Will Thomas and I gave a talk on Austrian Economics at Atlas Summit 2016, where I pointed out that Austrian Business Cycle Theory (ABCT) does not fit the empirical facts. ABCT claims that increasing savings/capital are the cause of economic growth, which is very similar to what classical and neo-classical economics states. I pointed out that in fact it is increasing levels of technology (inventions) that are the cause of economic growth not increases in capital. One of the questioners after the talk stated that inventions (technology) are part of capital.
Many people want to conflate increasing levels of technology with capital, however they are not the same. Capital as used in economics means those durable goods used in production.
In economics, capital goods, real capital, or capital assets are already-produced durable goods or any non-financial asset that is used in production of goods or services.
Adam Smith defines capital as “That part of a man’s stock which he expects to afford him revenue”. https://en.wikipedia.org/wiki/Capital_(economics)
The article goes on to explain how to determine if something as capital.
Classical and neoclassical economics regard capital as one of the factors of production (alongside the other factors: land and labour).
This is what makes it a factor of production:
The good is not used up immediately in the process of production unlike raw materials or intermediate goods. (The significant exception to this is depreciation allowance, which like intermediate goods, is treated as a business expense.)
The good can be produced or increased (in contrast to land and non-renewable resources). https://en.wikipedia.org/wiki/Capital_(economics)
Technological change is not a good, it is the process of inventing. It is true that when these new inventions are reproduced (manufacturing) then when purchased they become capital, but that is several steps removed. If we treat technological change as just part of capital then going out and purchasing capital goods is the same thing as inventing. However, the results are not the same. Purchasing (acquiring) capital without invention results in no real per capita increases in wealth over the long run. As a simple example assume that every farmer in the U.S. has the latest most up to date tractor their land can use. Adding more tractors (capital) does not increase the output of these farms. The same is true for capital in general.
A number of economists have pointed out that increasing levels of capital are not responsible for the tremendous economic growth experienced in the West since the Industrial Revolution. Among these economists are Robert Solow, Paul Romer, and Deirdre McCloskey. They all point to increasing levels of technology as the cause for our increased wealth. Our standard of living is defined by our level of technology.
On the other hand inventing at a faster rate does produce real per capita increases in wealth. Inventions can produce returns that are staggering. For instance, Eli Whitney’s invention of the cotton gin allowed a forty times increase in the output of cotton in the U.S. in one decade.
In science it is important to isolate the factors effecting an experiment. For instance, if you conflate wind resistance and gravity then you end up with the nonsense that heavier objects fall faster than lighter objects. This means you will never be able to create a parachute or an airplane.
In economics if we conflate inventions with capital, we make the mistake that third world countries will become wealthy if we provide them capital. In fact, this is exactly what Development Economics has said for years despite overwhelming evidence to the contrary. Conflating these two concepts will cause us to ignore the role of property rights for invention as being the biggest long term driver of wealth and instead focus on capital gains taxes or increasing the savings rate or increasing comsumption.
Inventions are the cause of real per capita increases in wealth, not capital. Conflating the two is illogical and results in nonsensical economic policies.
There is a myth by the anti-patent crowd that “overly broad” patents inhibit the development of new technologies. One of the classic examples they like to cite is the Selden Patent (US Pat. No. 549,160), which supposedly inhibited the development of the automobile around the turn of the century. A new paper ‘The “Overly-broad” Selden patent, Henry Ford and Development in the Early US Automobile Industry’ By John Howells and Ron D. Katznelson, shows that in fact the automotive industry prospered and inventiveness accelerated despite the Selden patent.
According to the paper:
First, neither the ALAM-adopted restrictive licensing policy based on the Selden patent, nor the public liability threats to purchasers of unlicensed vehicles (see sections 2.2.3-2.2.4) restricted entry into the automobile industry as shown by Figure 1.
Second, measures of automobile development show it to have been most rapid during the Selden patent term; Raff and Trajtenberg’s analysis of real, quality adjusted prices for the American Automobile Industry show that the fastest rate of price decline for a given automobile quality occurred between 1906 and 1911, within the term of the Selden patent prior to its 1911 adjudication: the rate of quality improvement was greatest in the 1906 – 1911 period and more than half of the quality gain for a given price observed to have occurred by 1980, had been attained in the period 1906 – 1911 (Raff and Trajtenberg 1996, p85, 91).
Third, rather than Ford being slowed down through patent litigation with the ALAM, from the foundation of the Ford Motor Company in 1903, Ford grew sales at an exponential rate faster than that of the total industry during the period of litigation. A serial developer of five major automobile models, which gained tenfold increase in sales every four years, can hardly be considered to have been “stifled.” The Ford Motor Company became the leading manufacturer of automobiles produced in 1906, a position the company retained until 1927; see Figure 2.
The paper provides overwhelming evidence that the Selden patent did not inhibit the automotive industry or the development of new technologies in the automotive industry. This should have been apparent to anyone familiar with the history of the automotive industry. The United States led the world in developing and manufacturing automobiles at the turn of the century and beyond. Selden had a U.S. patent and it was enforced in the U.S., so the facts do not square with the anti-patent narrative.
Another interesting part of the paper is that Ford knew that they would prevail in a lawsuit over the Selden patent. This is the value of well-defined laws and courts who stick to the law.
Selden’s patent was issued by the US Patent Office in 1895 and eventually was assigned to the Association of Licensed Automobile Manufacturers (ALAM) in early 1903. The ALAM publicly asserted that the Selden patent claims should be broadly construed, meaning that the entire automobile industry was within their scope. In October 1903 suit was brought against the Ford Motor Company under the Selden patent and when finally adjudicated on appeal in 1911 the Ford Motor Company was found not to infringe because although the patent was held valid, it was construed narrowly to cover an improvement to the obsolete Brayton engine. This was the embodiment with which Selden had experimented prior to 1879, the year he applied for a patent. Columbia Motor Co. v. CA Duerr and Co. 184 F. 893, 896 (2nd Cir. 1911). The narrow Brayton-based construction saved Selden’s claims, but they were not infringed since all gasoline engines in commercial use were Otto engines by 1911, rendering the patent economically worthless
Another anti-patent lie bites the dust. When a group or a movement consistently lies and promotes lies to support their position over and over again, as the anti-patent crowd has done, they should not be taken seriously by rational people.
There is a popular myth that great ideas are a dime a dozen (see here, here, and here). I don’t know what a great idea is. Is a Dick Tracey watch or a nuclear powered rocket a great idea? No, not if you don’t know how to implement them, then it is just a fantasy and unless you have plot with it, it is not even a good fantasy story. However, I do know what a great invention is and they are not a billion dollars a dozen. A great invention takes incalculable intellectual skill, years of training, years of hard work, and significant resources.
Pendulum of Justice, the first Hank Rangar Thriller, discusses this exact point.
“Hey Mike—we’ve heard your ‘good ideas are a dime a dozen’ speech before. The electric light bulb, the cotton gin, the polio vaccine, the microcontroller, hell, the CAT scan, were all a dime a dozen”
It is my opinion that this sort of nonsense is usually spread by people in finance, who are looking to improve their negotiation position or are just too intellectually challenged to really know when an invention is great. It also inflates their self-importance.
The reality is that most people do not create much more than they consume in their lifetimes and this includes many people in finance, even if they personally get rich. It is only by raising our level of technology that we increase our per capita wealth and only inventors increase our level of technology. Great inventors create incalculable wealth and even if they become wealthy, what they receive in payment is a pittance to what they provided.
I think this nonsense of “great ideas are a dime a dozen” is a spin out from the Austrian Economist Joseph Schumpeter who made a nonsensical distinction between innovation and invention, while denigrating inventions and inventors.
According to Wikipedia:
Following Schumpeter (1934), contributors to the scholarly literature on innovation typically distinguish between invention, an idea made manifest, and innovation, ideas applied successfully in practice
There is nothing inherently wrong with the distinction above, but the way it is applied blurs together a number of different skills. Blurring skills together shows a misunderstanding of the process of innovating. Broadly speaking, innovation can be broken into two distinct sets of skills: creation and dissemination. By creation I mean creating something new, not production – creating something old.
A subset of creation is invention. An invention is a creation with an objective repeatable result. A creation that is not an invention has a subjective result, such as the effect of a painting on a viewer, or the effect of a book on a reader. Many activities combine both a subjective creation and an invention, such as architecture. However, we can separate out the invention from the other creative elements and this helps our understanding of the process.
Dissemination may include a number of processes, such as education (marketing, sales), manufacturing, finance, and management. This is not to say that marketing cannot be creative, it clearly often is very creative. However, the creative part of marketing can be separated out from the dissemination or execution part of marketing. The same is true of manufacturing, which can definitely include inventing. But an invention related to manufacturing is part of the creation step not part of the dissemination step.
Finance can also have inventions. For instance, the invention of a fractional reserve bank is clearly an invention. It has the objective result of securitizing assets and turning them into loans and currency. A fractional reserve bank will securitize land and turn it into a loan and currency. Despite this, it is important to understand that the first person to develop the fractional reserve bank is inventing and the person operating the fractional reserve bank is disseminating.
All real per capita economic progress is the result of inventing. This is not to say that it is unnecessary to disseminate inventions, but if there were no new inventions there would not be any economic progress. We would be stuck in static world once all the inventions had been completely disseminated. Of course, if we stop all dissemination activities we will quickly starve to death.
It is my opinion that business and economic professors have focused on “innovation” instead of “invention” because they have no idea how to invent or how the process of inventing works. They concentrate on what they know, i.e. business and economic practices. As a result, the focus is on dissemination, under-appreciating the importance of inventing. In addition, it results in misleading business theories, such as:
– Management teams are more important than the quality of the invention.
– Execution is everything; patents and other IP do not matter.
– Get Big Fast.
The truth-test of these theories is directly related to the strength of the patent laws at the time the company is created. When patent laws are weak, these theories are more true and when patent laws are strong, these theories are less true. Unfortunately, when patent laws are weak these theories do not overcome the disincentive to invest in risky new technologies. Management teams do not build revolutionary or disruptive technologies, they just disseminate these technologies. These sorts of teams are like large companies and generally can produce a return with less risk by NOT developing high-risk technologies. They tend to focus on incremental technologies or on stealing someone else’s technology. While this may be good business advice in a period of weak patents, it is bad for our country’s competitiveness and our standard of living.
Technological progress (i.e., inventing), in the long run, is the only competitive business advantage. The best management team in the world selling buggy whips at the turn of the century could not overcome the technological advance of the automobile and stay a buggy whip company. The best management team in the world selling vacuum tubes in the 1940s, could not overcome the advance of transistors and semiconductors and stay a vacuum tube company. This country is littered with companies that had great management teams that were overwhelmed by changes in technology. For instance, Digital Computers had a great management team, but they could not overcome the advance of the personal computer. Digital Computers, Inc. failed to invent fast enough to overcome the onslaught of small inexpensive computers. US steel was not able to overcome the onslaught of mini-mills, aluminum, and plastics. This was not because they did not have a good management team, it was because the management team under- prioritized invention and over-prioritized execution or dissemination skills. Ford & GM have not become walking zombies because they did not have strong management teams, but because they have not invented. As a result, they have antiquated production systems and weak technology in their products. 86% of the companies in the Fortune 500 in 1959 are no longer there. Some of these companies disappeared because of bad management, but most companies disappeared because they did not keep up with changing technology. In other words, they did not invent.
Inventions(i.e., advances in technology) are the ONLY WAY to increase real per capita incomes and the only long term business advantage.
Schumpeter – another Austrian School of Economics Failure.
Law professor Adam Mossoff examines the latest patent deform bill, the Venue Act, in his editorial in the Washington Times entitled Weighing the Patent System. This ACT makes it more difficult for patent owners to select the venue of their choice. The legislation would not change the venue rules for any other class of plaintiffs or defendants, which shows the Act is arbitrary and makes patent owners second class citizens.
Aside from these concerns, the more fundamental problem is that the VENUE Act reflects ongoing bias against patent owners in the policy debates.
This bill is being pushed by a coalition of large companies. These companies do not think they should ever have to pay to use other peoples’ intellectual property. In other words they want to be legal thieves and they are willing to destroy the U.S. economy for their short term economic advantage.
It is widely recognized that the PTAB is incredibly biased against patents in both its procedural and substantive rules.
These new rules and procedures for challenging patents were pushed by the same coalition that is pushing the Venue Act.
Why Intellectual Property Rights? A Lockean Justification, by Professor Adam Mossoff, is probably one of the most important papers written on property rights in over a century. The point of the paper is to show Locke’s labor (physical and especially mental) theory of property rights provides the moral justification for intellectual property (copyrights and patents).
One of the strengths of the Lockean property theory is that it recognizes that IP rights are fundamentally the same as all property rights in all types of assets—from personal goods to water to land to air to inventions to books.
The paper clearly shows that Locke understood that it takes both mental and physical effort to obtain those things man needs to live. Anything that man makes valuable through his efforts, he obtains a property right in.
Locke himself expressly justifies copyright as “property” and approvingly refers to “Inventions and arts” in his summation of his theory that property arises from value-creating, productive labor that supports the “conveniences of life” in § 44 of the Second Treatise. In 1690, the legal concept of patents (property rights in inventions) did not exist yet, and so this is an explicit indication of Locke’s willingness to include what would later become the legal concept of patents within his property theory.
Locke explains that the world exists for “the use of the Industrious and Rational.”
Interestingly Locke distinguishes between copyrights (and patents by extension) and monopolies something that many modern critics of patents are unable to do.
In an essay on the statutory printing monopoly granted to the Stationers Company by Parliament, Locke condemns such monopolies as violating the “property” in creative works that “authors” rightly claim for themselves. In what might be a further surprising claim for many today who think copyright terms are too long, Locke writes in this 1695 essay that authors should have their property rights secured to them for their lifetimes or after first publication plus “50 or 70 years.”
I have argued that the term of a patent should be 35-40 years for the same reason. As I have explained here, no property right is eternally. Dead people do not have property rights.
Another misconception about property rights is that they are the same for every object or value created by man. As Mossoff explains Locke did not make this mistake.
As Locke first explained, property is fundamentally justified and defined by the nature of the value created and secured to its owner … To wit, different types of property rights are defined and secured differently under the law.
This naturally leads to a final observation: Given differences in produced values in the world, such as a water well, domesticated animals, a fecund farm, the desert sand used to make silicon for computer chips, air, broadcast spectrum, corporations, stock, credit, future interests, inventions, business plans, books, paintings, songs, and the myriad others, the specific legal doctrines that protect these values will vary.
It is amazing how many people miss this point, which leads to all sorts of erroneous ideas about what property rights are. This is perhaps the most important point in the whole article.
Property rights are highly misunderstood in today’s world by both lay people and academics. They are even misunderstood by many supporter of capitalism, particularly libertarians and supporters of Austrian Economics, but also by Objectivists and supporters of Ayn Rand.
Libertarians and the economics profession in general have accepted the utilitarian justification for property rights, which is a misnomer and turns property “rights” into arbitrary government grants. In addition, it fails to explain how property rights are acquired, who they belong to and why, among other problems.
Ayn Rand appears to be in basic agreement with Locke. She states:
Any material element or resource which, in order to become of use or value to men, requires the application of human knowledge and effort, should be private property—by the right of those who apply the knowledge and effort.
Capitalism: The Unknown Ideal “The Property Status of the Airwaves,” Capitalism: The Unknown Ideal, 122
Rand also discusses property rights in the chapter Patents and Copyrights in Capitalism: The Unknown Ideal. While she has some keen insights, she never developed a fully articulated theory of property rights.
In my limited research into the history of property rights theory there was excellent research and work starting around Locke and the Enlightenment. Before that property rights were derived from the King (government). In many ways the economics profession, particularly the Austrians have gone backwards to the idea that property “rights” are whatever the government says they are. Scholarship continued on property rights particularly in the United States at least until the first Homestead Act, which showed a clear understanding of property rights. However, that research had died by the time the FCC was created in 1934.
Locke, the Founders, and Ayn Rand understood that property rights are the cornerstone of freedom. Modern libertarians often think property rights can be replaced with contracts. This is confusing cause with effect. Contracts rely on property rights not the other way around. Some Objectivists undermine property rights by rejecting Locke, the Founders, and Rand’s understanding that each individual has a property right in themselves (Self Ownership or Self Sovereignty). This is also based on a misunderstanding of what property rights are and how they are derived.
Let’s hope that Adam Mossoff will continue his excellent work in this important area.
The libertarian crowd has been at the forefront of the anti-patent crusade. It is important to understand that libertarians are not consistent with classical liberals, such as the founding fathers and Locke. I have been looking for a way to illustrate this. Then I ran across a Wall Street Journal article by Matt Ridley, a darling of the libertarian crowd, which illustrated the differences perfectly. The article ostensibly was about government funding of science. I am sympathetic to the thrust of the article, however, in the second paragraph he states:
“Suppose Thomas Edison had died of an electric shock before thinking up the light bulb. Would history have been radically different? Of course not. No fewer than 23 people deserve the credit for inventing some version of the incandescent bulb before Edison, according to a history of the invention written by Robert Friedel, Paul Israel and Bernard Finn.”
This struck me as a very odd paragraph in an article on government funding of science. Edison was not funded by the government. Mr. Ridley and the people he cites may have never worked in fundamental research or with inventors. This may result in a misunderstanding of the differences between various inventions that lay people group together, which is the case with the paper cited in the article.
Ridley’s sole argument about Edison rests on the idea that other people were working on the problem. Thousands of people have tried to solve Fermat’s last theorem since 1637. Does that mean Andrew Wiles proof in 1994 was inevitable? Alternatively, only Edwin Armstrong worked on and invented FM (frequency modulation). Does that mean FM was not inevitable?
The article does stop there however, it goes on to denigrate the work of almost every great inventor and scientist since the Enlightenment, concluding with the statement:
“Simultaneous discovery and invention mean that both patents and Nobel Prizes are fundamentally unfair things. And indeed, it is rare for a Nobel Prize not to leave in its wake a train of bitterly disappointed individuals with very good cause to be bitterly disappointed.”
Ridley is not just attacking government funding of science, he is contending that discoveries and inventions are equally likely, given a range of researchers. If you take the statement above literally, it means that everyone working in technology and science are robots.
However, Ridley provides no evidence for his position and ignores the large variations in the rate of science advancement and inventions in both time and geography. This is not surprising, as Mr. Ridley did the same thing in his book The Rational Optimist, where he claims that most inventions were never patented, however a simple fact check showed that every invention he mentions is the subject of numerous patents.
The excellent book, The Most Powerful Idea in the World by William Rosen, shows that the Industrial Revolution, which was really an explosion in new inventions, was the result of property rights for inventions, i.e., patents, as does my book Source of Economic Growth.
One of the differences between classical liberals and libertarians is that classical liberalism celebrates great people, particularly those who used reason in the areas of science and technology. The Enlightenment was about celebrating the power of reason and rejecting faith and determinism. Thomas Jefferson said the two of the greatest people in the history of the world were Isaac Newton and John Locke.
Perhaps Ridley’s position is not shared by most libertarians. Yet, a recent panel discussion on Reason TV, part of the libertarian magazine Reason, shows Ridley’s position is widely shared. One panelist compared patents to slavery and taxi medallions. Another panelist made Ridley’s point that most inventions were never patented. But, if you eliminated everything in your house that was subject to a patent or made by a process that was once patented, your house would not exist. Most people will quickly understand that all the electronics would be gone, but so would the refrigerator, the electrical power, and even the glass in your windows was subject to patents extending back to Venice.
It would be easy to brand such an anti-intellectual property as arising from jealousy or self-aggrandizement, however, I think that would be a mistake. These libertarians are pushing a version of F. A. Hayek’s cultural evolution. Hayek’s ideas on cultural evolution are based on the impotence of reason. Hayek argues, that the demand for rational, conscious (“political”) control of the concrete particulars of social life is based upon a misunderstanding of the process of cultural evolution and on a hubristic and dangerous overestimation of the capacity of the conscious reasoning intellect.”
Ridley is just applying Hayek’s ideas on cultural evolution to science and technology. He is not the only one; the libertarian/Austrian economist Peter Lewin from University of Texas at Dallas, sadly my alma mater, makes a similar point. He emphasizes that most technical knowledge is tacit knowledge which is something we know but cannot prove or of which we are not conscious. In other places Lewin discusses “social knowledge” which appears to be tacit knowledge we hold collectively. Both Lewin and Hayek are fans of David Hume, who said causation does not exist (or cannot be proved) and induction is invalid or could not be proven valid. For many libertarians the anti-induction, anti-reason David Hume, is a hero.
Classical liberals know that causation exists, that Induction as a methodology, is not only valid, but the source of all knowledge. The most important value to a classical liberal is Reason. They understand that there is no such thing as social knowledge or knowledge of which we are not conscious. Classical liberals understand each person’s mind functions independently and therefore they celebrate great inventors and scientists. They know that without these great people, it is entirely possible that we would still be living in the Dark Ages. One only need look at North Korea, Cuba, or the Middle East to understand that technological progress is not inevitable and is not the result of some determinist spontaneous order.
What is interesting if you look closely at the arguments of Ridley, Hayek, and Lewin is that they are collectivist at an epistemological or cultural level. Their argument against a centralized government appears to be that it distorts this collectivist acquisition of knowledge.
Classical liberals and libertarians both appear to support free markets or capitalism. Beyond this they diverge, especially for the modern beltway libertarians. Classical liberals base their support of capitalism in reason and natural rights, which are discovered by reason. Libertarians base their arguments for free markets based on collective acquisition of knowledge that is disrupted by government interference.
Libertarians often align themselves with Ayn Rand, and claim her as one of their own, however, their ideas are incompatible with Rand’s. Rand herself was highly critical of the creed of Libertarianism, calling them “hippies of the Right.” If Matt Ridley had written Atlas Shrugged, the economy would have hummed along based on spontaneous order and John Galt would not be a genius inventor.
 http://www.firstprinciplesjournal.com/articles.aspx?article=1513&theme=home&page=3, Hayek on the Role of Reason in Human Affairs, Linda C. Raeder, Palm Beach Atlantic University
This is a review of Carl Menger’s book Principles of Economics published in 1871. I will be judging this book on three criteria: 1) Is it adhering to the philosophy of science? 2) Does it address the question of what is the cause of real per capita increases in wealth? and 3) Does it address the question of what was the cause of the industrial revolution? These last two questions are the most important in all of economics and it is impossible to write something that is profound if it does not address a profound question. I will also be analyzing Menger’s “subjective” theory of value and prices.
Philosophy of Science
Menger addresses this issue in the Preface. He discusses the remarkable advances of the hard sciences and the high regard in which they are held. He also laments that economics is held in very low regard.
This method of research, attaining universal acceptance in the natural sciences, led to very great results, and on this account came mistakenly to be called the natural-scientific method. It is, in reality, a method common to all fields of empirical knowledge, and should properly be called the empirical method. The distinction is important because every method of investigation acquires its own specific character from the nature of the field of knowledge to which it is applied. It would be improper, accordingly, to attempt a natural-scientific orientation of our science. (P.47)
Menger however never states why it would be improper to use the philosophy of natural sciences. He implies that he is using the “empirical method” however he never explains what he means by that. The rest of the book has almost no empirical evidence in support of Menger’s positions. Menger’s lack of clarity on this point is consistent with much of the rest of the book. This means that it is often possible to argue that Menger held two contrary positions and find support for both in this book. This in and of itself is support that Menger did not follow the philosophy of science, however it is a useful rhetorical tool. In addition, his major protégé, Ludwig Von Mises, explicitly rejects the philosophy of science, in favor of philosophical rationalism.
Menger’s major intellectual influence was Franz Brentano, an Austrian philosopher best known for his works related to psychology. Brentano wrote a book entitled Perception is Misception, in which he claims that perception is erroneous. “In fact he maintained that external, sensory perception could not tell us anything about the de facto existence of the perceived world, which could simply be illusion.” Since Menger considered Brentano a friend and intellectual influence and Menger did not refute this position, it is reasonable to assume that Menger was sympathetic to Brentano’s anti-perception idea. This anti-perception point of view is very reminiscent of Plato. Plato’s ideas are not consistent with science.
The overwhelming evidence is that Menger did not follow the philosophy of science. This means that none of the major Austrian economists, Menger, Von Mises, or Hayek based economics on the philosophy science. Austrian economics is not a science.
Source of Economic Growth
This section, The Causes of Progress in Human Welfare p. 71, is the part of Menger’s book I consider most important. It also appears to be the payoff for pages of description of first, second, third, etc. order goods. Even Menger admits that his definition of these is a bit vague, however first order goods appear to be consumables or consumer goods. Menger argues that economic growth is the result of creating more second or high order goods. This is just a long winded way of saying increasing capital goods causes economic growth, which had already been said by many other economists. Not only has this already been said by other economists, but it is wrong. He also has one throw-away line about human knowledge.
“Nothing is more certain than that the degree of economic progress of mankind will still, in future epochs, be commensurate with the degree of progress of human knowledge.”
He never builds on this, he does not explore how human knowledge is created, how it results in increases in economic wealth, or what knowledge is important to economic growth. His followers, such as Mises also do not build on this, they all focus on increases in savings and capital as the cause of growth in the economy.
In a technologically stagnant economy adding more capital at best can lead to some sort of optimum output, but can never exceed this level. (I describe and provide evidence for this in much more detail in my book Source of Economic Growth). As a simple example, imagine Robinson Crusoe fishing with a spear. The spear is a second order good or higher under Menger’s approach. Now if Crusoe creates more spears will he have more fish? No, since he can only use one spear at a time. At best having more spears will allow him to replace his spear more quickly if he breaks or loses a spear. Another example is that if every farmer that can use a tractor has one, then giving them more tractors will not increase the production of first order goods. This has been shown empirically and Robert Solow’s paper (Solow, Robert M, Technical Change and the Aggregate Production Function, The Review of Economics and Statistics, Vol. 39, No. 3 (Aug., 1957), pp. 312-320) is just one of many that prove this.
Menger fails to answer the question of what causes real per capita increases in wealth.
Menger never mentions the industrial revolution in this book. The Industrial Revolution is the first time that people escape subsistence living (the Malthusian Trap) in large numbers. It is the most significant event in the economic history of the world and Menger shows no interest in it. By the time Menger wrote Principle of Economics the Industrial Revolution was at least seventy years old and had exploded in the United States. This shows a profound disinterest in the empirical side of economics. It would be like an astronomer ignoring and eschewing the telescope or biologist who refuses to do or even explore the results of dissections.
Menger does not compare the economies of different countries or the economy of a country at different times, despite the profound differences in the economies of countries around the world. This is not how a scientist thinks or works. Instead Menger examines propositions in his own head, like the monks of the middle ages arguing over how many angels can dance on a pin head. Menger’s style is completely consistent with Mises praxeology – philosophical rationalism.
The cause of real per capita increases in wealth is increasing levels of technology (new inventions) and the cause of the Industrial Revolution is legally enforceable property rights for inventions (patents) as William Rosen, shows in his excellent book The Most Powerful Idea in the World and I show in my book Source of Economic Growth.
Menger does not discuss inventions, technology, knowledge, patents or their importance in economics. Menger fails to add anything useful to the two most important questions in all of economics.
Menger is generally credited with the idea of subjective value in economics. This is described as a reaction to the labor theory of value described in classical economics, which is an intrinsic theory of value. Despite this many people have argued that Menger was not advocating a subjective theory of value. Note that when modern Austrians use the term subjective value they mean that values are disconnected from reality – they are peoples’ arbitrary decisions. The interesting thing is that in his Principles of Economics you can find support for both positions. For instance, if you want to argue that Menger was advocating an objective theory of valuation you can provide the following quotes:
Value is thus the importance that individual goods or quantities of goods attain for us because we are conscious of being dependent on command of them for the satisfaction of our needs. p. 115
Value is therefore nothing inherent in goods, no property of them, but merely the importance that we first attribute to the satisfaction of our needs, that is, to our lives and well-being, and in consequence carry over to economic goods as the exclusive causes of the satisfaction of our needs. p 116
Menger also makes this distinction between real and imaginary goods. He appears to be making a point about objective values, however he never does anything with these concepts once he introduces them.
Note that Menger never defines what he means by needs. Are needs anything someone wants? Menger never says. Then he talks about the satisfaction of needs. Is this a personally, subjective decision? Menger never says.
On the other hand if you want to say Menger was advocating the modern value subjectivism of Austrians, then you can find these quotes.
It is a judgment economizing men make about the importance of the goods at their disposal for the maintenance of their lives and well-being. Hence value does not exist outside the consciousness of men. It is, therefore, also quite erroneous to call a good that has value to economizing individuals a “value,” or for economists to speak of “values” as of independent real things, and to objectify value in this way. P. 121
The measure of value is entirely subjective in nature, and for this reason a good can have great value to one economizing individual, little value to another, and no value at all to a third, depending upon the differences in their requirements and available amounts. What one person disdains or values lightly is appreciated by another, and what one person abandons is often picked up by another. P. 146
Hence not only the nature but also the measure of value is subjective. Goods always have value to certain economizing individuals and this value is also determined only by these individuals. P.146
Another factor favoring the subjective theory of values is that Menger is clear that ethics and morality are outside the study of economics.
But it seems to me that the question of the legal or moral character of these facts is beyond the sphere of our science. P. 173
Here he is talking about the morality of charging interest, however it is clear that this statement is a more general statement about economics. This suggests that Menger’s ethics, like most Austrians, is some version of Utilitarianism, which means he rejects Locke’s and Rand’s Natural Rights. Another quote that supports this point of view is Menger’s ideas of property.
The entire sum of goods at an economizing individual’s command for the satisfaction of his needs, we call his property. His property is not, however, an arbitrarily combined quantity of goods, but a direct reflection of his needs, an integrated whole, no essential part of which can be diminished or increased without affecting realization of the end it serves. P.76
Property, therefore, like human economy, is not an arbitrary invention but rather the only practically possible solution of the problem that is, in the nature of things, imposed upon us by the disparity between requirements for, and available quantities of, all economic goods. P. 97
The first quote is really Menger’s definition of property. Note that this over 200 years after Locke. It is a clear rejection of Locke and Natural Rights.
The second quote is a forerunner of the inane idea that property “rights” are socially useful tools for allocating scarce resources adhered to by Austrians.
Menger’s position on subjective value is confused. Note that this is not the work of scientist, which shows once again that Menger’s ideas are not based on the philosophy of science. Despite this Menger’s rejection Natural Rights, rejection of ethics in economics, and the direction his students took suggests that on balance Menger was an advocate of the radical subjective theory of value.
I undertook this task because a number of people I have respect for argued that Menger was not the same as Hayek or Von Mises. In addition, a number of well-known Objectivists have tried to reconcile Austrian Economics with Objectivism. I have analyzed in depth the irrational roots of the two main branches of Austrian Economics: 1) Hayek and 2) Von Mises. I have shown that the positions of Austrians on a number of positions are absolutely flawed including their position on property “rights”, the Austrian Business Cycle, their position on fractional reserve banking, and their position on intellectual property. Carl Menger has not proven to be the savior of this fall from grace. This is not to say that other schools of economics are better or that there is nothing useful in Austrian economics. For instance, Menger’s marginal utility is a useful concept, but hardly profound.
I found Principle of Economics boring, repetitive, and written in the pseudo-scientific style of many pop management books or psychological self-help books. This is consistent with other books I have read by Austrians. The best writer among the major Austrians is Hayek.
I did not force myself to read every word of Principle of Economics because it is boring, repetitive, and non-scientific. I will not apologize for not reading all of a book that is clearly not based on science. I also will not waste my time reading anymore books by Austrians. I know more about the underlying tenants of Austrian economics than many of its proponents, just as I know more about the underlying tenants of christianity than many of its proponents.
Objectivism and Austrian economics are incompatible. I think many Objectivists are fooled into supporting Austrian economics because they talk about free markets. Austrian economics is not the product of reason, the Enlightenment, and the philosophy of science. It is best described as a branch of the Scottish “Enlightenment”, which really was a counter enlightenment movement. If Objectivism wants to make progress in economic science it needs to wall itself off from Austrian economics.
 https://mises.org/library/philosophical-origins-austrian-economics, The Philosophical Origins of Austrian Economics, Mises Institute, by David Gordon, June 17, 2006.
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