Nationalökonomie

0:00Ladies and gentlemen, welcome to our eighth installment of the seminar on the lifetimes and work of Ludwig von Mises. We are approaching the end. We are just one and a half days away from the end of the seminar. And so it's only befitting that we now come also to the treatise which is at the end of Mises' work achievement in his European years. He moves to the United States in 1940. We've already mentioned this. and he spends there the last third of his year and correspondingly tomorrow the day will be dedicated to this period of his life. He worked on this treatise of economics which finally appeared under the title National Economie during the six years that he spent at the Graduate Institute for International Studies in Geneva The book finally appeared in May 1940, so the very month that Mises later called the worst month in European history.

1:02He did not even seem to take exception for his book, but I must assume he must have taken exception for his book. In any case, it was bad timing, not only because he could not really enjoy its publication, being surrounded by the German armies approaching from the north and the Italian armies approaching from the south. But also because while the war disrupted the intellectual division of labor, many of the copies that Mises sent to his friends and colleagues never reached their destination. The publisher went bankrupt shortly thereafter. So it was a book that certainly would have disappeared in the history of thought and would have been only of antiquarian interest had it not been for his immigration to the US and had it not been for the subsequent publication of Human Action in 1949, which raised again interest for this predecessor.

1:57Now, the fact is that both books are essentially similar. They have the very same structure, the very same arguments. There are, in fact, very few significant differences about which I will come to talk a little bit later. Let's first talk about the structure of the book and what I say now holds true for both books, Nationale Economie and Human Action. Both books are systematic treatises. In this respect, they distinguish themselves from the usual textbooks of the time and the usual textbooks that are still published today. Again, I refer to those who are economics students among you.

2:42You know that a typical textbook in microeconomics or microeconomics is usually a juxtaposition, consists in a juxtaposition of different models and different ideas that are not compatible, contradict one another, that do not necessarily build on one another. The better textbooks authors today are finally approaching something like a logical structure, but they are far away from the standard that Mises reached in 1940 with his book which is not only systematic but also encompassing and which leads the leader through an entire system of economic thought because it builds an argument step by step. Mises starts from the most fundamental, most basic or most generally applicable considerations to more and more refined considerations.

3:33So I'll just give you now the system in an overview and thereafter we'll come to talk about six major contributions. There are more, six major contributions in this book, six defining characteristics, namely its anti-psychologism, its insistence on the rationality of liberalism and capitalism, its theory of entrepreneurship in the context of a theory of equilibrium and profit and loss, interest theory in conjunction with consumer sovereignty, business cycle theory and an update on the socialist calculation debate. Okay, so first now the system in an overview. In the introduction, which is virtually identical to the one in Human Action, Mises sets the agenda for the book.

4:23The 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, namely epistemology and value theory. He then offered his system in 751 pages, organized into six parts. Now all his previous discoveries could appear in the correct context, in the proper place, along with the new elements that he had developed during his Geneva years. Part 1 deals with the features of human action that exist under all conceivable conditions of action. After our first chapter, in which he gives an initial characterization of action, emphasizing in particular the distinction between behavior and action, Mises deals with the epistemological problems of the signs of action, Chapter 2.

5:17So first comes the first analysis of human action, and he distinguishes in particular the difference between behavior and action. Behavior and action. Behavior, we might say, is the movement of the human body through time and space, the physical things that are being done, the activity, let's say. But action is more. Behavior is just a part of action. Action also involves ends that are being pursued by this activity, and it involves the foregone alternatives. We must see always what is being done in conjunction with what is renounced to. There is choice. That's precisely this a priori aspect of economic science.

6:03It puts what we can observe, observable behavior, in context with the choice alternatives that necessarily must have been foregone because you cannot do all things at the same time. And again the example, I give my lecture, so I have to renounce drinking my coffee or dancing on the first floor, etc. And then only in the second chapter, Mises can talk about the epistemology of the science of human action. First, presentation of the subject matter, then discussion of the epistemological features. Then in Chapter 3 he turns to a more detailed analysis of action in which he argues that phenomena such as exchange, price, costs, success and failure, and profit and loss are in a fundamental sense not given only in the context of a market economy, but are features of human action in general, they are categories of action.

7:02In Chapter 3, he also deals with the categories of means and ends, end 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, something that we talked about on the first day. According to Menger's principles, economic science studies the relations between man's needs and the economic goods necessary to satisfy these needs.

7:52In Varaz's elements, as well as in the mainstream of the 1930s and 1940s and up to the 1980s, economic science was essentially about prices and quantities traded on the market. But in human action, respectively national economy, the true object of the science was understood to be human action and in particular choice. Choice. Let me repeat this, maybe again I insist on this point. So for Menger, economic science concerns the causal relationships that exist between human needs and the satisfaction of these human needs through material means. And value is a particular relationship that exists between different means for the satisfaction of human needs.

8:42Choice does not enter the picture. Human action does not really enter the picture. We have a theory of needs and satisfaction of needs. That's the quantum leap that comes with Mises' theory, in particular with Human Action. Suddenly the emphasis and the crucial juncture is choice itself. In another noteworthy passage of part one, 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.

9:29Yet these additional ends are by virtue of the very fact that they are additional ends less important than those that are already served with a smaller supply. Here Mises departs from all other economists, most notably from Mises who had adopted Gossens psychological interpretation of the law. Mises draws a sharp line between praxeology and psychology and he emphasizes the ramification of this in other important passages of the book. We'll come to talk about some of these later on. Now part two of the book. Again, Human Action and National Economy.

10:14Here, Mises deals with those features of human action that come into play whenever an individual interacts with other individuals. Later in the book, he analyzes the particularities of three fundamental types of social systems. The Market Economy, that's part four. Socialism, part five. And the Hempard Market Economy, part six. So you start from the fundamental level of what is most general, all the features of human action that hold true under any circumstance. Then you move to a more particular context, human action in the context given by the presence of other human beings, interaction. And then he moves on to single out or to focus on the particular types of interaction that there can be.

11:06Interaction within a pure market economy, interaction within a socialist economy and an interventionist system. He also restates here the third part, the theory of society that he had presented in socialism, but this time in its proper context. He stresses the Ricardian law of association and the crucial role of reason in shaping human society. Then comes part three. Here he completes 20 years of intellectual assimilation of his 1920 essay on the impossibility of economic calculation under socialism. 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, which he does in parts 4 to 6.

11:58Of course, he had anticipated this architectonic necessity in the Essays on Value Theory that he had written in the 1920s, but it is one thing to stress the difference between valuation and calculation in a general argument, it is quite another to apply this insight in concrete analysis. So here we have it finally. And so we have here with this third part of national economy a great parenthesis that is closed. It's the first great research project that I talked about in my first, it was not the first, it was lecture number three when we talked about the theory of money and credit. It's the first great research project that started in the early 1900s and is now closed in 1940 with this third part This is the third part, which really sums it up, the general theory of economic calculation, which is the organizing principle of the entire book and, as Mises believes, of economic science.

13:02In part four, he deals with the market economy. This part is over 400 pages long, more than half of the book. Here, Mises restates a good number of the theories he had developed in previous works, the theory of monopoly, the theory of money and credit, his famous business cycle theory, the theory of wages and the doctrine of the harmony of interests of all market participants. But rather than simply repeating himself, he presents thoroughly revised versions of his previous thoughts. 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, The Theories of Imperfect Competition. In The Theory of Money, he brooks no exception to the rule that political modifications of the money supply are unwarranted from an economic point of view.

14:08This is also something that was still present in the first edition of The Theory of Money and Credit, on which he radically breaks with this previous view in Human Action. and finally, also in part four, he integrates his business cycle theory with interest theory, a subject he had never addressed before in writing. Besides 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 uncertain world World and on the other hand entrepreneurship in the sense of a fundamental economic function, namely the function of bearing risk under uncertainty. It is this economic function that gives rise to the specific income component called profit and loss. It was one of the great contributions of national economy to clarify the role of this entrepreneurial function in the and the workings of the market economy.

15:17Mises 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 4 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 the ground had been laid to explain the nature and significance of entrepreneurship. Okay, so in practical terms this means for those who have not yet read Human Action, you don't read this chapter first, okay?

16:03This will shock you or bore you in the worst of cases. It's a very academic chapter. The best way to read Human Action is to start, in fact, with part four because there he deals with the market economy and to jump the first chapter there too. As you directly start with chapter 15, which deals with prices. We go directly into the subject matter, you as entrepreneurs and so on. That's in any way the way I recommend reading Human Action for the beginner. Start there, read this fourth part and then you go back. Then you go back and read the first three parts. And then you read part four again.

16:49When you've done this, you move on to part five and six. In part five, Mises deals with socialist societies. He does not restate all the main findings of his book Socialism. Rather, he concentrates on the centerpiece of his refutation of the socialist program, namely 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.

17:39We'll talk about this later in some more detail. In part 6, Mises 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 argument remains the same. Interventionism is counterproductive because it does not attain the professed ends of its authors. National economy featured entirely new and important contributions. Even in those places where Mises restates his older doctrines, he had revised them, often substantially. It was therefore highly unusual for Gottfeld von Haberler, his friend, to claim a few years later in a confidential evaluation for Yale University Press, which considered commissioning a translation of the book, that it contained hardly anything new.

18:31Now, that was not mean. We must take it that this was Abba La's honest conviction. Yeah, but one must have the impression that he had not read the book very well. It was not very different in the case of Morgenstern, was not a friend of Mises, but Mises had sent a copy of Human Action and Morgenstern said, Thank you. I've received your book on economic behavior and read it with great interest. But he formulated a title, he gave the wrong title of the book. So it was clear that he had not read the book. And the only question I asked myself was then whether this was consciously done, whether he wanted really to show his old master that he had no interest in the book.

19:23Okay, so that's the general outline of the book and we have the same structure again with the same structure in Human Action. There are three main differences between Human Action and Nationale Economie. The first one is that it concerns the first part of the book where Mises lays the foundations of the analysis and here we have also a discussion of epistemological theories and of methodology, how to approach the analysis of economic systems. Here Mises addresses the basic or fundamental tenets of rival approaches, rival theories. Now those rival theories that were important in the German language context in which he first worked were not necessarily the same that were important in his new context, in the new world in America. So in Nationale Economie, he discussed the approaches of Ottmar Spann, whom we have already mentioned, the theoretician of universalism, author of the most successful economics textbook in Germany, and of Karl Marx, also very influential.

20:33In the US, Spann was virtually unheard of. Marx was heard of but was not very important. What attracted the attention of the American economists and social scientists was the approach known as positivism. That is the idea of applying in social analysis the same methods that are applied in the natural sciences. So Mises changed the emphasis, cut out Spahn and brought in discussions of the Vienna Circle and to less extent of Popper and so on. and so on, often without mentioning them by name. The second big difference is an addition, an additional chapter 6 in the first part, in which Mises presents a theory of probability and of uncertainty.

21:29This did not exist in national economy and we must also speculate about the reason because he never explained why he added this chapter. But again, we must assume that he did this in order to take account of the new context given in the United States. Again, positivism reigns supreme, application of the quantitative methods that are used in the natural sciences. So, he needs a more in-depth, even more in-depth discussion going into the technical details, speaking about quantitative relationships that can prevail. So he talks about probability and he talks about uncertainty and he does this in critical discussion of the theory presented by his brother Richard.

22:19Now this might seem like a pure family feud and in fact it is so a little bit but just a little bit because as a matter of fact Richard von Mises' theory is the standard probability theory The probability theory is still taught today. Again, those of you who have a training in social sciences, whatever discipline, and yet your statistics class, and the probability theory, the relative frequency theory that you learn there, is the theory that has been first proposed by Richard von Mises. So therefore, Richard von Mises is an unavoidable step. You get some Mises always, and you have the social sciences, but here in Alabama you get especially Ludwig von Mises. And now Ludwig von Mises improves on the theory of his brother and he stresses in particular the presence of uncertainty which is absent in the treatment of his brother which is nothing to say about.

23:20And of course uncertainty is of fundamental importance because it's the one factor, the cause of profit and loss of a specific income component that cannot exist without uncertainty. Uncertainty, the difference between risk and uncertainty, risk is quantifiable probability and uncertainty is unquantifiable probability, something that evades, escapes our attempt at quantification. And Mises used somewhat different terms, the terms risk and uncertainty are the terms proposed by Frank Knight. Mises used the terms class probability and case probability, so class probability is the quantifiable probability and case probability, well, concerns just individual cases, cannot generalize, cannot form averages and so on.

24:16And the third main difference between human action and national economy concerns the conclusion. What is just a conclusion in national economy is elaborated into a part seven in human action. and this part seven spells out the cultural, social, philosophical implications of economic science. Let us now take a somewhat closer look at these main areas that I've singled out before, anti-psychologism, rationality of capitalism and liberalism, theory of entrepreneurship, interest theory, to Business Theory, Applications to Business Cycle Theory, and the Socialist Calculation Debate.

25:12Okay, first, anti-psychologism. So Mises stressed, again, in continuity with his previous works, stronger insistence, that economics and psychology, or we might more generally say, praxeology is the logic of human action. And psychology are two different fields, that's not to say that psychology is not important for human decision making, but economics is not about psychology, it does not depend on psychology. Let me give you a couple of examples. First of all, one praxeological category is means ends in all human action.

25:58We have the presence of means that are used to pursue ends, to pursue certain ends. I talk to you in order to convince you about certain things that I find in human action. You attend in order, hopefully in order to learn something about Ludwig von Mises. We eat in order to survive, but also in order to have pleasure and so on. So in all action we have the presence of means and we have the presence of ends. Now, there's also a psychological aspect to this, when different actors use different means to attain the same end. Some people eat bananas to fill their hunger, other people eat steaks. And that is because they feel different pleasures in eating bananas or steak, and also they might have different purses.

26:47Our opinions about the relationship between means and ends also have something to do with psychology. In our psychology, in our mind, we have a conviction that there is a causal connection between the means that we use and the ends that we seek. For example, we might climb up the ladder into a plane because we believe that this will be a means to bring us to a foreign country or another city and so on. But we might also climb up the ladder to the second floor of this building and jump out of the window because we think this will bring us eagle-like on our wings on our wings and we will fly off to California or whatever.

27:38So take this example as an absurd example, a completely wrong opinion about the causal connection between means and ends. I might be of the opinion, psychologically, going to the second floor and jumping out of the window will make me grow wings and I will fly off to California. Now this would be wrong, a particular psychological condition, but it has nothing to do with the fact, it does not alter the fact, that my behavior is a means for me to attain a certain end. So whether we are right or wrong about this, whatever the psychological aspect of these things are, it does not alter the fact that we always use means to attain an end. The praxeological category is there, irrespective of what the psychological aspect of the behavior might be.

28:31Another example, from Carl Menger we have learned that the market economy is geared toward the satisfaction of consumer needs. Now this holds true irrespective of the psychological condition, both of consumers and of producers. It holds true irrespective of what consumers like, that is, from a psychological point of view, for which kind of products or goods and services they are inclined. The market economy satisfies them. But it also satisfies them irrespective of the psychological inclination of the producers. Whatever producers might think about the importance of their activity and so on, we have a market process in which there is a selection The selection of only the most efficient or I say the most profitable firms, irrespective again of the psychological disposition of entrepreneurs, whether they like the activity or not, whether they believe themselves, it's very important or less important, it does not matter.

29:33Mises stressed the importance of psychology and information for example, information that different agents have, In particular, that there are information differentials, that's of course a fundamental point, consideration in Friedrich von Hayek's social philosophy. For Hayek, the market economy is a great mechanism by which information is most efficiently used. It's transmitted and communicated and used in the most efficient way. and that is because it's impossible to centralize information, to make all information available at a central place, to centralize it, but it is possible to communicate through the action of the market information from one place of the economy to another.

30:29Now Mises granted this, such information differentials exist and it's very difficult, if not impossible, to centralize information. But this has nothing to do with praxeology per se, it does not exhaust praxeology. Let's say even if there are no information differentials, if all market participants had the same knowledge, there would still be another component that comes into place, namely appraisement. People would still appraise the very same information differently. They would think it has a different value. For example, you might have two entrepreneurs considering an investment project and they both think correctly, let's say, that the investment projects will bring a return of 30%.

31:21Now, one of them might engage in this project and the other one might not, and the reason could simply be that one has a preference, 30% is a high enough return for him to warrant giving up leisure time, so he does this, and for the other 30% is not yet high enough, so he prefers staying at home, watching football and doing other nice things. You see, so even if there's no information differential, if all people are perfectly well informed with the same psychological precondition, then still other considerations come into play that will create a different reaction toward the same environment. The next major point that I mentioned before is Mises' insistence that capitalism and liberalism are rational.

32:12There are rational systems of thought and that completely revolutionized the mental attitude of man towards social organization. Mises in his social philosophy stresses a point of departure that has been affirmed since the ancient times, since Plato and through the Middle Ages, Aquinas and all major philosophers have stressed the following point that the division of labor is more productive than isolated production. Two people hunting rabbits and collecting berries in isolation from another will not be as productive, taken together, if we add up the products, then if they cooperate, if they coordinate their productive activities.

33:10I could give you examples and those of you who will attend the second week, next week the Summer University, you will see my example, I'll demonstrate this in detail, but that's the fundamental fact. This is a fundamental fact. The vision of labor is more physically productive. There are greater quantities of goods and services available. Now, it follows from this, and this is the great inference that classical economists have drawn, it follows from this that individuals have an incentive to cooperate. Even if they do not like one another personally, or even if they hate one another, They still have an incentive, an economic incentive to cooperate. They still have an incentive to associate, thus to create society.

33:59Society therefore emerges without it being necessary that people be forced or coerced to behave properly and to respect one's fellow beings because each one has an incentive to do this. Of course, we know there are also incentives to violate the rules of society, not to respect one another, become a thief or become a murder, robber or whatever. Yeah, these incentives exist too, but it's not the only thing, it's not the only incentive that is present. It's also an incentive to respect one another, because one can profit from cooperation, and cooperation can take place only if I respect the property of my neighbor. Now, Mises stresses the significance of this discovery. He says the following in Human Action.

34:49The historical role of the theory of the division of labor as elaborated by British political economy from Hume to Ricardo consisted in the complete demolition of all metaphysical doctrines concerning the origin and operation of social cooperation. It consummated the spiritual, moral and intellectual emancipation of mankind, inaugurated by the philosopher of Epicureanism. It substituted an autonomous rational morality for the heteronomous and intuitionist ethics of older days. Law and legality, the moral code and social institutions are no longer revered 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.

35:50Now, in other words, before this discovery, before the classical economists had drawn this inference from the fundamental fact of the productivity of the division of labor, one had to explain what is the incentive that brings people together to form a society. Well, and then the case that was typically stressed was, well, okay, you have superior human beings and inferior human beings. The superior human beings cannot possibly profit from the inferior ones. Therefore, if they help them at all, then the least thing that the inferiors can do is to obey commands. So this, according to Mises, is a metaphysical doctrine, because he ignores this fundamental fact that even the superior ones, to the extent that they exist, profit from cooperation with the inferior ones.

36:47Again, the point that Jean-Baptiste Say had made, and before him, after him, others. Even if one nation as a whole is superior to our nation, the Chinese can do everything better. I repeat the phobia of my students. The Chinese can do everything better. Well, it does not follow that Chinese do not profit from our cooperation. Even if we are inferior, well, they are still better off when we are there. And as a consequence, we have, all of us together, we have an incentive to cooperate. to cooperate. But there's still another metaphysical approach to society which consists in what Mises called the collectivist approach. And here we pretend that society lives alive on its own. It is not what results when individuals cooperate, when individuals out of their own motive get together.

37:46But it's something that exists without being observable, touchable, knowable directly in any direct way. But we believe it exists, society as such exists and should live and is important for each of us. And this society is then threatened by the egoism or the egotism of the individual members. So for me the society is only what results from the cooperation of individuals. From a collectivist point of view, society is something that exists, something unknowable, metaphysical, something that exists apart from individuals. And individuals, well, definitely depend on society for their well-being.

38:32So, the inference is that, well, in order to make mankind flourish, we've got to protect society against the egoism of the individuals which seek to destroy it. Of course, now the question is, what are these interests of society that we no longer define depending on the interests of each individual who cooperates with other individuals? How do we know these interests? How do we know these necessities? So that's the point Mises makes, well since we cannot know them, there's only one solution to this riddle, to this metaphysical riddle, we need to have a special case of persons who are the high priests of society and who tell us what the needs of society are, what the interests of society are and then use coercion to force others into conformity with these alleged needs.

39:25Now all of this again is not the approach of capitalism and liberalism, both these elements of the social philosophy of liberalism and capitalism is rational, it is scientific, it is based on science, verifiable, refutable facts. All elements in the demonstration developed by the classical economists and their successors are readily verifiable fact. It's a fact that the division of labor is more productive than isolated production. It's a fact therefore that each individual has an incentive to cooperate. It's a fact therefore that society will emerge spontaneously irrespective of whether we have a high priest to tell us to get together or not.

40:14There's no metaphysics here, it's just rock bottom facts. The third major area in which Mises made a contribution was, as I've said before, the theory of equilibrium, profit and loss, and entrepreneurship. Carl Menger in Boehm-Bawerk again had explained how the structure of production or that the structure of production is geared toward consumer needs. But again, we have to recall that in Menger's and Boehm-Bawerk's approach, we have by and large a theory of the causal relationships that exist between needs and the means suitable to satisfy these needs.

41:01The question is, how does it come that the structure of production is created in a way suitable to satisfy these needs? We know that there are causal relationships, but who does, who is it that recognizes these causal relationships? Who is it that modifies the structure of production if the needs change? There was no theory of the sort in the writings of Menger and of Boehm-Bawerk. Now, a very important step toward the development of such a theory was presented in Joseph Schumpeter's Theory of Economic Development. We talked already about this and the central figure in this theory is the entrepreneur.

41:46The entrepreneur who for Schumpeter is essentially an innovator, an innovator who, as he later put it, creatively destructs the existing structure of production. The innovator overthrows the routine that existed up to now in the market, it brings up projects that are superior to the existing ones. And as a consequence some firms go bankrupt and these new innovative firms are put at their place. The structure of production results therefore from the activity of a special breed of mankind which is the entrepreneur, the innovator. Schumpeter went into some detail explaining the different types of innovations that come here into play.

42:33Most notably so the innovator develops new products, he discovers new markets both for his products and for his factors of production. He develops new forms of organization and he develops new production techniques. He is an innovator. Now, what Mises' argument amounts to is to say, well, first of all, the Schumpeterian contribution raised the following problem. How can we reconcile this with the traditional Austrian approach? For Menger, the structure of production suits the needs of the consumers.

43:18For Schumpeter, the structure of production results from innovation, of the entrepreneurial innovation. So is there a contradiction here? And Mises said no. He said no. He created the synthesis and said the profits realized by entrepreneurs are not obtained for innovation per se. It's not just because we innovate, we do something new, something different from what has been done before, that we obtain profits. It's only for innovation that is useful from the point of view of consumers, that improves things from the point of view of consumers. So innovation, and Schubert was right in this, innovation disrupts the ways of the economy, establishes new forms of production and so on.

44:11But that's not necessarily good entrepreneurship, that's not necessarily what brings about profits. Profits only come into play if the innovation is useful. Not all innovation is useful. Not all technological advance is also useful for the entrepreneurs. And so entrepreneurs are rewarded only for innovation that is useful for consumers. we have here a market process. Now this of course raises, so we have a conjunction between entrepreneurship and profit and loss. Now this raises the next question, how can we define profit and loss? In particular, what's the difference between profit and loss on the one hand and interest payments on the other hand?

45:02Is this the same thing, is this different, a different name? And so here Mises stated the matter crystal clear much, well, in fact no writer before may put the matter so clear, so Mises said, okay, there is a difference between interest on the one hand and profit and loss on the other hand. Interest is a price spread between our selling proceeds from the point of view of an entrepreneur, of the selling proceeds on the one hand and our cost expenditure on the other hand, a price spread that exists that subsists even in general equilibrium. Now what is general equilibrium? General equilibrium is a situation in which no entrepreneur commits an error.

45:47All production decisions are optimal from the point of view of the acting person. He doesn't sink any money into black holes. that Ludwig holds and he is successful in his ventures, okay? That's the definition of general equilibrium. In such a situation there subsists a spread between selling proceeds and cost expenditure which is caused by time preference. We rather prefer present goods to future goods As a consequence, if we invest our present resources into an investment project and we could consume them right now, well, in order to do this, we need to be rewarded and otherwise we would not do it and so each individual entrepreneur invests only because of time preference if you can expect a spread, a surplus and because the same incentive exists for all other entrepreneurs This surplus cannot be arbitraged away. That's the Boehm-Bawerkian theory of time preference, the Boehm-Bawerkian theory of interest.

47:02Now profit and loss are additional income components that arise as a consequence of error. For example, if I invest too much money into the production of microphones, this means that I will pay prices for the factors of production needed to make microphones that are too high as compared to the prices that I can finally realize for the product. Okay, so I commit an error. I want to realize a certain surplus, I want to realize a certain interest, but I'm wrong about the amount of money that I can obtain for the product.

47:52So I pay now too much for the factors of production. So in this case we would have an income component that we call loss, that is a negative income component. We do not earn even interest, we earn less than the interest, and the difference is loss. But it can also happen that we make a profit, and profit arises if our competitors are wrong, if they do not perceive that there are profit opportunities or surpluses to be reaped in our line of business. Let's say there is a sudden additional consumer demand for lamps, and I'm a lamp producer. So, with increased demand the prices for LEMs go up and as a consequence the difference between my cost expenditure and my selling proceeds will increase.

48:41So, I make a surplus beyond interest and this surplus is called profit. It would not exist if my competitors had realized that the demand for LEMs increases because in this case they would have invested in my line of business. So they would have paid higher prices for the factors of production that are needed for lamp making, factors of production that I need too, suitable workers and raw materials and so on. So the prices would have gone up and because more lamps are on the market, the prices for lamps would have fallen. So the price, the difference, the spread between cost expenditure and selling proceeds would have been squeezed until we reach interest.

49:27The pure interest component only. So if I make an extra surplus because my competitors have erred, they were wrong, well then this income component, my income component is called profit. It has a very ingenious, very crystal clear distinction that Mises proposes here, but it's in fact, well, we can explain this today quickly Now, this presupposes, of course, then again, the crucial notion of general equilibrium that I've used before.

50:12Therefore, Mises stated the matter a little bit differently, he said in order to explain the situation in which no error occurs, we need to consider a special hypothetical situation that cannot possibly exist in the real world, namely a routine economy in which everything repeats itself from one day to another. and this routine economy called the evenly rotating economy. The crucial consequence of such an economy is that people do not err because they know what's going on. It's just the same thing as yesterday. So they cannot possibly be wrong. So Mises has then all elements in place to have a coherent theory of these three elements.

51:03All the three are needed and in dependence of one another, equilibrium, profit and loss, and entrepreneurship.

51:14The fourth major contribution that he makes in national economy concerns interest theory. That's a subject on which he had not yet written before. He had relied on the work of his teacher Boehm-Bawerk. Boehm-Bawerk had proposed a revolutionary theory of interest in which he formulated interest as resulting from human choice, resulting from human action. It's not a compensation for any goods or service. It is something that results, an income component that results from human decision making. Decision making, as Mises would later stress, well, we always prefer something to another, so we have a value differential.

52:03And so the fact that there is interest, interest payments on the market, results from the fact that entrepreneurs prefer certain goods to other goods. And in particular, present goods to future goods. Present goods are more valuable than future goods. As a consequence, if I have ever to invest for future consumption, well I need to be compensated. Now this theory was, Boehm-Bawerk combined this explanation, this time preference explanation of interest with a third factor that stressed the physical productivity of capital and it will lead us too far now to go into this detail.

52:48Before we come to Mises, there is one intermediate step, namely the formulation of a pure time preference theory of interest. Boehm-Bawerk, by the way, has not yet used the word time preference. This expression is due to Frank Fetter, an American economist, who was also the first one to propose a pure time preference theory of money. So he gets rid of this third element that Boehm-Bawerk had stressed, the higher productivity, physical productivity of capital, and he focuses entirely on time preference. Now for both Fetter and Boehm-Bawerk, time preference is a psychological phenomenon. We prefer present goods to future goods because as a tendency we underestimate our future, the future availabilities of goods.

53:46And so time preference has a psychological root. Now, what Mises does can be summarized in two steps. First, he rejects the psychological foundation of time preference and he proposes a praxeological foundation of time preference. And second, he links up this praxeological mechanism that causes time preference with consumer choices. So rejection of psychologism. And second, integration of synthesis between the theory of consumer sovereignty and interest theory.

54:42Like Boehm-Bawerk, Mises believed that time preference was the only proximate cause of interest. But rather than seeing the ultimate cause in certain psychological dispositions of the human being, He followed Frank Fetter and also Franz Joel 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 race would perish. This does not mean that time preference is the only factor determining human actions.

55:31It 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 rather than later ones. Consider, as an example, three alternative fishing processes. The first one leads to catching one fish at the end of one hour, the second one to catching ten fish but only at the end of one day, And the third one to catching 100 fish, all of them at the end of a week.

56:29Assume we observe a person pursuing the production process leading to a catch of 10 fish at the end of a day. At the end of the day, Mises here 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 explanation within his overall theoretical framework.

57:21Consumption here appears at the root of all economic phenomena. Carl Menger and his disciples had argued that consumer choices directly determine the prices of consumer goods and that indirectly they also determine the prices of producer goods. Now, time preference too, and with it the phenomenon of capital and interest, appear to be rooted in consumption. The great attraction 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.

58:10In the field of interest, as in the broader market process, the consumer is sovereign. So Mises then systematizes something. Both Boehm-Bawerk and Menger had stopped short in creating the system. At some point, there was on the one hand subjective value, marginal value on the one hand, and there was the second element, time preference, on the other hand. So we have in fact two bases for economic analysis. Now Mises shows that ultimately it's only one element. In all cases we have consumer choice. The system is generalized.

58:57Now Mises applied this findings and interest theory also to business cycle theory. In one important respect that I had announced already when we spoke about The Theory of Money and Credit, to which we now come, namely to the explanation of the variations of the rate of interest. We have seen that in Mises' theory of the business cycle, the crucial consideration is that intertemporal misallocation of resources can take place if the interest rate is decreased. Below the level, well, below which level, right? So that's the question. In his Theory of Money and Credit, Mises had relied on the framework of Knud Wichsel, a Swedish economist, who had stressed the difference between a natural rate of interest and a monetary rate of interest.

59:52The natural rate of interest being the one that would be established in a barter economy, and the monetary rate of interest the one being established in a monetary economy. So if the same economy used money, now this implies a severe problem, namely, first of all, it cannot be readily conceived how a barter economy could ever have such a thing as a rate of interest. What is the rate of interest? I'll say 17%. Obviously, we need to have the same units above and below in the mathematical expression. We cannot say 17 oranges divided by 100 apples equals 70%. That's not the case. Only if we have the same dimension above and below.

1:00:4717 oranges divided by 100 oranges, we have 17 percent. Now how can this be in a barter economy? In fact it cannot be. We need to have money prices here. So we can speak meaningfully of a rate of interest only in the context of a rate of interest, of a ratio of interest maybe, of a rate of interest only in the context of a monetary economy. But even if we assume, now for the sake of argument, that rates of interest could exist in a barter economy, we still have the problem, an even more formidable problem, namely the presence of Cantillon effects. Money is not neutral. Money affects all prices, therefore it affects all profitabilities of production processes, it affects therefore what is being produced, what is being consumed, it affects all the incomes of the market participants.

1:01:43So what sense does it make to compare the natural rate of interest, if there is such a thing, to a monetary rate of interest? All things would be different in these two different economies. So it's not at all clear how this Vixalian approach could be fruitfully applied in the type of business cycle theory that Mises formulated in the early 1900s. But now he finds a way, he comes up with a solution, he says, well, no, we don't fold, that's not the relevant consideration, that's not the relevant comparison, not between a natural rate, a water economy rate and a monetary economy rate. The crucial consideration is the rate of interest as it would be established in an unhandled market economy and the rate of interest as it would result from credit expansion.

1:02:37Intervention. So we have again a greater unison also with this theory of interventionism, in which the relevant comparison is always between the operation of a market economy on the one hand and government interventionism on the other hand. Respect of property rights on the one hand, violations of property rights on the other hand. That's what we compare. And it now applies this also in the field of business cycle theory. We speak of a variation of the interest rate as compared to the interest rate that would have been established in an unambered market economy. And then finally, well there's also, I mentioned in passing, related improvement that we find in the Streatus Nationale Economie as compared to The Theory of Money and Credit, namely that he has now a pure cash balance approach for the demand for money, There is a demand for money, so he now gets rid of the error that we discussed before that was pointed out by Don Patinkin and which Mises seemed to accept Visa's theory that the value of money is exclusively determined by the value of the things that can be bought for money.

1:03:56Now in Nationale Economie, finally, he stresses, there is a demand for money per se. And of course, we do demand money because we want to buy other things with this money. But money renders us certain services, marketable goods, and it is for these services that we demanded. So the value of money is not exclusively fully determined by the value of the goods that we can buy for money. The last point that I should like to discuss very briefly is the update that he gives us on the socialist calculation debate. In the late 1920s and throughout the 1930s, several theoreticians with more or less left-wing orientations developed responses to the challenge he had given in his 1922 and 1922 works on the impossibility of socialist calculation in a socialist society.

1:04:59And there were in particular two new approaches that required a response. A response according to one approach 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 to 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 économie was published they were achieving the status of a new orthodoxy that would survive half a century.

1:05:54We might mention in particular the authors Fred Taylor, Carl Landauer, Dickinson, Lerner, and Oskar Lange. One of the new theoreticians, the Polish socialist Oskar Lange, thought some compensation for Mises might be in order, given that it was his powerful challenge that forced the socialists to recognize the importance of an adequate system of economic accounting to guide the allocation of resources in a socialist economy. Lange therefore proposed that a statue of Professor Mises ought to occupy an honorable place in the Great Hall of the Central Planning Board of the Socialist State.

1:06:42Very generous. But no socialist state was generous enough to follow up on this suggestion. But as I've learned from our friends here, the University of Wroclaw created a statue of Oskar Lange and preserved it into our day, which was surely a monument to the preranity 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. Here I like to mention in particular the various editions of the most important Western textbook of the post-war years.

1:07:34Paul Samuelson's Economics. Up to the very last edition that appeared before the collapse of the Soviet Empire, the 1989 edition, Samuelson stated the following, quote, the Soviet economy is proof that contrary to what many skeptics had earlier believed, the socialist command economy can function and even thrive, unquote. This notion evaporated in 1989. The fall of the Berlin Wall opened everyone's eyes to the stark reality that 70 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.

1:08:21In socialism, Mises had analyzed the idea of market socialism even before any socialist had thought of it. And he had already identified its Achilles Heel, moral hazard, and we talked about this yesterday. Artificial markets would make managers irresponsible. Some of the benefits of successful management would still be private, 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. 18 years later, in Nationale Economie, Mises did not miss the opportunity to note the irony that, according to this proposal, the market economy was such a bad thing that it had to be reintroduced through the back door as soon as the new socialist regime is established.

1:09:17You 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? should be established. These decisions lay in the hands of, as Mises said, capitalists, entrepreneurs and speculators. 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.

1:10:09No 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 or capitalism. It would be no system at all. Said Mises, it would be chaos. Mises then finally turned to another scheme that had been developed in the interwar period as a response to his critique of economic calculation and socialism. And according to this scheme socialist societies should use the equations of mathematical economics to solve the problem of economic calculation.

1:10:56Here Mises restates an argument he had presented in a 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. I quote Mises, it 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. Now that's fairly abstract. Let me put it otherwise. In order to, so you have a system of equations that describes the relationships that exist between prices and quantities.

1:11:51Relations that must exist of some sort due to scarcity. There must be some relations. If I increase the quantity of boots that are produced, then necessarily I can produce less butter. So there will also be implications for the prices of boots and of butter. Now the question is, how can I use such a system of equations to make concrete investment decisions as a central planning board? And what Mises says is well, in order to give empirical flesh to it, we can only take those data, those information that are available now. But the presently existing economy is not one that is in equilibrium.

1:12:38It is an economy in disequilibrium. So the information that we get empirically do not help us in order to know how the equilibrium in economic would look like. And second, even if you knew what it looked like, it would not help us much because we would still not know what the next step should be. Even if I know, let's say, how the perfect equilibrium economy should be in 10 years, I still have the problem, the question, what should I do next? What's the first step toward getting there? And he argues, in this article that I just mentioned, he argues, well, in a real existing economy, entrepreneurs do not need to know this.

1:13:26They can operate with the existing price system, which has expressed the beliefs of their fellow entrepreneurs, beliefs that might be wrong, but it doesn't matter. They are bound up in a competitive process and their main task is to make a profit. If they make a profit, as we know from theoretical analysis, they must serve consumer needs, otherwise they could not. So if they make a profit, they necessarily bring the economy closer to equilibrium. In order to make a profit, they just can rely on the existing price system, imperfect and disequilibrium as it is. That's Mises-Argnar. So we do not need this in order to be successful in practice.

1:14:11And even if we knew it, even if we could apply, could develop equilibrium models of the economy, they would be of no use in practice. Mises then concluded that this fundamental conceptual problem made it superfluous for him to deal with the practical problems of central planning that Pareto and Hayek had raised. Pareto and Hayek had stressed the problem of centralizing knowledge and of communicating knowledge from one end of the economy to another. So, Mises did not deny that such a problem exists, and he did not diminish its importance, he just said, well, but that's not all. There's also this other problem, a fundamental problem of economic calculation.

1:14:58Okay, I'll stop here and give you 12 minutes for questions. Please. Well, Mises did not use this expression. This would have been disparaging when he said it was a step back. No, he did not say this. He said things like, that is just a practical problem. Hayek had raised the consideration of this practical problem, and he always said, but that's not all.

1:15:47In fact, you're right, the socialists, Lippincott, for example, they made the statement, well, what Hayek and Robbins are doing is typical of somebody who has, in principle, already considered defeat. and then moves on to raise additional practical problems. And Mises never did this. He said that Hayek and Robbins did not say Mises. The socialists were very well aware that Mises had not retreated from his position. Well, you might be right, I also believe that he believed it was a retreat, but he did not say it, okay, he did not say it.

1:16:37Yep.

1:17:07Yeah, Mises raises this possibility very briefly. I don't remember exactly where, whether, probably already in the Theory of Money and Credit, if not then in this 1928 book, and also in Nationale Economie, and he says, okay, what happens then is simply that certain investments would not take place. That's all, but there would be no waste of capital. So we remain below our possibilities, but we do not positively waste capital. If the interest rate drops below the equilibrium, then we have positive waste. That is, we not only remain below our possibilities, but far more so than if we had just stopped investing for a certain amount of time.

1:17:59We know that Mises saw that there was a difference between his treatment of the socialist calculation problem and Hayek's treatments. Did Hayek also see that there was a difference? That's a good question. I had the impression that that was not necessarily the case. From what Hayek later said in the later 1970s, after Mises' death, about how he perceived the importance of Mises' work, he said, well, often Mises did not put things quite right. And much of what he wrote in the 1930s and thereafter was meant to clarify the point that Mises had.

1:18:52So you always believe that Mises had a point, but not necessarily that he stated it correctly. And I think that was also his attitude to this question. He thought that Mises had a point, but the way he expressed it was not acceptable. Of course, from a psychological point of view, we can explain this by saying, by saying Hayek started from this Vizierian framework and so for him there could be no talk of an impossibility of economic calculation under socialism. Of course it was possible in principle. So the only difficulty that could he enter into place was a practical one. Mises had raised this practical difficulty also in his 1920 essay. So Hayek thought that he was just going to clarify matters, So, from the answers that you gave, one can infer that there was no correspondence between Mises and Hayek, what was their respective understanding of each other's argument?

1:20:04There is not much correspondence, there is a little bit of correspondence and I quote this also in the book, in the chapter that deals with the Geneva years. So in the context of the discussion of this 1938 paper in which he criticizes Hayek, therefore the paper is also interesting and has been reprinted a few years ago in the Quarterly Journal of Austrian Economics. So it's one of the few papers where Mises names names and says well Hayek is wrong in this. Yeah, and there wasn't ensuing a little correspondence on this, and they obviously also discussed this at conferences, but Hayek was unconvinced. So, somebody else before I give you the word again? What was Wichsel's justification for saying that an asset is just that?

1:20:53Well, Wichsel believed in the Wheel of Money theory. He believed that money just provided a monetary layer over the economy, but did not fundamentally affect what was going on. That's just a minor point. Why do you think Mises seldom names names? Why did Mises seldom name names? Well, that's another issue that I also have discussed in this book. Much earlier on, when he makes up his mind about attacking always ideas, never persons. It comes up in the context of a corruption affair and he could have the opportunity to indict the persons involved, but he wants to attack the ideas and say, okay, if I do both, then I would be mingled up in these affairs and these affairs and people would maybe think that I was just an X to grind with this but my task, my professional task as an economist is to fight bad ideas and so it's exceptional in this case too that you mentioned Hayek but probably well various possibilities why this was so.

1:22:02Did he ever make an exception and really nail a person? No. Never? No. Can you elaborate a little bit more on Mises' relationship with Morgenstern? Morgenstern? Mises' relationship with Morgenstern. Well, there's not much that I've found. There is no correspondence between the two. There is virtually no correspondence. I mean, the entire 50 years or so that they knew one another, There are maybe five letters that I have. They are usually of an informative sort, no exchange of ideas and so on. But it must be said that Mises in general did not use correspondence as a way of exchanging or developing, formulating his ideas.

1:22:50It was not his thing. That's why he wrote books and articles. Morgenstern, as I've said, he was the assistant of one of his rivals, Ottmar Spann. He was not necessarily, sorry, he was an assistant to Hans Maier. He was interested in economic theory but was inspired by the Viserian framework, was another Viserian. There was a certain proximity between Mises' thoughts and Morgenstern's ideas in that they both rejected the general equilibrium framework Work, Economic Analysis, and Morgenstern early on, so he writes his 1928 Habilitation Thesis in which he discusses problems of forecasting.

1:23:44He says because we have the interdependence of human choice, in order to make a correct choice, I need to anticipate what the other person is doing. For example, what customers are doing, but also what competitors are doing. But for him it's the same thing. In order for him to make a correct choice, he needs to anticipate what I'm doing. So we have the problem, I know that you know that I know that you know, that I know that you know, that I know that you know, and so on. And so because of this, he said, well, that's such a riddle that makes it impossible that we can ever apply general equilibrium theory. So we need to come up with something different, and that's the reason why he pushed into developing game theory, that's of course the approach with which his name is today associated.

1:24:37So there was some common ground in the rejection of this entire positivist approach, general equilibrium and forecasting and so on, he did not believe in this, but he delved into a completely different direction. Then as a person, I believe Morgenstern was not too much to Mises' liking. I believe he was very egocentric, very, very egocentric, and more subservient also than Mises to power, both in the time in the Vienna years and in the U.S. Of course, Morgenstern in the early Cold War era was a big time Cold Warrior and got lots of money for his research projects from the Department of Defense because game theory was held to have major applications in wartime planning and so on.

1:25:36and so on. Yep. The discussion of the profitability and uncertainty that are vaguely reminiscent of what I've come across in the portfolio theory of systematic and unsystematic risk. Is there some kind of a relationship or was there a discussion between Mises and the people that were in the portfolio? What are the three most important aspects in your theory of money and credit? Is it something that is vaguely reminiscent of what I've come across in portfolio theory of systematic and unsystematic risk? Is there some kind of relationship or was there a discussion between Mises and the people that worked in portfolio theory about that kind of thing? I didn't know, I did not find any evidence that there were, well, discussions of course do not survive on documents, I found no correspondence and nothing. Yeah, but certainly Mises read these works.

1:26:23And, well, portfolio theory, right, we have these distinctions between systematic and unsystematic risk, but fundamentally, New classical economists believe that any type of risk, whether it's systematic or unsystematic, can be quantified, on the basis of different theories of probability, Bayesian probability theory and so on. And that's precisely the point that Mises was challenging. That was his point. There are certain types of risk, case, or case probability that you cannot quantify, to quantify and which raise a fundamental challenge for quantitative economics and also then of course for purely quantitatively based investment decisions.

1:27:10Investment is not a mechanism. It would be nice if it were. Okay, we'll leave it here. See you tomorrow morning.