Entrepreneur's Net Worth: Mises's Praxeological Concept of Capital
Capital Papers On the Web
● Bohm Bawerk on the origin and meaning of the word "capital"
● Frank Fetter: "Recent Discussion of the Capital Concept"
● Edward Cannan: "Early History of The Term Capital"
November 10, 2000
Abstract
In Human Action, Ludwig von Mises employed two radically different notions of capital. The first was equivalent to what accountants call net worth. In calculating her profit and loss, the individual conceives of her income in terms of a change in net worth. If we shift the focus to an income stream, net worth (capital) can be said to refer to the capitalized value of that stream. Thus, the concept of capital as net worth implies capital accounting. This notion was truly subjectivist and fully consistent with the subjective theory of value and cost that was initiated by the early Austrian economists. The second notion was produced material factors of production.
Mises recognized that the basis for distinguishing produced material factors from other non-produced and non-material factors was not consistent with the Austrian theory of value and cost. With some caution, he nevertheless employed the second notion, especially in his discussion of the relationship between economic action and time. One possible explanation for this was his desire to deal with the capital controversies of the period.
This paper carefully analyzes the passages in Human Action in which the capital goods notion is used. It argues that Mises unwisely restricted what could have been a broader discussion that would account for all factors of production (i.e., roughly higher-order goods, in Carl Menger's terminology). The significance of this lies in the fact that modern neo-Austrian economists have apparently neglected Mises's first notion and accepted his second notion of capital goods. Or they have ignored Mises altogether and employed the capital goods notion in their work. By doing so, they risk neglecting the subjective theory of value and cost in their discussions of the relationship between time and economic action. The paper also shows that some of Mises's capital goods' discussions are trivial and out of place.
Outline
1.Entrepreneur's Net Worth and Capital Accounting
a.Capital as an Entrepreneur's Net Worth
b.Capitalism as the Preserve of Capital Accounting
2.Entrepreneur's Net Worth Vs. Capital Goods
a.Definition of Capital Goods
b.Capital vs. Capital Goods
c.Monetary Calculation and Capital Goods
i.Could Capital Goods Exist Before Monetary Calculation?
ii.Real Capital
iii.Private and Social Capital
2.Capital Goods and Time
a.Capital Goods and Production
i.Critique
b.Capital Goods as Time Stored Up
i.Critique
c.Capital Goods and Choice: A Digression
i.The "Capital Goods" Problem
d.Trivial and Misdirected Arguments
i.Capital Goods Lengthen the Period of Production
ii.Capital Goods Facilitate Economic Development
iii.Fallacies of Central Planning
iv.Saving
v.Cash Holding and Capital Accumulation
3.Conclusion
Entrepreneur's Net Worth: Mises's Praxeological Concept of Capital
In several recent works, I have advanced the proposition that there was a major change, indeed a revolution in the Austrian theory of value and cost. I claimed that the thrust of this revolution can be traced to the concept of the entrepreneur as the embodiment of distinctly human action under the conditions of the market economy. In an amateurish book published in 1990, I laid out a somewhat premature and stylized description of the method I believed Ludwig von Mises employed to bring about this "new subjectivist revolution." Following Mises (Mises 1966: 61; 251-5), I defined entrepreneurship in relation to a set of "economic functions." I went on to make an effort to pinpoint the concept of the entrepreneur by defining it as "that part of economic interaction under the conditions specified in the definition of the market economy which cannot be represented by robots."(Gunning 1990: 85) By making an analogy between distinctly human action to an isolated actor and action in a market economy, I deduced three characteristics of the entrepreneur: appraisement, undertaking, and uncertainty-bearing. I claimed that these three characteristics are necessarily present in every complete entrepreneurial act and, therefore, are the embodiment of the economic interaction that cannot be represented by robots. In my conclusion, I discussed Mises's contribution. I wrote:
The great accomplishment of some of the later classical and early neoclassical economists is that they developed the marginal productivity theory of value and distribution, in which economic interaction is placed into functional categories. This procedure helps the economist construct an image of fully integrated economic interaction from the "macroeconomic" view. Mises recognized that the marginal productivity theory was the application of methodological apriorism and the old subjectivism to economic interaction under the conditions specified in the definition of the market economy. The particular characteristics of economics are represented by the functional categories of consuming, saving, producing and supplying factors, which are associated with the roles of the consumer-saver, producer, and factor supplier. To show how these functions get performed by human actors - in other words, to incorporate the a prior categories of action into his images of the market economy - the economist defines consuming as the ultimate end and producing through the employment of factors as the means. He also assumes that all economic action occurs through time in an environment of intersubjective uncertainty. To demonstrate the subjectivity of economic analysis, he contrasts (a) an image of an economy in which robots who behave according to algorithms ("maximizers") occupy the roles of consumer, producer and factors supplier with (b) an image of a market economy, in which these behaviors are performed as a consequence of entrepreneurship. Entrepreneurship encompasses the role of making appraisals and, most importantly, of betting that one's appraisals are more correct than someone else's by bearing uncertainty. The image is built step-by-step by identifying more and more manifestations of entrepreneurship.
In short, the early economists succeeded in converting economics into the study of the abstract and only distinctly human activities entailed in a market economy: those activities that get personified in the image of the appraising, decision making and uncertainty-bearing entrepreneur. Following the marginal productivity theory, the study of economics became (or should have become) mainly the study of entrepreneurship and its various manifestations.
Mises's great accomplishment was to recognize how the method used by the early economists, which he dubbed the method of imaginary constructions, was related to the subjectivist revolution of the 19th century. It is this connection that makes it appropriate to call Mises's work the new subjectivism.
A couple of years later in an upstart journal that was unknown to most economists (and which has since changed its name), I presented a history of the entrepreneur concept in which the highest point is the definition of entrepreneurship as "the distinctly human aspects of human action performed under the conditions specified in the definition of the pure market economy."(Gunning 1992b: 282; see also Gunning 1992a) In light of the many writings that employ the term "entrepreneur," it now seems prudent to add the descriptive adjective "praxeological" in order to distinguish this concept. In a 1997 paper, I showed more directly how Mises's methodology and his concept of the praxeological entrepreneur transformed the older Austrian theory of value and cost of Menger and Bohm Bawerk.(Gunning 1997) In a companion paper, I broadened the scope of my investigation to include the American economist Herbert Davenport, showing how he also contributed to this transformation, although his work went unrecognized by Mises.(Gunning 1998a) Both of these papers were written outside of the normal research outlets for Austrian economists. The same was true of a paper on the theory of entrepreneurship in Austrian economics, which again prompted the view that Mises had carried the theory to its highest point.(Gunning 1998b)
The transformation of the theory of value and cost, which I have associated with Mises, has not spread to other Austrian economists. This is partly because the others have not recognized its foundation-shaking implications. Quite simply, to comprehend the transformation requires a transformation of one's one view of and even definition of economic phenomena. Correspondingly, it requires an attention to methodology that is extremely rare among today's members of the economics profession. This transformation was not achieved by F. A. Hayek, Israel Kirzner, Murray Rothbard, or Ludwig Lachmann - to name the other major 20th century leaders of the Austrian school.
If I am correct in claiming, as I did in my 1990 book, that the transformation in the Austrian theory constitutes a revolution in economic thinking and if Austrian economics bears some semblance to science, in which manifestly less adequate theories get replaced by manifestly more adequate theories; then it is inevitable that the new subjectivism, as I called it, will be adopted. The aim of this paper is to spur this development by demonstrating how the transformed theory of value and cost is relevant to capital theory. It will be argued that Mises's Human Action contained an theory of capital that was quite different from the capital theory of other Austrian economists and that this theory is derivable from the transformed theory of value and cost. As a result, it seems correct to say that Mises revolutionized capital theory by making the concept more subjective than it had ever been.
Mises was both the herald and the first expositor. He had the difficult task of communicating with individuals to whom the methodology and definitions he proposed were totally new. It is not surprising under such circumstances that some of his presentations would remain incomplete. Revolutions in the thinking of the intellectuals of science can only occur when the revolutionary uses existing terms that have existing meanings to persuade that these terms and meanings need to be replaced. The persuader walks a tightrope so to speak. On the one hand, he must use the old words and meanings. On the other hand, he cannot fully endorse these and indeed must eventually denounce them. We shall see that Mises did not succeed in doing this for the case of the concept of capital. As one might expect, his exposition used two concepts of capital - a revolutionary new praxeological concept and an old materialist concept. The main goal of using the old concept seems to have been to deal with the contemporary capital controversies, thereby showing the superiority of the praxeological view. The result, however, was that he seemed to implicitly endorse the materialistic concept in economic discussions, which is just the opposite of what he apparently intended. By demonstrating how the use of the second concept led Mises (1) to arguments that were less general than they could have been and (2) to make some statements about capital that were both trivial and misdirected, I will make the argument that the best future policy for Austrian economists is to completely jettison the concept of material capital.
Subjectivism is an approach to the study of phenomena that places subjects' perceptions, expectations, and plans about the phenomena above the study of the phenomena the mselves. A good example of Mises's subjectivism in economics is his criticism of Eugen Bohm Bawerk's theory of interest. This theory was based partly on the assumption that more roundabout methods of production are more physically productive. Mises criticized it on the grounds that the productivity of methods of production should be defined in terms of (1) whether subjects perceive the methods and, given that they do, (2) subjects' perceptions of the utility or income that they expect the methods to yield.(Mises 1966: 488-9; Mises, 1974) Another example is his definition of capital. He points out that economists "erred in classifying 'capital' as an independent factor of production along with the nature-given material resources and labor."(Mises 1966: 493) He presents his argument best in his discussion of land. He writes the following:
The modern theory of value and prices is not based on the classification of the factors of production as land, capital, and labor. Its fundamental distinction is between goods of higher and of lower orders, between producers' goods and consumers' goods...The law controlling the determination of the prices of the factors of production is the same with all classes and specimens of these factors...The only reason why the old economists were puzzled by this fact was that they operated with a general term land that neglects differences in productivity.(ibid.: 636)(1)
By using the concept of a good, he is referring to Menger, who wrote that for a thing to be a good, a subject must know how the item can be used to satisfy what we would today call a want.(Menger 1981: 52) For this reason, we can safely assume here that Mises meant value productivity. Given this interpretation, the last sentence means that the old economists' concept of land also neglects changes in consumer wants, other complementary resources, and knowledge. In other words, Mises is arguing that the old economists erred in their theory of value (i.e., the theory of price and cost) by assigning the factors "land" and "capital" position in their analyses that is higher than the perceptions, expectations, and plans about this factor. More specifically they misplaced their emphasis by neglecting the part that "land" and "capital" played in individuals' calculations about how to best satisfy their wants.(2)
Another example of his subjective approach to capital is what appears to be his must fundamental discussion:
The calculating mind of the actor draws a boundary line between the consumer's goods which he plans to employ for the immediate satisfaction of his wants and the goods of all orders--including those of the first order--which he plans to employ for providing by further acting, for the satisfaction of future wants. The differentiation of means and ends thus becomes a differentiation of acquisition and consumption, of business and household, of trading funds and of household goods. The whole complex of goods destined for acquisition is evaluated in money terms and this sum--the capital--is the starting point of economic calculation.(ibid.: 260-1)
In spite of Mises's general commitment to subjectivism, his treatise Human Action contains extensive discussions of capital goods, which he defines as intermediate products and material factors of production. This seems to reflect a pragmatic approach to communicating ideas. He writes:
When [economics] distinguishes within the class of factors of production the original (nature-given) factors from the produced factors of production (the intermediary products) and furthermore within the class of original factors the nonhuman (external) factors from the human factors (labor), it does not break up the uniformity of its reasoning concerning the determination of the prices of the factors of production.(ibid.)
Note that in this passage he defines all higher order goods as capital.
The view of this paper is different. It will be argued that thepraxeological usage and the material usage of the term capital are so different that for Mises to include both usages in his work was bound to detract from the major 20th century advance in the Austrian theory of value and cost.(3) This was the discovery that subjective value theory assigns to the role of the entrepreneur all distinctly human money-seeking action under the conditions of the pure market economy. Entrepreneurship uses the same methods to appraise "original" factors as it does to appraise produced factors. The same is true for material and non-material factors. Moreover, the uncertainty with which entrepreneurship must deal is no different for produced, material factors than for other factors. By pragmatically accepting material differences among factors, Mises helped lead Austrian economies away from a praxeological theory of entrepreneurship.(4) Moreover, by stressing materiality, Mises made it harder for the interpreter of the Austrian theory to identify the subjectivist principle that a factor of production's value corresponds to a subjective appraisal made by a particular individual acting in the entrepreneur role.(5)
The centrality of appraisement and the entrepreneur role is evident in Mises's first definition of capital described above:entrepreneur's net worth. Although he did not use this term, his meaning is evident in his discussion. Capital, he said, refers to the income-generating potential of the higher order goods from the viewpoint of an individual. The concept is derived from the individual's effort to employ capital accounting to calculate his profit and loss.(ibid.: 260-1)
This paper argues that Mises's use of the term capital to refer to both entrepreneur's net worth and to produced material objects was a serious tactical error. It claims that his discussion of capital goods is strained and misleading. He would have been well advised to omit it. The main purpose of the exercise is not to criticize Mises but to support the argument that within Mises's writings is a subjectivist concept of capital that is superior to that of other Austrian economists. Space considerations prevent the author from demonstrating that this is so. The limited aim in this paper is to elucidate this concept and to demonstrate its presence in Mises's work.
Part one introduces the notion of capital as equivalent to an entrepreneur's private net worth and shows its relationship to capital accounting and monetary calculation. Part two contrasts the idea of capital as an entrepreneur's net worth with capital goods and shows how Mises differentiated these terms in his initial discussion of the topic. Part three assesses most of Mises's discussion on the relationship between capital goods and time. Part four presents a brief conclusion.
Bohm Bawerk on the origin and meaning of the word "capital."
1. ENTREPRENEUR'S NET WORTH AND CAPITAL ACCOUNTING
Mises's most fundamental definition of capital is an entrepreneur's net worth. Since a person's net
worth cannot be calculated without using the capitalization formula, this definition assumes the
use of capital accounting, as an instrument of monetary calculation. This concept of capital
seems to have escaped the notice of modern neo-Austrians.(6) Thus it is wise to follow Mises's
discussion of "capital" step by step.
Capital as an Entrepreneur's Net Worth
With the exception of a brief section on the procedure of economics, Mises devoted the first three parts of Human Action(about 25%) to an elucidation of praxeology. The rest of the book is about economics. He introduced the subject of capital as private net worth in chapter 10, where he discussed "Economic Calculation and the Market." He first points out that "[t]he distinctive mark of economic calculation is that it is neither based upon nor related to anything which could be characterized as measurement."(Mises 1966: 209) This is because
the exchange ratios which we have to deal with are permanently fluctuating. There is nothing constant and invariable about them. They defy any attempt to measure them. They are historical events, expressive of what happened once at a definite instant and under definite circumstances...Numbers applied by acting man in economic calculation do not refer to quantities measured but to exchange ratios as they are expected -- on the basis of understanding -- to be realized on the markets of the future to which alone all acting is directed and which alone counts for acting man.(ibid.: 210)
The point here is that individuals use money to compare prospective outcomes of alternative courses of action. Acting as an entrepreneur, an individual tries to obtain the greatest satisfaction through exchange. To compare different alternative courses of action, he attaches his own personal, subjective money tag to them. "How is the action likely to effect my revenues and costs?," he asks. To anticipate future conditions, individuals use "understanding," which in this context roughly means trying to put oneself into the shoes of other actors in an effort to predict their future behavior.(ibid.: 51-58)
When Mises goes on to discuss the purpose of economic calculation, he introduces the term "capital."
The task which acting man wants to achieve by economic calculation is to establish the outcome of acting by contrasting input and output...It is with regard to this problem that the fundamental notions of economic calculation -- capital and income, profit and loss, spending and saving, cost and yield -- are developed.(ibid.: 210-1, italics added)
Capital here seems to refer to the present value of the future expected income. His point, which might easily be overlooked, is that in performing their calculations, individuals in the market economy use capital accounting. Capital accounting enables an individual to compare revenues and costs that are expected at different times. Without it, one could not construct the capital-income formula. Implicit in this, of course, is the presence of some means of discounting, like time preference ( a personal discount rate) or interest rates.
Notice that if we want to make Mises's use of the term capital consistent, we must regard capital
as acting man's net worth, or equity. Capital accounting then becomes the means that an actor use
to calculate net worth on the basis of expected income and a discount rate. One is reminded of
what earlier economists called "the process of capitalization" as a necessary part of each
individual's decision making.(7) Note further that because this definition of capital refers to all
potential sources of future income, it is broad enough to include such things as rights to
command other actors to perform tasks, rights to use other peoples' land, accounts receivable,
debts owed (on the negative side), and goodwill. Thus capital in this definition bears no
resemblance to the concept of capital goods, which Mises introduces later in this discussion and
which is discussed below. On the contrary, it is virtually identical to an individual's appraised
value of what Menger called higher order goods.(Menger 1981: 55-58) Indeed, this definition of
capital appears to distinguish Mises from all other writers on capital in the Austrian tradition,
excluding Menger.
Capitalism as the Preserve of Capital Accounting
Just before beginning his description of the "economics of the market society," Mises writes a brief section telling how the theory of action can be applied in a society containing a division of labor, private property, and money. In such a society, "[m]onetary calculation is the guiding star of action." It "is the method of calculating employed by people acting within the frame of society based on private control of the means of production." "It is a mode of computation designed for ascertaining private wealth [net worth] and income and private profits and losses of individuals acting on their own behalf within a free enterprise society." It "is the main vehicle of planning and acting in...free enterprise."(Mises 1966: 229-230)
[m]onetary calculation reaches its full perfection in capital accounting...[by establishing] the money prices of the available means and confront[ing] this total with the changes brought about by action and by the operation of other factors.(ibid.: 230)
Up to this point in the book, Mises had not defined the entrepreneur. Thus, he did not mention entrepreneurship in these passages. However, since profit is the specific income of the entrepreneur (ibid.: 254), his use of the term "profits and losses" make it evident that he was writing here about what he would later in the book call the entrepreneur function, or entrepreneurship. In other words, monetary calculation involving capitalization is the province of entrepreneurship. Entrepreneurship makes the calculations; it plans and acts on the basis of expected profit and loss.
Mises goes on to discuss the term "capitalism." He says that people have dubbed the system of
free enterprise "capitalism" in order to deprecate or smear it. "However, this term can be
considered very pertinent. It refers to the most characteristic feature of the system, its main
eminence, viz., the role the notion of capital [read: capital accounting and the corresponding
notion of an actor's net worth] plays in its conduct."(ibid.: 230)
2. ENTREPRENEUR'S NET WORTH VS. CAPITAL GOODS
We turn now to Mises's more direct discussions of "capital," specifically to the beginning of his chapter called The Market. The first section of the chapter defines the market economy as a "social system of the division of labor under private ownership of the means of production"(ibid.: 257). We focus on the second section, entitled Capital Goods and Capital, which comprises approximately five pages.
Definition of Capital Goods
Mises begins by describing a fundamental characteristic of human beings: "There is an impulse inwrought in all living beings that directs them toward the assimilation of matter that preserves, renews, and strengthens their vital energy."(ibid.: 259) Enhancing one's vitality, Mises says, is conscious and purposeful. He goes on to say that man's "ingenuity leads to the construction of tools." Then he discusses products that make it possible to lengthen the average period of time between the beginning and end of a production process.
The products accumulated for this purpose are either intermediary stages in the technological process, i.e., tools and half-finished products, or goods ready for consumption that make it possible for man to substitute, without suffering want during the waiting period, a more time-absorbing process for another absorbing a shorter time. These goods are called capital goods.(ibid.: 260, italics added)
It appears here that he means for capital goods to exclude the so-called natural resources, or land. He also seems to want to exclude what we now call "human capital" - physical and intellectual skills. Finally, he apparently means to exclude legal rights. Thus the set of items that constitute capital goods is much narrower than the set identified by Menger. It is also narrower than Mises's set of factors of production to which individuals apply capital accounting in making appraisals.
Capital vs. Capital Goods
Mises proceeds to distinguish between capital goods and capital.
From the notion of capital goods one must clearly distinguish the concept of capital. The concept of capital is the fundamental concept of economic calculation, the foremost mental tool of the conduct of affairs in the market economy. Its correlative is the concept of income.....The whole complex of goods destined for acquisition is evaluated in money terms, and this sum -- the capital -- is the starting point of economic calculation...That amount which can be consumed within a definite period without lowering the capital is called income. If consumption exceeds the income available, the difference is called capital consumption. If the income available is greater than the amount consumed, the difference is called saving. Among the main tasks of economic calculation are those of establishing the magnitudes of income, saving, and capital consumption.(ibid.: 260-1, italics added)
It is essential to understand precisely what Mises means by "capital" in these statements. First, one should recognize that it refers to the money values. It is "the whole complex" in "money terms." Thus it refers to the subjects' money evaluations of the items in the complex. Second, since he writes of the "whole complex of goods destined for acquisition," we must assume that the items he has in mind are not merely the material capital goods. We must assume that he has in mind all assets in terms of the future income that is expected to be derived from them. Mises writes as much:
The calculating mind of the actor draws a boundary line between the consumer's goods which he plans to employ for the immediate satisfaction of his wants and the goods of all orders -- including those of the first order -- which he plans to employ for providing by further acting, for the satisfaction of future wants.(ibid.: 260)
If a person uses up some of the natural fertility of his land, then this also is capital consumption,
so long as he put a price on that fertility. The same is true for "human capital" and legal rights. If
he had anything else in mind, he would have, at some stage, criticized Menger's definition of capital.
Monetary Calculation and Capital Goods
Could Capital Goods Exist Before Monetary Calculation?
Mises applies his concept of capital as an accounting tool by discussing a common error. First, he describes an unobjectionable metaphor. He notes that writers tend to look back in time and apply the accounting concept to earlier times when there was no market economy and, therefore, no economic calculation. "[W]e may say metaphorically that (the savage ancestors of the human race) too used capital." This applies as well to the primitive husbandmen's "reluctance to kill a pregnant hind" and the "uneasiness felt by even the most ruthless warriors in cutting fruit trees..."(ibid.: 261) This is a metaphor because, in these early times, no money existed and therefore no capital accounting could occur.
The metaphor can be misused. In particular, it was misused by "[s]ome economists [who] concluded that 'capital' is a category of all human production...and that it does not depend upon the practice of monetary calculation." This is an error because the
concept of capital cannot be separated from the context of monetary calculation and from the social structure of a market economy in which alone monetary calculation is possible. It is a concept which makes no sense outside the conditions of a market economy.(ibid.: 262)
Real Capital
Another error is the concept of real capital. Mises points out that the concept of a sum of the various factors of production is an "empty concept" because it is "of no use to acting." It is "merely an enumeration of physical quantities of thousands and thousands of various goods." Mises's point is that without specifying (1) a system of markets and prices and (2) calculating minds to appraise the factors, there is no way to determine the relative importance of these various goods to economic actors. He goes on to criticize the idea of the "productivity of capital" as one that is based on the empty concept of real capital. Then he criticizes those who "explain interest as an income derived from the (empty concept of the) productivity of capital."(ibid.: 263)
Private and Social Capital
Mises finishes off this section by discussing the vacuousness of the concept of social capital:
People began to mediate upon a concept of social capital as different from private capital. Starting from the imaginary construction of a socialist economy, they were intent upon defining a capital concept suitable to the economic activities of the general manager of such a system. However...in a socialist economy there are capital goods but no capital."(ibid.: 264)
Mises writes here that although the socialist manager can designate some goods as capital goods, there is no capital because the socialist society contains no prices or economic calculation.(8)
It is worth pausing to consider the broader implications of this statement. By emphasizing the
privateness of capital, Mises appears to imply that the only concept of capital that is relevant in a
market economy is private capital -- the entrepreneur's net worth calculated, by means of capital
accounting, by a particular individual acting in the role of the praxeologicalentrepreneur.(9)
Nevertheless, he mentions the entrepreneur only once in this section. He says that "[t]he notion of
capital...is a device of capitalists, entrepreneurs, and farmers eager to make profits and to avoid
losses."(Mises 1966: 264) This economizing on the use of the term "entrepreneur" is puzzling in
light of the fact that in the previous chapter, Mises had clearly recognized the central role that the
entrepreneur function plays in the explanation of economic interaction. He could have included a
reference to the function of the entrepreneur in all of his discussions of capital. But he did not. In
my view this was a serious tactical error. All of the major points in this chapter hinge on the
reader's taking what Davenport called "the entrepreneur point of view" of capital.(Gunning
1998b, 350-1) Yet it seems that one must read between the lines in order to receive this message
from Mises.
3. CAPITAL GOODS AND TIME
Mises's chapter on "Action in the Passing of Time" contains a more extensive discussion of capital goods. He does not begin this treatment until he has completed two lengthy chapters on the market and prices and another long chapter on exchange involving money. The purpose of delaying the treatment, one assumes, is that he believes that before one can understand the relationship between capital and time under the conditions of a market economy, one must first know how to construct an image of a market economy in which time is not emphasized.
The main purpose of the chapter seems to be to define the concept of capital goods in terms of an individual's time preference. In other words, he wants to develop a definition of capital goods that requires the user of this term to think of an individual's time preference. In doing this he decides to adopt the "convention" of limiting the capital goods concept to produced material goods. If one follows Mises, it would be logically incorrect to use the term capital goods in any context other than with reference to an individual's judgment about how the material goods in question fit into his scheme for satisfying his wants over time. A material good that lies outside an individual's purview with respect to his efforts to satisfy his wants over time is not a capital good.
The contention of this paper is that Mises's decision to confine his discussion about how higher order goods are used in relation to time preference to material goods is an error in two related senses. First, the main points relating to time preference are more general than is suggested by his discussion. As a result, the ordinary reader is likely to miss the full significance of his effort to link appraisals to time preference. Second, by neglecting to emphasize the generality of the principles, Mises diverts attention away from one of his most important contributions to economic theory - his praxeological concept of the entrepreneur. I will try to illustrate these points by critiquing most of the points he makes in this chapter.
Capital Goods and Production
In the first section of the chapter, Mises asserts that the accumulation of capital goods is necessary before people can begin to use longer periods of production than they are currently using.
People eager to embark upon processes with a longer period of production must first accumulate, by means of saving, that quantity of consumers' goods which is needed to satisfy, during the waiting time, all those wants the satisfaction of which they consider more urgent than the increment in well-being expected from the more time-consuming process. Accumulation of capital begins with the formation of stocks of consumers' goods the consumption of which is postponed for later days."(ibid.: 491)
Here he says that in order to make the production period longer than it otherwise would be, individuals must save a larger part of their stocks of durable consumers' goods than they otherwise would. This, he says, is part of the process of capital accumulation.
A stock of consumers' goods need not be integrated economically into the "orbit of production." Surpluses of consumers' goods that are stored for later consumption are simply wealth. To be integrated economically into production, they must be employed as means of subsistence.(ibid.) Once integrated into the orbit of production, the surpluses "are replaced first by the intermediary products of a process with a longer period of production and then later by the consumers' goods which are the final product of these processes."(ibid.) The
intermediary products.., the produced factors of further production...change hands in the course of events; they pass from one plant to another until finally the consumers' goods reach those who use and enjoy them.(ibid.: 492)
Mises's reason for pointing this out is evidently to focus the reader's attention on those consumers' goods that are "integrated into the orbit of production."
Mises's main aim in this section is to illustrate the limits placed by time preference on what he calls capital accumulation. He achieves this by considering the case in which production processes with longer periods of production are technologically superior. He begins by pointing out that individuals would accumulate stocks of durable consumers' goods even if processes requiring a longer period of time were not technologically superior, that is, even if the longer processes did not result in a greater physical output of desirable goods than shorter processes. The reason is that accumulation makes it "feasible to aim at goals which could not be thought of before on account of the length of the production period required."(ibid.: 490) Nevertheless, technological processes with a longer period are superior. However, if technological processes with a longer period are superior, why do actors not always prefer the longer processes? The answer is time preference. "What restricts the amount of saving and investment is time preference."(ibid.: 491) No one would want to "accumulate all of the capital" that is possible to accumulate, since everyone has a preference for not only distant future goods but also near future goods.
To see how Mises negotiates the terminology problem, consider the following statement about capital accounting and capital goods.
All of these ventures and processes are intellectually controlled by capital accounting, the acme of economic calculation in monetary terms. Without the aid of monetary calculation men could not even learn whether -- apart from the length of the period of production -- a definite process promises a higher productivity than another...Capital accounting starts with the market prices of the capital goods available for production, the sum of which it calls capital...It is the indispensable compass of production in the market economy.(ibid.)
By saying that "capital accounting starts with the market prices of capital goods available for production," he makes it appear as if capital accounting does not apply to the factors of production that are not capital goods - land, to intellectual and physical skills, and to legal rights. Surely, however, he does not mean this.
Critique
We must begin by endorsing, and even embracing, Mises's main point that time preference limits the willingness of people to embark on lengthier production projects than those that they choose. But now we must question the wisdom of distinguishing between durable consumers' goods, intermediary products and other factors of production (or higher order goods).
Why imply that the shift to longer periods of production must start with the formation of stocks of consumers' goods and that it must pass through stages in which people use tools and produce factors of further production. Surely, the shift can occur without this.
If we begin with a stationary system, we can imagine several kinds of changes that could lead an individual to shift to longer production periods without his producing additional stocks of consumers' goods or intermediary products. First, there could be an increase in the physical productivity of the more lengthy processes that is completely independent of human choice. The best example might be agricultural production due to systematic and relatively permanent changes in weather conditions. Second, people might use their brain power to discover ways to increase the physical productivity of either or both the shorter and more lengthy production processes. Third, people might deliberately change their desires for the products of the longer vs. the shorter production processes. It might be argued that this, in fact, is a change in time preference. Whatever we call it, Mises did not consider it. Fourth, people might improve their physical or intellectual skill in producing products. The only initial state in which Mises's implications are logically correct is one in which none of these four events can occur without first accumulating consumers' goods and then producing intermediate products. Such an initial state is characterized by such extreme scarcity that people are unwilling to wait at all yet sufficient goods are produced without waiting to insure their survival. This initial state is conceivable but it is not relevant to the conditions of any society that we know or have known.
We are forced to conclude that nothing is gained building an image of an individual or an economy in which the accumulation of consumers' goods and intermediary products as antecedent to the shift to production processes with longer periods of production.
Praxeology, as a means of describing historical events, demands that changes be described in terms of action - either in terms of the action that causes historical events, action that responds to changes due to non-action, or both. We describe changes in action under the conditions of the market economy by referring to entrepreneurial appraisals and decisions and to how individuals deal with the uncertainty entailed in their decisions. Mises's choice to focus on produced material factors of production inclines us to forget the entrepreneur point of view.
The important point is that, as quoted above, "[t]he modern theory of value and prices is not
based on the classification of the factors of production as land, capital, and labor."(ibid.: 636) We
can illustrate how time preference affects choices within the framework of the modern theory of
value and prices without using the concept of the accumulation of capital goods. We need not
step outside the theory and we are liable to forget entrepreneurship if we do.
Capital Goods as Time Stored Up
Notwithstanding Mises's focus on capital goods and not on the other factors of production in the previous section, he goes on in the next section to remind his readers of one of the most important insights of the subjective theory of value: that all factors of production are treated identically by the calculating mind. The businessman might adopt a superficial rule of thumb in distinguishing (1) "nature-given material factors, (2) the human factor - labor, and (3) capital goods - the intermediary factors produced in the past."(ibid.: 492) However, "it was a serious mistake for the economists to agree with the businessman's superficial view...The...factors of further production produced in the past...are not an independent factor."
Having reminded readers of this, he goes on to the major subject of this section. He writes that the factors produced in the past "are the joint products of the cooperation of the two original factors - nature and labor - expended in the past."(ibid.: 493)
He uses this observation to launch a critique of the view that capital goods are "labor and nature stored up." We can see why this view is wrong, he points out, by comparing the price faced by a purchaser of a particular capital good, e.g., a machine, to the sum of the prices of the factors of production needed to produce the machine. When a man chooses to buy the machine, he is not buying stored labor and nature; he is buying "time stored up." A person who buys the machine instead of the factors used to produce it, is "nearer the goal of production."(ibid.)
Note that the argument here is forward-looking. Someone who purchases a machine in accord with his plans to produce goods in the future, he says, expects his purchase to save time because otherwise he would need to take the time to produce the machine.
Critique
The critique is that this line of reasoning applies not only to machines but to all kinds of factors, so long as the factor, or its substitute, is available in the market. First, the purchase of durable consumers' goods, as compared with producing them, may save time. Similarly, the purchase of more fertile land, compared with the purchase of less fertile land and the production of irrigation and fertilization goods, may save time. Finally, the purchase of skilled labor, compared with unskilled labor combined with a training program, may save time. Thus, a more accurate statement is that the purchase of a factor of production, compared to producing it or to choosing an alternative where time must be sacrificed to produce a substitute, enables a person to be "nearer to the goal of production." This is a truism that has nothing specifically to do with capital goods. Nothing is gained by using the term "capital goods" here and there is a risk that much will be lost. The best way to show that an existing factor of production is time stored up is to refer to how entrepreneurship sets the price of the factor in question relative to how it sets the prices of the factors need to produce it or its substitutes.
Capital Goods and Choice: A Digression
Given that reasoning about capital goods applies to all higher order goods, why did Mises want to retain the concept of capital goods at all? One possible answer is that professional economists had become accustomed to using this language. One apparent goal of Mises's discussion of capital goods was to deal with some of the relevant economics literature. Among other things, Mises wanted to "explode the objections against the time preference theory" raised by Frank Knight.(ibid.: 492n)(10) In a 1934 paper Knight had argued that the concept of time preference and a period of production are mere details that have no fundamental importance for understanding the market interest rates. He wrote that because individuals capitalize all expected streams of consumption wealth into a present value, the important fact is the size of this value, not the particular times at which the various income streams are expected or desired to be realized. Among other things, he used this argument to disparage the Austrian theory of the trade cycle, as presented by F. A. Hayek.(Knight, 1934: 286)(11) Knight also recognized the fact that the subjective value theory had debunked the classical classifications of the factors of production. However - and this is a point that Mises must have recognized - Knight continued to use it in his professional writings to refer to material goods.(Knight 1921: 124-5n)
To refute Knight, Mises had to show why time preference is important, regardless of the market value of the factors of production that the current generation of entrepreneurs had inherited from their predecessors. So he pointed out that "[w]e are the lucky heirs of our fathers and forefathers whose saving has accumulated the capital goods with the aid of which we are working today."(Mises 1966: 492) Because of this, we are better off. He went on to point out that, regardless of this, entrepreneurship must still adjust to time preference. Unfortunately, his discussion seems less clear on the issue than I am suggesting here.
As important as it may have seemed to deal with criticisms of Austrian time preference theory, Mises's reference to capital goods in this passage and in others must be regarded as unfortunate. To introduce the notion of capital goods in an argument that time preference must be accounted for in the theory of value is unnecessary and misleading. Whether the current generation inherits numerous tools and durable consumers' goods, bountiful land, a store of encyclopedic knowledge, a system of legal rights, or nothing; individuals will appraise what they regard as the factors of production in accord with their expectations about the particular times at which the factors can help to produce future goods. If time preference changes so that consumers are more forward-looking (for example, if they begin to regard the wealth of future generations as relatively more important), they will send a signal to entrepreneurship that longer-term investments are more profitable relative to shorter-term investments than they previously were. They will want to save more and for a longer period. This will, other things equal, cause the rates of interest on long term loans to fall relative to short-term loans. It may not affect the size of the present capitalized market value of the factors of production but it will be a crucial element in entrepreneurial decisions. If entrepreneurs fail to adjust, a trade cycle is likely.
This digression is essential if one hopes to comprehend Mises's writings on capital goods in light of the subjective theory of value. In every case where Mises uses the term "capital good" the reader should substitute: "an item, action, characteristic of action, legal right or expectation based on reputation that entrepreneurship plans to use in producing future money income."
Why, one might ask, would a writer so aware of the subjective value theory as Mises take such a
huge risk of being misinterpreted? We have already mentioned his apparent desire to deal with
the "capital controversies" in the professional literature. If this answer is correct, then it would be
wise to state that problem with which Mises aimed to deal before completing our interpretation
of Mises on capital goods.
The "Capital Goods" Problem
Mises conceived of the problem of capital in relation to a theory of plan revision in light of changes that occur after a decision has been made to produce definite capital goods.(12) We now turn to this problem. As stated by Mises, the problem is best represented by using the term "data." He introduces this term with regard to what he calls the "convertibility of capital goods":
The convertibility of capital goods is the opportunity offered to adjust their utilization to a change in the data of production...As the conversion of capital goods from the employment originally planned to other employments becomes necessary through the emergence of unforeseen changes in the data, it is impossible to speak of convertibility in general without reference to changes in the data which have already occurred or are expected. A radical change in the data could make capital goods previously considered to be easily convertible either not convertible at all or convertible only with difficulty.(ibid.: 504)
Data refer to
the bodily and psychological features of the acting men, their desires and value judgments, and the theories, doctrines, and ideologies they develop in order to adjust themselves purposively to the conditions of their environment and thus to attain the ends they are aiming at. These data...are perpetually fluctuating and varying; they change from instant to instant.(ibid.: 646)
These passages suggest that the problem with which Mises wanted to deal is that of synchronization among the plans of the numerous actors in the market economy and items that are regarded by them as factors of production available to complete those plans. Entrepreneurship makes a plan at time s to satisfy some want at a future time t. At time s, it begins to divert factors of production away from alternative uses. However, a change in expected demand or knowledge of how to satisfy demands occurs between time s and t. Entrepreneurship, regarding its initial plans as no longer yielding the highest profit, changes its plans. It may come to regard as non-factors (i.e., as items worthless in production) items or services that it previously regarded as factors. And it may come to regard as factors items and services that were previously not regarded as such.
It is essential to realize that this problem of the "convertibility of capital goods," as Mises calls it, is not confined to capital goods, as he defines them. Since the completion of plans depends not only on the presence of durable consumers' goods, tools, and intermediary products but also on the nonhuman original factors of production ("land"), legal rights and even expectations based on reputation; the problem he has in mind is not exclusively a capital goods problem. It is a factor of production and entrepreneurship problem.
We now return to our critique of the Misesian text.
Trivial and Misdirected Arguments
When one recognizes Mises's aim of illustrating the relevance of time in economic decision-making, some of the arguments he makes in his pages on "capital goods" seem trivial. Others seem unrelated to capital goods at all. In this subsection, we consider such arguments.
Capital Goods Lengthen the Period of Production
An example of a trivial argument is the one that Mises uses to support the claim that the production of capital goods lengthens the period of production. He begins by pointing out that
not every employment chosen for the utilization of capital goods...requires a process of production in which the period of production from today on to the maturing of the product is longer than with all processes already adopted previously. It may be that people, having satisfied their more urgent needs, now want goods which can be produced within a comparatively short period...The reason why these goods have not been produced previously was...that there was a more urgent employment open for the factors required.(ibid.: 495)
This seems to say that whereas previous capital goods were used (or existing capital goods are used) in production processes with periods of production that take, say, an average of two years to complete; a person may decide to produce a new capital good to be used in a production process that only takes one year to complete. Mises does not tell us why this fact is important. One possibility is that he is making a distant reference to the notion of an average period of production. A choice to produce a new "short-production-period" capital good could reduce the average period of time between when production with capital goods in general is started and the overall consumption benefits are felt. But why would Mises want to refer to the concept of the average period of production? He had already pointed out that this concept is as vacuous as the concept of real capital.(see above)
Although he does not explain why he thinks it is important, he proceeds to produce an argument to defend the view that "every increase in the supply of capital goods available results in a lengthening of the period of production and of waiting time."(ibid.) He considers the choice to produce a capital good. At the time the individual chooses to produce it, she compares her having a consumers' good at the earliest time with her having a consumers' good at the end of the production period in which the capital is involved. Because she chooses the latter, she increases her capital goods and causes the period of production to be lengthened farther than it would have been if she had chosen to use the resources to produce a good in the shortest period.
This argument is trivial. It says that if an individual chooses not to use her resources to produce
some good in the shortest amount of time possible, but instead uses them to produce a good for a
later time, the result will be that she possesses more resources in the future than otherwise. More
importantly, to a reader who had not completely rejected the concept of the average period of
production and the classical tripartite division of the factors of production, Mises might seem in
these pages to have accepted these ideas. He would have done better to omit any further reference
to capital goods and to avoid any connection between capital and the period of production.
Capital Goods Facilitate Economic Development
In describing Rumania around 1860 Mises points out that the Rumanians were short of capital goods. Rumania already had technological knowledge. Development depended on its having capital goods. Without capital goods, the Rumanians would have had to begin by saving in order to make workers available for the performance of more time-consuming processes of production. Because the West lent capital goods, Rumanians were able to save time. This "made it possible for them to multiply very soon the productivity of their labor."(ibid.: 497). He concludes:
Shortage of capital goods means that one is further away from the attainment of a goal sought than if one had started to aim at it at an earlier date...Capital shortage is a dearth of time...To have capital goods at one's disposal is tantamount to being nearer to a goal aimed at.(ibid.)
Mises is conscientious enough to recognize that the development of Romania has no necessary relationship to capital goods. He shows this with the following qualifier: "To have capital goods means, other things being equal, a temporal gain." In a footnote he says that this "implies also equality in the quantity of nature-given factors available."(ibid.) By adding this qualifier, he reduces his statement to a triviality. It says that if the goods produced in the past accomplish the producer's aim of enabling the production of more goods in the future than would have otherwise been possible, then the possession of those goods will have enabled the possessor to produce more goods in the future. This is a truism, albeit a trivial one, it seems.
Moreover, the focus on capital goods and nature-given factors may lead us to neglect other appraisable factors of production. These other factors are highlighted by the rapid development of various countries during the post-World War Two era. Far more important than the presence of time-saving capital goods were the relatively free trade regimes, the "entrepreneurial spirit" of the people (i.e., that they knew or were highly disposed to learn how to make and conserve money through market interaction and to build trust and trustworthiness), the common law or tradition of forming and honoring contracts, and the technological knowledge possessed or acquired by the producers. An astute investor would not have lent his money to someone intent on moving capital goods to Rumania if he expected the Romanian government to confiscate the goods or if he thought that Rumanian workers and managers would not know how to use them to make money. Consider a community in which members are disposed to accept and keep promises of future goods, services, and money in trade. Compared with a similar community in which the level of trust and trustworthiness is substantially lower, the former will be able to grow quicker and to a greater extent because existing wealth can be put to work as guaranty for loans. Such a disposition does not fall under the class of produced material factors implied by the term "capital goods." The point is that Mises's approach shifts the reader's focus away from where it should be. It should not be on produced material goods but on all items, actions and properties of actions that entrepreneurship may regard as factors of production.
Similarly trivial and misleading is the argument that Mises borrows from J. B. Clark (1899) to the effect that if two countries are equal in two respects except that one has a greater quantity of capital goods (i.e., goods that were produced in the past and that continue to be regarded as such), one will have higher wage rates and standards of living.(ibid.: 498-9)
Fallacies of Central Planning
In a section entitled "The Influence of the Past Upon Action," Mises seems to misplace two fallacies of central planning. We discuss each in turn. The first is the infant industry argument. This is the claim that a beginning industry in a nation needs protection from international competitors to be successful in the long run. Those who make this claim support it with the argument that because the "older industries have acquired an advantage by their early start...[t]hey are now fostered by a merely historical, accidental and manifestly 'irrational' factor."(ibid.: 509) In the long run, the government-protected firms will prove their worth because the locations at which they are built are at least as profitable as those at which the industries are now located. However, the firms cannot obtain the financing to pay the high cost of starting up at these locations. Thus, they need special protection until they have passed the startup stage. The fallacy here is the idea that a central planner knows more about the profitability of where to start a new firm than the individuals in the market economy.
Mises makes this point clearly. However, he states his argument by referring to material capital. He says that if consumer demand and knowledge of how to satisfy it dictate that the industry should exist in the country where it is being protected, firms would already have abandoned nonconvertible and nontransferable capital goods in other countries. But why refer to capital goods? The logic of the argument has nothing specifically to do with capital goods. Whether one location is more favorable in the long run does not depend specifically on capital goods. Non-produced factors, skilled work, an entrepreneurial spirit, etc. are just as important.
The real issue here is whether the goods that the infant industry is expected to produce should be imported, produced domestically by international firms, or produced domestically by domestic firms. With free markets in the factors across international boundaries, we presume that individuals acting as entrepreneurs choose the locations that they believe will yield the highest profit. And we expect them to be more correct than incorrect. The important point is that this issue is about the potential benefits of central planning relative to entrepreneurial planning. That firms use capital goods is an extraneous element. Therefore the argument does not fit into this section on capital goods.
The second fallacy is that big business may misuse "the patent system to withhold from the public benefits it could derive from technological improvement."(ibid.: 510) In other words, a company may apply for a patent on a new product or method of production in order to keep a competitor from producing that product or method and subsequently competing more effectively with the company's existing product or method of production. The company has no intention of adopting the new product or method of production. It is because of this that the company withholds benefits from the public. Mises argues that if a patent is worth employing, the company has an incentive to employ it and, therefore, would not withhold the benefits from the public. However, this argument has nothing distinctly to do with capital goods. A patent is not a capital good; it is a monopoly right. Mises's argument here is again about central planning and not capital goods. What Mises should focus on is the entrepreneurship's appraisal of the right vs. the central planner's appraisal.(13)
Saving
Similarly misleading and trivial is the notion that "additional capital can be accumulated only by saving, i.e., a surplus of production over consumption." To support this notion, Mises shows that saving can occur not only by means of restricting consumption but also in three other ways:
1. Natural conditions have become more propitious. Harvests are more plentiful. People have access to more fertile soil...Cataclysms...have become less frequent...Epidemics have subsided.
2. People have succeeded in rendering some production processes more fruitful without investing more capital goods and without a further lengthening of the period of production.
3. Institutional disturbances of production activities have become less frequent. The losses caused by war, revolutions, strikes, sabotage, and other crimes have been reduced.(ibid.: 515-6)
Saving could presumably also occur if there was an increase in trust and trustworthiness among actors, if the banking system became more "mature" and money less subject to extreme fluctuations in quantity, and for a myriad of other non-material reasons. Any event, chosen or not, that results in more higher order goods would raise the amount of saving, as defined here. However, such events need not raise the amount of capital goods in Mises's sense. Again, the question is: why focus on capital goods? Equating saving with capital goods production is distracting.
Cash Holding and Capital Accumulation
Mises's focus on the physical nature of capital goods leads him to make an error, or at least an omission, in his first discussion of cash holding (hoarding). He begins by pointing out that "[i]f an individual employs a sum of money not for consumption but for the purchase of factors of production, saving is directly turned into capital accumulation."(ibid.: 522) The money that otherwise would have been used to demand consumers' goods is used to demand factors of production. This, Mises implicitly asserts, is capital accumulation. He goes on to argue that capital accumulation can occur even if the individual holds his saving in the form of cash.
If we assume that the supply of money in the market system does not change, this conduct on the part of the saver will not directly influence the accumulation of capital and its employment for an expansion of production. The effect of our saver's saving, i.e., the surplus of goods produced over goods consumed, does not disappear on account of his hoarding...If nobody employs the goods -- the nonconsumption of which brought about the additional saving -- they remain as an increment in the amount of capital goods available, whatever their prices may be. The two processes -- increased cash holding of some people and increased capital accumulation -- take place side by side.(ibid.: 522-3)
While Mises is correct in saying that the physical goods do not disappear, he is wrong to disregard the change in their relative prices. Indeed, the non-consumption of particular goods (or more correctly the decreased demand for them) is likely to cause some factors to lose their "goods character." Their prices would fall to zero. The material items would still exist but, under current conditions, would become irrelevant to economic analysis. In the paragraph that follows the above quotation, Mises recognizes that the fall in demand for the factors of production will cause their prices to fall. Strangely, however, does not regard this element as possibly compromising the capital accumulation.
What one ought to realize is that when consumers buy and consume particular goods, they render those goods incapable of further satisfying wants and, at the same time, confirm the entrepreneurial expectations that led those goods to come into existence in the first place. By the same token, if consumers do not buy and consume particular goods, they disappoint entrepreneurial expectations. As a result, the entire structure of prices from which money itself derives its purchasing power may change.
Contrary to Mises's argument, increases in cash holding (hoarded money) that are not
accompanied by plans for future spending send a signal that it is less profitable to use factors
than it used to be. The logic of this criticism is clear when we imagine the consequence of each
individual acting in the consumer role deciding to hoard all of his saved money without
expressing or implying plans for a future purchase. All production would immediately become
unprofitable. Production would cease. The prices of all higher order goods, as determined by a
previous appraisals, would fall to zero. In effect, there would be no resources even though the
material items that previously constituted resources still exist.
4. Conclusion
It seems ironic that Mises was a pivotal figure in both (1) the advancement of the subjectivist Austrian theory of value and cost, which had entrepreneurship at its core, and (2) the continuation of the material concept of capital in Austrian economics. Mises promoted the idea that entrepreneurship, as the mandatory of consumers, and profit and loss are essential in explaining economic interaction under the conditions of the market economy. These characteristics of the market economy were fully consistent with his view of economics as a branch of praxeology and with his subjectivism. A careful reading of Human Action demonstrates that Mises's most important concept of capital was not his "capital goods" concept but his definition of capital as entrepreneur's net worth. This idea implies the use of capital accounting as a tool of monetary calculation used by entrepreneurship in its appraisement of the factors of production.
Why did he jeopardize the prospect that readers would receive his message about praxeology and entrepreneurship by employing a materialist definition of capital? Earlier in this paper, I suggested that perhaps he was merely following the customary practice in the economics profession of employing the term "capital" in a dual sense. He seemed to want to deal with various arguments in the economics literature. Whatever the reason, he has been accompanied by and followed in his definition by a host of other neo-Austrian writers.(14) These writers have not been so careful to employ the praxeological concept of capital that Mises had in mind.(ibid.: 515) I cannot in the present paper catalogue the host of errors and omissions that have resulted from this neglect of (1) the Mengerian insight that the appraisals of all higher order goods are made according to the same principles and (2) the Davenport-Knight-Mises insight that our focus in describing the economic interaction under the conditions of the market economy ought to be entrepreneurship. It will have to be sufficient to point out that, with the exception of Menger, the Austrian writings on capital goods, including those of Mises, have served to lead modern Austrians away from these important insights.
Notes
2. Mises's view is consistent with the subjectivist view of price and cost, or what is often called the subjective theory of value. This view can be found in the writings of Carl Menger (1981 [1851]), J. B. Clark (1899), Phillip Wicksteed (1910), Frank H. Fetter (1904a), Herbert Davenport (1908, 1914), and Frank Knight (1921).
3. See Gunning, 1997 and 1998a .
4. Israel Kirzner, in particular, has deliberately chosen to de-emphasize appraisement and uncertainty.(Kirzner1982 and Jack High 1982). Kirzner has written noted that Mises's contribution to entrepreneurship is may not be immediately obvious from Human Action.(Kirzner 1994: 105) He goes on to write that Mises portrays "the market as an entrepreneurial driven process." It would be more correct to say that Mises describes the market economy as an entrepreneurial process or that his image of the market economy is that of an entrepreneurial economy. As he writes everyone is an entrepreneur.(Mises 1966: 252-3) Accordingly, an understanding of his theory of entrepreneurship not only necessary in order to understand his image of the market economy, the two concept of congeneric. For the author's view of the history of entrepreneurship in Austrian economics, see Gunning 1988b.
5. Note that the claim is not that the material capital concept may lead one to disregard the idea that the market value of capital goods is the result of appraisals. It is that it may lead one to neglect the proper praxeological procedure of (a) assigning the act of making the appraisals to entrepreneurship and (b) representing subjectivity by assuming that different members of the "entrepreneur class" appraise differently.
6. The term "neo-Austrian" was employed by Kirzner to describe a mix of different ideas of economists who associate themselves with "the revival of interest in the ideas of Carl Menger and the earlier Austrian School, particularly as these ideas have been developed through the work of Mises and Hayek."(Kirzner 1987: 149)
7. See Frank Fetter (1904b) and Herbert Davenport (1914, chapter 14, 15). Both writers argue that a proper notion of capital is one that begins by understanding the capitalization process -- the process through which the mind determines the present value of its expected future income. The views of these two writers on the role of capitalization in the economic process were not identical, however.(Gunning, 1998b)
8. Mises continues the discussion at ibid.: 521. In my view, the concept of social capital is dealt with much more clearly by Davenport (1908: 141-55).
9. By praxeological entrepreneur, I mean entrepreneurship as the driving force of the market economy. This is the functional, or broad, concept that Mises describes on p. 252-3.
It is worth noting that Davenport defines private capital as follows:
Private capital, that form of capital with which actual business is concerned, includes, as we have seen, all forms of durable private wealth -- all such property of any individual as requires an appreciable period of time for the rendering of its services, -- all possessions any of the incomes of which are so far remote in time that some of these suffer in present price estimation by the very fact of this remoteness, -- all wealth the present worth of which involves the application of the principle of time discount, -- all wealth remunerated according to the dollar-time unit. Private capital is merely those private possessions which are bases of private income. This capital is productive, truly, -- acquisitive, gainful, -- but not necessarily so in the social sense of contributing to the general welfare or of increasing the aggregate of incomes, but only of increasing the owner's income.(Davenport 1914: 335)
10. Besides Knight, Mises cited writings on capital in professional journals by Hayek and Machlup. See "capital" in the index of Human Action.
11. Knight's disaffection with time preference was not a reaction to the Austrian theory. In his first major work, Knight asserted that time preference, or discount, has only an indirect effect on the interest rate and only over a long period of time. It is negligible "in relation to the total demand for capital."(Knight, 1921: 330n)
12. This was the starting point for two later Austrian writers on capital goods. See Ludwig Lachmann 1978 [1956]: 8 and Israel Kirzner 1966: 47.
13. Mises appears to recognize that his argument is really about central planning and not about capital since he goes on to describe several cases in which socialist planners and military leaders neglected to adopt a technological advance until after the time seemed ripe for its adoption.(ibid.: 512-3)
14. First there was Hayek's exploration of "the interrelations between the different parts of the material structure of the process of production" and his discussion of "in general terms what type of equipment it will be most profitable to create under various conditions, and how the equipment existing at any moment will be used..."(Hayek 1941: 3; Ahiakpor 1997: 273). Then there was Ludwig Lachmann's belief that the chief problem of capital theory is to explain why heterogeneous capital goods "are used the way they are; why in a given situation some alternatives are rejected, others selected...[We want to know] what governs the choice or rejection of alternative uses when unexpected change compels a revision of plans."(Lachmann 1978 [1956]: 8). Next there was Israel Kirzner's interest in "revisions of plans," which he maintained "cannot be understood without reference to the stocks of equipment, raw materials, half-finished products and finished products, that are available at the relevant dates."(Kirzner 1966: 47) Finally, Murray Rothbard defined capital poetically as "an intricate, delicate, interweaving structure of capital goods"(Rothbard 1962: 836). He defined a capital good as a produced factor of production.(ibid.: 258) Rothbard also seems to have focused on capital goods as part of a planning process, although his treatment of this is less straightforward than that of Lachmann and Kirzner.(1) More recently, Peter Lewin (1994), in describing Austrian capital theory for a prestigious publisher, completely ignores Mises and does not recognize entrepreneur's net worth as capital. However, he does approve of Menger's definition of capital as all factors of production. In a recent book (Lewin 1999), he follows Ludwig Lachmann in defining the factors of production (Lachmann's "capital") as they are viewed through the eyes of individuals who have plans to use them in a production process. This leads him to recognize the importance of the acts of capitalization and appraisement. He parts with Lachmann in two ways, however. First, he assumes that "capital" refers to all of the factors of production. This includes "human capital."(ibid.: ) Lachmann had defined it as the heterogeneous "stock of material resources."(Lachmann 1978: 11) This is a welcome departure and could have led him to the more general view of the market economy as being driven by individuals acting in the role of praxeological entrepreneurs. However, his second departure precluded this insight. Specifically, he considered only the plans of the employers in firms, who receive the residual as a result of their contracts with other factors of production to help in the production process. This makes his analysis less general than that of Mises. As a result, he is not and cannot be led to the general insight that an understanding of the market economy must begin with the idea of net worth as perceived by the praxeological role of the entrepreneur. It is only by means of this insight that the a theory of the prices of the factors of production (Lewin's "capital") can be integrated into the modern Austrian theory of value and cost. (For a description of this theory see Gunning 1997.) This is not to deny the importance of considering the diverse and often inconsistent plans regarding the use of factors of production. The entrepreneurs' calculations of their respective net worth requires such planning. In this planning the separate, specialized entrepreneurs will try, as best they can, to take account of the plans of others. But they cannot hope to fully succeed. Therefore, one can say that entrepreneurs' plans will always, in some measure, be inconsistent.
References
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