Economics from the Ground Up
[Preface to Revised Edition of Man, Economy, and State with Power and Market, May 1993]
One of the unhappy casualties of World War I, it seems, was the old-fashioned treatise on economic "principles." Before World War I, the standard method, both of presenting and advancing economic thought, was to write a disquisition setting forth one's vision of the corpus of economic science. A work of this kind had many virtues wholly missing from the modern world. On the one hand, the intelligent layman, with little or no previous acquaintance with economics, could read it. On the other hand, the author did not limit himself, textbook-fashion, to choppy and oversimplified compilations of currently fashionable doctrine. For better or worse, he carved out of economic theory an architectonic — an edifice. Sometimes the edifice was an original and noble one, sometimes it was faulty; but at least there was an edifice, for beginners to see, for colleagues to adopt or criticize. Hyperrefinements of detail were generally omitted as impediments to viewing economic science as a whole, and they were consigned to the journals. The university student, too, learned his economics from the treatise on its "principles"; it was not assumed that special works were needed with chapter lengths fitting course requirements and devoid of original doctrine. These works, then, were read by students, intelligent laymen, and leading economists, all of whom profited from them.
Their spirit is best illustrated by a prefatory passage from one of the last of the species:
I have tried in this book to state the principles of economics in such form that they shall be comprehensible to an educated and intelligent person who has not before made any systematic study of the subject. Though designed in this sense for beginners, the book does not gloss over difficulties or avoid severe reasoning. No one can understand economic phenomena or prepare himself to deal with economic problems who is unwilling to follow trains of reasoning which call for sustained attention. I have done my best to be clear, and to state with care the grounds on which my conclusions rest, as well as the conclusions themselves, but have made no vain pretense of simplifying all things.
Since the brilliant burst that gave us the works of Wicksteed (1910), Taussig (1911), and Fetter (1915), this type of treatise has disappeared from economic thought, and economics has become appallingly fragmented, dissociated to such a degree that there hardly is an economics any more; instead, we find myriad bits and pieces of uncoordinated analysis. Economics has, first, been fragmented into "applied" fields — "urban land economics," "agricultural economics," "labor economics," "public finance economics," etc., each division largely heedless of the others. More grievous still has been the disintegration of what has been confined to the category of "economic theory." Utility theory, monopoly theory, international trade theory, etc., down to linear programming and games theory — each moves in its sharply isolated compartment, with its own hyperrefined literature. Recently, growing awareness of this fragmentation has led to vague "interdisciplinary" admixtures with all the other "social sciences." Confusion has been worse confounded, with resulting invasive forays of numerous other disciplines into economics, rather than the diffusion of economics elsewhere. At any rate, it is somewhat foolhardy to attempt to integrate economics with everything else before economics has itself been made whole. Only then will the proper place of economics among the other disciplines become manifest.
I think it fair to say that, with only a single exception (Ludwig von Mises's Human Action), not one general treatise on economic principles has appeared since World War I. Perhaps the closest approach was Frank H. Knight's Risk, Uncertainty, and Profit, and that was published far back in 1921. Since then, there has been no book of remotely as broad a scope.
The only place where we can find economics treated with any degree of breadth is in the elementary textbooks. These textbooks, however, are sorry substitutes for a genuine Principles. Since they must, by their nature, present only currently received doctrine, their work is uninteresting to the established economist. Furthermore, since they may only boil down the existing literature, they must of necessity present to the student a hodgepodge of fragmented chapters, each with little or no relation to the other.
Many economists see no loss in all this; in fact, they herald these developments as signs of the enormous progress the science has made on all fronts. Knowledge has grown so vast that no man can encompass it all. Yet economists should at least be responsible for knowing economics — the essentials of the body of their discipline. Certainly, then, these essentials could have been presented by this time. The plain fact is that economics is fragmented precisely because it is no longer regarded as an edifice; since it is considered a congeries of isolated splinters, it is treated as such.
Perhaps the key to this change is that formerly economics was regarded as a logical structure. Fundamentally, whatever the differences of degree, or even of proclaimed methodology, economics was considered a deductive science using verbal logic. Grounded on a few axioms, the edifice of economic thought was deduced step by step. Even when the analysis was primitive or the announced methodology far more inductive, this was the essence of economics during the 19th century. Hence, the treatise on economic "principles" — for if economics proceeds by deductive logic grounded on a few simple and evident axioms, then the corpus of economics can be presented as an interrelated whole to the intelligent layman with no loss of ultimate rigor. The layman is taken step by step from simple and evident truths to more complex and less evident ones.
The "Austrian" economists best perceived this method and used it most fully and cogently. They were the classic employers, in short, of the "praxeologic" method. In the present day, however, the prevailing epistemology has thrown over praxeology for methods at once too empirical and too "theoretical." Empiricism has disintegrated economics to such an extent that no one thinks to look for a complete edifice; and, paradoxically, it has falsified economics by making economists eager to introduce admittedly false and short-cut assumptions in order to make their theories more readily "testable." Alfred Marshall's distrust of "long chains of deduction," as well as the whole Cambridge impetus toward such short cuts, has contributed a great deal to this breakdown. On the other hand, verbal logic in economic theory has been replaced by mathematics, seemingly more precise and basking in the reflected glory of the physical sciences. The dominant econometric wing of mathematical economists also looks for empirical verifications and thereby compounds the errors of both methods. Even on the level of pure theoretical integration, mathematics is completely inappropriate for any sciences of human action. Mathematics has, in fact, contributed to the compartmentalization of economics — to specialized monographs featuring a hyperrefined maze of matrices, equations, and geometric diagrams. But the really important thing is not that nonmathematicians cannot understand them; the crucial point is that mathematics cannot contribute to economic knowledge. In fact, the recent conquest of mathematical economics by econometrics is a sign of recognition that pure mathematical theory in economics is sterile.
This book, then, is an attempt to fill part of the enormous gap of 40 years' time. Since the last treatise on economic "principles," economics has proceeded a long way in many areas, and its methodology has been immeasurably improved and strengthened by those continuing to work in the praxeological tradition. Furthermore, there are still great gaps in the praxeological corpus, since so few economists have worked at shaping it. Hence, the attempt in this book to develop the edifice of economic science in the manner of the old-fashioned works on its "principles" — slowly and logically to build on the basic axioms an integrated and coherent edifice of economic truth. Hyperrefinements have been shunned as much as possible. In short, Professor Taussig's quoted statement of intention has been mine also, with the addition that I have felt it necessary to include, at pertinent points, refutation of some of the main opposing doctrines. This was especially needed because economic fallacy prevails far more widely than in Taussig's time.
I have indicated briefly that there has been one general treatise since World War I. Professor Paul Samuelson has written rhapsodically of the joy of being under 30 at the time of publication of Keynes's General Theory. I can say the same for the publication of Ludwig von Mises's Human Action in 1949. For here at last was economics whole once more, once again an edifice. Not only that — here was a structure of economics with many of the components newly contributed by Professor Mises himself. There is no space here to present or expound Mises's great contributions to economic science. That will have to be done elsewhere. Suffice it to say that from now on, little constructive work can be done in economics unless it starts from Human Action.
Human Action is a general treatise, but not an old-style Principles. Instead, it assumes considerable previous economic knowledge and includes within its spacious confines numerous philosophic and historical insights. In one sense, the present work attempts to isolate the economic, fill in the interstices, and spell out the detailed implications, as I see them, of the Misesian structure. It must not be thought, however, that Professor Mises is in any way responsible for these pages. Indeed, he may well differ strongly with many sections of this volume. Yet it is my hope that this work may succeed in adding a few bricks to the noble structure of economic science that has reached its most modern and developed form in the pages of Human Action.
The present work deduces the entire corpus of economics from a few simple and apodictically true axioms: the Fundamental Axiom of action — that men employ means to achieve ends, and two subsidiary postulates: that there is a variety of human and natural resources, and that leisure is a consumers' good. Chapter 1 begins with the action axiom and deduces its immediate implications; and these conclusions are applied to "Crusoe economics" — that much maligned but highly useful analysis that sets individual man starkly against Nature and analyzes his resulting actions. Chapter 2 introduces other men and, consequently, social relations. Various types of interpersonal relations are analyzed, and the economics of direct exchange (barter) is set forth. Exchange cannot be adequately analyzed until property rights are fully defined — so chapter 2 analyzes property in a free society. Chapter 2, in fact, marks the beginning of the body of the book — an analysis of the economics of voluntary exchange. Chapter 2 discusses the free market of barter, and the subsequent chapters treat the economics of indirect — or monetary — exchange. Thus, analytically, the book deals fully with the economics of the free market, from its property relations to the economics of money.
Chapter 3 introduces money and traces the patterns of indirect exchange on the market. Chapter 4 treats the economics of consumption and the pricing of consumers' goods. Chapters 5– 9 analyze production on the free market. One of the features of this consumption and production theory is the resurrection of Professor Frank A. Fetter's brilliant and completely neglected theory of rent — i.e., the concept of rent as the hire price of a unit service. Capitalization then becomes the process of determining the present values of the expected future rents of a good. The Fetter-Mises pure time-preference theory of interest is synthesized with the Fetter rent theory, with the Austrian theory of the structure of production, and with separation of original from produced factors of production. One "radical" feature of our analysis of production is a complete break with the currently fashionable "short-run" theory of the firm, substituting for this a general theory of marginal value productivity and capitalization. It is a "general equilibrium" analysis in the dynamic Austrian sense, and not in the static, currently popular Walrasian sense.
Chapter 10 expounds a completely new theory of monopoly — that monopoly can be meaningfully defined only as a grant of privilege by the State, and that a monopoly price can be attained only from such a grant. In short, there can be no monopoly or monopoly price on the free market. The theory of monopolistic competition is also discussed. And chapter 11 sets forth the theory of money on the free market, along with an extensive discussion of the Keynesian theories.
Having completed the theory of the purely free market, I then turn, in the final chapter, to applying praxeological analysis to a systematic discussion of various forms and degrees of coercive intervention and their consequences. The effects of coercive intervention can be studied only after fully analyzing the construct of a purely free market. Chapter 12 presents a typology of intervention, discusses its direct and indirect consequences and the effects on utility, and sets forth a necessarily brief analysis of the various major types of intervention, including price control, monopoly grants, taxation, inflation, and government enterprise and expenditures. The chapter and the book conclude with a brief summary assessment of the free market, as contrasted to interventionist and other coercive systems.
For this revised edition, I have decided to keep the original text and footnotes intact, and to confine any changes to this revised preface. Professor Mises died in 1973, and the following year, as luck would have it, the Austrian School of economics that Mises had kept alive in an almost underground existence burst forward into a spectacular revival. It is no accident that this revival coincided with the virtual collapse of the previously dominant Keynesian paradigm. Keynesians had promised to steer the economy easily away from the recurring pitfalls of inflationary boom, and recession and unemployment; instead, they would insure permanent and stable prosperity, bringing us full employment without inflation. And yet, after three decades of Keynesian planning, we faced a new phenomenon that cannot even exist, much less be explained, in the Keynesian paradigm: inflation combined with recession and high unemployment. This unwelcome specter first appeared in the inflationary recession of 1973–74, and has been repeated since, the last time being the recession of 1990–?.
The Austrian revival of 1974 was also spurred by F.A. Hayek's receiving the Nobel Prize for economics that year, the first free-market and nonmathematical economist to be accorded that honor. The economics profession's obsession with the Nobel reawakened interest in Hayek and in the Austrian School. But this award to Hayek itself can be no coincidence, since it reflects disillusion by economists in Keynesian macro-models.
Since 1974, the number of Austrians, books and articles by Austrians, and interest in the school, has greatly multiplied. It is a reflection of the difference in the quality of academia in the two countries that, even though there are proportionately fewer Austrian School economists in Britain than in the United States, Austrian economics is accorded a great deal more respect in Britain. In British textbooks and surveys of thought, Austrian economics, while not often winning agreement, is treated objectively and fairly as a respectable wing of economic thought. In the United States, on the contrary, while there are a large number of sympathizers as well as adherents in the profession, Austrians are still marginalized, unheeded, and unread by the bulk of economists.
Intellectual curiosity has a habit of breaking through, however, especially among college and graduate students. As a result, the Austrian School has flourished over the last two decades, despite severe institutional obstacles.
In fact, the number of Austrians has grown so large, and the discussion so broad, that differences of opinion and branches of thought have arisen, in some cases developing into genuine clashes of thought. Yet they have all been conflated and jammed together by non-Austrians and even by some within the school, giving rise to a great deal of intellectual confusion, lack of clarity, and outright error. The good side of these developing disputes is that each side has clarified and sharpened its underlying premises and world-view. It has indeed become evident in recent years that there are three very different and clashing paradigms within Austrian economics: the original Misesian or praxeological paradigm, to which the present author adheres; the Hayekian paradigm, stressing "knowledge" and "discovery" rather than the praxeological "action" and "choice," and whose leading exponent now is Professor Israel Kirzner; and the nihilistic view of the late Ludwig Lachmann, an institutionalist antitheory approach taken from the English "subjectivist"-Keynesian G.L.S. Shackle. Fortunately, there is now a scholarly journal, The Review of Austrian Economics, where the reader can keep apprised of ongoing developments in Austrian economics, as well as other publications, conferences, and instructional courses of the Ludwig von Mises Institute. The Mises Institute, founded on the centenary of his birth, keeps alive the spirit of Mises as well as the paradigm that he has bequeathed to scholarship and to the world. For the latest on the three Austrian paradigms, the reader is referred to the Mises Institute working paper by the present author, "The Present State of Austrian Economics" (November, 1992).
My overriding intellectual debt, of course, is to Ludwig von Mises. But apart from that, I can never fully express my personal debt. His wisdom, kindness, enthusiasm, good humor, and unflagging encouragement of even the slightest signs of productivity among his students were a lifelong inspiration to those who knew him. He was one of the great teachers of economics, as well as one of the great economists, and I am grateful to have had the opportunity of studying for many years at his Seminar in Advanced Economic Theory at New York University.
I can also never fully express my gratitude to Llewellyn H. Rockwell, Jr., who, at a low point in Misesian economics, with no endowment, no large pledges of support, and armed only with an idea, founded and dedicated his life to the Ludwig von Mises Institute. Lew has done a remarkable job of building and expanding the Institute, and of devoting himself to the Misesian paradigm. In addition, Lew has been a close and valued friend and intellectual colleague for many years. It is obvious that, without his efforts, this new edition would never have seen the light of day.
Finally, I must at least try to convey how grateful I am to another long-time colleague, Burton S. Blumert, of the Mises Institute and head of the Center for Libertarian Studies, Burlingame, California. Self-effacing and indispensable, Burt is always there — with wit, wisdom, kindness, and friendship.
It is impossible to list all the friends and acquaintances who, over the many years, have taught and inspired me in the area of Austrian economics, or in the wider arena of political economy, and in the nature of coercion of freedom. I am grateful to them all. None of them, of course, are responsible for any errors herein.
 Frank W. Taussig, Principles of Economics (New York: Macmillan, 1911), p. vii.