Gross And Net Product

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The other day I happened to be talking to a politician who was also a successful entrepreneur. He knew of the absurdity that when there is more taken in tax receipts or borrowed from future taxpayers, this extraction of wealth adds to the GDP statistics. Creating more outside money via QE does the same. All activities like this say nothing about the health of the economy. Now two entrepreneurs talking together instinctively know that “turnover is vain and profit is sanity,” i.e., what we are concerned with is the profits or health of our companies, and not whether they have a bloated balance sheet or high turnover. The salesman who comes back and waxes lyrical about his enormous success at winning a megabuck contract is met with suspicion by the entrepreneur-owner until the critical question of “what net margin do we make?” is answered satisfactorily. The book Capitalism by George Reisman — one of only four hand-picked PhD students of Mises —  goes into great detail on why the GDP statistic is an absurdity and how we miss accounting for two thirds of the real economy (Chapter 15, pages 673-682). I strongly recommend a read. Mark Skousen has also exposed some absurdities and proposed better measures (PDF), and our very own contributor Sean Corrigan and our founding fellow, Anthony Evans have their own measure centred on the measuring of the private productive sector of the economy. books[1]I recently was blessed to find a pristine first edition of Ludwig von Mises’s 1922 book Socialism in the original German and the first English language translation from 1932. Re-reading this definitive demolition of all socialist arguments, I thought this small section, written some 30 years before politicians became infatuated with GDP statistics, would be worthwhile blogging about.

Gross and Net Product

The most ambitious attempt to contrast productivity and profitability derives from the examination of the relationship between gross product and net product. It is clear that every entrepreneur in the capitalist system aims at achieving the largest net product. But it is asserted that rightly considered the object of economic activity should be to achieve not the largest net product but the largest gross product. This belief, however, is a fallacy based upon primitive speculations regarding valuation. But judged by its widespread acceptance even today it is a very popular fallacy. It is implicit when people say that a certain line of production is to be recommended because it employs a large number of workers, or when a particular improvement in production is opposed because it may deprive people of a living. If the advocates of such views were logical they would have to admit that the gross product principle applies not only to labour but also to the material instruments of production. The entrepreneur carries production up to the point where it ceases to yield a net product. Let us assume that production beyond this point requires material instruments only and not labour. Is it in the interest of society that the entrepreneur should extend production so as to obtain a larger gross product? Would society do so if it had the control of production? Both questions must be answered with a decided no. The fact that further production does not pay shows that the instruments of production could be applied to a more urgent purpose in the economic system. If, nevertheless, they are applied to the unprofitable line then they will be lacking in places where they are more urgently needed. This is true under both Capitalism and Socialism. Even a socialist community, supposing it acted rationally, would not push certain lines of production indefinitely and neglect others. Even a socialist community would discontinue a particular line of production when further production would not cover the expense, that is to say, at the point where further production would mean failure to satisfy a more urgent need elsewhere. But what is true of the increased use of material instruments is true exactly in the same way of the increased use of labour. If labour is devoted to a particular line of production to the point where it only increases the gross product while the net product declines, it is being withheld from some other line where it could perform more valuable service. And here, again, the only result of neglecting the principle of net product is that more urgent wants remain unsatisfied whilst less urgent ones are met. It is this fact, and no other which is made evident in the mechanism of the capitalist system by the decline in the net product. In a socialist community it would be the duty of the economic administration to see that similar misapplications of economic activity did not occur. Here, therefore, is no discrepancy between profitability and productivity. Even from the socialist standpoint, the largest possible net product and not the largest possible gross product must be the aim of economic activity. Nevertheless, people continue to maintain the contrary, sometimes of production in general, sometimes of labour alone and sometimes of agricultural production. That capitalist activity is directed solely toward the attainment of the largest net product is adversely criticized and State intervention is called for to redress the alleged abuse. This discussion has a lengthy ancestry. Adam Smith maintained that different lines of production should be regarded as more or less productive according to the greater or smaller amount of labour which they set in motion.29 For this he was adversely criticized by Ricardo who pointed out that welfare of the people increased only through an enlargement of the net product and not of the gross product.30 For this Ricardo was severely attacked. Even J. B. Say misunderstood him and accused him of an utter disregard for the welfare of so many human beings.31 While Sismondi, who was fond of meeting economic arguments by sentimental declamations, thought he could dispose of the problem by witticism: he said that a king who could produce net product by pressing a button would, according to Ricardo, make the nation superfluous.32 Bernhardi followed Sismondi on this point.33 Proudhon went as far as to epitomize the contrast between socialistic and private enterprise in the formula: that although society must strive for the largest gross product the aim of the entrepreneur is the largest net product.34 Marx avoids committing himself on this point, but he fills two chapters of the first book of Das Kapital with a sentimental exposition in which the transition from intensive to extensive agricultural methods is depicted in the darkest colour as, in the words of Sir Thomas More, a system “where sheep eat up men,” and manages in the course of this discussion to confuse the large expropriations achieved by the political power of the nobility, which characterized European agrarian history in the first centuries of modern times, with the changes in the methods of cultivation initiated later on by the landowners.35 Since then declamations on this scheme have formed the stock equipment of the controversial writings and speeches of the socialists. A German agricultural economist, Freiherr von der Goltz, has tried to prove that the attainment of the largest possible gross product is not only productive from the social point of view but is also profitable from the individual point of view. He thinks that a large gross product naturally presupposes a large net product, and to that extent the interests of the individuals whose main object is to achieve a large net product coincide with those of the State which desires a large gross product.36 But he can offer no proof of this. Much more logical than these efforts to overcome the apparent contrast between social and private interests by ignoring obvious facts of agricultural accountancy, is the position taken up by followers of the romantic school of economic thought, particularly the German etatists, viz. that the agriculturist has the status of a civil servant, and is therefore obliged to work in the public interest. Since this is said to require the largest possible gross product it follows that the farmer, uninfluenced by commercial spirit, ideas or interests, and regardless of the disadvantages, which may be entailed, must devote himself to the attainment of this end.37 All these writers take it for granted that the interests of the community are served by the largest gross product. But they do not go out of their way to prove it. When they do try, they only argue from the point of view of Machtpolitik (power politics) or Nationalpolitik (national policy). The State has an interest in a strong agricultural population since the agricultural population is conservative; agriculture supplies the largest number of soldiers; provision must be made for feeding the population in time of war and so on. In contrast to this an attempt to justify the gross product principle by economic reasoning has been made by Landry. He will only admit that the effort to attain the greatest net product is socially advantageous in so far as the costs which no longer yield a profit arise from the use of material instruments of production. When the application of labour is involved he thinks quite otherwise. Then, from the economic point of view the application of labour costs nothing: social welfare is not thereby diminished. Wage economies which result in a diminution of the gross product are harmful.38 He arrives at this conclusion by assuming that the labour force thus released could find no employment elsewhere. But this is absolutely wrong. The need of society for labour is never satisfied as long as labour is not a “free good.” The released workers find other employment where they have to supply work more urgent from the economic point of view. If Landry were right it would have been better if all the labour-saving machinery had never existed, and the attitude of those workers who resist all technical innovations which economize labour and who destroy such machinery would be justified. There is no reason why there should be a distinction between the employment of material instruments and of labour. That, in view of the price of the material instruments and the price of their products, an increase of production in the same line is not profitable, is due to the fact that the material instruments are required in some other line to satisfy more urgent needs. But this is equally true of labour. Workers who are employed in unprofitably increasing the gross product are withheld from other lines of production in which they are more urgently required. That their wages are too high for an increase in production involving a larger gross product to be profitable, results indeed from the fact that the marginal productivity of labour in general is higher than in the particular line of production in question, where it is applied beyond the limits determined by the net product principle. There is no contrast whatever here between social and private interests: a socialist organization would not act differently from an entrepreneur in the capitalist organization. Of course there are plenty of other arguments which can be adduced to show that adherence to the net product principle may be harmful. They are common to all nationalist-militarist thinking, and are the well-known arguments used to support every protectionist policy. A nation must be populous because its political and military standing in the world depends upon numbers. It must aim at economic self-sufficiency or at least it must produce its food at home and so on. In the end Landry has to fall back on such arguments to support his theory.39 To examine such arguments would be out of place in a discussion of the isolated socialist community. But if the arguments we have examined are untrue it follows that the socialist community must adopt net product and not gross product as the guiding principle of economic activity. The socialist community equally with the capitalist society will also transform arable into grass land, if it is possible to put more productive land under the plough elsewhere. In spite of Sir Thomas More, “sheep will eat up men” even in Utopia, and the rulers of the socialist community will act no differently from the Duchess of Sutherland, that “economically instructed person,” as Marx once jeeringly called her.40 The net product principle is true for every line of production. Agriculture is no exception. The dictum of Thaer, the German pioneer of modern agriculture, that the aim of the agriculturist must be a high net yield “even from the standpoint of the public welfare” still holds good.41 [29. ]A. Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book II, Chap. V (London 1776, Vol. I, pp. 437 ff.). [30. ]Ricardo, Principles of Political Economy and Taxation, Chap. XXVI (Works, ed. MacCulloch, 2nd ed. [London 1852] pp. 220 ff.). [31. ]Say, in his Notes to Constancio’s French Edition of Ricardo’s works, Vol. II (Paris, 1819), pp. 222 ff. [32. ]Sismondi, Nouveaux Principes d’Économie Politique (Paris, 1819), Vol. ii, p. 331 footnote. [33. ]Bernhardi, Versuch einer Kritik der Grande, die für grosses und kleines Grundeigentum angeführt werden (Petersburg, 1849), pp. 367 ff.; also Cronbach, Das landwirtschaftliche Betriebsproblem in der deutschen Nationalökonomie bis zur Mitte des 19. Jahrhunderts (Vienna, 1907), pp. 292 ff. [34. ]“La société recherche le plus grand produit brut, par consequent la plus grande population possible, parce que pour elle produit brut et produit net son identiques. Le monopole, au contraire, vise constamment au plus grand produit net, dût-il ne l’obtenir qu’au prix de l’extermination du genre humain.” (“Society seeks the largest gross product and thus the largest possible population, because for it gross product and net product are the same thing. On the other hand, monopoly continually aims at the highest net product which it can obtain only at the price of exterminating the human race.”) Proudhon, Système des contradictions économiques ou philosophie de la misère (Paris, 1846), Vol. I, p. 270. In Proudhon’s language “Monopoly” means the same as Private Property. Ibid., Vol. i, p. 236; also Landry, L’utilité sociale de la propriété individuelle (Paris, 1901), p. 76. [35. ]Marx, Das Kapital, Vol. I, pp. 613-726. The arguments about “the theory of compensation for the workers displaced by machinery” (ibid., pp. 403-12) are vain in view of the Marginal Utility Theory. Publisher’s Note: The page references cited here are pp. 738-821 and 478-488, respectively, in the English edition. [36. ]Goltz, Agrarwesen und Agrarpolitik, 2nd ed. (Jena, 1904), p. 53; also Waltz, Vom Reinertrag in der Landwirtschaft (Stuttgart and Berlin, 1904), pp. 27 ff. Goltz contradicts himself in his arguments, for, to the assertion mentioned above, he adds immediately: “Nevertheless the amount remaining as net profit from the gross product after deducting costs varies considerably. On the average it is greater with extensive than with intensive cultivation.” [37. ]See Waltz, op. cit. pp. 19 ff. on Adam Müller, Bülow-Cummerow and Phillipp v. Arnim, and pp. 30 ff. on Rudolf Meyer and Adolf Wagner. [38. ]Landry, L’utilité sociale de la propriété individuelle, pp. 109, 127 ff. [39. ]Landry, L’utilité sociale de la propriété individuelle, pp. 109, 127 ff. [40. ]Marx, Das Kapital, Vol. I, p. 695. [41. ]Quoted by Waltz, Vom Reinertrag in der Landwirtschaft, p. 29.

Did The Savings Glut Or Massive Monetary Epansion Cause The Boom And The Bust?

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Ambrose Evans-Pritchard recently pinned the blame for the financial crisis on “Asia’s `Savings Glut’”. This idea is not new. For readers who may have missed it the first time, we’re republishing this article from September 2009 which argues that monetary policy caused the boom, the bust and the savings glut.

Martin Wolf – Global Imbalances

Martin Wolf – Global Imbalances

Distinguished commentator and economist Martin Wolf of the FT holds that the savings glut was the source of the excess liquidity that caused the current crisis in which we all find ourselves. Wolf’s views are expressed crisply in this PowerPoint presentation. In summary, he tells how the Mercantilist approach of the emerging nations after the Asian crisis of the 90s led to a policy of setting exchange rates to encourage exports and limit imports, supported by the stockpiling of foreign currency (a majority in USD) to fund the whole program. The imbalances can be seen as either a “savings glut” or a “money glut.” I believe from reading Wolf’s articles in the FT that the suggestion is that the savings glut nations not only have policies of fixing exchange rates to encourage exports over imports but also that the people in those nations have a much greater propensity to save than their Western counterparts. It is argued that this demand for money, certainly in USD, causes the Federal Reserve to embark on an expansionist policy. From page 15 of Wolf’s presentation:

  • My own view is that the savings glut caused the money glut, by driving the Federal Reserve to pursue expansionary monetary policies, which then led to the reserve accumulations in the creditor countries
  • But it is also possible to view the Federal Reserve as the causal agent: the money glut causes the savings glut
  • Either way, the reserve accumulations and fixed exchange rates played a big role in the story

I interpret Wolf’s remarks to mean that when the massive accumulated USD reserves in the emerging nations were partially spent, a surge in liquidity arrived back at the shores of the USA, causing a housing bubble, subprime lending, less than secure CDO’s etc and the bust we now observe. Wolf is in good company. It would seem that Federal Reserve Chairman Ben Bernanke has endorsed this view in at least the following two recent speeches. Chairman Ben S. Bernanke, Council on Foreign Relations, Washington, D.C., March 10, 2009 :

Financial Reform to Address Systemic Risk

The world is suffering through the worst financial crisis since the 1930s, a crisis that has precipitated a sharp downturn in the global economy. Its fundamental causes remain in dispute. In my view, however, it is impossible to understand this crisis without reference to the global imbalances in trade and capital flows that began in the latter half of the 1990s. In the simplest terms, these imbalances reflected a chronic lack of saving relative to investment in the United States and some other industrial countries, combined with an extraordinary increase in saving relative to investment in many emerging market nations. The increase in excess saving in the emerging world resulted in turn from factors such as rapid economic growth in high-saving East Asian economies accompanied, outside of China, by reduced investment rates; large buildups in foreign exchange reserves in a number of emerging markets; and substantial increases in revenues received by exporters of oil and other commodities. Like water seeking its level, saving flowed from where it was abundant to where it was deficient, with the result that the United States and some other advanced countries experienced large capital inflows for more than a decade, even as real long-term interest rates remained low.

Chairman Ben S. Bernanke, The Morehouse College, Atlanta, Georgia, April 14, 2009:

Four Questions about the Financial Crisis

Importantly, in our global financial system, saving need not be generated in the country in which it is put to work but can come from foreign as well as domestic sources. In the past 10 to 15 years, the United States and some other industrial countries have been the recipients of a great deal of foreign saving. Much of this foreign saving came from fast-growing emerging market countries in Asia and other places where consumption has lagged behind rising incomes, as well as from oil-exporting nations that could not profitably invest all their revenue at home and thus looked abroad for investment opportunities. Indeed, the net inflow of foreign saving to the United States, which was about 1-1/2 percent of our national output in 1995, reached about 6 percent of national output in 2006, an amount equal to about $825 billion in today’s Dollars. Saving inflows from abroad can be beneficial if the country that receives those inflows invests them well. Unfortunately, that was not always the case in the United States and some other countries. Financial institutions reacted to the surplus of available funds by competing aggressively for borrowers, and, in the years leading up to the crisis, credit to both households and businesses became relatively cheap and easy to obtain.

The Error

I submit that these two great economists have made a grave error. The government of the USA has legal tender laws that allow only it, ultimately, to create USD via its sanctioned agent, the US Federal Reserve. As it is in charge of the stock of Dollars and the fractional-reserve banking system, it is (counterfeiting aside) the sole source of all issuances. As I have pointed out in other articles on this site, we use money to exchage our goods and services that we make/provide for sale for other goods and services. Money is the final good for which all other goods and services exchange. Dollars in the USA are the final good you use to exchange your goods for goods offered by other people. A price of a good exchanged for another good is the amount of money paid for that good. If the pool of money is getting larger, there will be more Dollars to exchange for goods and services. If the quantity of goods and services offered for sale and the number of Dollars in circulation are growing at the same rate, it is possible to argue, if you are prepared to set aside the problems of relative prices, that the “general price level” will be unaffected. However, any economist would argue that if the supply of money increases faster than the supply of goods and services, prices will rise: like any other good, money is devalued by creating more of it. Therefore, the cause of the crisis can be found only at the door of the monetary authority that created the money in the first place – i.e. the Federal Reserve and other deficit-nation central banks – and not with the saving glut nations. All they have done is seek to exchange some of their goods and services for some of the goods and services of the USA, expressing a time preference along the way. This transfer of ownership does not in itself “bid up prices” to create an “asset price boom”: it is the creation of new money which devalues it. If new Dollars are locked away for a time and only return to their original economy in an abrupt fashion, they could well seem to be the cause of a sudden asset price bubble, but the prior cause can only be the creation and supply of the wherewithal to do this in the first place.

A Note on Mercantilism

Wolf mentions in his PowerPoint presentation quite rightly that the modern trade regime we have is “in short, a mercantilist hybrid”. Many of the Classical Economist and Political Philosophers such as Hume, Locke, Smith and in later times David Ricardo, point out in various writings that the bullion (gold and silver) that was invariably money was not wealth as such but that the goods they exchanged against were. So, create more money with no associated increase in productivity and the prices of things will rise. Consequently, the Mercantalist goal of having exports higher than imports and thus more bullion at home would just mean that prices would rise at home and cause a flow of that specie to move away from home. Therefore, if in the analogy you substitute US Dollars for bullion, our saving glut nations will get nowhere fast pursuing this policy. Gold represented claims on already produced wealth. Thus it makes perfect sense that the more wealthy (industrially-devloped, capitalistic etc) countries had more gold historically. As we do not have a link to gold anymore, the USD acts in its capacity as the World Reserve Currency, like gold of old. Using this analogy, the gold producer / gold miner writ large is the Fed and other Central Banks. Dollars will flow away from the mine in exchange for goods and services and this causes a transfer of ownership of goods and services from people in the USA to people in the saving glut nations but can have nothing to do with asset price bubbles as the money was printed by the Fed and no one else. To argue that the savings glut itself has caused the asset price boom is seemingly to endorse the Mercantalist doctrine that was so clearly discredited many moons ago. Some other reflections on this concept of a “Savings Glut” disturb me and lead me to question whether it is really a meaningful concept at all. These saving glut nations still seem to have massive gluts but if spending the glut caused the bubble, you would expect the glut to have fallen as well; seemingly, it has not. If nations save to create a glut, they must indeed refrain from consumption on domestic goods to boost the supply of export goods. This means cheap goods arrive on the shores of the deficit nations. Can this cause a boom across the economy? I think not. The deficit nations are largely well-developed. As a 40-year-old entrepreneur with a mature business and a happy family, all well rooted in Hertforsdhire, I often say to my wife, “If I was 18 again, I would be straight out to China to exploit some of those massive developmental opportunities. The whole economy seems to be like Manchester was in the Victorian times.” So why do savings there, which should attract a greater rate of return there, not stay there? In summary, the Fed has more than doubled its money supply since the mid 90’s as have other leading deficit nations. The savings glut and the boom and bust is only attributable to the lax money creation programs of irresponsbile central bankers around the world. They have a poor understanding of economic history and they make an intellectual mistake in misunderstanding what those Classical thinkers knew: money is not wealth.

Forward To Liberalism

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It was a great pleasure and a privilege to be asked by Jeff Tucker of Laissez Faire Books to write this foreword to Liberalism, the timeless classic written by Ludwig von Mises in 1927. This edition of Liberalism is available through the Laissez Faire Club. Foreword by Toby Baxendale This is a timeless book. It is a book of political thought. In fact, it is Mises’s only book fully dedicated to this subject. As he mentions in his own opening remarks, he has kept it brief so as to appeal to the widest audience he can without dumbing down his message. For those readers new to Mises — you may have heard, for example, that this genius created the foundations of economics from using the epistemology of Kant with shades of Aristotle to set the logical deductive foundations of economics, and you find this a bit too heavy going for your opening introduction to the thoughts of arguably the greatest economist ever — then I submit, you have your great starter book. By opening your account of this man here, you will embark on a fascinating discovery of more than just the economic program of liberalism. But as you then progress to other works by Mises, you will encompass the whole philosophical corpus of liberalism. I read this book as a counterblast against the direction in which John Stuart Mill took liberalism in his post–On Liberty writings, down the route of socialism and in defense of a truly positive conception of liberalism. This quote is tucked away in the appendix.

John Stuart Mill is an epigone of classical liberalism and, especially in his later years, under the influence of his wife, full of feeble compromises. He slips slowly into socialism and is the originator of the thoughtless confounding of liberal and socialist ideas that led to the decline of English liberalism and to the undermining of the living standards of the English people. Nevertheless — or perhaps precisely because of this — one must become acquainted with Mill’s principal writings: Principles of Political Economy (1848) On Liberty (1859) Utilitarianism. (1862) Without a thorough study of Mill it is impossible to understand the events of the last two generations. For Mill is the great advocate of socialism. All the arguments that could be advanced in favor of socialism are elaborated by him with loving care. In comparison with Mill all other socialist writers — even Marx, Engels, and Lassalle — are scarcely of any importance. One cannot understand liberalism without a knowledge of economics. For liberalism is applied economics; it is social and political policy based on a scientific foundation.

Mises’s greatest student, F.A. von Hayek, some 17 years later wrote his more famous The Road to Serfdom in a similar vein to Mises’s 1927 Liberalismus (the original title and date of issue). [1] As with all Mises’s works, there are no compromises; where Hayek throws compromise to interlocutors, Mises does not. J.S. Mill in On Liberty was indeed the first to bring to the modern reader the distinction between the negative and positive conceptions of liberty. Negative liberty is total and unconditional freedom from acts of intervention on the part of the state and its enforcers. Positive liberty, in contrast, is the freedom to participate in the various activities of life, which may involve some compromise of negative liberty in order to empower individuals to fulfill their lives, such as the provision (via coercion of you and others) of a nicer house for a poor person so he can participate in the peaceful enjoyment of life. According to Mill’s distinction, the book you are about to read is formally in the negative tradition. However, I would encourage the view that this book is actually a very empowering and positive outline of the political theory of liberalism — and should be viewed that way. There is nothing negative about justifying the existence of the sovereign to have the sole duty to protect your private property so you can have the quiet and peaceful enjoyment of it. (The lay reader will please observe that private property is not just items like your house and other chattels; it is the entire possession of your own mind, your own body, both spiritual and temporal.) This is truly a magnificent and positive conception of liberty. Mises confirms this point and illustrates with an example in chapter 3, part 8, “Freedom of Movement”:

Liberalism has sometimes been reproached on the ground that its program is predominantly negative. This follows necessarily, it is asserted, from the very nature of freedom, which can be conceived only as freedom from something, for the demand for freedom consists essentially in the rejection of some sort of claim. On the other hand, it is thought, the program of the authoritarian parties is positive. Since a very definite value judgement is generally connoted by the terms “negative” and “positive,” this way of speaking already involves a surreptitious attempt to discredit the political program of liberalism. There is no need to repeat here once again that the liberal program — a society based on private ownership of the means of production — is no less positive than any other conceivable political program. What is negative in the liberal program is the denial, the rejection, and the combating of everything that stands in opposition to this positive program. In this defensive posture, the program of liberalism — and, for that matter, that of every movement — is dependent on the position that its opponents assume towards it. Where the opposition is strongest, the assault of liberalism must also be strongest; where it is relatively weak or even completely lacking, a few brief words, under the circumstances, are sufficient. And since the opposition that liberalism has had to confront has changed during the course of history, the defensive aspect of the liberal program has also undergone many changes. This becomes most clearly evident in the stand that it takes in regard to the question of freedom of movement. The liberal demands that every person have the right to live wherever he wants. This is not a “negative” demand. It belongs to the very essence of a society based on private ownership of the means of production that every man may work and dispose of his earnings where he thinks best. This principle takes on a negative character only if it encounters forces aiming at a restriction of freedom of movement.

Why, according to Mises, is the liberal program only about the protection of private property? Let us read Mises’s own words from chapter 1, part 1, “Property,” as he can encapsulate the answer far better than I can:

Human society is an association of persons for cooperative action. As against the isolated action of individuals, cooperative action on the basis of the principle of the division of labor has the advantage of greater productivity. If a number of men work in cooperation in accordance with the principle of the division of labor, they will produce (other things being equal) not only as much as the sum of what they would have produced by working as self-sufficient individuals, but considerably more. All human civilization is founded on this fact. It is by virtue of the division of labor that man is distinguished from the animals. It is the division of labor that has made feeble man, far inferior to most animals in physical strength, the lord of the earth and the creator of the marvels of technology. In the absence of the division of labor, we would not be in any respect further advanced today than our ancestors of a thousand or ten thousand years ago. Human labor by itself is not capable of increasing our well-being. In order to be fruitful, it must be applied to the materials and resources of the earth that Nature has placed at our disposal. Land, with all the substances and powers resident within it, and human labor constitute the two factors of production from whose purposeful cooperation proceed all the commodities that serve for the satisfaction of our outer needs. In order to produce, one must deploy labor and the material factors of production, including not only the raw materials and resources placed at our disposal by Nature and mostly found in the earth, but also the intermediate products already fabricated of these primary natural factors of production by previously performed human labor. In the language of economics we distinguish, accordingly, three factors of production: labor, land, and capital. By land is to be understood everything that Nature places at our disposal in the way of substances and powers on, under, and above the surface of the earth, in the water, and in the air; by capital goods, all the intermediate goods produced from land with the help of human labor that are made to serve further production, such as machines, tools, half-manufactured articles of all kinds, etc. Now we wish to consider two different systems of human cooperation under the division of labor-one based on private ownership of the means of production, and the other based on communal ownership of the means of production. The latter is called socialism or communism; the former, liberalism or also (ever since it created in the nineteenth century a division of labor encompassing the whole world) capitalism. The liberals maintain that the only workable system of human cooperation in a society based on the division of labor is private ownership of the means of production. They contend that socialism as a completely comprehensive system encompassing all the means of production is unworkable and that the application of the socialist principle to a part of the means of production, though not, of course, impossible, leads to a reduction in the productivity of labor, so that, far from creating greater wealth, it must, on the contrary, have the effect of diminishing wealth. The program of liberalism, therefore, if condensed into a single word, would have to read: property, that is, private ownership of the means of production (for in regard to commodities ready for consumption, private ownership is a matter of course and is not disputed even by the socialists and communists). All the other demands of liberalism result from this fundamental demand.

From chapter 1, part 8, “Democracy”:

For the liberal, the state is an absolute necessity, since the most important tasks are incumbent upon it: the protection not only of private property, but also of peace, for in the absence of the latter the full benefits of private property cannot be reaped. These considerations alone suffice to determine the conditions that a state must fulfil in order to correspond to the liberal ideal. It must not only be able to protect private property; it must also be so constituted that the smooth and peaceful course of its development is never interrupted by civil wars, revolutions, or insurrections.… Here is where the social function performed by democracy finds its point of application. Democracy is that form of political constitution which makes possible the adaptation of the government to the wishes of the governed without violent struggles. If in a democratic state the government is no longer being conducted as the majority of the population would have it, no civil war is necessary to put into office those who are willing to work to suit the majority. By means of elections and parliamentary arrangements, the change of government is executed smoothly and without friction, violence, or bloodshed.

Although Hobbes is never mentioned in Liberalism, I see much of Hobbes in Mises. I read Leviathan as the great British philosopher Michael Oakeshott did in his famous introduction to the 1946 edition of that book, as being the founder of the British Enlightenment tradition. Mises sits full square in that tradition. Tearing up the ancient natural-law tradition and setting up the sovereign state as the master protector of the private property of all individuals, thus guaranteeing the fullest possible freedom to live ones life in peace. In addition he was undoubtedly a committed democrat with regard to his favoured method of choosing who runs the sovereign. If you have come to this book to find out a little bit about Mises the economist — and no, not just any economist, but as I mentioned before, arguably the greatest economist ever — you will be pleased to find some great insights that you should savor until you read his full epistemological and economic treatise, Human Action. One of my favorite university debates as a student at the London School of Economics (LSE) was with socialist students, foaming at the mouth with great indignation regarding all they perceived as injustice in the world, riven with jealousy and envy, concerning why we should not be bothered about the wealth displayed by “the rich.” When confronted by a rabid debater suggesting that all Rolls Royce cars should be scrapped and all production stopped because with millions starving in the world the money should be spent on feeding these people, I would typically respond with this: “What have you got against the hard-working people of Crewe [a town in Cheshire, UK, where the famous car is a major employer] and the honest money they earn making these things and then spend freely on other goods and services? Why should they not be allowed to earn a living providing things people want instead of being put out of work to satisfy your political objectives?” As I reread Liberalism to write this foreword, I discovery from Mises, with his laser-like logical precision, I am totally wrong! The buying of the Rolls Royce car by the rich should not be defended on those grounds but by a far sounder chain of economic reasoning. I quote from the section called “The Inequality of Wealth and Income“:

Our defence of luxury consumption is not, of course, the argument that one occasionally hears, that is, that it spreads money among the people. If the rich did not indulge themselves in luxuries, it is said, the poor would have no income. This is simply nonsense. For if there were no luxury consumption, the capital and labor that would otherwise have been applied to the production of luxury goods would produce other goods: articles of mass consumption, necessary articles, instead of “superfluous” ones.

Mises’s rejoinder:

The luxury of today is the necessity of tomorrow. Every advance first comes into being as the luxury of a few rich people, only to become, after a time, the indispensable necessity taken for granted by everyone. Luxury consumption provides industry with the stimulus to discover and introduce new things. It is one of the dynamic factors in our economy. To it we owe the progressive innovations by which the standard of living of all strata of the population has been gradually raised.

It is a pleasure to have one’s reasoning corrected by the great master. There is plenty of good economic reasoning packed into this short book. I will leave you with one final analogy that I hope will stay in your mind between the diligent doctor who advises the right, slow, and brick-by-brick economic way to prosperity and the impatient politician who wants to bring jam today and jam tomorrow with endless sunshine forever, as readers of this book who fall into the former camp along with Mises may find this a useful way of describing the liberal predicament to others:

If a doctor shows a patient, who craves food detrimental to his health the perversity of his desire, no one will be so foolish as to say: “The doctor does not care for the good of the patient; whoever wishes the patient well must not grudge him the enjoyment of relishing such delicious food.” Everyone will understand that the doctor advises the patient to forgo the pleasure that the enjoyment of the harmful food affords solely in order to avoid injuring his health. But as soon as the matter concerns social policy, one is prone to consider it quite differently. When the liberal advises against certain popular measures because he expects harmful consequences from them, he is censured as an enemy of the people, and praise is heaped on the demagogues who, without consideration of the harm that will follow, recommend what seems to be expedient for the moment.[2]

For lovers of the liberal program, our task is thus hard, but one thing is for sure: reason is on our side, and Mises is one of its finest servants. I hope you enjoy the book. Thank you, LFB, for bringing this book back to life for a new audience. Toby Baxendale Ayot St. Peter, Hertfordshire, UK June 10, 2012 [1] When, in the section titled “The Impracticability of Socialism,” Mises discusses the “calculation problem” — that is, the impossibility of economic calculation under socialism — we can see that what became the more famous Hayekian “knowledge problem” is touched upon here. The leadership of a socialist society would thus be confronted by a problem that it could not possibly solve. It would not be able to decide which of the innumerable possible modes of procedure is the most rational. The resulting chaos in the economy would culminate quickly and irresistibly in universal impoverishment and a retrogression to the primitive conditions under which our ancestors once lived. I mention this not to in any way denigrate the masterful work of Hayek — just to underscore the true primacy of his teacher, Mises. [2] Mises mentioned the traditional factors of production in this quote but does not mention that it is the entrepreneur who combines these factors to make useful things for his fellow man in a constantly dynamic and moving economy. Rest assured, all of Mises’s other works are replete with this valuable insight that makes economics relevant to the real world. I can only assume that this is missed out here as it is covered off so well elsewhere.

Hugh Hendry v. Joseph Stiglitz

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I received this YouTube clip from a friend of the Cobden Centre and I think it is fantastic. It shows the fundamental banality of the mainstream economists and their entrenched views: more “political cohesion”, more debt, spend, spend, spend … Such advice will push our economies over the edge. Investor Hugh Hendry gives Nobel Laureate Joseph Stiglitz a taste of reality. [youtube height=”400″ width=”620″]http://www.youtube.com/watch?v=E4MAifsp-8E[/youtube]

Fraud – Documentary

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This is a documentary that is long overdue, written from the perspective of the Austrian School. These are the economists of Business Cycle Theory — the theory that predicted our boom and bust. I invite you to watch this film and make up your own mind. Austrian School views were prevalent up to the 1930s, when politicians embraced the ideas of John Maynard Keynes. Tested to destruction, Keynesian policies were finally dropped by policymakers all over the globe, only to be replaced by an economic framework that used the same methodological tools. Stressing money as the Alpha and the Omega, Monetarism came to prominence in the 1980s. By the 90s it had faded into the void, replaced by politicised central bank interest rate manipulation and attempts at “demand management”. The failure of this latest form of economic central planning is what we observe today. The Austrian School, being the only school showing the errors of all of the approaches above, is slowly regaining its influence. This film will do its bit to spread our ideas. It is a crowd-funded documentary, so if you enjoy the film I urge you make a donation. [vimeo height=”340″ width=”620″]http://vimeo.com/45687897[/vimeo]

A Great Teacher

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Professor Pete Boettke is one of our advisors and friends. In the English speaking world, if you want to know anything about economics – go to Pete, from the most obscure point to the most life changing, Pete will have a good grounding in it. In fact, economics is just a branch of knowledge Pete is familiar with.  He is a polymath across the social sciences as all good people who style themselves as economists should be. He is the father and grandfather now of a growing body of social scientists, schooled in the Austrian tradition. This is a positive thing for the world. The concept of “Mainline” economics is Pete’s great contribution, in his latest book, to our understanding of economics, as opposed to the hapless mainstream economics we are confronted with in the halls of academia, the media and politics – be it the Platonic abstracters who come up with the mumbo jumbo of perfect competition, rational expectations, modern portfolio theory, the efficient market hypothesis, and so on, or the aggregating Keynesians and monetarists. What we know as Austrian economics underlies the majority of what is good in economics, the individual human actor being historically specific and unique in all he does, the subjective values of the acting individual being the driving force of the market, the entrepreneur as alpha and omega of the market process, deductive reasoning from solid fact IS the mainline theme. The mainstream have diverted from this plumb line and just as we moved down into the Dark Ages from the age of reason of the Greeks and Romans and back up into the Renaissance of the Europeans, we will eventually move back to mainline economics. This is a hopeful and realistic message from Pete and his new book. Our friend Jeff Tucker has reviewed Living Economics here. Living Economics

Pete gives a good talk about his book here.

Professor Gabriel Calzada introduces Pete at the start of this lecture. Gabriel heads the Insituto Juan de Mariana, a leading Spanish Austrian institute and is a Professor at the Universidad Rey Juan Carlos. This is where Professor Jesus Huerta De Soto leads the economics department – a Pete Boettke for the Spanish speaking world. The Universidad Francisco Marroquin is another leading Spanish speaking university in Guatemala, which has acknowledged Pete with a Honorary Doctorate. It is wonderful to see the English and Spanish speaking world-class institutions link up in this way. In a very humbling speech during his acceptance of the honorary doctorate, Pete reminds us we are always students of life and what we learn best is actually learning how to learn. His acceptance speech starts 7 mins into this video.

Fraud

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This is a documentary that is long overdue, written from the perspective of the Austrian School. These are the economists of Business Cycle Theory — the theory that predicted our boom and bust. [vimeo height=”360″ width=”620″]http://vimeo.com/45687897[/vimeo] I invite you to watch this film and make up your own mind. Austrian School views were prevalent up to the 1930s, when politicians embraced the ideas of John Maynard Keynes. Tested to destruction, Keynesian policies were finally dropped by policymakers all over the globe, only to be replaced by an economic framework that used the same methodological tools. Stressing money as the Alpha and the Omega, Monetarism came to prominence in the 1980s. By the 90s it had faded into the void, replaced by politicised central bank interest rate manipulation and attempts at “demand management”. The failure of this latest form of economic central planning is what we observe today. The Austrian School, being the only school showing the errors of all of the approaches above, is slowly regaining its influence. This film will do its bit to spread our ideas. It is a crowd-funded documentary, so if you enjoy the film I urge you make a donation.

Our Central Bankers Are intellectually Bankrupt

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The best article we’ve seen in the FT for a long time, courtesy of Ron Paul …

The financial crisis has fully exposed the intellectual bankruptcy of the world’s central bankers. Why? Central bankers neglect the fact that interest rates are prices. Manipulating those prices through credit expansion or contraction has real and deleterious effects on the economy. Yet while socialism and centralised economic planning have largely been rejected by free-market economists, the myth persists that central banks are a necessary component of market economies.

Continue reading …

From Nuts To Paul Krugman

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An excellent article from Amity Shlaes:

Nut cases. That’s what they are. And if you take an interest in them, you are a nut case, too. That’s the consensus among credentialed economists who describe advocates of a return to the monetary regime known as the gold standard. In fact, the economic pack will marginalize you as a weirdo faster than you can say “Jacques Rueff,” if you even raise the topic of monetary policy in relation to gold. An example of such marginalizing appears in a recent issue of the Atlantic magazine. Author Adam Ozimek lists four rules upon which economists overwhelmingly agree. Right away, that puts readers on guard; they don’t want to be the only one to disagree with eminences. The first rule Ozimek offers is that free trade benefits economies. So obvious. That makes the penalty for disagreement higher. Then you read down to the final principle: “The gold standard is a terrible idea.” By putting the proposition in such strong terms, the author raises the penalty for disagreeing. If you don’t subscribe to this view, you risk both being classed as the kind of genuine nut case who believes in protectionism, and enduring the disdain of other economists — “all economists,” as the Atlantic headline writer summarized it.

Shlaes goes on to consider gold’s real record and the recent debate between Ron Paul and Paul Krugman. I recommend the whole article.

Austrian Economics In Shanghai

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Extraordinary things are happening in China, as we know. On the liberty-loving front, we can report a really interesting and path-breaking conference organised by our friend Ken Schoolland: The Shanghai Austrian Economic Summit A milestone event this summer in China. Sponsored by the International Society for Individual Liberty, we have 20+ speakers, 8 from the Mont Pelerin Society, attendees from across Asia, Europe, and the US, and a post conference tour. On a related note, Sean Corrigan informs us of another exciting development for Chinese liberalism: Mao Yushi Wins the Cato Institute’s 2012 Milton Friedman Prize for Advancing Liberty – Forbes