstract; it says nothing about “what” wants
are felt or what concrete means are used to gratify
them—except for the triad of personal capacity, exter-
nal means and materials, and “technology” (if this is
distinguished from “labor-power,” which there are
good reasons for doing). Nonhuman agents call for most
comment, first because the tradition has made a false
distinction between “land” and other “capital goods,”
and secondly because of failure to relate these clearly
to “capital.”

The first subhead—the Crusoe economy under given
conditions—can be treated briefly. Differences be-
tween different forms of productive capacity as to
conditions of maintaining a constant supply do not
justify the recognition of productive factors but some
differences cannot be ignored; this would not be too
unrealistic for labor-power and technology; but non-
human agents present the same problem of choice for
maintenance as for growth, and the two will best be
considered together, later. Much of what is commonly
called production of such indirect goods is not capital
creation but maintenance of an existing stock, hence
is assumed with stationary conditions. To begin with,
productive capacity might, for simplicity, be arbitrarily
treated as a unit, making it Crusoe's problem to appor-
tion it among the uses known to him so as to achieve
maximum total want-satisfaction. The relevant general
principles have been stated above. They are summed
up in (a) diminishing “marginal utility” and (b) appor-
tionment so that equal units (of negligible size) make
equal additions to total satisfaction in all uses. The
name comes from an early translation of the German
Grenz (meaning boundary). The three discoverers used
other names: Jevons had called it “final degree of
utility,” Menger simply “importance” or “meaning”
(Wichtigkeit or Bedeutung), and Walras “scarcity”
(rareté).

The precise meaning and conditions of validity have
been controversial; subtleties may be ignored here, but
the discovery was pivotal for the transition from polit-
ical economy to analytical economics, and (as also
noted before) it was later recognized that parallel
principles hold for apportioning productive resources—
diminishing marginal productivity and equalization for
final units in all uses. The principles hold for the al-
location of any single kind of good—added to a com-
plex of others, assuming “correct” combination, recog-
nizing complementarities and antagonisms. In social
life analysis of consumption is much simplified by the
intervention of money, an income as a fluid resource
to be apportioned in purchasing various consumables
available, at their prices. More precisely, that part of
a person's income that is devoted to consumption—for
the whole is commonly divided between this use and


053

investment for future increase. Treatment of this ap-
portionment belongs under the next heading.

The Crusoe Economy with Planned, Net Investing.
It is, of course, “income” which people consume or
live on—with occasional, mostly temporary, additions
from “disinvesting” capital previously accumulated.
Theoretical analysis commonly assumes that consump-
tion, at some time, is the sole end of economic activity—
making increased future consumption the end of saving
and investing. (Smith, op. cit., p. 625; but on p. 352
national power is the end of policy, and on p. 397 there
are “two distinct objects,” revenue for the people, and
for support of the public services, in which “defence
is much more important than opulence,” p. 431.) In
social life, consumption is by no means the whole end,
even if we add the security that wealth gives against
events that may disrupt one's income, which might
bulk large with a Crusoe. Social motives such as rivalry
and prestige would be absent, but he would presumably
wish to be purposely active, and would have many
reasons for raising his scale of living—if not explicitly
for the distant future.

Detailed speculation on this point would not be
useful here, and it is simply postulated that he invests
for progress as well as to prevent decline. The usual
assumption makes progress mean an increasing con-
sumable income (also available for further investment).
In a stationary economy, only income is really pro-
duced; reproduction is a part of maintenance. Income
consists of services, rendered by persons or by “prop-
erty” (wealth, capital goods)—only “scarce” things
having economic value. Logically, persons, as yielding
valuable services, are property, but entailed as to own-
ership. (Where there are slaves, they class with work
animals or machines.) In a free society, persons are not
bought and sold, thus are not effectively capitalized
and are reasonably not counted as wealth; but, to
repeat, they are essentially like (other) capital goods
economically. Some personal earnings are in effect
capitalized through contracts for services, and other
obligations; but enforcement of these is limited as a
protection to general freedom.

As just indicated, capital is primarily “capitalized
income,” the present value embodied in a capital-good.
A Crusoe might need the capital concept, if he actively
decided to maintain a constant income, and it is re-
quired for any rational decision on net investment. In
society, there are other facts, especially the production
for sale of income sources, that make it necessary to
know the “present-value” of a future stream or flow
of income. Such production, by net investment, implies
a value result in excess of cost, which must also be
known. As investing requires time, it involves a rate
of growth,
which is that of the income to be had by
stopping further investment at any point. This concept
is most familiar as the compound-interest formula and
curve, but applies as well to growth of any population,
and elsewhere. It is pivotal for the understanding of
economic analysis.

Simple compounding by years (or other periods) is
expressed by the formula, A = (1 + r)n, where A is the
amount accumulated by one dollar in n years at the
simple interest rate r, the growth for a year. This r
includes some interest-on-interest as well as on the
principal. To separate the two, compounding should
be continuous, the period being reduced to zero. (The
formula becomes enr, where r and n have the former
meaning, enr replacing (1 + r)n; e is the number
2.7182818..., a mathematical constant, the base of
“natural” logarithms.) A present-value is found by dis-
counting
the future income, using the same formula
in reverse (and same rate) to find the investment that
will yield the income stream in question.

Rational investing calls for using that available op-
portunity which affords the highest rate-of-growth. The
discounting is simple where the future income is to
be perpetual (the normal case, as will be shown). Then
the present value is simply ¼ per income unit, the
annual yield divided by the rate as a percentage. (A
dollar per year in perpetuity at 5% annually is worth
$20.) For a time-limited future income, use of the
formula involves some algebra, but that need not be
explained here.

Investment theory is abstract and unrealistic, in that
an investor could never have the knowledge required
for accurate calculation; but (to repeat) that is at least
as true of mechanics, where the procedure is not
questioned. In a social economy, money is used and
is lent at interest, which introduces complications,
calling for further analysis, best taken up under the
next heading. The need to analyze the growth rate of
investment apart from lending and interest is a main
reason for considering the Crusoe economy, where this
is obviously excluded.

The Free Social-Economic Order, Assuming Sta-
tionary Conditions.
Under this head, II-A in the sug-
gested scheme, what is to be considered is the station-
ary economy (or stationary state) which was much
discussed early in the present century, especially in the
American economic literature. It was pioneered by
John Bates Clark, whose book, The Distribution of
Wealth,
was published in 1899, following earlier arti-
cles. Clark's main object was to advocate the marginal-
productivity theory of income-distribution and defend
it ethically. He assumed two productive factors, labor
and capital, including land in the latter. About the
same time, Alfred Marshall, of Cambridge University,
published a more realistic, though less systematic,


054

treatment in connection with discussion of price-
determination over long and short periods. He ex-
tended the former to include “secular changes” in
conditions of demand and supply, but did not explicitly
work out this concept. (See his Principles of Economics,
Book V, p. 379 in the sixth edition, little changed in
his “final” eighth edition.) However, the subject comes
up again in his treatment of “Distribution” in Book
VI, which involves fallacies that must be pointed out.

It may be Marshall's (obvious) veneration of his
classical forebears, especially Ricardo, that led him to
commit himself to the idea of a real stationary-state
in the future—implied by ultimate equilibrium rates
of wages and interest—which implies the same as
regards “rent.” He said (following Ricardo) that land
is (approximately) fixed in supply (most explicitly on
p. 170; cf. also pp. 534-36) and called its rent a “sur-
plus” (p. 429, Glossary). Of land acreage this is true;
of the economic land that is leased or bought and sold,
not true at all. Ricardo's land, as “original and inde-
structible,” never existed since human beings have
planned economically. Imagination can by abstraction
form an idea of such “powers of the soil,” but they
cannot be separated in practice from “artificial” ones,
in various meanings, and evidence shows that these
account for most or all of present land value; in fact,
past investment probably exceeds this, on the average.
Moreover these elements exist in all productive agents.
As to the “surplus” theory, reasoning at an arithmetical
level shows that rent viewed as a surplus is the mar-
ginal product, and either theory applies to any “factor
of production.” (Marshall improved on J. S. Mill in
seeing that the increase in land value is not free of
cost.)

Marshall's main error, as regards stationary condi-
tions (from which Clark can be exonerated) also results
from following the “classicals,” specifically in neglect-
ing the nature and the consequences of technological
progress. This of course has offset any tendency to
“diminishing returns” from labor or capital or both.
Wages have risen manifold, in the face of a similar
population growth; the rate of interest has shown
something of a seesaw, moving upward or downward
at different periods (but not very much) with the fluc-
tuating growth of investment opportunity, which in
principle fixes it. The most serious error, still common
in economic writings since Marshall, is failure to note
that new technology is chiefly produced by investment,
which increases the yield of and demand for all kinds
of productive services, however these may be classified.
Moreover, this field of investment shows the opposite
of diminishing returns; scientific and technical progress
constantly opens the way to more progress, with no
assignable limit. (And it also changes the character of
both labor and economic land.)

One can use the concept of a stationary economy
as a postulate useful for analysis (which Clark perhaps
meant, and which can be read into Marshall's words),
but should make it clear that asserting a tendency
towards a long-run equilibrium assumes “other things
equal” which could not be, and that such tendencies
are more than offset by others making for indefinite
cumulative change. Clark also failed to recognize this.
The exposition has already trespassed on the subject
matter of the next section where, incidentally, it will
be shown that even in a social economy, if stationary,
there would be little occasion for the lending of money.

The Market Economic Order with Growth: Capital
and Interest; Rent, Wages, and Profit.
Discussion of
section II-B needs as introduction a brief description
of the economic order under which modern progress
has occurred, which should begin with a historical note.
The “existing order” is a mixture of organization forms,
mainly based on free exchange, especially two which
arose out of feudalism in roughly historical sequence.
The enterprise system was preceded by a handicraft
stage, with marketing of products but little dealing in
the means of production. To be pictured are families—
perhaps with one or more apprentices—each special-
izing in a final product, using simple tools owned by
the users. The product is sold in a market for money,
with which are bought for consumption various prod-
ucts of other family units. Each of these maintains its
own productive capacity, of person and property, and
may increase this more or less, as in the Crusoe econ-
omy. This system survives to a substantial extent, in
farming, repair work, and professional services. (Our
familiar social-ethical problems due to inequality,
wealth, and poverty, could arise in such a system—and
did, in history.)

The past few centuries have seen handicraft pro-
gressively replaced by a much more complex system,
rooted in a higher order of specialization. In an enter-
prise-economy, production of any final good is carried
on by an organization of persons and equipment, with
much internal specialization of roles. This enterprise
is legally owned by a person or small group, the
“entrepreneur,” who buys from outside owners most
of the labor power and property services it uses. The
entrepreneur may also own any part of the property
it uses—often subject to creditor claims, a complication
to be considered in due course. The simplest arrange-
ment is for the entrepreneur to hire property services,
paying rent; the correct meaning of that term applies
to all property alike, the traditional limitation to
“land” being a misuse of words. (The term “rent” might
well apply to the hiring of persons, where the payment
happens to be called “wages”—or, it would make for
clear thinking if a common word, such as “hire” were
used for both.)


055

The working of the system is explained by describing
the general equilibrium which “economic forces” tend
to establish, relative to given conditions—as to persons
and their wants, resources, and technology—or, in
Marshall's words, “would bring about if the conditions
of life were stationary long enough for them to work
out their full effect” (op. cit., p. 347). Some limitations
of this tendency will call for notice. At equilibrium,
simultaneously all consumer expenditures would buy
at the margin equal increments of satisfaction and all
productive resources would yield (marginally) equal
increments of value product, all prices being equal to
costs (ignoring monopoly). The economic forces are
human preferences, expressed in partly rational
choices. This conclusion should be qualified by the fact
that the system pictured embodies “feedback” princi-
ples, and as in a mechanical situation, these typically
produce oscillations, where responses are not instanta-
neous—and they do so in economic affairs, creating
serious problems.

Enterprise organization is inevitable, if men strive
to get ahead, which they often do (not universally, as
Adam Smith strangely assumed). It can hardly be
imagined without use of money, as a unit of value and
intermediary in exchange. (But, to repeat, money-
lending is not inevitable, since a loan is always equiva-
lent to another transaction, a lease or sale.) The main
economic decisions are made formally by entrepre-
neurs, interacting with their opposite numbers in mar-
kets, and acting directly or through agents whom they
hire. But they are finally responsible to consumers and
owners of productive agents—act in a real sense as
agents of both, and “at equilibrium” have no power
at all. (Describing the system as “consumer sover-
eignty” states a half truth.)

Both business and politics are dominated by the
agency relation. Personal freedom is mostly freedom
to choose agents—usually among competing seekers
of the role. The entrepreneur is the central figure of
the modern economy. Each buys productive services,
makes products, and sells both in markets, in competi-
tion with all others, hoping to make some profit. This
profit is an element in the entrepreneur's own income
(along with the earnings of his own services or prop-
erty); but it is as likely to be negative, i.e., a loss, as
a gain, which the word “profit” misleadingly suggests.
The profit-system should be called profit-seeking, or
“profit-and-loss.” As noted above, the classical polit-
ical-economists misconceived profit, failed to distin-
guish the entrepreneur function, and only incidentally
recognized loan interest. Even J. S. Mill merely divided
“gross profit” into three parts (op. cit., p. 407), and
then endorsed (on p. 416) the Ricardian theory. (This
system was taken over by the Marxists and used logi-
cally in propaganda for a social revolution—in place
of its strange use as a basis for a doctrine of laissez-
faire; in the case of “rent” it served, also logically, in
propaganda for land-value confiscation—by some po-
litical unit itself without the individual owner's essen-
tially valid claim—which Marshall recognized.)

Profit, correctly defined (including loss), is clearly the
result of an imperfect working of the competitive
market system, due in turn to the uncertainty of the
future and the limited foresight of entrepreneurs. (If
any one of them knew the future, he would not suffer
loss, and if his competitors knew, he could not make
a gain.) Uncertainty can often (in practice not always)
be reduced by insurance or dealing with cases in
groups, but never eliminated. To understand enterprise
and profit, it is useful first to imagine a situation in
which labor alone is productive and where just two
persons wish to cooperate. The matters on which they
must agree—what to produce, by what procedure, and
the division of the joint result—might conceivably be
settled by negotiation. But this would be difficult, and
it seems more reasonable to expect formation of a
partnership, in which one party will make the decisions
and grant to the other a stated amount of the product,
himself taking any excess over the agreed share, and
making up the loss if there is a deficit. The “active”
partner is then an entrepreneur, paying wages and
receiving profit, or incurring loss. (The entrepreneur
might consider what he could have made by working
alone as wages and view profit as only the difference
between this and what he realizes.) No new principle
is introduced if either or both parties also furnish the
services of nonhuman productive agents which they
may own; payment for the use of any such item will
be a rent.

The next step in the explanatory hypothesis has been
suggested, and is a pivotal idea. Instead of a lease for
any nonhuman agent, the parties may agree on a sale,
the previous owner taking a “note” for the price, and
receiving interest instead of rent. Under theoretically
ideal conditions—perfect knowledge and economic
rationality—the sale price and interest rate would
make the payment (per time unit) the same as in the
other case. Under conditions resembling those of real
life, the actual figures would be fixed by the best op-
portunity open for investment, the principal being the
cost of creating a new income source with the same
yield as that whose use is being transferred. Shifting
attention from the two-person situation to a competi-
tive economy, intelligent selection of opportunities in
the market will fix a uniform rate—after allowance for
costs, uncertainties, attitudes towards risk-taking, and
especially for complications due to the use of money.

If a temporary arrangement is desired, an agreement
for later resale will still make the two arrangements
fully interchangeable. The result will differ if risk


056

attitudes differ—or as will be explained, if the actual
risk differs for the two parties. The latter is the case
in real social life, and this is the main general reason
why the lease procedure is used in some cases and the
sale in others.

In a social economy, income-yielding assets are
bought and sold, at prices which strongly tend to equal
their expected yield capitalized at the going interest
rate, which in turn strongly tends to equal the rate
to be expected on the best new investment opportu-
nities open. But these prices are affected by numberless
uncertainties, and any rise or fall in the value of an
asset impinges on the formal owner. Hence if the
prospective user of a given asset is on any ground more
optimistic as to its future market value than is the
current owner, who turns it over to him for use, they
will agree on a price making a sale with a loan prefer-
able to both parties over any lease on which they can
agree, and conversely for the opposite situation.

However, the motive for lending money, rather than
leasing some income source, is vastly strengthened in
the major type of cases where it is done in modern
life, that is, not in connection with the transfer for
use of existing assets, but with investment by one party
to create a new source of income to be used by another.
This again could be arranged, by the first party making
the investment himself and leasing the result to the
other; but the two must then agree on the kind of
capital good to fit the needs of the prospective user,
and for obvious reasons they usually agree on a loan
of money. In fact, of course, lending money to entre-
preneurs for “real” investment has become a major
vocation—that which now best defines the “capitalist.”
Thus the act of investing is divided: owners of abstract
wealth held in the form of money (itself to them an
investment) invests the money financially by lending
to entrepreneurs who invest materially by buying pro-
ductive services and creating income sources. (Other
complications arise, but need not be considered here.)
Each mode of investing may involve a “profit” (or loss),
i.e., may yield more or less than might have been had
through perfect foresight.

Some lending and borrowing is done for other pur-
poses, notably consumption in anticipation of receiving
income, or to avoid a sale of assets. This consumption
loan is unimportant in the market, and finally comes
under the same principles—apart from a motive of
charity. Any economic loan must have security and is
always an alternative to the sale or lease of the asset
in question. In a progressive society, a person's con-
sumption of capital merely subtracts something from
its growth in the whole economy. (Net social disinvest-
ment hardly occurs, or does so only under disor-
ganization by a crisis.)

It has been held that as investment grows the yield-
rate must tend to fall—due to diminishing returns. As
noted above, this ignores the fact that much investment
increases the yield of capital-goods by creating new
knowledge, a field of investment that shows no tend-
ency to exhaustion but rather the contrary—and also
goes into more people, and useful human qualities
other than technical knowledge. And much goes into
exploration for natural resources. These familiar fields
perhaps tend to become at some time fully known, but
not in combination with new knowledge, and exhaus-
tive knowledge cannot be foreseen. As to the yield-rate,
the reasonable expectation is more of what has hap-
pened through modern history, some “seesaw” in the
rate of yield as opening of new investments runs ahead
of or falls behind exhaustion of old. Moreover, “the”
rate in any market at any time is a complex of “pure
interest” and numerous other factors (risk, transaction
cost, etc., and especially the monetary situation and
business prospects), so that the true rate is not definitely
determinate.

A pivotal idea in the published discussion of interest
theory has been the “dogma” that interest is paid
because human nature systematically prefers present
goods to future goods of like kind and amount. This
is a fallacy because it overlooks two patent facts: first,
that while one does not want to postpone today's
consumption until tomorrow, neither does one want
to consume tomorrow's provisions today; and further,
that perpetual postponement of all consumption is
impossible. Given provisions for two days, there seems
to be no economic principle or general fact of psy-
chology to determine the precise distribution between
the two. Abstract rationality would surely call for
something near uniformity over time, but some persons
will diverge in one direction and some in the other.
Of this, Alfred Marshall gave the homely illustration
of boys eating a plum pudding: some will pick out the
plums and eat them first, some will save them to the
last, and others eat them as they come to them. An
intelligent person of means (not on the point of suicide)
will certainly consume some of his income (or wealth,
by disinvestment) day by day, and keep some provision
for the future; but as to how much of the latter he
will invest for a future increase, again no general prin-
ciple can say.

It surely seems reasonable to prefer enjoyment while
one is alive rather than after death; but, as remarked
before, people do deliberately leave accumulated
wealth at death—and significant net social accumula-
tion depends on the wide prevalence of such conduct.
Economic science can say only that decision between
consuming and investing some part of one's means is
a matter of taste, not arguable—like consumption


057

choices—(ignoring contracted obligations) and that
rational conduct dictates making any investment that
is made at the going rate; i.e., at the margin of growth
of capital wealth in the society at the time, or in some
newly discovered better opportunity—where the re-
turn above the going rate would be profit.

Two Major Qualifications of General Economic
Analysis.
The treatment thus far has dealt with “pure”
theory, oversimplified in two respects in particular,
where it must be supplemented, though very briefly.
One of the two is monopoly—including “monopoloid”
situations where either sellers or buyers are too few
for effective competition—the other, money and prob-
lems due to its use. The former may be more quickly
disposed of as to main essentials. Historically, as ob-
served earlier, the founders, Smith and Ricardo, wrote
“nonsense” about monopoly pricing; and J. S. Mill was
little better. By 1890, Alfred Marshall had stated the
principle correctly, in words and mathematically. (A
mathematical study had been published in French by
A. A. Cournot in 1838, but it received general notice
only when rediscovered and published in English, in
1897, as Researches Into the Mathematical Principles
of Wealth,
with a bibliography of mathematical eco-
nomics by Irving Fisher.)

The monopolist's interest plainly is to adjust the
supply and through it the price so as to maximize his
total net revenue or profit (not to maximize the price).
Monopoly is less important in fact than it is psycholog-
ically because the public greatly exaggerates both its
prevalence and still more the real evil. Much monopoly
is “natural,” even inevitable, and more is beneficial.
Governments grant temporary monopolies by patent,
copyright, etc., to encourage useful innovations, and
a large share of those privately set up work in the same
way. On the other hand, the public encourages costly
monopolies in the fields of labor and agriculture, and
in foreign trade, though “protection” does not directly
establish monopoly, as early writers said.

Exaggeration of the occurrence of monopoly is a
common ground for condemning free enterprise
—alleging that market competition is unreal or
ineffective. This ignores bankruptcy figures and other
facts proving the contrary. Pointing out the error does
not imply that business monopolies do not exist or
present no serious public problems, but public action
itself causes restrictions more costly to society. The
classical political economists thought monopoly bad,
but proposed no action except negatively not to estab-
lish them. In modern times “anti-trust” laws have
become familiar, but in the United States they exempt
highly restrictive labor unions, and “administered”
prices.

Money and Interest. The Business Cycle. It is hard
to say briefly anything objective and useful about
money, even ignoring all the preaching about its evils.
Denunciation is largely based on confusing it with
wealth, and wealth (also commonly confused with
income) is merely one form of power. Here the classical
political economists deserve credit; they tried to get
behind its mask or “veil,” though, as has been shown,
what they said about economic reality was largely
fallacy. And they strangely ignored for the most part
the main problem that arises from the use of money.
That problem is the periodic occurrence of “hard
times,” alternating somewhat cyclically with prosper-
ous periods. Some exception is called for by J. S. Mill's
treatment of speculation and crises (op. cit., Book III,
Ch. XII). “Mercantilist” writers had held that abun-
dance of money causes good business, either directly
or by way of lower interest rates. In the 1740's, David
Hume published his Essays with the pivotal idea that
with an increasing quantity of money, selling prices
rise more rapidly than cost prices, thus raising profits,
and conversely for falling prices—which causes busi-
ness prosperity and depression, the latter with unem-
ployment and misery.

From the sixteenth century, writers noticed the
effect of rising prices (due to influx of silver and gold
from the New World) in favoring debtors at the ex-
pense of creditors. Adam Smith noted the loss incurred
by receivers of feudal rents, etc., which had been
converted into cash from payment in kind. The infla-
tion of the period of the French Revolutionary and
Napoleonic wars led to demands that obligations be
repaid in money of the same value as that in which
they were contracted. Meanwhile, John Locke and
others had been developing in explanation the “quan-
tity theory of money”—or quantity and circulation
velocity, as even Locke recognized the role of the
latter.

A pivotal idea for cycle (or “conjuncture”) theory,
but slow to be recognized, is the general fact already
mentioned, that supply-and-demand adjustments work
on the “feedback” principle, like a speed-governor on
an engine, a thermostat, etc., and that all such mecha-
nisms produce oscillations. Thus any price normally
shows cycles of rise and decline, more or less regular,
extensive and prolonged—as normal-price theory
should recognize. The basis of the phenomenon is “lag”
in response of an effect to its cause. When the produc-
tion of “x” is profitable (say of hats, an example from
Russian propaganda) it tends to expand, but time is
required for new supply to reach the market and re-
duce the price, and, meanwhile, under individualistic
control, the movement tends to be overdone, “glutting”
the market and reversing itself. (This is abstractly an
argument for central advance planning and control—if


058

it could be guided by complete foresight and were free
from evils of its own.) The cycles for an item will be
longer as it takes longer to expand production or to
exhaust an existing supply or its sources. Further, a
price bulge that would naturally be temporary is likely
to be mistaken for a trend, prolonging the effects
through reduction of current output to prepare for a
later increase. This is obvious with livestock, when
animals that would have been marketed are held back
for breeding purposes; similar causes operate elsewhere.

Familiar facts make the value of money an extreme
case for oscillation. The current “price”—the recipro-
cal of the general price-level—is not conspicuous, and
the position of equilibrium is vague in comparison with
commodities which have an organized market or a
known cost of production. And, more important, the
self-perpetuation and self-aggravating tendency of
price-movements is magnified. Rising prices make it
seem preferable to hold goods rather than money and
so to speed up the turnover of money; this stimulates
real production, especially through bank loans, creating
deposits which circulate as equivalent to more money.
Hence further rise of prices and greater profit margins,
and so on. But shortage of labor and decrease of its
quality, along with rising wages, help bring the boom
to an end—which tends to be precipitate and may
cause a panic in the loan market. Typical and pivotal
is a sharp contraction in the capital-goods industries,
spreading to those serving consumption. In the depres-
sion of the 1930's about half the calamitous unemploy-
ment occurred in the field of “durables,” which had
furnished about a fifth of the total employment.

In general, what happens at the peak of a boom—its
collapse and a drastic reversal of the trend—is readily
explained and even predictable; and in principle the
boom is largely remediable through monetary and fiscal
action. But no one knows just when to act or how much
action to take, and the public mind opposes “killing
prosperity,” and in any case tends to blame the “money
power” for the unfavorable consequences. At the bot-
tom of the cycle the situation is very different. It is
not clear why the decline stops just where it does, or
why the pickup is slow, which gives many observers
the impression of a stable equilibrium along with ex-
tensive idleness of labor and other resources. This is
self-contradictory, but explanation of the situation in-
volves many factors and discussion beyond the scope
of this article. Adjustments, including liquidations, must
be carried out, requiring time; and an essential fact
is that potential investment opportunities must be seen
far ahead, and seized by individuals. On the whole
subject, controversy is abundant.

A major aspect is the relation between monetary
phenomena and the interest rate—or rates. Boom con
ditions raise the demand for money in the investment
market and throughout the economy. At the time of
a collapse, the need for “cash” to meet commitments
may create a “panic” or near panic, causing a demand
for loans at fantastically high rates, not connected with
the long-run determination of the rate by investment
opportunities. Under such conditions one can hardly
speak of “the” rate of interest. Where the security
seems good, loans may be available at very low rates,
and otherwise only at very high rates, or not at all,
forcing bankruptcies. A full discussion would prompt
analysis of the Great Depression of the 1930's, the
“New Deal” measures, and the role of the ideas publi-
cized especially by John Maynard Keynes (later Lord
Keynes), who stressed the aspect of interest as a rent
on cash, rightly as regards very short-period changes.

From the pivotal fact of the wide instability of the
general price level and its consequences follow two
others: first, that money, and circulating credit, must
be “managed”—a policy of laissez-faire here has
“intolerable” results; but secondly, that the manage-
ment cannot be very effective, consistently with social
freedom in economic and other respects. The measures
taken under the “New Deal” administration of the
1930's to deal with unemployment and distress (“pump
priming” through public make-work projects) were
ineffective; unemployment was finally cured by the
outbreak in Europe of World War II.

Movements Opposed to Analytical Economics.
Many aspersions have been cast on “political economy”
since Carlyle referred to it as “that dismal science.”
This attitude may be found in the New Testament
condemnation of the desire for riches and money. But
to idealists all science is dismal, since it describes the
real, in contrast with the ideal or perfect. And eco-
nomics is an extreme case, because it deals with cost,
the need to give up one good to get another; and the
same prejudice doubtless underlies the popular con-
demnation of trade, and the market organization of
production and distribution.

There is a special ground for disliking historical
economic thought in its advocacy (overt, implied or
imputed) of the policy of laissez-faire. The earliest
public opposition to Adam Smith's teaching rested on
humanitarian grounds. It is pointed up by the reversal
of position by the Italian scholar, Jean Charles Léonard
de Sismondi, who first supported Adam Smith, in a
book, De la richesse commerciale (1803), but in 1819
revolted against the position in his Nouveaux principes
d'économie politique.
His second position was sound
and well taken, for, as noted earlier, Smith's great work
was one-sided propaganda for “natural liberty,” with
little argument either way from economic analysis. He
never spelled out the meaning of the “invisible hand”


059

said to harmonize the individual interest with that of
society. Nor did he recognize the real logic of his
position, the view that there is no real social interest,
that society is merely an organization of individuals
for mutual economic advantage. The state is viewed
as a means, never an end with values of its own—
except perhaps as implied by the recognition of
“defence,” rated as “much more important than
opulence” (op. cit., p. 431). The “hand” should not
be interpreted as “Providence,” or a mystical force,
as is often done.

However, laissez-faire (an expression not used by
Smith or Ricardo) is not an economic doctrine, but a
political one. As already explained, the validity of
economic freedom as a policy depends on that of the
social ethics of utilitarian (instrumentalist) individ-
ualism, which has serious limitations. This policy issue
has nothing to do with economics as a science, which
assumes only the partial (analytical) descriptive
truth of its principles, not their ethical rightness—
any more than the assumption of “frictionless condi-
tions” in mechanics implies that friction (and other
qualifications) should be ignored by engineers in ap-
plying the principles. The common accusation of “un-
reality” of economic theory is as valid for theoretical
mechanics.

On the other hand, the critics (on the ground in
question) are open to the criticism that merely abstract
repudiation of laissez-faire means anarchism and ig-
nores stated qualifications. Smith listed and developed
three general exceptions to the system of natural lib-
erty, as tasks of the sovereign (op. cit., p. 351). Any
constructive criticism of laissez-faire must point out
concrete evils of freedom and at least indicate in gen-
eral terms feasible measures for the control and sup-
plementation of free-market relations that can reason-
ably be expected to remedy or mitigate them. Taking
measures implies a political order; and modern West-
ern nations are committed to “democratic” govern-
ment—law making and enforcement by representatives
of the citizen body, chosen by majority vote, the citi-
zens including all normal adults. (Smith and his early
followers said nothing about the form of government,
the nature of the “sovereign.”) In the modern West,
the primary task of government is to define and main-
tain the maximum permissible freedoms, notably mar-
ket freedom, freedom presupposing a fair degree of
legal order. (The second of Smith's exceptions, after
defence, was to maintain “an exact administration of
justice” in Book IV, Ch. IX.) This would now include
much more than he intended, though much might be
read into his treatment of this and the other two ex-
ceptions, or that of taxation. The democratic political
order and the economic order of markets and enter
prise are now each a part of the other—all based on
“cultural” freedom, religion included.

The most extreme opponents of the market eco-
nomic order, and of the science which analyzes it, are
the Marxists, who repudiate democracy also, in favor
of nothing, i.e., anarchism, as far as the documents
state. The original and still sacred “scripture,” the
Communist Manifesto, demands the “violent overthrow
of all existing [bisherige] social order,” by and for the
workers of the world, who “have nothing to lose but
their chains [and] have a world to gain.” Marx defined
government as the agency by which a ruling class, of
owners, exploits the workers. The revolution should
establish a “dictatorship of the proletariat,” giving no
indication of its organization for unitary action. This
has worked out in fact as the dictatorship of a self-
perpetuating clique, led by a “chairman”; it is mis-
called a “party” and the system is miscalled “commu-
nism.” In Russia, where its advocates came to
power—against Marxist predictions—the regime is
much farther from communism than is the (also mis-
named) “capitalism” of the free nations. But the doc-
trine (in essence an application of Ricardian economics)
has been embraced by innumerable bright minds and
has conquered over half of the world.

More reasonable, being more moderate, is the oppo-
sition movement called “socialism.” Its advocates have
stood for a democratic government, making the prob-
lem again one of politics. They have generally accepted
the main body of economic science, but have advo-
cated governmental ownership and management of the
bulk of income-yielding wealth (by some political
body), with “just” distribution of burdens and benefits.
Political control of income distribution would separate
this from payment for productive services, and destroy
the free economic system. In the case of labor, as an
incentive, pay might correspond to some extent with
productive contribution, hence with the scarcity of
particular abilities. Socialists have also been vague
about the productive organization, as well as on justice,
and disagree widely on details; they agree chiefly in
denouncing capitalism. The word “socialism” replaced
“Owenism,” stigmatized by Marx as “utopian”—along
with other early schemes, in contrast with his own
so-called “scientific” socialism. Claim to this descrip-
tion rested on the “materialistic interpretation of his-
tory,” which is neither materialistic nor scientific—nor
even “economic,” as it is often called—but dialectical,
in an inverse-Hegelian sense; but it did logically imply
inevitability.

The first socialists to be called such, as a school, were
the “Ricardian” group. They are so named because
they based their teaching on the labor theory of pro-
duction, drawing the common inference, the right of


060

laborers to the whole product. A book with this title,
The Right to the Whole Produce of Labor (1899) by
an Austrian, Anton Menger, has in the English transla-
tion an Introduction by H. S. Foxwell, which gives
perhaps the best account of the group. They were
theorists not, like Owen, reformers. Some Owenites
tried to put the labor theory into practice by setting
up labor-exchanges, stores where workmen brought
products to receive “scrip” stating their labor-time
value, to be sold to others on the same terms; they
were short-lived. Owen, Charles Fourier, Étienne
Cabet, and other utopians established communistic
colonies in America, attracted by cheap land; some
became famous, but all failed.

The first Ricardian Socialist, in time, was William
Thompson (1785?-1833) whose Principles of the Dis-
tribution of Wealth
appeared in 1824. He was perhaps
also the most influential, since Marx is thought to have
taken from his book the idea of surplus-value. (He
might have gotten it from J. S. Mill by merely renam-
ing what Mill defined as profit.) John Gray and J. S.
Bray argued on similar lines, holding that property is
stored-up labor, and an owner should receive only
postponed wages for its labor cost. (Marx's labor-cost
theory would take account of the labor-cost of produc-
ing laborers.)

To the criticism that socialists have offered no plan
for the organization of an economy without private
ownership, a few exceptions should be noted, notably
“The Webbs” (Sidney and Beatrice), Outline for a
Socialist Constitution for Great Britain,
and G. D. H.
Cole, Guild Socialism Restated (both London, 1920).
Also a book by Carl Landauer, Theory of National
Economic Planning
(1944, p. 47), and others, might be
named. Of late there has been a tendency to use
“planned economy” in place of “socialism,” as more
appealing. Whatever the name, the general issue of so-
cialism versus free enterprise is a matter of degree and
of details; as the Prince of Wales, later King Edward
VII, said in 1895, “We are all socialists now.” It is
pointless to argue for either system in general; but for
the modern Western mind there is a presumption in
favor of the market order, unless there is a good reason
to the contrary, since it affords more freedom.

There is a question “how” socialistic a nation could
become and still preserve democratic forms, i.e., not
lead to a dictatorship. To repeat, the problem is one
of politics, having little to do with economics as a
science. Of this, the most general principles are valid
for any social order; while (somewhat) intelligent
beings engage in production, distribution, and con-
sumption and form a society, “economic” decisions will
be made, by some units and for some units—wisely
or otherwise—and details do not affect the abstract
theory. The concept covers all more or less effective
means-ends relations, including “function” in sub-
human life.

The intellectually more serious opposition to
“orthodox” economics has been “historicism.” Its con-
tention is methodological—that the proper subject
matter of economics is not inferences from familiar
principles of economy, but description and induction
from current facts and history. This doctrine originated
in Germany and is characteristically German, as the
more prevalent one is British. The alternative view has
had advocates in English works; of these writers, T. E.
Cliffe-Leslie is perhaps most important, though Sir
William Ashley and many other economic historians
might be named; also perhaps, R. H. Tawney, who was
more socialistic. His book, Equality (London, 1929),
raises a serious problem for advocates of freedom, since
inequality of power limits effective freedom. And
inequality tends to grow, since power can be used to
get more power, and this is conspicuously true of
economic power. Its growth has been largely checked
by differential taxation, public education, and other
measures, and by some natural counter-tendencies.

German historical economics was doubtless sug-
gested by the historical jurisprudence of Friedrich K.
von Savigny and others. Montesquieu was a cultural
forerunner. Two German historical schools are com-
monly recognized—the first led by W. Roscher, B.
Hildebrand, and K. Knies, the second by Gustav
Schmoller. This last was a “tsar” and censor of German
university economics for a generation, under the
Empire of 1871. He was important as a historian as
well as a propagandist. Karl Bücher and others of the
“schools” were more interested in history than in con-
ceptual or mathematical analysis.

The anti-deductivist writers called for a science not
of wealth alone but of life—as Othmar Spann, a ro-
mantic adherent stated it (Tote und lebendige Wissen-
schaft,
2nd ed., 1928)—with only special attention to
the economic aspect; i.e., they opposed the “narrow-
ness” and the unreality of analysis and specialization.
(One might ask, why only “life,” not the world, since
man is a part of it, and high authorities say that life
is nothing but physics and chemistry.)

An offshoot of the German movement was American
“Institutionalism” which flourished around the turn
into the twentieth century. Thorstein Veblen was its
best known champion—writing satire along with
science—and had a devoted follower in Clarence E.
Ayres. John R. Commons wrote on economic institu-
tions chiefly from a legal standpoint, and Wesley C.
Mitchell was sympathetic; he was claimed as an insti-
tutionalist, but his main work, on money, statistics, and
business cycles, belongs to “orthodox” economics.


061

What should be said about these opposition move-
ments is that there is no conflict at all with orthodoxy.
One can advocate a policy or write historical or socio-
logical economics at will, distinguishing the result from
history or sociology as far as possible. There was little
excuse for a “methods quarrel” (Methodenstreit) such
as raged in Germany and Austria after the publication
of Carl Menger's Untersuchungen (“Inquiries into
Methods”) in 1883—chiefly between him and Gustav
Schmoller. One may contend that inductive treatment
is superior, or even that no other economics should
be written. But it remains true that price theory yields
laws more useful for guiding action than any other
comparably simple view of social phenomena (e.g.,
criminology). There has been much effort to find pre-
dictive historical laws, but success has been sadly lim-
ited. Perhaps the major achievement has been Sir
Henry Sumner Maine's formula, “from status to con-
tract” (Ancient Law [1930], p. 182). Hegel used some-
what similar words, but with a very different meaning.
Doubtless enough has been said about the conflicting
approaches; but a final word may revert to the paral-
lelism of economic theory with the science of me-
chanics, where the abstraction and unrealism are
greater, but their necessity and usefulness are not
questioned.

BIBLIOGRAPHY

Background for this topic, and important bibliographies,
can be found especially in Joseph A. Schumpeter, History
of Economic Analysis
(New York, 1954; published posthu-
mously), and Edmund Whittaker, A History of Economic
Ideas
(New York, 1939). Other useful volumes are: Eric Roll,
A History of Economic Thought (New York, 1939; 3rd ed.,
1942); J. F. Bell, History of Economic Thought (New York,
1953); Alexander Gray, The Development of Economic Doc-
trine
(London and New York, 1931); the last is less compre-
hensive than the others. Valuable for the history of “laissez-
faire” are D. H. Macgregor, Economic Thought and Policy
(Oxford, 1949); and Edward R. Kittrell, “'Laissez-Faire' in
English Classical Economics,” Journal of the History of
Ideas,
27 (1966), 610-20. Additional studies are Edwin
Cannan, A History of the Theories of Production and Distri-
bution in English Political Economy from 1776 to 1848,
3rd
ed. (London, 1924); Mark Blaug, Ricardian Economics: A
Historical Study
(New Haven and London, 1958); and Paul
T. Homan, Contemporary Thought (New York, 1928).

The following are the best editions of economic classics.
Adam Smith, The Wealth of Nations, ed. Edwin Cannan,
2 vols. (London and New York, 1904). It is available in
reprints, and in a useful abridgment of W. J. Ashley, Selected
Chapters and Passages from The Wealth of Nations
(London,
1895; 1906). David Ricardo, Principles of Political Economy
and Taxation,
Vol. I of Works and Correspondence, ed. P.
Sraffa and M. H. Dobb, 10 vols. (Cambridge, 1951-55). John
Stuart Mill, Principles of Political Economy, ed. W. J. Ashley
(London and New York, 1909). A new version has an intro-
duction by V. W. Bladen, textual editor J. M. Robson,
2 vols. (Toronto, 1965). E. von Böhm-Bawerk's chief works
are Kapital and Kapitalzins, Vol. I, Geschichte und Kritik
der Kapitalzinstheorien
(Innsbruck, 1884), trans. William
Smart as Capital and Interest (London, 1890; 1932); Vol.
II, Positive Theories des Kapitals (Innsbruck, 1889), trans.
William Smart as The Positive Theory of Capital (London,
1891; 1923).

On Socialism the following are recommended: Alexander
Gray, The Socialist Tradition, Moses to Lenin (London and
New York, 1946; reprint 1968); and Harry W. Laidler, His-
tory of Socialism,
rev. ed. (New York, 1968).

Still useful is R. H. I. Palgrave, Dictionary of Political
Economy,
ed. Henry Higgs, 3 vols. (London and New York,
1926).

FRANK H. KNIGHT

[See also Anarchism; Authority; Cycles; Democracy; Eco-
nomic Theory of Natural Liberty;
Enlightenment; Equality;
Freedom; Individualism; Liberalism; Marxism; Nationalism;
Progress; Property; Socialism; State.]