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Eugen von Böhm-Bawerk (Born February 12, 1851; Died 1914) was in
the right place at the right time to contribute importantly to the development
of Austrian economics. Studying at the University of Vienna, he was twenty
years old when Carl Menger's Principles of Economics appeared in print
in 1871. His formal university training was in law (and thus he was not
actually a student of Menger's), but after completing his doctorate in law in
1875, he began preparing himself both at home and abroad to teach economics in
his native Austria. A parallel progression from law to economics characterized
the career of his classmate (and, later, brother-in-law) Friedrich von Wieser,
best known for his Natural Value published in 1893. The strong influence of
Menger's writings on Böhm-Bawerk's thinking, together with a life-time
relationship with Wieser, made him a natural for expositing and developing the
Austrian theory. In the judgment of Schumpeter (History of Economic Analysis,
New York: Oxford University Press, 1954, p. 846), Böhm-Bawerk "was so
completely the enthusiastic disciple of Menger that it is hardly necessary to
look for other influences." Böhm-Bawerk's career as a scholar,
however, was an intermittent one. The most significant span of scholarly
activity was his years at the University of Innsbruck (1881-1889). It was
during the 1880s that he first published two of the three volumes of his magnum
opus, Capital and Interest. His later years were dominated by his duties
as the Austrian Minister of Finance, a position he held, though not
continuously, throughout the 1890s and beyond-and for which he is fittingly
honored by having his likeness on Austria's one-hundred schilling note. After
serving in this capacity and assuming other governmental duties, he returned to
teaching in 1904. With a chair at the University of Vienna, he became a
colleague of Wieser, successor to the retired Menger. Students who passed
through the university during the last decade of Böhm-Bawerk's career (and
life: he died in 1914) included Joseph Schumpeter and Ludwig von Mises.
In 1959 the twelve-hundred pages of Capital and Interest were translated
into English by Hans Sennholz and George Huncke and published as a single
volume. Reviewing this new translation, Mises described this "monumental
work" as "the most eminent contribution to modern economic
theory." He indicated that no one could claim to be an economist unless he
was perfectly familiar with the ideas advanced in this book, and he even went
so far as to suggest--as only Mises could--that no citizen who takes his civic
duties seriously should exercise his right to vote until he has read
Böhm-Bawerk! The first volume of Capital and Interest, titled
History and Critique of Interest Theories (1884), is an exhaustive survey of
the alternative treatments of the phenomenon of interest: use theories,
productivity theories, abstinence theories, and many more. Most significant in
this early work is his devastating critique of the exploitation theory, as
embraced by Karl Marx and his forerunners: Capitalists do not exploit workers;
they accommodate workers-by providing them with income well in advance of the
revenue from the output they helped to produce. More than a decade later,
Böhm-Bawerk was to revisit the issues raised by the socialists. Karl Marx
and the Close of His System established that the question of how income is
distributed among the factors of production is fundamentally an economic-rather
than a political-question. And the Austrian answer effectively rebutted the
labor theory of value as well as the so-called "iron law of wages."
Böhm-Bawerk's Positive Theory of Capital (1889), offered as the
second volume of Capital and Interest, contains his most substantial and
profound contribution to our understanding of the economy's time-consuming
production processes and of the interest payments they entail. But this volume
offers much more. Its treatment of "Value and Price" (Book III)
builds on Menger's Principles to present a distinctly Austrian version
of marginalism. It is here that we find Böhm-Bawerk's celebrated
discussion (p. 143) of the pioneer farmer faced with decisions about the
allocation of his sacks of grain among the various uses-as basic feed for
himself, his chickens and his parrots, and as an ingredient for making brandy.
The essence of Austrian marginalism is conveyed with his telling the story of
what would happen (Parrots beware) if the farmer were to suffer the loss of one
sack of grain. This story and many variations on it, told countless times by
textbook writers over the decades since, stand in contrast to the
twice-differentiable total-utility functions that evolved from William Stanley
Jevons' marginalism and the general-equilibrium equations that dominate in Leon
Walras'. Appendicies to the third edition of the second volume (1909-1912)
appeared as a separate third volume in 1921 with the title Further Essays on
Capital and Interest.
Here, Böhm-Bawerk offers clarifications, qualifications, and extensions to
his theory and responds to his critics. These essays, which contain much of
substance, also reveal much about its author's scholarly and rhetorical
methods. Böhm-Bawerk reasons like an economist and argues like a lawyer;
his most critical remarks are directed towards those whose theories most
closely resemble his own. For instance, Gustav Cassel's theory, in which the
interest rate brings the supply and demand for "waiting" into
balance, is flatly rejected. And despite the fact that the Austrian school is
noted for its attention to methodological matters, Böhm-Bawerk took a
no-holds-barred approach. Schumpeter articulates the implicit maxim:
"Write little or nothing on method, and instead work the more
energetically with all available methods."
Modern economics is notorious for its inattention to capital in the sense of an
intertemporal structure of intermediate goods. Production takes time, and the
time that separates the formulation of multiperiod production plans and the
satisfaction of consumer demands is bridged by capital. If mentioned at all in
modern textbooks, these aspects of economic reality are introduced as "the
thorny issues of capital," a tell-tale phrase that portends a dismissive
treatment of this critical subject area. Though a lacuna in mainstream
economics, Austrian economics has almost from its beginnings given a special
prominence to capital theory. With a full awareness of all the thorns,
Böhm-Bawerk built his academic career around the goals of understanding
the relationship between capital and interest and extending value theory to the
context of intertemporal allocation.
Early in his career, Böhm-Bawerk took up a central question that was much
discussed by his contemporaries and predecessors. "Is there any
justification for the payment of interest to the owners of capital?" The
justification, in his view, rests on a simple fact of reality: people value
present goods more highly than future goods of the same quantity and quality.
Future goods trade at a discount, or alternatively, present goods trade at a
premium. The payment of interest is a direct reflection of this intertemporal
value differential. This interest, or agio, paid to capitalists allows workers
to receive income on a more timely basis than would otherwise be possible.
Böhm-Bawerk's "agio theory" and its implications for the
alternative "exploitation theory" were undoubtedly enough to win him
recognition by historians of economic thought. But with it he broke new ground
and was able to parlay his refutation of socialist doctrine into a new
understanding of the capitalist system.
His Positive Theory culminates in a macroeconomic model of general equilibrium
that serves to illuminate the classical issues of capital accumulation and
technical progress, to resolve the neoclassical problem of the existence and
the determination of the rate of interest, and to do still more. He combined
his agio theory of interest with Menger's theory of marginal value to show that
given the wage rate that the market establishes, profit-maximizing
capitalist-entrepreneurs will engage in production activities that not only
employ the labor force to the fullest but also fully absorb the economy's
subsistence fund. Making use of the earliest and most foundational Austrian
insights and taking an economywide perspective, Böhm-Bawerk linked the
intertemporal structure of production to the intertemporal preferences of
workers and other income earners. Nearly a half-century before John Maynard
Keynes made assertions to the contrary and offered them up as a General Theory,
the Positive Theory showed that the market for labor and the market for
loanable funds-or, more broadly, the market for subsistence-could
simultaneously find their respective equilibria.
We have it, then, that Böhm-Bawerk was a macroeconomist--and a
self-reflective one at that. The classical economists, especially Ricardo,
could in retrospect be considered macroeconomists in an era that predates any
hint of the modern distinction. The actual word "macroeconomics," of
course, is a relatively modern one. Paul Samuelson, who reorganized the subject
matter of economics on the basis of a first-order distinction between
microeconomics and macroeconomics, traces the distinction itself to Ragnar
Frisch and Jan Tinbergen and dates the word's debut in print to Erik Lindahl in
1939. But in his 1891 essay on "The Austrian Economists" cited
earlier, Böhm-Bawerk wrote that "One cannot eschew studying the
microcosm if one wants to understand properly the macrocosm of a developed
economy." Packed into this understated methodological maxim is both his
desire to understand the macroeconomy and his recognition that microeconomic
foundations are essential for a viable macroeconomics--a view that, in the
mainstream, dates only to the mid 1960s.
To aid in his exposition of the macroeconomics of capital and interest,
Böhm-Bawerk introduced his bull's-eye figure-a pattern of concentric rings
intended to depict the time-structure of production. Production begins in the
center with the use of the original means (land and labor); the process
emanates outward over time; and the final product emerges at the outermost ring
to satisfy the consumers' ultimate ends. Two bull's eye figures appearing on
consecutive pages are used to contrast a well-developed economy with a
less-well-developed one.
This idiosyncratic depiction can be seen as a forerunner of the more
straightforward representation of the means-ends framework introduced by F. A.
Hayek during the interwar period. The Hayekian triangle captures the essential
linearity-not to deny that there are significant non-linearities-in the
structure of production. The triangle, which is divided along the time axis
into "stages of production," corresponds closely with the bull's eye
figure, which is divided along the radius into "maturity classes."
Though static by its very construction, the bull's-eye figure, as well as the
better known Hayekian triangle, is intended to facilitate the analysis of
change. What is the nature of the market forces that govern the allocation of
resources among the various rings? Böhm-Bawerk's formal analysis-and the
simple graphics plus some arithmetic illustrations is the extent of the
formalities-helps the reader in "getting the picture." For
Böhm-Bawerk, however, "getting the picture" is but a prelude to
"telling the story." His story telling, his informal analysis of the
nature of the process of change, breaks free of the static representation. In
the case of the stationary state, the concentric rings have two
interpretations: (1) the production process can be seen as proceeding over time
from earliest input to final output and (2) the areas of the rings can
represent the amounts of the different kinds of capital (goods in process) that
exist at a given point in time. But to depict the stationary state is only to
establish a starting point for a discussion of change. Böhm-Bawerk briefly
considered the question: "What is the procedure if we wish just to
preserve the amount of capital in its previous magnitude?" His answer,
given in short order, is followed by the more important question: "What
must be done if there is to be an increase in capital?" The answer to this
key question, which distinguishes Austrian macroeconomics from what would later
become mainstream macroeconomics, involves a change in the configuration of the
concentric rings. Several types of changes are suggested, each entailing the
idea that real saving is achieved at the expense of consumption and of capital
in the outer rings and that the saving makes possible the expansion of capital
in the inner rings.
Böhm-Bawerk indicates that in a market economy it is the entrepreneurs who
bring such structural changes about and that their efforts are guided by
changes in the relative prices of capital goods in the various rings. Formal or
informal, the message is clear: An expansion of the capital structure is not to
be viewed as a simultaneous and equiproportional increase in capital in each of
the maturity classes; it is to be viewed as a reallocation of capital among the
maturity classes. Overlooked by his predecessors and largely ignored by the
modern mainstream, this is the market mechanism that keeps the economy's
intertemporal production plans in line with the intertemporal preferences of
consumers. The significance of this market mechanism was at issue in his debate
with John B. Clark, who held that once capital is in place, the maintenance of
capital is automatic and that production and consumption are, in effect,
simultaneous. Although a modern reader may conclude that Böhm-Bawerk won
the debate and that in later years Hayek was similarly victorious in his debate
with Frank Knight, the development of mainstream macroeconomics reflects the
implicit belief that it was Clark and Knight who won.
It is easy for modern Austrian economists to see that Böhm-Bawerk was just
a step away from articulating the Austrian theory of the business cycle. This
step, which was actually taken by Mises and Hayek, would have involved a
comparison of changes in the configuration of the rings on the basis of whether
those changes were preference-induced or policy-induced. A change in
intertemporal preferences in the direction of increased saving reallocates
capital among the rings such that the economy experiences capital accumulation
and sustainable growth; a policy-induced change in credit conditions, that is,
a lowering of the interest rate achieved by the lending of newly created money,
misallocates capital among the rings such that the economy experiences
unsustainable growth and economic crisis. Development of the theory in this
direction was beyond Böhm-Bawerk for the simple reason that he would not
allow himself to venture into monetary theory. His attitude toward this subject
matter is revealed in the letters to Swedish economist, Knut Wicksell, whose
ideas about the divergence of the market rate of interest and the natural rate
would become an important part of the Austrian theory. In 1907, he wrote:
"I have not myself given thought to or worked on the problem of money as a
scholar, and therefore I am insecure vis-à-vis this subject." In
1912: "You know that I do not really feel competent as regards the
extremely difficult theory of money." Also in 1912, referring to The
Theory of Money and Credit, in which Mises first articulates the Austrian
theory of the business cycle, Böhm-Bawerk mentions to Wicksell "a
book on the theory of money by a young Viennese scholar, Dr von Mises. Mises is
a student of myself and Prof. Wieser, which, however, does not mean that I
would want to take responsibility for all his views. I have just begun to read
his book myself, and am not yet familiar with its content." And finally in
1913, a year before his death, "I have not yet included the theory of
money in the subject-matter of my thinking, and I therefore hesitate to pass a
judgement on the difficult questions it raises."
Schumpeter lists five general subject areas that Böhm-Bawerk excluded from
his research agenda, one of which was money: Böhm-Bawerk endorsed the
"indestructible core of truth" in the quantity theory, but accepted
the idea that money is a veil. A second excluded area-in retrospect a clear
corollary to the first-was business cycle theory: Böhm-Bawerk took
economic crises to be "neither an endogenous nor a uniform economic
phenomenon but rather the consequences of what are in principle accidental
disturbances of the economic process." (The other three excluded subject
areas are population, international trade, and applied price and distribution
theory.)
We can easily forgive Böhm-Bawerk for these sins of omission. When a
profound thinker makes a great leap forward, we are not entitled to complain
that the leap was not greater still. We should recognize instead that the
successive leaps by Mises, Hayek and others have made Böhm-Bawerk's look
all the greater. Early and modern literature on Böhm-Bawerk's economics
has identified many supposed sins of commission as well. Much of the criticism
comes from with the Austrian school: His theory was insufficiently
subjectivist. His defense of the agio theory of interest relied needlessly on
psychological considerations. His reckoning of production time was
backward-looking rather than forward-looking.
Criticism from outside the Austrian school stem largely from undue attention to
Böhm-Bawerk's arithmetic illustrations and from attempts to restate his
theory in the language of formal neoclassical theory. His conclusions about the
relationship between the interest rate and the degree of roundaboutness in the
production process apply less generally that he would have us believe. The
economy's intertemporal structure of capital cannot be reduced to a single
number. The definitional dependence of the average period of production on the
rate of interest invalidates much of his theory. Fortunately, these and many
other criticisms leave intact the essential ideas that were important to
Böhm-Bawerk and to the future development of Austrian theory. As
substantial an economist as Schumpeter could claim that interest is a
disequilibrium phenomenon and fantasize about a long-run equilibrium where
market forces have pushed the interest rate to zero. John Maynard Keynes
imagined interest to be a purely monetary phenomenon. Creating what Hayek
called a "mythology of capital," Frank Knight, following Clark, held
that production and consumption occur simultaneously, that the period of
production is irrelevant, and that the interest rate is wholly determined by
technological considerations. These and other twists and turns in twentieth
century views of capital and interest give increased significance to the
enduring wisdom of Eugen von Böhm-Bawerk.
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