The Editors of this magazine have requested from my pen an account of the work of that group of economists which is popularly called the Austrian School. Since I am myself a member of the group, possibly I shall prove to be no impartial expositor. I will, nevertheless, comply with the request as well as I can, and I will attempt to describe what we Austrians are actually doing and seeking to do.
The province of the Austrian economists is theory in the strict sense of the word. Their researches take their direction from the theory of value, the corner-stone being the well-known theory of final [marginal] utility. This theory can be condensed into three unusually simple propositions. The value of goods is measured by the importance of the want whose satisfaction is dependent upon the possession of the goods. Which satisfaction is the dependent one can be determined very simply and infallibly by considering which want would be unsatisfied if the goods whose value is to be determined were not in possession. And again, it is evident that the dependent satisfaction is not that satisfaction for the purpose of which the goods are actually used, but it is the least important of all the satisfactions which the total possessions of the individual can procure. Why? Because, according to very simple and unquestionably established prudential considerations of practical life, we are always careful to shift to the least sensitive point an injury to well-being which comes through loss of property. If we lose property that has been devoted to the satisfaction of a more important want, we do not sacrifice the satisfaction of this want, but simply withdraw other property which had been devoted to a less important satisfaction and put it in place of that which was lost. The loss thus falls upon the lesser utility, or -- since we naturally give up the least important of all our satisfactions -- upon the "final utility." Suppose a peasant have three sacks of corn: the first, a, for his support; the second, b, for seed; the third, c, for fattening poultry. Suppose sack a be destroyed by fire. Will the peasant on that account starve? Certainly not. Or will he leave his field unsown? Certainly not. He will simply shift the loss to the least sensitive point. He will bake his bread from sack c, and consequently fatten no poultry. What is, therefore, really dependent upon the burning or not burning of sack a is only the use of the least important unit which may be substituted for it, or, as we call it, the final utility.
The first complication is that due to exchange. If the only winter coat I possess be stolen, I shall certainly not go shivering and endanger my health, but I shall simply buy another winter coat with twenty dollars which I should otherwise have spent for something else. Of course, then, I can buy only twenty dollars' worth less of other goods, and, of course, I shall make the retrenchment in goods which I think I can most easily dispense with; i.e., whose utility, as in the foregoing example, is the least; in a word, I shall dispense with the final utility. The real thing, therefore, which is dependent upon whether or not I lose my winter coat is the satisfactions that are most easily dispensed with, the satisfactions which, in the given condition of my property and income I could have procured with twenty dollars more; and it is upon those other satisfactions. which may be very different in nature, that, through the workings of substitution by exchange, the loss, and with it the final utility dependent on it, is shifted.
A second interesting and difficult complication of the substitution of goods is due to production: viz., given a sufficient time, the goods whose substitution is under consideration could be replaced by production. As in the former case the goods were replaced by the use of money, so in this case they can be replaced directly by the conversion of materials of production. But, of course, there will be less of these materials of production left for other purposes, and just as surely as before the necessary diminution of production will be shifted to that class of goods which can be most easily dispensed with, which is considered least valuable.
Take Wieser's example: If a nation finds weapons necessary to the defence of its honor or its existence, it will produce them from the same iron which would otherwise have been used for other necessary, but more or less dispensable utensils. What, therefore, happens to the people through the necessity of procuring weapons is that they can have only somewhat less of the most dispensable utensils which they would have made of the iron; in other words, the loss falls upon the least utility, or the final utility, which could have been derived from the materials of production necessary to the manufacture of the weapons.
From this point, again, the way leads to one of the most important theoretical principles, which under a certain form has long been familiar. This principle is that the value of those goods which can be reproduced at will without hindrance shows a tendency to coincide with the cost of production. This principle comes to light as a special case of the law of final utility, occurring under given actual conditions. The "cost of production" is nothing else than the sum of all the materials of production by means of which the goods or a substitute for the same can be reproduced. Since, then, as above pointed out, the value of the goods is determined by the final utility of their substitute, it follows that so far as that substitution can be made ad libitum, the value of the product must coincide with the final utility and value of the materials of production, or, as is usually said, with the cost of production.
The question of the relation of cost to value is properly only a concrete form of a much more general question -- the question of the regular relations between the values of such goods as in causal interdependence contribute to one and the same utility for our well-being. The utility furnished by a quantity of materials from which a coat can be produced is apparently identical with the utility which the completed coat will furnish. It is thus obvious that goods or groups of goods which derive their importance to our welfare through the medium of one and the same utility must also stand in some fixed, regular relation to one another in respect to their value. There is a corollary to this general and important proposition. Very commonly several goods combine simultaneously to the production of one common utility; for example, paper, pen, and ink serve together for writing; needle and thread for sewing; farming utensils, seed, land and labor for the production of grain. Menger has called goods that stand in such relation to one another "complementary goods." Here rises the question, as natural as it is difficult: How much of the common utility is in such cases to be attributed to each of the cooperative complementary factors? and what law determines the proportionate value and price of each?
To this end the theory of final utility helps in the simplest way. It is the old song again. Only observe correctly what the final utility of each complementary factor is, or what utility the presence or absence of the complementary factor would add or subtract, and the calm pursuit of such inquiry will of itself bring to light the solution of the supposed insoluble problem. The Austrians made the first earnest attempt in this direction. Menger and the author of this paper have treated the question under the heading Theorie der komplementaren Guter; Wieser has treated the same subject under the title Theorie der Zurechnung (theory of contribution). The latter, especially, has in an admirable manner shown how the problem should be put, and that it can be solved; Menger has, in the happiest manner, as it seems to me, pointed out the method of solution.
Thus prepared, the Austrian economists finally proceed to the problems of distribution. These resolve themselves into a series of special applications of the general theoretical laws, the knowledge of which was obtained by a tedious, but scarcely unfruitful, work of preparation. Land, labor, and capital are complementary factors of production. Their price, or what is the same thing, rate of rent, wages, and interest, results simply from a combination of the laws which govern the value of the materials of production on the one hand with the laws of complementary goods on the other hand.
In the last number of this Journal Professor J.B. Clark has given in some detail his views upon the origin of interest, and has there placed in opposition to my theory his own theory of "permanent capital" and its "specific productivity." Professor Clark seems to regard my theory of interest as a sort of abstinence theory. He believes that, so far as my theory of interest is concerned, production periods are significant, because "there are in society persons who must wait through such intervals in order to have their wants gratified" (p. 259).
On page 363 of my Positive Theory I have expressly stated that by "the much abused expression, Reward of Abstinence, the existence of interest cannot be theoretically explained; one cannot hope in using it to say anything about the essential nature of interest; every one knows how much interest is simply pocketed without any 'abstinence' that deserves reward!" Furthermore, I have emphatically and repeatedly laid it down that, at a rule, capitalists do not forego any personal indulgence when loaning or investing productively their present goods. For they would not, even in the absence of such an opportunity for investment, consume their capital stock at the present moment, but would in any event preserve it to provide for themselves in the future. In other words, for them the subjective use-value of present goods is no greater than that of future goods. Therefore, I do not at all hold -- nor is it a presupposition of my theory -- that any one must suffer want or hunger during the periods of production. My theory, on the contrary, hinges upon the objective fact that certain fruitful methods of production are "time-robbing", or demand a "sacrifice of time" in the sense (as explained on page 82) that "they procure us more or better consumption goods, but only at a later period of time." The remaining steps in the explanation are as follows: Time-robbing, roundabout methods of production, can of course be employed only when one is provided to the very end that one shall not in that interval suffer want). The disposal of present goods becomes thus a condition to the employment of more advantageous methods in production: hence that active and intense demand for present goods, the supply of which is always limited, which finally gives rise to an agio upon them; i.e. to interest. In this exposition it is nowhere presupposed that any one suffers from leaving present wants unsatisfied, or that any one practices painful abstinence. Nowhere is interest explained as a compensation for a special personal sacrifice undergone by the capitalist or by any one else; but it is explained simply as the result of the objective fact that the commodity "present goods", which the capitalist holds in his hand, has greater value than the commodity "future goods" for which he in any way exchanges the former commodity. Or, as I have expressed the matter on page 336 of my Positive Theory, interest is the "legitimate consequence of the constant fact that present goods are more useful and are more desired than future goods, and that they are never present and offered in unlimited abundance. This agio [i.e. for present goods], thus organically necessary, is given directly on the loan market in the shape of interest, while on the labor market it is given in the form of a price for labor which remains under the amount of the future product of labor."
The lengthening of the periods of production plays an important part in my theory. There are two ways of computing the length of production periods. One may have reference [as Professor Clark does] to the "absolute period." which is computed "from the moment on which the first hand was laid to the making of its first intermediate product right down to the completion of the good itself." But one may also have reference to the period "which elapses on the average between the expenditure of the original productive powers, labor, and uses of land, as successively employed in any work, and the turning out of the finished consumption goods." Among other things I have shown that a lengthening or shortening of the period is possible, and how it is so, in this sense. It was for that reason that I expressly added (p. 90): "Where I have spoken above of extension or prolongation of the roundabout process of production, and of degrees of capitalism, I must be understood in the sense just explained. The length or the shortness of the process, its extension or its curtailment, is not to be measured by the absolute duration of the period that lies between the expenditure of the first atom of labor and the last... But it is to be measured by the average period which lies between the successive expenditure in labor and uses of land and the obtaining of the final good." Professor Clark's argument that in a certain other sense a lengthening of the production period is not possible, therefore, again seems to me to be an argument directed against a theory which I do not hold.
The lengthening of the period in my sense, as a rule, goes hand in hand with an increase of invested capital. Professor Clark cites the case of two mills, a water-mill and a steam-mill, which yield the same rate of interest on capital invested, though their "production periods" are of unequal lengths, the production period of the water-mill being much longer because of the long life of the dam, race, wheel-pit, etc. He finds in this example proof that production periods "may be lengthened or shortened without affecting the productivity of industry" (p. 275), and evidently thinks he has here brought forward an argument against my assertion that lengthening production periods makes productive processes more fruitful.
I shall not discuss the example at length. For the benefit of those who may care to look into the matter more closely, however, I would observe that Professor Clark's argument seems to me to rest upon an ambiguity, which he has evidently overlooked, in the use of the word "productivity". By equally great "productivity of industry" in the case cited he means equally high rates of interest on the capital invested. In my theory, however, the term has reference to an entirely different matter. It there refers to the consideration whether for the expenditure of a unit of original productive powers -- i.e., for each day's or each month's labor -- a man gets equally great products or products greater in some instances than in others. These are two very different matters; and the reader will readily perceive that, in the case of production periods of unequal lengths, equal productivity in the first sense and equal productivity in the second sense, not only need not, but can not coincide with each other.
By way of a simple illustration let us assume that the expenditure of one hundred days' labor, wages being at two dollars a day, will produce at the end of a production period of one year one hundred articles worth each two dollars and ten cents. Upon an invested capital of two hundred dollars this yield a profit of ten dollars in one year or an interest of 5 per cent. Were the production period two years and the technical productivity the same, -- that is to say, were the product of one hundred days' labor and a production period of two years only one hundred pieces of the same commodity, -- then there would be a profit of ten dollars upon a capital to two hundred dollars invested for two years. The capital would therefore bear only 2 1/2 per cent interest; and the "productivity of industry", as Professor Clark understands the phrase, would be lessened. If productivity, in Professor Clark's sense, is to remain undiminished, "technical productivity," as I use the term, must evidently be greater in the process extending over a period of two years. If in the two-year period one produces with one hundred days' labor one hundred and five pieces of the commodity, there is a final return of two hundred and twenty dollars and fifty cents, or an interest upon the capital of 5 per cent per annum.
And this is true of Professor Clark's illustration. If the average production period and period of investment of capital are really greater in the case of the water-mill, then the technical productivity of the labor spent upon the water-mill must also be greater, in order to secure to the capital invested the same rate of interest for the longer time!