17. A Treatise on Economics

0:00Chapter 17 A Treatise on Economics Nationale Economie came after press in May 1940, just in time to survive the collapse of its publisher, only to be buried under the avalanche of the war. Many of the copies Mises sent to friends and colleagues never reached their destinations. Mises took it with some humour. I suppose the Nazis used them as fuel. The book survived only because Because its English-language successor, Human Action, drew incomparably more attention from readers all over the world, but it was in Nationale Ökonomie that Mises first presented the entire system of thought that he had developed during more than 30 years of intense study. Human Action, a treatise on economics and Nationale Ökonomie are virtually identical in general architecture. There are a few substantive differences between the books, but these differences is pale in comparison to the differences that separate both of them from all similar works.

1:00In the present chapter we will therefore quote Human Action wherever possible. In Human Action Mises placed a greater emphasis on refuting positivism, whereas in Nationale Economie he had refuted in particular Spann and Marx. Moreover, in Human Action he added a chapter on general probability theory, and he expanded the conclusion of Nationale Economie into to a comprehensive seventh part of human action that dealt with the social and cultural significance of praxeology. He had planned an American edition early on and had anticipated modifications of his text to accommodate the particular background of his American readers. The typical economics textbook was, then as now, just an amalgamation of incompatible bits of theory.

1:49Mises' treatise presented social laws as one coherent whole, and it drew an encompassing picture of social reality in a step-by-step manner, moving from the most general phenomena to the most specific. It was social philosophy in the best sense. Mises understood the importance of a full treatise. A book of smaller scope and size could not put the various ideas in context. Mises had to educate his readers before he he could convince them, an essential task in the age of interventionism, in which the average citizen was constantly exposed to pro-government propaganda. Replying to a reader, he once said, I try to answer the questions you are asking me in my books. A book is in fact a letter written to all one's friends, to those the author has already acquired, as well as to those he hopes to acquire in the future.

2:41But Mises did not have exaggerated confidence in the power of the written word. In a 1957 letter to a friend from Mexico, he expressed his wish to discuss very soon the theoretical problems that this friend had raised in his previous letter. A personal meeting would be necessary, because a thorough discussion of those problems can, in writing, only be done in the form of a book, and the written word can never replace the spoken word. A System in an Overview In the introduction, virtually identical in Human Action, Mises set the agenda for the book. The treatise would present the system of economic science in the light of two central problems that had been neglected in all previous works in the field, epistemology and value theory. This emphasis demonstrates in turn the crucial importance of Grundprobleme for the development of nationaleconomie. He then Mises offered his system in 751 pages, organised into six parts. Now, all his previous discoveries could appear in their correct context, along with the new elements that he had developed

3:44during his Geneva years. Part 1 deals with the features of human action that exist under all conceivable conditions of action. After a first chapter in which he gives an initial characterisation of action, A fine point to notice, the treatment of epistemology came after the definition of action, because science and epistemology are themselves instances of action. Another fine point, in human action Mises adopts the pragmatist definition of truth, which works in practice, and maintains this definition throughout all later writings.

4:30He then turns to a more detailed analysis of action, chapter 3, in which he argues that phenomena such as exchange, price, costs, success and failure, and profit and loss are not given only in the context of a market economy, but are features of human action in general. They are categories of action. In chapter 3 he also deals with the categories Studies of Means and Ends and of Preference. Mises did not follow the terminology of the older Austrian school in speaking of value. Instead, he used the term preference, which better conveys that the category of action is rooted in human choice. This terminological decision certainly helped to avoid confusion, especially since Menger, the father of Austrian value theory, had emphasized that value had nothing to do with human free will. According According to Menger's principles, economic science studies the relation between man's needs and the economic goods necessary to satisfy those needs. In Walrass's element, as well as in the mainstream of the 1930s and 1940s and up until the 1980s, economic

5:37science was essentially about prices and quantities traded on the market. But in national economy, the true object of the science was understood to be human action, and in particular, choice. In another noteworthy passage of part 1, Mises presents for the first time the law of diminishing marginal utility as a praxeological law. It has nothing to do with the psychological phenomenon of satiation. Rather, the law concerns the simple fact that larger supplies of a homogeneous good can serve more ends than smaller supplies. Yet, these additional ends are by virtue of the very fact that they are additional ends Less important than those already served with the smaller supply. Here, Mises departs from all other economists, most notably from Wieser, who had adopted Gossens' psychological interpretation of the law.

6:28Mises draws a sharp line between praxeology and psychology, and he emphasizes the ramifications of this in other important passages of the book. We will take a look at some of these below. In part two, our author deals with those features of human action that come into play whenever However an individual interacts with other individuals. Later in the book he analyzes to particularities of the three fundamental types of social system, the market economy part 4, socialism part 5, and the hampered market economy part 6. He also restates the theory of society that he had presented in socialism, but this time in its proper context. In socialism, an economic and sociological analysis, the theory was presented not in in the first part, which dealt with fundamentals, but in one of the subsequent parts that dealt with particular problems of socialist orders. He stresses the Ricardian law of association and the crucial role of reason in shaping human society.

7:29In part 3 he completes 20 years of intellectual assimilation of his 1920 essay on the impossibility of economic calculation in socialist commonwealths. In some 35 pages he finally offers a general Theory of Economic Calculation. What is more, he presents it in its proper place, namely before turning to the analysis of any concrete system of human cooperation, parts 4 to 6. Of course, he had anticipated this architectonic necessity in the essays on value theory he wrote in the late 1920s, but it is one thing to stress the difference between valuation preference and calculation in a general argument. It is quite another to apply this insight in Concrete Analysis. Part 4 on the market economy is over 400 pages, more than half the book. Here Mises restates a good number of the theories he had developed in previous works, the theory of monopoly prices, the theory of money and credit, his famous business cycle theory, the theory of wages, and the theory of the harmony of interests

8:32of all market participants. But rather than simply repeating himself, he presents thoroughly He expands the monopoly theory he first developed in socialism, placing special emphasis on the discussion of Marxist monopoly theory. He presents the theory of the harmony of interests in an entirely new formulation and rejects the Anglo-Saxon theories of Keynes and of Robinson and Chamberlain in perfect competition. In the theory of money he brooks no exception and to the rule that political modifications of the money supply are unwarranted from an economic point of view and, finally, he integrates his business cycle theory with interest theory, a subject he had never addressed before in writing.

9:18Besides interest, the central novelty in his analysis of the market economy was his emphasis on the role of the entrepreneur. Mises carefully distinguished between entrepreneurs as those who take successful action in an in an Uncertain World and Entrepreneurship in the sense of a fundamental economic function, the bearing of risk under uncertainty. It is this economic function that gives rise to the specific income component of profit and loss. It was one of the great contributions of nationale économie to clarify the role of this entrepreneurial function in the workings of the market economy. Yet Mises felt he could not achieve this without a somewhat roundabout Exposition. To define entrepreneurship it is necessary to give a proper definition of profit and loss, but for Mises this was impossible without a clarification of the nature of equilibrium and its role in economic science. He therefore saw himself forced to start Part IV with a somewhat basic chapter dealing with the methods necessary for the discursive analysis of the market economy, with various equilibrium concepts in particular. Only then did he feel that

10:24In Part 5, which deals with socialist societies, Mises does not restate all the main findings of socialism, rather, he concentrates on the centrepiece of his refutation of the socialist program, the impossibility of economic calculation, wherever the means of production are collectively owned. Thus, Part 5 must be considered an extension of Part 3. Mises discusses the schemes of socialist calculation developed in the 1930s, most notably in the Anglo-Saxon world. He refutes the idea of generating prices through an artificial market and also contests the notion that mathematical economics could overcome the calculation problem, even theoretically. In part six he delivers a far more comprehensive and detailed discussion of interventionism than he had in his essays from the mid-1920s. The general line of the The argument remained the same. Interventionism is counterproductive because it does not attain the professed ends of its authors.

11:29Nationale Economie featured entirely new and important contributions. Even in those places where Mises restates his older doctrines, he has revised them, often substantially. It was therefore highly unusual for Gottfried von Haberler to claim a few years later in a confidential evaluation for Yale University Press, which considered commissioning a translation Anti-psychologism Mises' exposition of economic science differed decisively from all modern authors in that it drew a sharp line between praxeology and psychology. This has remained a defining feature of the works of his disciples. Mises did not contest that the psychological background of a person, his worldview, knowledge, conscious have an immediate impact on his behaviour. Neither did he ignore the important psychological problems that his friend F.R. Hayek began to stress in those years, in particular that of knowledge acquisition. Mises's point was that there were also laws of human behaviour that exist in complete independence of these psychological dispositions. For example, in In Chapter 4, Mises discusses ends and means, scales of values and scales of needs. He does

12:48not deal with the question of how or why people select ends and means, or how or why they have certain values and certain needs. He argues that in every human action we do use means to attain ends, and that needs and values can be ranked. Murray Rothbard later argued that as a consequence of the mere fact that people rank their choice alternatives, it It follows that demand curves must slope downward to the right. Mises made no such interference. He was sceptical about the use of graphical methods in exact analysis. He did accept them as pedagogical devices. In Chapter 15, The Market, he points out that consumers are sovereign because their buying decisions steer the market. This is obviously true, irrespective of what consumers buy or the reason why they make these purchases. Therefore he does not deal In Chapter 16, Prices, Mises states that the number of market participants determines how narrow the margins are within which prices are determined. Yet this implies that the

13:51number of market participants has no influence on how prices are formed. Irrespective of the number of market participants, market prices are always determined by the decisions of marginal buyers and sellers. Thus, all prices can be explained as a result of the Praxeology is the science of these laws. It examines the ramifications of the mere fact that a man makes this or that choice. Considering the relationship between a choice and its consequences, praxeology examines the suitability of different means to attain particular ends. In praxeological analysis, the ends are given, not in the sense that human beings cannot Mises would later discuss the irrelevance of homo economicus for modern economics in human action. He concluded that the orams concerning commodity prices, wage rates and interest rates refer to all these phenomena without any regard to devotives causing people to Buy or to Sell or to Abstain from Buying or Selling.

15:06With respect to the knowledge of market participants, Mises emphasized the fact that the individual market participants are not equally well informed, yet even if they all had the same information, they would appraise this information differently. As to equilibrium, he stated again and again that the market never reaches such a state, that it is a mere mental construct, the only Only function of which is to analyze profits and losses, that is, the equilibrium construct is needed to explain a particular component of price spreads. It is not required to explain prices, wages, interest, commodity prices, as such. Consequently, in Mises's view, equilibrium is not the right benchmark for the evaluation of the market. To critics of economic science who complain that the market never produces a perfect balance between different goods and Services, Mises replies in two steps. First, he points out that this fact of imbalance does not refute economic doctrine, because economic science explains any state of affairs as it results from the fact that consumers make certain valuations. Second, he observes

16:14that the relevant benchmark for the market is government intervention, and because government officials are not supermen, one cannot make the a priori assumption that entrusting them Capitalism and Liberalism are Rational In Socialism and Liberalism, Mises had argued that human society was founded on the basis of the higher physical productivity of human cooperation as compared to individuals acting on their own. This was the crux of the classical Social Liberal Social Philosophy and the cornerstone of the political programme of laissez-faire, Manchesterism. A nationale économie Mises set out to contrast this social philosophy with competing worldviews.

17:01He stressed that economic analysis had given a purely fact-based account of the origin of human society. The scientific theory, as developed by the social philosophy of 18th century rationalism and liberalism and by modern economics, does not resort to any miraculous interference of Superhuman Powers. Every step by which an individual substitutes concerted action for isolated action results in an immediate and recognisable improvement in his condition. The advantages derived from peaceful cooperation and division of labour are universal. They immediately benefit every generation and not only later descendants. For what the individual must sacrifice for the sake of society is amply compensated by greater advantages. His Sacrifice is only apparent and temporary. He forgoes a smaller gain in order to reap a greater one later.

17:53No reasonable being can fail to see this obvious fact. When social cooperation is intensified by enlarging the field in which there is division of labour, or when legal protection and the safeguarding of peace are strengthened, the incentive is the desire of all those concerned to improve their own conditions. In striving after his own rightly understood interests, the individual works toward an intensification of social cooperation and peaceful intercourse. Society is a product of human action, that is, the human urge to remove uneasiness as far as possible. He then went on to point out the larger cultural and philosophical significance of this discovery. The historical role of the theory of the division of labour, as elaborated by British political The Social Economy from Hume to Ricardo consisted in the complete demolition of all metaphysical doctrines concerning the origin and to the operation of social cooperation. It consummated the spiritual, moral and intellectual emancipation of mankind inaugurated by the philosophy of Epicureanism. It substituted an autonomous rational morality for the heteronomous and

19:01intuitionist ethics of older days. Law and legality, the moral code and social institutions are no longer reserved as unfathomable decrees of heaven, they are of human origin, and the only yardstick that must be applied to them is that of expediency with regard to human welfare. A few years later, Joseph Schumpeter pointed out that the social analysis of the classical economists had its roots in medieval scholasticism. St. Thomas Aquinas and his followers had pioneered Methodological Individualism and Utteritarian Justifications of Social Institutions By contrast, divine law and omnipotent government were Protestant inventions. Thus, the economists had explained society as a human creation, designed and implemented by cooperating individuals who satisfy individual needs. In contrast, alternative approaches such as universalism and collectivism stipulated that society could be defined independently of individual To the collectivists, society is an entity living its own life, independent of and separate from the lives of the various individuals acting on its own behalf and aiming at its own ends, which are different from the ends sought by the individuals. Mises went on to

20:17point out that the conception of society has a natural conclusion, then, of course, an antagonism between the aims of society and those of its members can emerge. In order to safeguard the flowering and further development of society, it becomes necessary to master to the selfishness of the individuals and to compel them to sacrifice their egotistic designs to the benefit of society. What is needed, therefore, is a definition of the proper interests of society thus conceived. Mises observed that science was at a loss to provide such a definition. As a consequence, all these holistic doctrines are bound to abandon the secular methods of human science and logical reasoning and to shift to theological Social or Metaphysical Professions of Faith. Mises emphasized the epistemological dimension of this problem. The essential problem of all varieties of universalistic, collectivistic and holistic social philosophy is, by what mark do I recognize the true law, the authentic Apostle of God's Word, and the legitimate authority, for many claim that Providence has sent them, and each of these prophets preaches another gospel. Equilibrium, profit

21:28and Loss and Entrepreneurship. It was through the writings of Carl Menger and Eugen von Boehm-Bawerk that Mises had come to understand the market economy as a rational social order in which all factors of production are geared toward the satisfaction of consumer wants. Not only the allocation of the production factors, but also the incomes of the owners of these factors ultimately depended exclusively on their relative contribution to the satisfaction of Human Wants. All values, all prices, as Frankfurter had put it, depend on the daily referendum in the market democracy. The market is a democracy where every penny gives a right of vote. A few pages later he states, So each is measuring the services of all others and all are valuing each. It is the democracy of valuation. But in none of his predecessors did Mises find a satisfactory account of the process through which the structure of production Innovation was brought in line with consumer preferences. His fellow Boehm-Bawerk seminar member Josef Schumpeter had brilliantly shown how entrepreneurs drive the market. According

22:32to Schumpeter's theory of economic development, entrepreneurs are innovators who constantly interrupt the smooth operation of an inert economy. Schumpeter had a point. Innovation does play a central role in the market economy, but how does this fit with the Mengerian picture of the Market Economy as a Rational Social Order. Was there a contradiction between the Schumpeterian notion that entrepreneurs reap profits for innovation and the Mengerian insight that all incomes depend on consumer wishes? In Nationalökonomie, Mises reconciled Schumpeter with Menger. From Schumpeter he adopted the idea that entrepreneurs are the motor of the market process, but they cannot earn a profit for innovation per se, only for innovations that improve the satisfaction of Consumer Wants.

23:19Entrepreneurs constantly adjust the structure of production to what they expect will be the future preferences of consumers. The different entrepreneurs act in effect as advocates for different consumer needs. Based on their estimates of what they expect to obtain for an imagined product in the future, they go to the factor markets where they compete with other entrepreneurs, bidding up prices for the available factors of production, workers and material supplies. This pricing process determines the incomes of all factors of production and it ensures that only the most important investment projects, important in terms of future consumer spending, will be realised. The driving force of entrepreneurship is the profit motive. Profit is the specific remuneration a person receives for bearing uncertainty. In the market economy, entrepreneurs act with due caution and responsibility because they are personally liable for any wrong decisions.

24:12Loss is the punishment for unsuccessful entrepreneurship. Profit and loss are together the measure of entrepreneurship. Are all businessmen entrepreneurs? Are all entrepreneurs businessmen? If not, how could entrepreneurs be distinguished from regular businessmen and other market participants? Mises answered these difficult questions by defining entrepreneurship as a social function, Money as the function of assuming responsibility for the uncertainty of the future. The entrepreneur in Mises' theory is not a person, but a role played by people, and it is not at all limited to businessmen. Ultimately anyone can be an entrepreneur to the extent that he assumes the repercussions of uncertainty. Profits and losses do not only determine the income of businessmen, but also of wage earners and capitalists. They always come mixed with with specific factor incomes such as wages and interest.

25:13One of the great problems Mises had to solve in this theory was to give a precise definition of profit and loss. In particular, he had to distinguish profit and loss from interest. His solution was that profit and loss were the results of human error. In other words, profits and losses can only exist in situations of disequilibrium. In contrast, money interest ultimately springs from time preference and has nothing to do with whether the market participants make good or bad decisions. Money interests exist both in general equilibrium and in disequilibrium, whereas profit and loss exist only in the latter case. But then this line of argument makes it necessary to clarify the precise meaning of general equilibrium as well as its role in economic analysis. Mises argued that general equilibrium, which which he called the stationary economy, stationaire wirtschaft, in human action he called it the evenly rotating economy, is a purely methodological device, it is an imaginary construct, a Duncan Bild, that has no counterpart in the real world, its only purpose is for the definition

26:22of profit and loss. Consumer Sovereignty and Interest In national economies Mises finally delved into Interest Theory, the primary research area of his revered teacher Boehm-Bawerk. In his classes at the University of Vienna in the 1920s, Mises had frequently dealt with contemporary interest theories. In those years he had also planned to write a paper on the subject, but there had always been other projects that seemed more important. In Geneva he was finally at leisure to fill this gap. He started lecturing on capital and related problems in the Winter Semester of 1936-1937. By then, Mises must have made his mind up about these questions. When Bawerk had initiated the Austrian tradition of defining the phenomenon that was at issue in interest theory, he argued that the interest rates paid in the context of credit operations are in fact a secondary aspect of a larger phenomenon. The primary aspect of this phenomenon was given in certain price differences that could be observed on the market.

27:29The starting point for Boehm-Bawerk's theory was the common observation that successful business was characterized by a positive spread between the sum total of the prices paid for its factors of production and the sum total of prices received as proceeds for its products. Entrepreneurs earned more money by selling their products than they spent on the factors of production that brought these products into being. This phenomenon raised the fundamental question of whether the entire spread between selling proceeds and costs expenditure can be arbitraged away through entrepreneurial competition or whether at least part of this spread could never be eliminated. In other words, is there a part of it that contains a pure interest component? And if so, what is its cause? Boehm-Bawerk's great achievement was to formulate the problem of interest theory as As a value problem, a question of demonstrated preference between goods, interest results from human choice and exchange, rather than being caused by some factor outside of human action. As the result of preference in action, interest reflects a fundamental value inequality,

28:36the choice of a more valuable alternative over a less valuable one. Observable interest rates manifest an inequality between the value of products and the total value of the corresponding In Menger's view, interest was the value of a component part of the factors of production, whereas Boehm-Bawerk saw it as a value differential. But where did such a value differential come According to Boehm-Bawerk, present goods have in general greater subjective value than future goods of equal quantity and quality.

29:24The American economist Frank Fetter later coined the term time preference to designate this phenomenon. It is because of a time preference for present goods over future goods that factors of production, which will yield products in the future, are less valuable than the corresponding quantity of otherwise equal products existing here and now. Boehm-Bawerk emphasized that time preference is only the proximate cause of interest. The ultimate cause is something even more fundamental. He famously argued that time preference is itself caused by two psychological dispositions, one, that current needs are usually less well satisfied than future needs, and two, that human beings tend to underestimate future needs. He also argued that time preference is caused by the higher physical productivity of more roundabout methods of production, his famous third cause of time preference.

30:18Mises rejected Boehm-Bawerk's psychological explanation of time preference. Psychology, Mises argued, could never establish that time preference was an element of the very nature of human action. In some actions, the psychological forces that Boehm-Bawerk described were at work and led to a preference of present over future goods of the same kind. But in In other instances, the very opposite was the case. Boehm-Bawerk himself had admitted this point, which is why he held that time preference existed only in general, but not in all cases of human action. Mises also criticised Boehm-Bawerk for having failed to develop a truly praxeological theory of the period of production. The Boehm-Bawerkian view of the nature of time preference had two related shortcomings.

31:05First, it was difficult to reconcile with the fact that values and prices are manifested in human choice. If choice is free, how is it that future values by their very nature, or at least as a rule, stand in a determinate relationship to present values? Second, and more importantly, the Boehm-Bawerkian approach was in conflict with the theory of subjective value. His view of time preference concerns the value differential between homogenous presents present and future goods, but the very fact that two goods exist at different points in time automatically makes them heterogeneous goods. Boehm-Bawerk himself admitted this implicitly when he emphasized that the values of present and future goods is liable to be different because they are intended for the service of a different set of wants. The second point is devastating for the old time preference theory, for one cannot even make claims with with respect to present and future goods of the same quality, without contradicting oneself.

32:04Moreover, as can be seen from Boehm-Bawerk's equivocal description of the time preference phenomenon, which stresses that only in general are present goods preferred over identical future goods, he did not assert that time preference was universally positive. Neither did Erwin Fischer and Frank Fetter think that this was the case. They even argued that time preference could be negative. In the hands of Mises' predecessors, then, time preference theory was a mere assertion that a determinate relationship between the values of future and present goods of the same kind existed. None of its champions proposed a tenable explanation for the supposed relationship other than the intuitive reference to the visible facts of the market, that the selling proceeds from products were higher than the expenditure on the corresponding factors of production. But these are the very facts to How did Mises solve these problems? He asserted on a priori grounds that time preference is, at all times and places, positive. Human action, by its very nature, involves a preference for sooner rather than later fulfilment of one's needs.

33:13Time Preference is not the result of the psychological dispositions of man, but of the temporal nature of action. Years later, Mises nicely summarized this point in private correspondence.

33:43survived the month of February. If the phenomenon we call time preference were not to exist, people would only consume what is subject to speedy decay. Other things they would always only save and invest as the outcome of such a behaviour would in their eyes mean a greater yield than the result of investing them for a shorter period. Mises had not so much clarified the phenomenon that his predecessors had in mind when they They used the term time preference, but had instead given a complete restatement of the theory. When Boehm-Bawerk, Fetter and Fischer used the term time preference, they referred to an observable value differential between two physically similar goods existing at two different times. But when Mises used the term, he referred to a counterfactual value differential between two alternative uses of one and the same good. Time preference concerns the value When I use a good now rather than later, I demonstrate that I prefer to use the good now rather than later, and this in turn necessarily means that the value of its present use is higher for me than the value of the use I might have made of it in the future.

35:01Like Boehm-Bawerk, Mises believed that time preference was only the proximate cause of interest. But rather than seeing the ultimate cause in certain psychological dispositions of the human being, he followed Frank Fetter and Franz Kuhl in arguing that the ultimate cause was the necessity of consumption. The fact is that human beings cannot survive if they do not consume, hence there must be some time preference in human action or the human and Race would perish. This does not mean that time preference is the only fact to determine human actions. It means that in order to survive, human beings must at some point prefer shorter production processes to longer ones, even though the longer ones would be more physically productive. Mises argued that one would always choose the longest production process if one could disregard the need for survival through time. It is the need to survive that prompts The Acting Person also to consider the passage of time and to prefer, at some point, sooner results to later ones. Consider three alternative fishing processes. The first one leads to

36:03catching one fish at the end of one hour, the second to catching ten fish but only at the end of one day, and the third to catching one hundred fish, all of them at the end of a week. Assume we observe a person pursuing the production process leading to a catch Mises explains the person did not pick the 100-fish alternative because his time preference was stronger than the additional gain he would have gotten from the longer process. He does not want to wait a week. The only reason he picked the 10-fish alternative at all, rather than the 1-fish alternative, is that in this case the attraction of the additional gain was strong enough to overcome his time preference. Let us highlight the significance of this This explanation, within the overall theoretical framework of Misesian economics. Consumption here appears as the root of all economic phenomena. Carl Menger and his disciples had argued that consumer choices directly determine the prices of consumers' goods and that indirectly they

37:04also determine the prices of producers' goods. Now time preference, too, and with it the phenomena of capital and interest appear to be rooted in consumption. The great attraction The conclusion of this explanation, at least from Mises' point of view, was that it did not stress any psychological dispositions of man, but relied on the fundamental fact that there can be no human action without consumption. The consumption theory of time preference thus seamlessly integrates the theory of capital and interest into the general theory of prices. In the field of interest, as in the broader market process, the consumer is sovereign. Business cycle theory restated. In light of his theory of interest, Mises now clarified the relationship between interest and changes in the quantity of money.

37:55The Austrian-Misesian theory of the business cycle asserts that intertemporal misallocations result from inflation-induced reductions of the interest rate. But what was the precise meaning of reduction? Mises did not mean to assert that simple changes of the interest rate would induce a business cycle. The fact that today's interest is lower than yesterday's does not by itself mean that a misallocation has occurred. In his Theory of Money and Credit, Mises had based his analysis on the Mixelian distinction between the natural rate of interest and the money rate. But this distinction was untenable in light of Mises' work on economic calculation and on the non-neutrality of money. There is no such thing as a natural rate of interest, defined as the rate of interest that would prevail in a barter economy. And even if there were such a natural rate of interest, it would still be irrelevant for the analysis of a monetary economy. Money is not just a veil over a barter economy. It affects all economic relations. Prices, incomes, allocation and

39:01social positions in an economy using money are completely different from what they would be in a society with no common medium of exchange. And so the interest rate in a monetary economy is necessarily different from what it would have been in the same economy if the market participants had decided to forgo the benefits of money. Even if one could hypothetically If we compare natural and money interest rates, which is not the case, it would not follow that inter-temporal misallocations would ensue whenever the natural rate was higher than the money rate. In Nationale Economie, Mises gave a new exposition of his business cycle theory. He came up with a new benchmark to identify pernicious reductions of the monetary interest rate. The relevant benchmark was no longer the Wixellian natural rate that would exist if the economy were a barter economy.

39:52It was rather the monetary interest rate that would exist in the absence of credit expansion. Any increase in the supply of credit on the market will reduce the interest rate, but if the increase comes from printing paper money or banknotes rather than from savings, then the artificially lower interest rate falsifies the entrepreneurial profit calculus. In light of the decreased interest rate, a great number of business projects appear to be profitable and are launched, but the material factors of production necessary for the physical completion of the greater number of projects do not exist. Credit expansion does not mean expansion of the real factor endowment of the economy, it merely means expansion of the money supply through the credit market. It follows that it is physically impossible to sustain the new structure of production that resulted from the credit expansion. The boom must eventually end in a bust. Mises stresses that the boom is not a phase Update of the socialist calculation debate Mises did not believe that the argument in favour of socialist calculation had made any

41:05progress, but the new pro-socialist arguments provided an opportunity for further elaboration from his side. He distinguished four types of proposed solutions to the problem he had The first candidate's solution seeks to perform economic calculation in terms of labor time, à la Neurat. But this approach cannot work because of the material factors of production and the heterogeneity of different types of labor. The second candidate parallels the first in that it seeks to unearth a substitute for money prices as a medium of calculation. Only here the proposed substitute is not labor time, but utility, as in Mises' theory. In his rebuttal, Mises points out that human beings cannot measure utility but only rank it. The utilities of units in different sized supplies are necessarily unequal. Because of this lack of homogeneity, they cannot serve as units in a calculus of value. According to the third proposal, socialist communities could create an artificial market by ordering the plant managers to behave as if they were employed in capitalist firms. The idea was

42:10to combine the benefits of a price system and social control through government-appointed managers, but without creating bureaucracy and monopoly. Such schemes had become fashionable during the 1930s, and by the time Nationale Oknui was published, they were achieving the status of a new orthodoxy that would survive half a century. One of the new theoreticians, the Polish socialist Oskar Lange, thought some compensation for Mises might be in order, Lange proposed that a statue of Professor Mises ought to occupy an honourable place in the great hall of the Central Planning Board of the Socialist State.

42:58No Socialist State was generous enough to follow up on this suggestion, but the University Rudslal created a statue of Oskar Lange and preserved it into our day, surely, as a monument to the perennity of his message. Generations of students were taught that socialism was, in theory at least, a viable economic system. Some authors even went so far as to argue, statistics in hand, that the Soviet economies of Eastern Europe were superior or about to become superior to the capitalist economies of the West. See, in particular, the various The Soviet economy is proof that, contrary to what many sceptics had earlier believed, the socialist command economy can function and even thrive. This notion evaporated in 1989. In actual practice, market socialism had never played a big role in the Eastern Some intellectuals were allowed to discuss the calculation problem and the market socialist solution, but in practice there was central planning, not any form of competitive pricing.

44:07Significantly, in the early 1960s, the Soviet professor, Yevsey G. Lieberman, received worldwide attention with his proposals to steer production with the help of price incentives. Incentives, needless to say Lieberman did not address, much less solve, the problems Mises had pointed out in 1922. Mises himself commented on this newest fad of economic planning in his observations on the Russian reform movement. The fall of the Berlin Wall opened everyone's eyes to the stark reality that seventy years of socialism had created nothing but misery, pollution and slavery. The world learned the hard way, what it could have learned in 1922 from a readily available book. In socialism, Mises had analysed the idea of market socialism even before any socialist had thought of it, and he had already identified its achilles heel, moral hazard. Artificial markets would make managers irresponsible.

45:06Some of the benefits of successful management would still be private – the increased reputation and Career Advancement of Successful Managers, but all of the costs of mismanagement would have to be borne by the citizenry at large, as a consequence the managers of the state would take on excessive risks, they would squander society's capital. Eighteen years later, in Natsunari Okonomi, Mises did not miss the opportunity to note the irony that, according to this proposal, the market economy was such a bad thing that had to be reintroduced through the back door as soon as the new socialist regime is established. He went on to chastise the champions of artificial markets for narrow-mindedness. The problem of the allocation of resources is not primarily a managerial problem within each plant, it is a problem of choosing where to place available capital, which of the existing plants should be expanded, which ones should be cut back, which new production sites should be established.

46:06These decisions lay in the hands of capitalists, entrepreneurs and speculators, and it was out of the question to extend the scheme of the artificial market to them. Restating the analysis of moral hazard along the lines given in socialism, Mises argued that playing capitalists would be completely irresponsible. No risk would be too high for the make-believe capitalists, because they themselves would hardly bear any negative consequences. Such a system would be neither socialism nor capitalism. It would be no system at all. It would be chaotic. He then turned to the fourth scheme, according to which socialist societies should use the equations of mathematical economics to solve the problem of economic calculation. Here Mises restates the argument he had presented in his 1938 French language article of the same title. Those mathematical equations describe a state of affairs that is already in Equilibrium, but not the concrete steps through which any equilibrium could ever be reached.

47:09It was an error to suppose that one could calculate the equilibrium state with data taken from an economy that is not in equilibrium. It was another error to believe that acting man, for his present-day calculations, needs to know the evaluations and appraisals that would obtain in the equilibrium state. He went on to conclude that this fundamental conceptual problem made it superfluous to The Deal with the Practical Problems of Central Planning that Pareto and Hayek had raised. A Pure Cash Balance Approach Natsunari Okunumi and Human Action completed the project Mises had started in 1912 with his treatise on money. In certain crucial respects, he decisively improved upon his earlier exposition of monetary theory. The author of Natsunari Okunumi is a better monetary In his biographical recollections, Mises is somewhat diffident on this point. He merely says that his work from 1940s had completed the great initial project of integrating marginal value theory with the theory of money. Some years later he used the harsher term misstatements

48:14to characterise the shortcomings of his early work. To a German correspondent he wrote, You cannot avoid going astray, Entgleisungen, if you take money out of the total context of market phenomena and deal with it separately. I have experienced this in my own case. The market process is an indivisible whole. One cannot subdivide it into pieces. My theory of money has reached maturity only in human action. The keystone of the mature theory concerns the central importance of the cash balance approach, which alone would explain money prices in terms of human action, rather than in terms of mechanistic metaphors such as the velocity of money. Mises now stressed that the demand for money was truly a demand for cash balances. The value of the cash balances was not simply borrowed from the value of the goods against which they could be exchanged, this was the view he championed at least in one crucial passage in The Theory of Money and Credit. There was an independent source of value in the services

49:14His later theory was already present in the first edition of his Theory of Money and Credit, but it was presented side by side with other statements taking the opposite point of view. Mises developed the cash balance approach to the demand for money starting from Menger's article Geld, Handwerder Buch der Staatswissenschaften. One possible source of Mises' second thoughts on this question was a short book that Edwin Canaan had published at the end of the First First World War, Money, its connection with rising and falling prices. In his 1942 lecture in Mexico City, Mises stressed that the individual demand for money was, in fact, identical with the individual's cash holdings and referred the audience to page 83 of Canaan's book.

50:00Mises also radicalised his stance on the usefulness of expansions of the money supply. In Theory of Money and Credit, he held that monetary expansion might be needed to accommodate greater Growth, at least under plausible circumstances. From 1940 onward he categorically rejected this notion. All benefits that might result from monetary expansion were now presented as being strictly ephemeral. They had no systematic positive impact, quite to the contrary.