by Ludwig von Mises
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THE HAMPERED MARKET ECONOMY
1. The Prevailing Doctrine of the Hampered Market Economy
With a few exceptions contemporary commentators on economic problems are advocating economic intervention. This unanimity does not necessarily mean that they approve of interventionistic measures by government or other coercive powers. Authors of economics books, essays, articles, and political platforms demand interventionistic measures before they are taken, but once they have been imposed no one likes them. Then everyone—usually even the authorities responsible for them—call them insufficient and unsatisfactory. Generally the demand then arises for the replacement of unsatisfactory interventions by other, more suitable measures. And once the new demands have been met, the same scenario begins all over again. The universal desire for the interventionist system is matched by the rejection of all concrete measures of the interventionist policy.
Sometimes, during discussion of a partial or complete repeal of a regulation, there are voices against changing it, but they rarely approve the given measure; they wish to prevent even worse measures. For instance, scarcely ever have livestock farmers been pleased with the tariffs and veterinary regulations that were adopted in order to restrict the importation of livestock, meats, and fats from abroad. But as soon as consumers demand the repeal or relaxation of these restrictions, the farmers rise in their defense. The champions of legislative labor protection have labeled every regulation adopted so far as unsatisfactory—at best to be accepted as an installment on what needs to be done. But if one such regulation faces repeal—for instance, the legal limitation of the workday to eight hours—they rise in its defense.
This attitude toward specific interventions is readily understood by anyone who recognizes that intervention necessarily is illogical and unsuitable, as it can never attain what its champions and authors hope to attain. It is remarkable, however, that it is obstinately defended in spite of its shortcomings, and in spite of the failure of all attempts at demonstrating its theoretical logic. To most observers, the thought of returning to classical liberal policies appears so absurd that they rarely bother to give it thought.
The defenders of interventionism often appeal to the notion that classical liberalism belongs to a past era. Today, they tell us, we are living in the age of “constructive economic policy,” namely, interventionism. The wheel of history cannot be turned back, and that which has vanished cannot be restored. He who calls for classical liberalism and thus proclaims the solution as “back to Adam Smith” is demanding the impossible.
It is not at all true that contemporary liberalism is identical with the British liberalism of the eighteenth and nineteenth centuries. Certainly modern liberalism is built on the great ideas developed by Hume, Adam Smith, Ricardo, Bentham, and Wilhelm Humboldt. But liberalism is no closed doctrine and rigid dogma. It is an application of the principles of science to man’s social life, to politics. Economics and social science have made great strides since the beginning of liberal doctrine, and thus liberalism also had to change, although the basic thought remained unaltered. He who makes the effort to study modern liberalism will soon discover the differences between the two. He will learn that knowledge of liberalism cannot be derived from Adam Smith alone, and that the demand for repeal of interventionistic measures is not identical with the call, Return to Adam Smith.
Modern liberalism differs from the liberalism of the eighteenth and nineteenth centuries at least as much as modern interventionism differs from the mercantilism of the seventeenth and eighteenth centuries. It is illogical to call the return to free trade an anachronism if the return to the system of protection and prohibition is not also seen as an anachronism.
Writers who credit the change in economic policy simply to the spirit of the age surely expect very little from a scientific explanation of interventionism. The capitalist spirit is said to have been replaced by the spirit of the hampered economy. Capitalism has grown old and, therefore, must yield to the new. And this new is said to be the economy that is hampered by government and other intervention. Anyone who seriously believes that such statements can refute the conclusions of economics regarding the effects of import duties and price controls truly cannot be helped.
Another popular doctrine works with the mistaken concept of “free competition.” At first, some writers create an ideal of competition that is free and equal in conditions—like the postulates of natural science—and then they find that the private property order does not at all correspond to this ideal. But because realization of this postulate of “competition that is really free and equal in conditions” is believed to be the highest objective of economic policy, they suggest various reforms. In the name of the ideal, some are demanding a kind of socialism they call “liberal” because they apparently perceive the essence of liberalism in this ideal. And others are demanding various other interventionistic measures. But the economy is no prize contest in which the participants compete under the conditions of the rules of the game. If it is to be determined which horse can run a certain distance in the shortest period of time, the conditions should be equal for all horses. However, are we to treat the economy like an efficiency test to determine which applicant under equal conditions can produce at lowest costs?
Competition as a social phenomenon has nothing in common with competition in play. It is a terminological confusion to transfer the postulate of “equal conditions” from the rules of sport or from the arrangement of scientific and technological experiments to economic policy. In society, not only in the capitalist order, but in every conceivable social order, there is competition among individuals. The sociologists and economists of the eighteenth and nineteenth centuries demonstrated how competition works in the social order that rests on private property in the means of production. This was an essential part of their critique of the interventionistic policies of the mercantilistic police and welfare state. Their investigations revealed how illogical and unsuitable interventionistic measures were. Pressing further they also learned that the economic order that corresponds best to man’s economic goals is that built on private property. Surely the mercantilists wondered how the people would be provided for if government left them alone. The classical liberals answered that the competition of businessmen will supply the markets with the economic goods needed by consumers. In general they couched their demand for elimination of intervention in these words: the freedom of competition must not be limited. With the slogan of “free competition” they demanded that the social function of private property not be hampered by government intervention. Thus the misunderstanding could arise that the essence of liberal programs was not private property, but “free competition.” Social critics began to chase a nebulous phantom, “genuinely free competition,” which was nothing more than a creature of an insufficient study of the problem and occupation with catchwords.1
The apology for interventionism and the refutation of the critique of interventions by economic theory are taken much too lightly with the assertion, e.g., by Lampe, that this critique
is justified only when it is shown simultaneously that the existing economic order corresponds to the ideal of free competition. Only under this condition must every government intervention be tantamount to a reduction in economic productivity. But no serious social scientist would venture today to speak of such a pre-established economic harmony, as the classical economists and their optimistic-liberal epigones envisage it. There are tendencies in the market mechanism that bring about an adjustment of disrupted economic relations. But these forces prevail only “in the long run,” while the readjustment process is interrupted by more or less sharp frictions. This gives rise to situations in which intervention by “social power” not only can be necessary politically, but also suitable economically . . . provided expert advice on the basis of strictly scientific analysis is available to the public power and that it is followed.2
It is most remarkable that this thesis was not written during the 1870s or 1880s when the Socialists of the Chair untiringly offered to the high authorities their infallible remedies for the social problem and their promises for the dawn of glorious times. But it was written in 1927. Lampe still does not see that the scientific critique of interventionism has nothing to do with an “ideal of free competition” and “preestablished harmony.”3 He who scientifically analyzes interventionism does not maintain that the unhampered economy is in any sense ideal, good, or free from frictions. He does not contend that every intervention is tantamount to a “reduction in economic productivity.” His critique merely demonstrates that interventions cannot achieve the objectives which their authors and promoters want to achieve, and that they must have consequences which even their authors and sponsors did not want and which run counter to their own intentions. This is what the apologists of interventionism must answer. But they are without an answer.
Lampe presents a program of “productive interventionism” consisting of three points.4 The first point is that the public authority “must possibly stand for a slow reduction of the wage level.” At least Lampe does not deny that any “public authority” attempt at holding wage rates above those an unhampered market would establish must create unemployment. But he overlooked the fact that his own proposal would bring about, to a lesser degree and for a limited time, the intervention which he himself knew to be unsuitable. When compared with such vague and incomplete proposals, the advocates of all-round controls have the advantage of seeming logical. Lampe reproaches me for not caring how long the transitional frictional unemployment will last and how severe it may be.5 Now, without intervention it neither will last long nor affect many. But undoubtedly the enactment of Lampe’s proposal can only bring about its prolonged duration and its aggravated severity. Even Lampe cannot deny this in the light of his other discussion.
Anyway, we must bear in mind that a critique of interventionism does not ignore the fact that when some production interventions are eliminated special frictions are generated. If, for instance, all import restrictions were lifted today, the greatest difficulties would be evident for a short time, but there would soon be an unprecedented rise in the productivity of human labor. These inevitable frictions cannot be mitigated through an orderly lengthening of the time taken for such a reduction of the protection, nor are they always aggravated by such a lengthening. However, in the case of government interferences with prices, a slow and gradual reduction, when compared with their immediate abolition, only prolongs the time during which the undesirable consequences of the intervention continue to be felt.
The two other points of Lampe’s “productive interventionism” require no special critique. In fact, one of them is not interventionistic, and the other actually aims at its abolition. In the second point of his program, Lampe demands that public authority eliminate the numerous institutional obstacles that stifle the occupational and regional mobility of labor. But this means elimination of all those government and labor union measures that impede mobility. This is basically the old demand of laissez passer, the very opposite of interventionism. And in his third point, Lampe demands that the central political authority gain “an early and dependable overview of the whole economic situation,” which surely is no intervention. An overview of the economic situation can be useful to everybody, even to government, if the conclusion is reached that there should be no interference at all.
When we compare Lampe’s interventionistic program with others of a few years ago, we recognize how much more modest the claims of this school have become. This is progress of which the critics of interventionism can be proud.
2. The Thesis of Schmalenbach
Considering the dismal intellectual poverty and sterility of nearly all books and papers defending interventionism, we must take notice of an attempt by Schmalenbach to prove the inevitability of the “hampered economy.”
Schmalenbach starts from the assumption that the capital intensity of industry is growing continuously. This leads to the inference that fixed costs become ever more significant while proportional costs lose in significance.
The fact that an ever larger share of production costs is fixed causes the old era of a free economy to draw to a close, and a new era of a hampered economy to begin. It is a characteristic of proportional costs that they occur with every item produced, with every ton delivered. . . . When prices fall below production costs, production is curtailed with corresponding savings in proportional costs. But if the lion’s share of production costs consists of fixed costs, a production cutback does not reduce costs correspondingly. When prices then decline it is rather futile to offset their fall through production cutbacks. It is cheaper to continue production with average costs. Of course, the business now suffers a loss which, however, is smaller than it would be in the case of production cutbacks with nearly undiminished costs. The modern economy with its high fixed costs thus has been deprived of the remedy that automatically coordinates production and consumption, and thereby restores the economic equilibrium. The economy lacks the ability to adjust production to consumption because to a large extent proportional costs have become rigid.6
This shifting of production costs within the enterprise “almost alone” is “guiding us from the old economic order to the new one.” “The old great era of the nineteenth century, the epoch of free enterprise, was possible only when production costs generally were proportional in nature. It ceased to be possible when the proportion of fixed costs became ever more significant.” Since the growth of fixed costs has not yet stopped and will probably continue for a long time, it is obviously hopeless to count on a return of the free economy.7
Schmalenbach at first offers proof for the relative rise in fixed costs with the remark that the continuous growth of enterprise size “is necessarily connected with an expansion, even a relative expansion, of the department that is heading the whole organization.”8 I doubt that. The superiority of a larger enterprise consists, among other things, in managerial costs lower than those of smaller enterprises. The same is true for the commercial departments, especially the sales organizations.
Of course, Schmalenbach is completely correct when he emphasizes that the costs of management and many other general costs cannot be reduced substantially when the enterprise works only at one-half or one-fourth of its capacity. But as management costs decline with the growth of the enterprise, calculated per unit of output, they are less significant in this age of big business and giant enterprises than formerly in the age of smaller operations.
But Schmalenbach’s emphasis is not here; it lies on the rise in capital intensity. He believes that he can simply conclude from the continuous formation of new capital and progressive application of machines and equipment—which is undoubtedly true in a capitalist economy—that the ratio of fixed costs will rise. But he must prove first that this is actually the case for the whole economy, not just for individual enterprises. In fact, continuing capital formation leads to a decline in the marginal productivity of capital and an increase in that of labor. The share that goes to capital declines, and that of labor rises. Schmalenbach did not consider this, which negates the very premise of his thesis.9
But let us also ignore this shortcoming and examine Schmalenbach’s doctrine itself. Let us raise the question of whether a relative rise in fixed costs can actually precipitate entrepreneurial behavior that deprives the economy of its ability to adjust production to demand.
Let us look at an enterprise that either from the start or because of a changed situation does not come up to its earlier expectations. When it was built its founders hoped that the investment capital not only would be amortized and would yield the going rate of interest but, in addition, would pay a profit. Now it has turned out differently. The product price has fallen so much that it covers only a part of production costs—even without allowance for the costs of interest and amortization. A cutback in output cannot bring relief; it cannot make the enterprise profitable. The less it produces, the higher will be the production costs per unit of output and the greater the losses from the sale of each unit (pursuant to our assumption that the fixed costs are very high relative to proportional costs, disregarding even the costs of interest and amortization). There is only one way out of the difficulty: to shut down entirely; only then can further losses be avoided. Of course the situation may not always be so simple. There is hope, perhaps, that the product price will rise again. In the meantime, production is continued because the disadvantages of the shutdown are thought to be greater than the operating losses during the bad time. Until recently most unprofitable railroads were in this situation because automobiles and airplanes entered the competition. They counted upon an increase in traffic, hoping to earn profits some day. But if such special conditions do not exist, production is shut down. Enterprises laboring under less favorable conditions disappear, which establishes the equilibrium between production and demand.
Schmalenbach’s error lies in his belief that the cutback in production, necessitated by the decline in prices, must take place through a proportionate cutback of all existing operations. He forgets that there is yet another way, namely, the complete shutdown of all plants working under unfavorable conditions because they can no longer stand the competition of plants producing at lower costs. This is true especially in industries producing raw materials and staples. In finishing industries, where individual plants usually manufacture various items for which production and market conditions may vary, a cutback may be ordered, limiting output to the more profitable items.
This is the situation in a free economy unhampered by government intervention. Therefore, it is utterly erroneous to maintain that a rise in fixed costs denies our economy the ability to adjust production to demand.
It is true that if government interferes with this adjustment process through the imposition of protective tariffs of appropriate size a new possibility arises for producers: they can form a cartel in order to reap monopolistic gains through reductions in output. Obviously, the formation of cartels does not result from some development in the free economy, but is rather the consequence of the government intervention, i.e., the tariff. In the case of coal and brick, the transportation costs, which are so high relative to product value, may, under certain conditions and without government intervention, lead to the formation of cartels with limited local effectiveness. A few metals are found in so few places that even in a free economy the producers may attempt to form a world cartel. But it cannot be said too often that all other cartels owe their existence not to a tendency in a free economy, but to intervention. International cartels generally can be formed only because important production and consumption areas are sheltered from the world market by tariff barriers.
The formation of cartels has nothing to do with the ratio of fixed to proportional costs. The fact that the cartel formation in the finishing industries is proceeding more slowly than in staple industries is not due to the slower rise in fixed costs, as Schmalenbach believes, but to the complex manufacture of goods nearer to consumption, which is too intricate for cartel agreements. Furthermore, it is due to the dispersal of production over numerous enterprises that are more vulnerable to competition by outsiders.
The fixed costs, according to Schmalenbach, prod an enterprise to embark upon expansion in spite of lacking demand. There are facilities in each plant that are used very little; even at full plant operation they are working with degressive costs. To utilize these facilities better the plant is enlarged. “Thus whole industries are expanding their capacities without justification by a rise in demand.”10 We readily admit that this is the case in contemporary Europe with its interventionistic policies, and especially in highly interventionistic Germany. Production is expanded without consideration of the market, but rather in view of the redistribution of cartel quotas and similar considerations. Again, this is a consequence of interventionism, not a factor giving rise to it.
Even Schmalenbach, whose thinking is oriented economically in contrast to that of other observers, could not escape the error that generally characterizes German economic literature. It is erroneous to view developments in Europe, and particularly in Germany under the influence of highly protective tariffs, as the result of free market forces. It cannot be emphasized too often and too emphatically that the German iron, coal, and potash industries are operating under the impact of tariff protection, and, in the case of coal and potash, also under other government intervention, and these are forcing the formation of syndicates. Therefore, to draw conclusions for the free economy from what is happening in those industries is completely incorrect. The “permanent inefficiency” so sharply criticized by Schmalenbach,11 is no inefficiency of the free economy, but inefficiency of the hampered economy. The “new economic order” is the product of interventionism.
Schmalenbach is convinced that in the not-too-distant future we must reach a state of affairs in which the monopolistic organizations will receive their monopolistic power from the state, and the state will superintend “the performance of the duties incumbent on the monopoly.”12 Surely, if for any reason we reject the return to a free economy, this conclusion completely agrees with that to which every economic analysis of the problems of interventionism must lead. Interventionism as an economic system is unsuitable and illogical. Once this is recognized it leaves us with the choice between lifting all restrictions, or expanding them to a system in which government directs all business decisions—in which the state determines what to produce and how, under what conditions, and to whom the products must be sold. This is a system of socialism in which private property at best survives in name only.
A discussion of the economy of a socialistic community does not belong with this analysis. I have dealt with it in another place.13
1See the critique of such errors, Halm, Die Konkurrenz [Competition], Munich and Leipzig, 1929, especially p. 131 et seq.
2Lampe, Notstandarbeiten oder Lohnabbau? [Public works or wage reductions?], Jena, 1927, p. 104 et seq.
3On “pre-established harmony” see, further my essay below, “Anti-Marxism.”
4Lampe, op. cit., p. 127 et seq.
5Ibid., p. 105.
6Schmalenbach, “Die Betriebswirtschaftslehre an der Schwelle der neuen Wirtschaftsverfassung” [The doctrines of business administration at the dawn of a new economic constitution] in Zeitschrift für Handelswissenschaftljche Forschung [Journal for trade research], 22nd year, 1928, p. 244 et seq.
7Ibid., p. 242 et seq.
8Ibid., p. 243.
9See Adolf Weber, Das
Ende des Kapitalismus [The end
of capitalism], Munich, 1929, p. 19.
op. cit., p. 245.
11Ibid., p. 247.
12Ibid., p. 249 et seq. Schmalenbach, op. cit., p. 245.