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Epistemological Problems of Economics
Ludwig von Mises

8
Inconvertible Capital

1. The Influence of the Past on Production

Suppose that, making use of our entire store of technological skill and our present-day knowledge of geography, we were to undertake to resettle the earth's surface in such a way that we should afterwards be in a position to take maximum advantage of the natural distribution of raw materials. And suppose further that for this purpose the entire capital wealth of the present were at our disposal in a form that would allow us to invest it in whatever way was regarded as the most suitable for the end in view.

In such a case the world would certainly take on an appearance that would be very considerably different from the one it now presents. Many areas would be less densely populated; others, in turn, more densely populated, than they are today. Land that is now cultivated would be allowed to lie fallow, while other land that today lies fallow would be farmed. Many mineral deposits that are presently exploited would be left unused. Factories would exist in fewer number than they do today and often in different locations. The great trade routes would follow other courses. In the factories themselves only the most modern machinery would be employed. Economic and commercial geography would have to be completely rewritten, and many machines and types of equipment still used today would remain only in museums.

It has been a repeated subject of criticism that the present actual state of affairs does not correspond to this ideal picture that we construct with the help of our technological and geographical knowledge, The fact that production has not been "made completely rational" is regarded as a sign of backwardness and wastefulness inimical to the general welfare. The prevailing ideology, which makes capitalism responsible for all evils, sees in this situation a new argument in favor of interventionism and socialism. Everywhere commissions and councils are set up "for the efficient use of resources." An abundant literature occupies itself with questions of "the most efficient utilization of the factors of production," and "making the economy rational" has become one of the most popular clich?s of the day. The treatment given this subject, however, scarcely touches upon the problems involved.

First of all, catallactics must take as the basis of its reasoning the proposition that only "true capital," in Clark's sense, has mobility, but that individual capital goods do not.[1] Capital goods as produced, material factors of production are intermediary steps on the way toward a definite goal?a consumer's good. If in the course of the period of production subsequent changes in the entrepreneur's goals are caused by a change in the data of the market, the intermediary products already available cannot always be used for the attainment of the new goals. This holds true both of goods of fixed and goods of circulating capital, although in greater measure of the former. Capital has mobility in so far as it is technologically possible to transfer individual capital goods from one branch of production to another or to transport them from one location to another. Where this is not possible, "true capital" can be shifted from branch to branch or from place to place only by not being replaced as it is used up and by the production of other capital goods elsewhere in its stead.

In accordance with the purpose of our investigation, we do not wish to take up the question of the mobility of goods of circulating capital any further. And for the time being, in considering the mobility of fixed capital, we shall disregard the case of a decrease in demand for the final product. The two questions that concern us are: What consequences are brought about by limitations in the convertibility of fixed capital in the event of a change in the conditions determining the location of industries or in the case of technological progress?

First, let us consider the second, simpler case. A new machine, more efficient than those used previously, comes on the market. Whether or not the plants equipped with the old, less efficient machines will discard them in spite of the fact that they are still utilizable and replace them by the new model depends on the degree of the new machine's superiority. Only if this superiority is great enough to compensate for the additional expenditure required is the scrapping of the old equipment economically sound. Let p be the price of the new machine, q the price that can be realized by selling the old machine as scrap iron, a the cost of producing one unit of product by the old machine, and b the cost of producing one unit of product by the new machine without taking into account the costs required for its purchase. Let us further assume that the advantage of the new machine consists merely in a better utilization of circulating capital?for example, by saving labor?and not in manufacturing a greater quantity of products, and that thus the annual output z remains unchanged. Then the replacement of the old machine by the new one is advantageous if the yield z(a - b) is large enough to compensate for the expenditure of p - q. We may disregard the writing off of depreciation in assuming that the annual quotas are not greater for the new machine than for the old one. Consequently, the case can very well occur that plants equipped with the older model are able to compete with those equipped with the better, more recent model. Every businessman will confirm this.

The situation is exactly the same in the first case. When more propitious natural conditions of production are made accessible, plants change their location only if the difference in net proceeds exceeds the costs of moving. What makes this a special case is the fact that obstacles standing in the way of the mobility of labor are also involved. If the workers do not also migrate and if there are no workers available in the regions favored by nature, then neither can production migrate. However, we need not go into this further, since we are interested here only in the question of the mobility of capital. We need merely establish the fact that production would change its location, even if labor were perfectly mobile, only if the conditions described above were met. This too is confirmed again and again by experience.

With regard to choice of location and technological performance, new plants appear most efficient in the light of the existing situation. But in both cases that have been discussed, consideration for capital goods produced in the past under certain circumstances makes the technologically best method of production appear uneconomical. History and the past have their say. An economic calculation that did not take them into account would be deficient. We are not only of today; we are heirs of the past as well. Our capital wealth is handed down from the past, and this fact has its consequences. What is involved here is not the play of irrational factors in the rationality of economic activity, as we might perhaps be inclined to say were we to follow a fashion in science that is hardly to be recommended. Nor are we confronted here with an instance of alleged "noneconomic" motives. On the contrary, it is precisely strict rationality that induces the entrepreneur to continue production in a disadvantageous location or with obsolete equipment. Therefore it would also be a mistake to speak in this connection of "symptoms of friction." This phenomenon can be most appropriately described as the effect of the influence of the past upon production.[2]

If technologically obsolete machines are retained, or if production is continued at an unfavorable location, it may still be profitable to invest new capital in these plants in order to increase their efficiency as much as the situation permits. Then a production aggregate that, from the purely technological point of view, appears outclassed can continue to compete profitably for a long time to come.

The merely technological view, which neglects the consideration of the influence of the past, finds it inexplicable, from the rational standpoint, how backward production methods can continue to exist alongside the more advanced. It resorted to all kinds of inadequate attempts at an explanation. One would think that the procedure of drawing upon the factors of the past to explain present conditions would have appeared especially obvious to the Historical School. Yet here too it failed completely. It could see in this problem nothing but ammunition for its attack upon capitalism.

This came very opportunely for the socialists of all varieties. On the one hand, the knowledge was growing that socialism could keep its promise of improving the lot of everybody only if it were a more productive system than capitalism. On the other hand, it was becoming increasingly evident that a sharp decline in productivity would very definitely have to be expected in the socialist planned economy. To the extent that people were becoming aware of these facts it became important for the socialists to collect seeming arguments with which one could justify the prophecy of abundance in the socialist community of the future. It seemed useful for this purpose to point repeatedly to the fact that under capitalism there is still technological backwardness everywhere. That the equipment of some enterprises does not conform to the ideal picture presented by the most advanced establishments was attributed, not to the influence of the past upon production or to the scarcity of available capital, but to the inherent shortcomings of capitalism. To it one contrasted the utopian vision of a socialist planned economy. It was assumed unhesitatingly and as a matter of course that under socialism all plants will be equipped with the most modern machinery and will be situated in the most favorable locations. We are not told, of course, where the resources for their construction and equipment are to come from.

Very characteristic of this method of providing a deceptive proof of the higher productivity of socialism is the book of Atlanticus-Ballod.[3] This work attained great renown in the recent past precisely because it harmoniously combines the bureaucratic socialism of the public functionary and Marxism. Here the attempt is made simply "to point out in an approximate way what could be accomplished with present-day science and technology under the natural conditions given today in a socialist-operated community."[4] To appreciate his method of treating the subject that lie embarks on with this declaration, it is enough to mention his statement that in German agriculture there will be "nothing left" for the socialist state to do "but to rebuild completely almost all farms." In place of the existing farms 36,000 new ones are to be set up, each with approximately 400 hectares of arable land.[5] Similar measures are to be taken in industry. How simply the question of obtaining capital is answered by Ballod is shown by his observation: "It is therefore quite out of the question for the individualist state to pay for the electrification of the railways. The socialist state can do so without great difficulties."[6] The entire book demonstrates no appreciation whatsoever of the fact that investment of capital is possible only within given limits and that in view of the scarcity of capital it would be the greatest waste to abandon still utilizable plants that have come down from the past solely because they would have been equipped differently if they were to be designed for the first time today.

Even a socialist community could not proceed differently from the capitalists of the economic order based on private property. The manager of a socialist economy would also have to take account of the fact that the means of production available are limited. He too would have to consider carefully, before abandoning a still utilizable plant to erect a more modern one in its place, whether there is not a more urgent need for the resources that the new plant must require. That a socialist community could by no means make this comparison of input and output, of costs and proceeds, because economic calculation is not possible under socialism, does not further come into question here. The impossibility of economic calculation makes a socialist economy based on the division of labor altogether unfeasible. A completely socialist economy can exist only in thought, not in reality. However, if one seeks, in spite of this, to describe the communist paradise in an imaginary construction, one must, in order not to become involved in self-contradictory nonsense, assign to the scarcity of capital the same role it plays in the economic life of capitalism.

In business practice the problem before us usually appears as the opposition between the viewpoint of the businessman, who coolly and calculatingly examines the profitability of investments, and that of the visionary engineer, who declares himself for the "technologically most perfect plant," even if it is unprofitable under the given circumstances. Wherever the pure technologist has his way, capital is malinvested, i.e., squandered.

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[1] Cf. Clark, The Distribution of Wealth (New York, 1908), p. 118.

[2] The influence of the past is also operative in the two cases that we have not considered: obstruction of the mobility of circulating capital and a decrease in demand for the final product. But this need not be gone into any further because the relationship is obvious from what has been said. Equally simple is the application to "durable goods" in Böhm-Bawerk's sense.

[3] Cf. Atlanticus-Ballod, Der Zukunftsstaat, Produktion und Konsum im Sozialstaat (2nd ed.; Stuttgart, 1919).

[4] Ibid., p. 1.

[5] Ibid., p. 69.

[6] Ibid., p. 213.

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