Chapter II: The Basic Data of Economics

“Je ne connais que trois manières d’exister dans la société: il faut être mendiant, voleur ou salarié.”

MIRABEAU

1. The Moral Foundation (the Business Principle)

The struggle against scarcity (deficiency of means) is the eternal basis of every human economy. It characterizes all ages, all climates, all social systems. The forms which this struggle assumes, however, show the greatest diversity. We may divide them into two principal groups: the individual forms and the social forms. The individual form of this struggle is exemplified in the isolated, exchangeless economy of a Robinson Crusoe with which we are here not concerned. We shall give our attention, therefore, only to the social form of the struggle against scarcity.

The social form of the struggle is manifested in the different methods men use to obtain those things which nature has not freely supplied. There are, in principle, three such methods, as a result of which we see three kinds of struggle. There is, first, the ethically negative method of using violence and/or fraud to procure for ourselves, at others’ expense, the means of overcoming scarcity. The second method is the ethically positive one of altruism, thanks to which goods and services are supplied to us without our being required to give anything in return. The third method does not lend itself easily to such brief description. It is not founded on egoism, if this implies that individual well-being is achieved at others’ expense. Neither is it founded on a selfless altruism, if this implies that individual well-being is neglected in order that others may benefit. It is, rather, an ethically neutral method by which, in virtue of a contractual reciprocity between the parties to an exchange, an increase of one’s own well-being is achieved by means of an increase in the well-being of others. This method, which may be termed “solidarity,” means that an increase in my well-being is achieved in a way which not only does not deprive others of well-being but which yields them, as a by-product of my gain, an increase in their own well-being.

In concrete terms, I may obtain the wherewithal to live either: by selling adulterated butter (first method); or I can be the object (or subject) of a gift of butter (second method); or, by following the axiom “honesty is the best policy,” I can acquire a fortune by attracting more and more customers with butter of irreproachable quality, kind and courteous service, finding out where I can buy butter cheapest, keeping a neat and attractive shop, etc. (third method). Whereas people are “handled” in a public facility such as the post office, in our shop they are “served.” In this last case I obtain the means which allow me to satisfy my needs neither by violence, exploitation, fraud, nor illicit profit, nor by accepting alms or gifts, but through the supplying of an equivalent service or good (performance principle). It is this method, based on the principle of reciprocity, of value given for value received, which is commonly referred to as “business.” It is the business method which characterizes that form of the struggle against scarcity which is based on exchange and the division of labor. Regarding the economic system in this way, however, raises several important questions and it is upon these that we must focus our attention.

In the first place, the three methods are by no means rigorously separated, but, on the contrary, overlap to a degree. Plainly, there is an essential distinction between defrauding your neighbor in the struggle for survival and accepting a charitable gift from him for the same end: the first and second methods are incompatible and cannot be employed simultaneously. But it is possible to combine the first method (fraud and/or violence) with the third (business), and also the second method (altruism) with the third. “War, trade, and piracy—an inseparable trinity,” declares Goethe’s Mephistopheles (Faust, II, 5), and, in truth, the history of the trading and colonizing nations is a history of invasions, piracies, and oppressive exploitation. It offers us a depressing demonstration of the truth that when left to our own devices, we tend to choose the first method and return nothing in exchange for a service received. Only the powerful influences of religion, morality, and law appear able to induce us to adhere scrupulously to the third method.

There are a variety of procedures for avoiding the rendering of a service equal to one received. Leveling a revolver at someone is one of the quickest but also one of the riskiest ways of getting something for nothing. Much safer and more efficient are the devices of special privilege and monopoly for they can be tricked out in ideological trappings which may make them seem not only innocuous but even beneficial to the general interest. The modern problem of monopoly can ultimately be defined in no other way than as a distortion of the principle of equivalence or reciprocity in exchange effected by means of the method of exploitation. Solving the monopoly problem, therefore, means nothing other than finding a way to eliminate this distortion.

If, as unfortunately happens, the method of “pure business” is often combined with fraud and exploitation, it is just as frequently commingled with elements of altruism. Indeed, business in the real world is not as ethically neutral as we at first supposed. There are businesses which embrace more or less an element of self-sacrifice (and, therefore, of uncompensated “giving”) and of genuine service. The medical profession is one example. Then, too, we expect of the scholar and of the artist that they put devotion to their vocations before mere gain, and that in practicing their profession they be not motivated by the principles of the delicatessen-owner. In these cases, the pure business principle is subordinated to a certain moral standard which we may call professional ethics. Members of such professions frequently have or are expected to have a strong service instinct. Expressions such as “trade” or “business,” applied to the professions of medicine or law, are felt to be out of place and demeaning. But even the pure businessman who adheres unbendingly to the principle of exact reciprocity in exchange does not, by so doing, remain completely neutral in an ethical sense. His unbending conduct, and the conduct of those with whom he does business, is at bottom conditioned by the acceptance of certain ultimate principles, for the lack of which the business society itself will in the long run founder. It is, therefore, of great importance not to forget the moral reserves which nourish the prosaic and in itself ethically neutral world of pure business, and with which it stands or falls.¹

The proportions in which the three methods are found and in which they are combined determine in the final analysis what we call the economic spirit of an age. The evolution of our own times can be better understood in the light of the double moral standard which has for so long prevailed: a sterner code is applied within the narrow circle of our own family and friends (internal morality) and a laxer one is employed in our dealings with strangers (external morality). For a soldier to steal from his bunk-mates is regarded as a low form of treachery, while to practice the same theft upon the occupants of a neighboring barrack passes for a feat of cunning. And let the same soldier return laden with loot taken from the citizens of a conquered country and his mates will give him a hero’s welcome. The evolution of the last few centuries can then be regarded as a process in which the domain of internal morality has been continuously enlarged while its content has been simultaneously diluted. In the Middle Ages, trade among the small group of provincial guilds was rigidly circumscribed while a large place was reserved to charity—a natural outgrowth of the deeply religious spirit of that time. But beyond these confines there was much unscrupulous and unrestrained exploitation. In the course of the development which saw the rebirth of ancient morality (humanism) and the secularization of the substance of Christian morality, the principle of sacrifice lost much of its force, even among members of the same family. In its stead appeared a new principle, and one which served at the same time to reduce the practice of violence and exploitation to negligible proportions, viz., the selfsame business principle we have been discussing.²

Not all of the consequences of this development were happy ones. “Business” has occasionally lain its cold and impersonal hand on the family, requiring children to pay their parents for room and board; and science, art, even religion itself, have become commercialized to a lamentable extent. On the other hand, the general use of the business method has had the effect of narrowly circumscribing the area in which violence and exploitation can be profitably employed and of enlarging the sphere of activities yielding equal benefits to the participants.

A proper appreciation of the differences among the three methods aforementioned will prove helpful in dispelling a double confusion met with today at almost every turn. On the one hand, there is the common mistake of attributing to the third method (business) acts which properly should be put to the account of the first (fraud, exploitation, etc.). Some of us still cling tenaciously to the belief that business is nothing else than a shameless picking of other people’s pockets, especially so when it is a question of as abstract and mysterious a business as the modern stock exchange. Just as deeply ingrained is the habit of describing business operations in terms suited only to acts of the first category. People speak of the “conquest” of markets and of the “imperialist exploitation” of foreign countries without realizing that they are confounding two entirely distinct categories of acts.³ The myth that the employer always necessarily exploits his employees is another of the same series of errors.

On the other hand, the second and third methods (altruism and business) are also frequently confused. It is a confusion deliberately encouraged by a certain breed of businessman who desires to have people see in him the devotee of self-sacrifice and disinterested service, though in reality he is motivated solely by business considerations. He speaks of “serving the customers,” he puts himself “at their disposal,” he bids us “be at home,” as if, like St. Francis of Assisi, he had nothing in his heart but the disinterested love of his fellow man. Each shop, each factory, becomes a kind of “studio” where work, relieved of its grosser motivations, is carried on on a higher and nobler plane. Cloaking ordinary business operations with such pious phraseology serves not only as effective advertisement, but is in the vanguard of the democratic instincts of our time. There is still, perhaps, unconscious resentment of the old contempt attaching to “people in trade,” and it is comforting if the illusion can be created that one is not simply working out his life within the drab business framework but that he is a dedicated being, a member even of a superior class. The “canonization” of business, if we may use the term, is particularly noticeable in the United States (witness the emergence of the peculiarly American doctrine of the “social responsibility” of business). It is accompanied by a tendency to relegate to a lower class all the professions which do not originate in business (scholars, civil servants, artists, career military officers). It is a process which has been made easier by the commercialization of these professions and the consequent perversion of the true hierarchies of rank and value—a grave American malady and one of which Europe, too, is beginning to exhibit the symptoms.

This complex of problems is one which properly should be of the greatest concern to economists. Indeed, before we pursue our inquiry any farther, it is necessary to stress the artificiality and extreme fragility of the pure reciprocity principle (business principle). “Business” is a product of civilization and it cannot exist for long in the absence of a specific constellation of conditions, chiefly moral, which support our civilization. The economic ingredient in the constellation is, as we shall see, free competition. But free competition cannot function unless there is general acceptance of such norms of conduct as willingness to abide by the rules of the game and to respect the rights of others, to maintain professional integrity and professional pride, and to avoid deceit, corruption, and the manipulation of the power of the state for personal and selfish ends. The big question of our time is whether we have been so heedless and unsparing in the use of our moral reserves that it is no longer possible to renew these vital props of our economic system and whether it is yet possible to discover new sources of moral strength.

2. What Are Costs?

The perpetual tension between means and wants (scarcity) at once explains the meaning and fixes the goal of our economic system founded on exchange and the division of labor (business principle). Since we possess only limited means of satisfying our unlimited desires, we are compelled, as we have seen, to make a rigorous selection from among many competing wants and to limit the satisfaction of any one such want in order to make the best use of the means at hand (economic principle). Some will say that this view of economic behavior is quite appropriate to the conduct of the housewife who must hold her expenditures within the limits of a fixed sum of money (use of income, economics of consumption), but that it does not apply either to individual economy insofar as it is economy of acquisition (procuring of income), nor to the national economy since, in these two cases, the means are not fixed but may be increased by production.

Further reflection shows, however, that production changes nothing with respect to the need for practicing economy in the use of means, but that it simply results in the transfer of the problem to a higher level (or levels). Why, for instance, do we not produce as much chocolate or paper as we can consume? Why is production stopped at a certain point—which in our business economy is determined by profitability—when there is still a large and unsatisfied need of paper and chocolate? Is this the result of a stupid organization of our economic system from which socialism will deliver us? Such questions do not merit serious reply, for it is clear that production is tied to “costs.” But “costs of production” mean simply that while the quantity of a given consumption good may be increased by production, we encounter a scarcity of certain ultimate factors of production whose quantity cannot be so increased. Ultimately, we are compelled to acknowledge the harsh facts that our capacity for work and our time are strictly limited; that the location and the fertility of the soil are immutable data of Nature; and that even tools and machinery cannot be increased in quantity according to our good pleasure. In using these ultimate factors of production for the production of one good, we thereby renounce the use of the same factors for the production of another good. When we draw a coverlet by one end, the other end does not become longer. We have, then, no other alternative but by means of choice and limitation to allocate the factors of production to the producing of the kinds and quantities of goods which will procure the maximum advantage from the available means.

It follows that the need to make the most economical use of a given supply of means is not the less urgent simply because we can increase this supply by production. The process of equating means and wants takes place in this case merely on a higher level. It is distinguished from the simple process of determining what use is to be made of a given supply of means in the same manner as the traveler’s estimation of the relative utilities of taking more and bigger bags on a journey is distinguished from the case of the soldier who must pack his sack with foreknowledge of exactly what articles he must get into it. In the case of the traveler, more trunks and suitcases are taken along only “at the cost” of other pleasures of the trip. Just so, the costs of production are nothing more, in the final analysis, than a faithful reflection of the utility that the factors of production would have furnished had they been otherwise employed—a utility which we renounce in favor of the one we have chosen. The costs of production, in sum, owe their existence and their amount to the competition of alternative uses for the factors of production.⁴ They stand for utilities which escape us at some other point in the national economy.

This is a principle of such overriding importance that it is worth dwelling on it in some detail. Suppose, for example, that it is planned to build a bridge. What are the problems that must be faced here? The first order of business is, generally, for technicians and engineers to calculate the costs of building a bridge of a given type and quality. These costs are subsequently compared with the traffic needs of the projected bridge site on the one hand, and on the other, with the possibility of financing the bridge out of the public purse. That is to say, we take into account the urgency of other public needs as this urgency is reflected in the possibility or impossibility of diverting a part of current tax revenue to the construction of the bridge or of increasing taxes in general. Taxes, on their side, represent the personal utility which the taxpayers must renounce in transferring a part of their purchasing power to the state. Thus we see that the “costs” of building a bridge are simply an indication that for the land which must be preempted, for the workmen who must be hired, and for the steel which must be used (including all the resources required in the making of the steel), there are still other uses. And it is the intensity of the competition among these alternative uses which determines the costs, greater or less, of the aforementioned factors of production. The process of production then, analyzed to its foundations, clearly shows the alternative nature of costs. In fine, the construction of the bridge will be justified from an economic point of view if it can be shown that it will result in the best possible use being made of the given means with relation to the national economy.

Our example—the building of a bridge—makes clear the important difference between the economic and the technical (or engineering) point of view. The job of the economist is to decide, first, whether the bridge should be built at all; secondly, whether it should be built on one site rather than another. For the economist the total quantity of means is fixed; his task is to discover the best use that can be made of them. The job of the engineer, on the other hand, is to achieve a given end—in our example, the construction of a bridge of a given quality in a given location—with the least means (technical principle). Here, differently than in economics, the end is given, while the means must be found. The successful solution of the technical problems involved in building a bridge does not in the least imply that its construction is justified economically. Economic justification follows only after costs have been entered on the ledger; only, that is, after the proposed use of means is compared with alternative possible uses and a satisfactory balance established among them. For all of this, confusion of technical with economic problems remains a tenacious undergrowth in the economic thought of our time. Fallacies stemming from it are particularly rife in the field of foreign trade (which is a fertile breeding ground for error in any case).

It is almost an idée fixe of contemporary economic policy to see economic advantage for the nation in the exploitation of technical discoveries and inventions and to support the production of synthetic foods or raw materials, even though the synthetic product costs more than the imported natural product and requires special measures to make it “competitive.” Apparently, only a minority comprehends that the same reasoning which is used to defend the production of synthetics can be used to justify cotton growing in the Arctic Circle so long as the engineers can supply the necessary greenhouses and artificial heat. Although the manufacture of synthetic materials has registered some notable successes and shows promise, in some cases, of even greater success in the future, the role of costs in this field cannot be ignored. Every so often, the complaint is heard that the limitations set on production by costs are the result of our stupid “capitalist” system, a ball and chain which we ought to shake off once for all and thereby win both riches and freedom. Such naive assumptions would quickly wither, were it more energetically made known that the problem of costs is nothing other than the problem of deciding whether the productive forces of a country will be better employed in one direction than in another. Here, certainly, is the most elementary problem confronting any economy, whatever be its organization.

3. Economic Equilibrium: the Possible Systems

We have now, perhaps, established the truth that in every economic system man is bound by the necessities of choice and limitation. Every economic system consequently must have available to it a device for balancing means with ends. We already have gained some idea of the equilibrium mechanism which is peculiar to our economic system. But for a still clearer apprehension of how this mechanism functions, we must examine briefly the several possible systems of equilibrium:

(a) System of the queue, which could as well be called the system of elbowing one’s way through the crowd, or the system of first come, first served. It is the simplest and most brutal form of equating supply with demand. It consists in offering the available supply to the public gratis and it invariably results in a more or less violent use of fist and elbow. This system is so unsatisfactory and so little able to guarantee that the most urgent needs of the community will be met that recourse to it is had only in exceptional cases. We are reminded, perhaps, of those occasions on which the beer runs out at “free beer” parties, or of neighborhood get-togethers at which the refreshments set out are quickly devoured by the first wave of guests to the dismay of those who come after. The experiment undertaken by the Soviet dictatorship in its early years is very instructive in this connection. The streetcars and other means of transport were placed at the disposal of the public free of charge. The result, as was to be expected, was such a crush of passengers that the government was soon compelled to return to the “capitalist” equilibrium mechanism (price system). Anyone who has ever tried to watch a parade through the head of the man in front of him knows that the best viewing spots must be preempted well ahead of time. Indeed, when the crowd is very large—as, for example, at the coronation or the funeral of a monarch—it is common practice to resort to the price system for the disposal of the better places. It is to be noted that the system of the queue is the more undesirable the greater the elasticity of demand for a good or service (see pp. 10 ff.). Hence, it will prove easier to put the water of the public fountains at the free disposal of the citizens than to allow them, as in the Russian case, to use the streetcars without paying. The proposal to have free medical services supplied by nationalized doctors should be examined in the same light. The experiences of the British with their National Health Service provide a costly lesson of what may be expected from such an arrangement.

(b) A rationing system shows a certain advance over the system of the queue. Here, too, goods are supplied gratis, but equilibrium is obtained by a systematic distribution of the available goods (rationing). It is such a mechanism which would operate in a pure Communist economy. Even in our economic system, however, it is occasionally necessary to have recourse to this method. Every soldier will recall that in the field not only was food rationed, but also cigars, cigarettes and pipe tobacco. The distribution of food did not involve any great difficulties since individual wants were fairly uniform. But the distribution of tobacco, cigarettes, etc., given the pronounced differences in individual preferences, was regularly followed by a lively private exchange where, under a primitive form, the price system again prevailed. This example shows that under a system of rationing (as well as under the queue system), the difficulties increase with the increase in the elasticity of demand for the rationed product.⁵

(c) The mixed system. Where prices are introduced, as in a mixed system, the disadvantages of queueing and rationing are somewhat mitigated. Generally, in such cases, the prices are fixed at levels insufficient to balance supply and demand. Nevertheless, the very existence of these prices tends to bring about a certain limitation of demand. What results, therefore, is a mixture of the price system with one or the other of the systems already described. During both World Wars the mixed system, under the names of “ceiling prices” or “price control,” was regularly imposed by the belligerent governments on their respective economies. Experience with this system, however, soon compelled abandonment of the queue-price system in favor of a rationing-price system. For it had become apparent that once the maximum prices were established, the equilibrium mechanism of the price system refused to work. When prices were prevented from rising to the point where supply and demand exactly balanced, a part of demand necessarily remained unsatisfied. The people who were ready to pay the maximum price queued up before the shops, but invariably those at the end of the line went away empty-handed. So intolerable did this situation become that recourse was finally had to a system of ration tickets for a list of selected goods.

Ultimately, of course, the disturbances which price controls provoked on the supply side, required government intervention in production itself. Indeed, during World War II, such intervention was universally practiced. The result was that each day that went by saw a further disappearance of the regulating principles of our economic system, ending in a veritable economic muddle. Following World War I, most countries hastened to put an end to the confusion by reestablishing a free economy, i.e., the unhindered price system. And in the post-World War II era, all advanced countries have sought, and rightfully so, to dismantle the system of wartime controls.

Rent controls, the most durable of the wartime price-ceilings, offer a good example of the evolution we have described, beginning with the queue-plus-price system and ending with the rationing-plus-price system. Our experiences with rent control have shown how intolerable in the long run is the situation created by the mixed system. Even in its less noxious form of prices combined with rationing, the marked inferiority of the mixed system vis-à-vis the price system is obvious. This has been publicly acknowledged even in the Soviet Union where the ending of rationing on certain classes of goods was celebrated as an example of progress on the road leading to a more normal situation.

The thoroughly abnormal circumstances of the Great Depression and later of World War II pushed many countries to new experiments with the mixed system. Thus, exchange control is in reality only a variant of the rationing-plus-price system, as is also the control and distribution by government of imported raw materials. The system of ceiling prices was also revived in the foodstuffs markets both under the form of the queue-plus-price system and the rationing-plus-price system. And here again the consensus was that the mixed system is at best only a temporary expedient. The continued repression of a natural force builds up explosive pressures with the result that the price system in one form or another inevitably breaks through the unnatural tensions and rigidities of the mixed system. The greater the amount of unsatisfied demand, the more numerous will be the subterfuges used to circumvent the maximum prices and the bolder will become the disregard for the law. Black markets, under-the-counter deals, illegal currency transactions—a thousand years’ experience has shown that these things accompany price control as shadows do the light. Such activities, customarily denounced as “fraud,” “smuggling,” etc., appear from the objective standpoint of economics merely as corrections of the mixed system by the price system. From the standpoint of ethics these “corrections” are less than edifying and are certainly not the work of the better members of society. Economically speaking, however, they are not always and necessarily harmful.

The United States’ experience with Prohibition in the pre-war era and in the postwar period the collapse of the command economy in Germany, Austria, and France prove that the maintenance of economic regulations to which the bulk of the population is opposed in conscience ends by exercising a strong demoralizing influence. A sort of respectability is attached to breaking the law. An economic system which continues to function thanks only to bootleggers, black marketeers, and smugglers becomes a focus of corruption which, little by little, poisons all the arteries of society. Here is a bitter lesson for those who continually petition for state control of economic life out of their moral indignation at the workings of the free economy.

All too often we hear a system of rationing being justified on the grounds that the goods in question are in “short supply” and that their distribution ought not to be left to the working of the price system. The reader is already aware that this point of view rests on a fundamental misconception. All goods which are not “free goods” are “scarce goods,” meaning that not everyone can get as much of them as he would like. To say that a “scarce good” is one for which the demand exceeds the supply can have meaning only in relation to a specific price, namely the price which is held by the public authorities below the so-called equilibrium price at which supply and demand are in equality and whose function it is to bring about this equality. Hence, demand can really exceed supply only in those extraordinary situations in which the shortage of essential commodities is so acute that it is considered advisable to ration the available goods equally among the citizens rather than to permit distribution to take place on the basis of the unequally distributed dollars.

Consider, in this connection, the extreme scarcities which prevailed in practically all types of goods during World War II. The plight of the economy is then comparable to that of a besieged fortress whose commander is compelled to ration bread and water with the utmost severity. In such case, everyone will approve the rationing of the vital commodities. But it is extremely doubtful whether this notion of the “besieged fortress” can be validly applied to the economy in peacetime. We should not forget that what we are concerned with in peacetime is not only fair distribution, but an increase in production itself. The dilemma inherent in any system of rationing thus becomes clear: in seeking to distribute the available supply as fairly as possible we run the risk of causing a constant diminishment of the amount available for distribution until, in the end, we get a system of rationed poverty, or “poorhouse socialism.” The more we depart from the situation of the “besieged fortress,” the more necessary it is to recommence production and the more self-defeating, therefore, does a policy of rationing with price control become. Keeping the prices of commodities as low as possible for reasons of social justice discourages their production precisely in the degree to which the price-controlled goods are essential. Such a policy ends by requiring the scarcest goods to be sold at the lowest prices. If the policy is not applied uniformly to all goods and services, it amounts to the conferring of a premium for nonproduction of the very goods most needed. The result is that in countries where such a policy is pursued, the stores are filled with the most nonessential and useless goods, the prices of which, precisely on this account, the authorities have left uncontrolled.

From the above it might assumed that a discussion of the mixed system should be reserved for a chapter on economic pathology. But this assumption would be incorrect. For although it is true that this system, when extensively applied, is dangerous and sometimes fatal, in small doses it is relatively harmless. We find it operative in an astonishingly large number of normal economic processes where it appears inopportune, for one reason or another, to use the price system in its pure form. Railroad, bus, and taxi fares, the prices of theatre and movie tickets, as well as many other prices, are ordinarily rigidly fixed, in spite of daily fluctuations in demand (institutional prices). The consequence is that these prices under certain circumstances fulfill only imperfectly their equilibrium function; such prices, for all practical purposes, become maximum prices, proof of which is seen in the block-long queues in front of movie houses and theatres where a hit show is playing, in the throngs that pack trains and busses, in the desperate mien of some paterfamilias as, homeward bound from vacation with his numerous offspring and equally numerous valises, he stands before the railroad station waving frantically (and vainly) at passing taxis. Even in these cases, there is a tendency for the price system to reassert itself. So we have the perennial ticket scalper, reserved seats on trains and . . . tips. If even these devices fail to correct the disequilibrium in demand, the institutional prices themselves will be changed in the end.

(d) The price system. The systems analyzed so far show so plainly the nature of the price system that a long explanation seems unnecessary. Its principal characteristic is that equilibrium (choice and limitation) is attained by leaving prices free to adapt themselves to the market situation, so that there is neither an excess of unsatisfied demand nor an excess of unabsorbed supply (equilibrium price). In the systems previously described, the question of who will bear the costs is distinct from the question of whose needs will be satisfied. In the price system, these elements are fused. The cost of satisfying a given want is imposed on the demanding individual in the price itself. But, as we have already seen, the existence of costs shows that the factors of production which are used for one purpose might have been used with equal advantage for some other purpose. Thus, the price system allocates the factors of production in a way which allows us to perceive, in broad outline, the process by which general economic equilibrium is attained.

Since, in a free price system, costs are necessarily borne by consumers, it is the consumers who decide what and how much shall be produced. Hence, it is the consumers who decide how the factors of production themselves are to be used. This mechanism functions ideally when not an iota of productive resources is employed in a way which yields less utility than if it were used in some other way. The tying of prices to costs, which many regard as one of the stupid quirks of “capitalism,” thus assumes a function which is central to any economic system, whatever its organization: the function, namely, of effecting the best possible allocation of the nation’s productive resources. This does not in the least imply that our economic system, founded for the most part on the price system, is perfect. For in the price system, only those individual demands count which are backed up by the requisite purchasing power. Even if the price system functioned ideally, the factors of production would be employed in the “best possible” manner only in relation to the existing (and unequal) distribution of income. No one will seriously pretend that our present distribution of income is the best possible. As the result of such unequal distribution a rich cat fancier, to take one example, can buy milk to feed her animals while milk is denied to the mother of a family of poor children because she cannot pay for it. We should not make the mistake of equating the explanation of the price system with a glorification of it, for this would be to fall into the error of the classical school which derived from such explanation premature conclusions with respect to economic policy (laissez-faire liberalism).

When we consider economic history, on the other hand, and in particular the recent history of the Soviet Union, we must conclude that the price system, in spite of all its imperfections and in spite of the situations in which it is inapplicable, remains the most natural method of solving the problem of economic equilibrium. Indeed, its essential irrepressibility is shown in the spectacular failure of the efforts to displace it and to frustrate it. An extremely differentiated society such as our own, resting on an intensive division of labor, is inconceivable outside the framework of the price system. Indeed, if the Communist economic experiment, and the National Socialist economic experiment which so closely resembled it, have proven one thing, it is that the most resolute will to impose collectivism is forced, in the end, to capitulate to the elemental equilibrium forces of the price system.

(e) The system of collective economy. To understand this last of the possible equilibrium systems, we must take account of a group of special needs to which none of the systems of which we have spoken thus far can be applied. Up to now, we have tacitly supposed that we were concerned only with the needs of individuals which are satisfied by an act of individual consumption (individual demand). But there are still other wants which are experienced by the members of society collectively (collective demand), without it being possible to distinguish the specific utility accruing to individuals from the satisfaction thereof. Some familiar examples are the collectively felt wants for armed forces, for a police force, for protection against epidemics, for street lights. The street light is an indivisible good which cannot be distributed individually to those who declare themselves ready to pay their “share” of the cost. Neither can we deny street lights to the general public because some people, such as lovers or burglars, are annoyed by them. It is the business of the state to satisfy these collective demands. It is the state which assumes the task of choosing and of limiting; it must procure the means of meeting costs in a manner which, contrary to the price system, is completely divorced from benefits accruing to individuals as such. The equity of the procedure resides rather in basing the collection of funds for the given collective demand on the ability of individuals to pay (taxation) . All the questions which arise with respect to this collective method of achieving equilibrium belong to the sphere of public finance which is consequently properly studied as part of general economics.⁶

The system of collective economy frequently finds application in cases where collective needs do not actually exist. Although in these cases the other equilibrium mechanisms could be employed, it is regarded as desirable on various grounds to treat the want in question as a collective want. Bridges and roads, for example, are, as a general rule, paid for on a collective basis out of taxes, although there is no reason why the price system would not work equally well in such cases. For proof, we need only recall the practice, common enough in former times and now revived in some countries, of charging tolls for the use of highways and bridges. It is our modern concern for social justice that has resulted in the placing of many hitherto individual needs in the category of collective needs. Primary education, for example, is today almost universally supplied on a collective basis. Other wants have become partly collective, such as secondary and university education, the cost of which is met for the greater part by the state.

The case of secondary and university education is particularly instructive. For in the degree in which the state assumes the costs, there arises a danger of oversupplying candidates for the professions, unless a method of limiting the admission of students is developed to replace the older ability-to-pay criterion (for example, numerus clausus, or better, a rigorous examination of students’ intellectual aptitudes). Hence, the cheaper higher education becomes, the more necessary it will be to increase the difficulty of examinations.

It should be noted, finally, that a system of complete “Communism” is reached when all needs are treated as collective needs and hence are satisfied in accordance with the system of collective economy (“from everyone according to his capacity, to everyone according to his needs”). The continued enlargement of the collective sector of the national economy, which is characteristic of the economic evolution of the last one hundred years, must therefore be considered as an enlargement of the “Communist” element in our economic system. The continued growth of the public sector (system of collective economy) at the cost of the private sector (price system) must, by the same token, be taken as an indication that an increasing number of economic processes are taking place in accordance with laws radically different from those which regulate the market economy.

NOTES

1. (p. 22) Economics and Ethics

Though the business method is in itself ethically neutral, business income may be used for ethically positive (altruistic) ends. The concept “individual increase of well-being” must, therefore, be understood in a broad sense, one which embraces all the possible objectives which the individual fixes for himself, including altruistic objectives. Certain Western peoples are noted as much for their charity and generosity as for their shrewd business insight. Money as an end in itself holds less attraction for them than it does for many Orientals who, while despising Western “business methods,” take a miser’s joy in accumulating treasure for its own sake. Experience shows that business is only a method of acquiring means which may be then employed for every imaginable object. Even charitable institutions find it necessary to use purely commercial methods to raise needed funds. Heinrich Schliemann, the ingenious discoverer of ancient Troy, amassed a fortune in business with the sole object of paying for the costs of his excavations. On this and related questions see the comprehensive study by P. Hennipman, Economisch Motief en Economisch Principe (Amsterdam, 1945). Other significant contributions to the literature on this subject include: L. von Wiese, Ethik in der Schauweise der Wissenschaften vom Menschen und von der Gesellschaft (Berne, 1947); F. H. Knight, The Ethics of Competition and other Essays (London, 1935); F. H. Knight, Freedom and Reform (New York, 1947). The role of ethics in economics is considered in detail in my own book, A Humane Economy (Chicago, 1960).

2. (p. 23) Capitalism and the Economic Spirit

The question of the origin of the modern economic spirit (spirit of capitalism) is one that has long interested students of economic history. Investigation has shown that the causes are many and complex and that they cannot be reduced to simple formulations, such as those advanced by Sombart, for example. The question can be studied only in connection with the intellectual history of Europe, in particular, the great movements of the Renaissance, of Humanism, of the Reformation, of nationalism, and of the Age of Enlightment. Max Weber has drawn attention to the especial influence of Calvinism on the growth of the business spirit in his celebrated and still much discussed work, The Protestant Ethic and the Spirit of Capitalism (New York, 1930). See also R. H. Tawney, Religion and the Rise of Capitalism (London, 1926); A. Rüstow, “Die Konfession in der Wirtschaftsgeschichte,” Revue de la Faculté des Sciences Economiques de l’Université d’Istanbul (1942, nos. 3,4); for more comprehensive discussion of this theme, see Rüstow’s major opus, Ortsbestimmung der Gegenwart (Vol. III, Zurich, 1957).

3. (p. 24) Capitalism and Imperialism

What has been described in the text as the fusion of the method of exploitation with the method of business is a standard fixture of Marxist theory. Marxists argue that an economic system reposing on the business principle (capitalism) necessarily impels the capitalist countries to expand their political power for purposes of economic exploitation. The truth is that political expansionism undertaken for the purpose of economic exploitation (economic imperialism) is a phenomenon as old as history itself. Moreover, it is precisely such exploitation to which our economic system is opposed. Economic imperialism exists today as at every other period in history and as under every other economic system. Nothing would be more false than to regard it as a necessary element of our economic system. The causes of imperialism have their locus in quite another world than that of business. Moreover, the theory which seeks to prove that “capitalism” cannot exist without the incessant conquest of overseas markets will be found upon close examination to be untenable. See J. Schumpeter, Social Classes and Imperialism: Two Essays (New York, 1955); S. Rubinstein, Herrschaft und Wirtschaft (Munich, 1930); R. Behrendt, “Wirtschaft und Politik im Kapitalismus,” Schmollers Jahrbuch (Vol. 57, 1933); W. Sulzbach, National Consciousness (Washington, D.G., 1943); W. Sulzbach, Capitalistic Warmongers, A Modern Superstition (Public Policy Pamphlet No. 35, University of Chicago Press, 1942); L. Robbins, The Economic Causes of War (London, 1939); W. Röpke, International Order and Economic Integration (Dordrecht, Holland, 1959).

4. (p. 26) Costs as a Renunciation of Alternative Utilities

The interpretation of costs as a loss of utility (“opportunity cost”) sheds light on what has long been one of the most baffling problems of economics. What are the “real” costs behind the money costs which we encounter initially in the market economy? One of the most important and least contested contributions of modern marginal theory was its discovery of the answer to this question. Prior to the application of the marginal analysis—and Marshall himself had held to this view—costs had been regarded as primarily the expression of and the compensation for the pain and sacrifice entailed in production (“pain cost”). This was a conception which found in Marx’s labor theory of value its purest and most radical formulation. There is some evidence that this interpretation of costs reflects the moral climate in which the English bourgeoisie of the eighteenth and nineteenth centuries lived, a climate in which every honest gain was thought to require a corresponding sacrifice. This tendency, and the economic errors which developed from it, are especially evident in W. N. Senior’s (1790-1864) attempt to describe and to justify the price of capital (interest) as an appropriate reward made to the saver for his sacrifice (“abstinence”). Doubtless, it was this attempt which inspired Ferdinand Lassalle to utter the well-known jest: “The profit from capital is the reward for privation! Admirable maxim, worth its weight in gold! The European millionaires, the ascetics, the penitent Hindus, the stylites perched on one leg on the tops of their pillars, arms outstretched, the body bent over, the face pale, proffering their cups to the faithful in order to collect the reward for their privations 1 In the midst of them, and overshadowing all the penitents, the penitent of penitents, the House of Rothschild!” The thought expressed here is indeed a disquieting one, for it is obvious that the so-called “sacrifice” of the saver (lender) diminishes with increasing wealth, to the point where saving among millionaires takes place in a quasi-automatic fashion. In due course, we shall see why interest must be detached completely from notions such as “sacrifice” and “reward.” The phenomenon of interest is independent of the concept of saving as a sacrifice or a pleasure, just as an author’s income from a novel is independent of the pleasure or lack of it the writing of the novel gave him. An author’s income is in reality contingent on his writing a good novel and on the fact that good novels are rare. Likewise, interest results from the fact that capital is at once useful and rare. There is simply not enough capital to supply the demands of all those who should like to use it. In the level of the interest rate, which must be entered on the ledger along with the other costs as the “cost of capital,” is reflected the utility of an alternative but rejected use of capital. What is true for capital costs is true, also, for all other costs. Costs, as reflected in prices, do not represent a compensation we are compelled to pay for a sacrifice someone has incurred, for often it is precisely the most laborious work and the dirtiest which is the least well paid. The function of costs is to compel us to compare the utility of our use of productive factors with the utility of some other alternative use of the same factors.

The interpretation of costs as a renunciation of alternative utilities involves a number of difficulties which we cannot deal with here. But it may be observed in passing that this interpretation is valid only when a means of production can be used in more than one way (“general” as opposed to “specific” means of production in Wieser’s terminology). These and other aspects of cost theory are the subject of lively discussion by present-day economists. See F. von Wieser, Theorie der gesellschaftlichen Wirtschaft, (2nd ed. 1924, pp. 61ff.; published in English as Social Economics, trans, by A. Ford, London, 1927); O. Morgenstern, “Offene Probleme der Kosten- und Ertragstheorie,” Zeitschrift für Nationalökonomie, (Vol. 2, 1934), 481-522; F. H. Knight, “Cost of Production and Price over Long and Short Periods,” Journal of Political Economy (Vol. XXIV, 1921), reprinted, together with other pertinent material, in Knight’s The Ethics of Competition (London, 1935); G. J. Stigler, The Theory of Price (2nd ed., New York, 1953); and finally the extended discussion of these matters in The Economic Journal, beginning in 1926 (by Sraffa, Pigou, Shove, Robertson, Robbins, et al).

5. (p. 29) The Pure Rationing System

The interesting lessons of a pure system of rationing operating under conditions of war, and the economic implications thereof, are presented in detail in R. A. Radford, “The Economic Organization of a P.O.W. Camp,” Economica (November, 1948).

6. (p. 35) Collective Economy—the Basis of Public Finance

The essential difference between the price system and the system of collective economy consists in this: in the price system, the equilibration of supply and demand occurs automatically in the market; in the collective economy, it is established as the result of conscious political decision. In the price system, individual preferences are directly manifested; their manifestation in the system of collective economy involves long and complicated detours. The fact that some private persons furnish their homes with Oriental rugs must as a general rule be regarded simply as an expression of their individual preferences. It is something to which no one can take exception, at least within the context of the existing distribution of wealth and income. But where the floors of public buildings are covered with Oriental rugs, we immediately begin to wonder whether waste or graft is being practiced by our public officials. We will have in this case grounds (generally good ones) for suspecting that a collective need is being satisfied at the expense of some more important need of individuals, i.e., of taxpayers. It is obvious that tendencies towards waste are inherent in a system of collective economy, particularly where, as in our age of swollen government budgets, the public sector has been continuously expanded. It is in any case difficult to conceive of any alternative method which would enable governments at all times harmoniously to coordinate the satisfaction of collective wants with the satisfaction of individual wants. Further examination of these problems would carry us deep into the intricacies of public finance. See H. Dalton, Principles of Public Finance (London, 1923); W. Röpke, Finanzwissenschaft (1929); K. Wicksell, Finanztheoretische Untersuchungen (1896); M. Cassel, Die Gemeinwirtschaft (1925); W. Gerloff and F. Neumark, Handbuch der Finanzwissenschaft (2nd ed., Vol I, 1951); O. Pfleiderer, Die Staatswirtschaft und das Sozialprodukt (1930); Ursula K. Hicks, Public Finance, (London, 1947); R. A. Musgrave, The Theory of Public Finance—A Study in Public Economy (New York, 1959).